Wednesday 12 December 2012

Killer Arguments Against LVT, Not (290)

We've got ourselves a real f-ing smart arse over at Liberal Conspiracy:

... the poorest still have to pay rent don’t they? And who do you suppose is going to see their rentals go up in price [if we had LVT]? You can’t stop tax incidence...

[LVT would be] paid by farmers isn’t it? So instead of costing X it would cost X+1. Well to cover that cost farmer will charge X+1 won’t he (or is most often the case X+1+a little extra). You are not going to stop the passing on of tax costs to the next link in the chain and finally the consumer. Again, tax incidence.


The incidence of a tax on the rental value of land is always entirely on the landowner. It cannot be passed in higher rents or higher prices.

Can shops put up their prices just because their rent goes up? Nope. They either pay the higher rent or go bankrupt. That sets the upper limit of the rent. Can a landlord with a mortgage put up his rent because interest rates (privately collected LVT) go up? Nope, because there is an upper limit to rents and he is already charging it!

Let's take a simple example of why high taxes on earned income kill the whole economy stone dead and why high taxes on rental income have no such effect:

1. The council owns some sites for market stalls which it rents out. Local wages are £20,000 a year and if you trade from one of these sites, you can make £40,000 a year profit. So people are happy to pay up to £20,000 a year rent.

2. Let's assume that the local council has power to set income tax rates, and the rates for trading income and rental income are currently both 30%.

3. The council then decides to sell off the market stalls and some bright spark in the finance department lays out the following options:

a) Sell off the market stalls and keep the flat 30% tax rate on both types of income,

b) Sell off the market stalls, reduce the tax rate on rental income to 0% and increase the tax rate on trading profits to 100%, or

c) Sell off the market stalls, increase the tax rate on rental income to 100% and reduce the tax rate on trading profits to 0%.

4. We can rule out (b) because if it is impossible to make a post-tax profit from trading from a market stall, nobody will want to rent them and the rental value will also be £nil.

5. (a) is of course a possibility worth considering. On total profits of £40,000, the site owner and the trader between them would pay £12,000 in tax, and the council gets a lump sum receipt from the sale of the plots, which is soon spent.

6. But what happens if the council goes for option (c)?

- Investors will clearly not be interested in buying up the sites because their net rental income would always be £nil so the price they will offer is no more than £nil.

- The only people who will be willing to buy the sites will be the traders themselves. They know, for a fact, that they can earn £40,000 profits (before rent) and that they are happy with post-tax income of £14,000 (because local wages are £20,000 less 30% tax = £14,000), so they will be happy to buy the sites subject to an LVT of £26,000. They will have no upfront cost of buying the site, because a 100% tax depresses the purchase price to £nil (investors won't out-bid them).

- So really, the council could achieve the same thing by selling the tenants the sites with a 100% interest-only, non-repayable, non-recourse, variable-rate mortgage. It just has to set the price and the interest rate so that the interest comes out at £26,000.

7. Remember that rent, taxes on rent and mortgage interest are the same thing. So before the "privatisation" of the sites, the council was collecting £20,000 in "rent" and £6,000 in "tax". Now it is collecting £26,000 in "LVT" (or indeed interest from the interest-only mortgages).

8. Why does anybody think that market traders would then put up their prices? The amount of money which their customers can spend has not changed, so neither do their prices or their turnover, or their gross profits before rent etc.

9. Even though market traders think that they are paying tax on their "profits", this is not true. The incidence of the LVT is entirely on them in their capacity as "land owner". For example, if one of the traders wants to retire and sub-let his site, can he charge more than £26,000 a year in rent to his sub-tenant? No of course not.

10. Would the retiree not make bloody sure that he gets a tenant in ASAP, seeing as he needs to cover his LVT bill? Of course. So the tax is no disincentive to trading from that site, no more than the rent was originally.

Here endeth.

13 comments:

Anonymous said...

Haha, what a twat. Throwing around a phrase like "tax incidence" clearly in complete ignorance of how it actually works. Even a 5-second Google search for "tax incidence inelastic supply" would have sufficed to correct him/her.

http://en.wikipedia.org/wiki/File:Tax_incidence_(producer).svg

Mark Wadsworth said...

RA, exactly.

This is so-o-o-o easy. There is supply and demand. Whichever is less price-elastic bears (most of) the tax, end of discussion. So...

Tobacco duty - borne by smokers, not tobacco growers/cigarette manufacturers.

Land value tax - borne by landowners, not tenants or customers.

http://www.taxplaza.org/images/inelastic-supply.gif

Equally interesting are cases where...

- supply and demand are both price-elastic. A tax is shared 50/50, there is little change in price but there is a huge fall in quantity (VAT).

- Supply and demand are both price-inelastic. A tax is shared 50/50, there are huge changes in price but little change in quantity (high corp tax on oil extraction or fuel duty). The only wealth creator in the chain, the refinery in the middle, with elastic demand, is pretty much unaffected by either kind of tax.

... hence out of those 4, VAT is clearly the worst. Land value tax is the best and the other two (tobacco duty and fuel duty) are OK.

Lola said...

Assuming the 'government' (council in your example) doesn't run off on a borrowing spree it seems to me that LVT also constrains government spending as it cannot collect more LVT than the market will stand. If LVT is set at an excessive rate landowners would simply abandon their land which of course the government could then take possession of but still would not be able to attract tenants themselves. Have I go that right? And if so it might explain why governments seem reluctant to introduce LVT - as the main way of collecting revenue.

Lola said...

...that is the tax take would always be at the optimum point on the Laffer curve?

Mark Wadsworth said...

L, yes. If the government set the LVT rate too high then some (unimproved) land would be abandoned, but the only way for the government to shift it would be to drop the rate again, in which case the former owner can cry foul.

With income tax, there is no "optimum point" on the Laffer curve, it is a trade off between "raising revenue" and "minimising damage to the economy", and at high rates, you do neither.

With LVT, it is a different Laffer curve entirely and hitting the "optimum point" will mean both raising max revenues AND minimising damage to the economy.

Bayard said...

It's amazing how pernicous this meme is: that all business is run on a cost-plus basis. I've had it quoted to me, when complaining about rising input costs, the reply has come "well you can just put your prices up then".

Mark Wadsworth said...

B, we've argued that point before (your purist view is correct - all businesses will in fact put up their prices but some will then go out of business).

But more relevant to the topic in hand is that:

Commercial rent = [porential gross income] minus [costs of labour and capital involved in providing goods or services]

A tax on commercial rent affects neither potential gross income, nor labour nor capital costs.

Residential rent = [average local earnings] minus [accepted minimum living standard].

A tax on that rent affects neither average local earnings nor what people consider to be the accepted minimum.

Bayard said...

Mark, I think you've got me wrong there: I wasn't advocating that view, I was saying that it is a commonly held misconception. However, now you come to mention it, most businesses don't have the time or energy to discover the profit maximising price in all cases and so some passing on of input cost increases is always possible without adversely affecting trade. In an economic utopia, where everyone is charging the maximum the market will bear, of course, then things like rent increases cannot be passed on. In this imperfect world, even rents are not always set at the top rate people can afford.

Mark Wadsworth said...

B, yes, your point was and is that companies only discover the profit maximising price by accident (some above it, some below it) and clearly there is more to it that cost-plus.

In my previous commment, some of the "cost-plussers" go bankrupt And some who don't dare hike prices will go bankrupt. They'd say the raw material prices finished them off, but nobody asks them because they are no longer in business.

Those that don't go bankrupt will be the cost-plussers who say "The raw material price increase wasn't really a problem, we just hiked our prices" and this goes into popular myth.

benj said...

Mark, I seem to remember you saying that even if other taxes were not replaced, rental incomes should be collected and redistributed anyway.


Businesses that are owner occupiers will indeed complain that a LVT would add substantially to their costs. Many of them would go out of business.

Therefore how can you state that LVT has no deadweight costs? Clearly they do.

(not a KLN, just seeing if you'll volley it into the back of the net, or a gentle tap in.)

Mark Wadsworth said...

BJ, LVT would, on the face of it, add to an owner-occupier business' costs, but it would not reduce it to an unprofitable level unless it were a really shit business to start with.

A sensible businessman uses "notional costing" and so if he owns his own premises, he stills works out his real profit or loss as if he were paying rent (and as if he were paying himself and his family members a full wage).

If he realises that he would be making a loss after paying rent, then he packs in his business and becomes a landlord.

LVT just turns "notional costs" into real cash costs, so ALL businessmen will be forced to make the sensible decisions they should have been making anyway.

And to whom do the shit businessmen rent their premises? To a more profitable business. So a shit business gets replaced with a more profitable one.

That's hardly a deadweight cost, is it? Replacing shit businesses with profitable ones? See also: creative destruction.

PS, in real life, Physiocrat once explained all this to a struggling business owner, and the next time he met him, he was no longer a struggling business owner but a comfortably-off landlord!

See also here

http://markwadsworth.blogspot.co.uk/2009/05/creative-destruction.html

with some nice Home-Owner-Ist bollocks in the comments.

benj said...

Mark,

Perhaps a simpler explanation could be as followings.

Owner occupiers enjoy an unfair competitive advantage over business that rent, because of their reduced costs. This acts as a barrier to entry to new business and as such is a deadweight cost itself.

All an LVT does is level the playing field and remove this cost. Yes some businesses will fail. But others that were previously priced out will succeed and flourish.

Mark Wadsworth said...

BJ, yes, that's much better than my version.

More to the point, assuming ALL businesses are owner-occupiers, if we replaced ALL taxes with LVT, then the tax paid by the average business would go down by 80% - 90%.

Very, very few businesses would end up paying more tax anyway - even those that are now struggling would become quite profitable.

The owners (and the employees) of those businesses then have a choice whether to spend their extra income on living somewhere nice or on other stuff (which in turn benefits other businesses etc).