Sunday, 18 October 2015

The tax shift: a very nuanced and circular calculation.

BenJamin and I were discussing this thorny topic in the pub, i.e. if we taxed land/location values instead of earnings/profits, and ignoring the boost to the economy from losing deadweight costs, how much would flow through into higher rents, which enable more taxes to be collected from land/location and enabling taxes on earnings/profits to be reduced yet further..?

We started by writing down what we know:

1. Just about all increases in wages flow through into higher rents. We know this for a fact; London wages are about £8,000 higher than the rest of the UK and rents are also about £8,000 higher. Back in the 1980s when the North Sea oil boom took off, people in Aberdeen were proud to boast that their house prices rose to London levels. That's Ricardo's law of rent #1, which applies on a regional basis.

2. Von ThĂĽnen's law of rent, which applies on an sub-regional basis says the same. Rents are the inverse of travel costs, and the bulk of travel costs is hours wasted, and the value people place on their time is "how much money they could earn if they moved closer to where they work and worked longer hours instead of commuting". There are plenty of London-wide statistics that back this up.

3. Effects 1 to 2 are short-term/static things. If only 1 and 2 were true, then by now, 90% of GDP would go into rents and normal living standards would be no higher than at the start of the Industrial Revolution, which is clearly not true.

We also know long-term that people are prepared to spend about one-third of their income on rent (gross or net income? This is unclear). This is a crude average and more relevant is Ricardo's law of rent #2, which says that any rent = net income minus cost of a normal, basic living standard. So if wages drop to or below this level, land/location rent is zero.

4. Also, to counter-act 3, what people consider a normal, basic living standard changes over time, and tends to go up. But whatever happens, rents tend to go up slightly faster than that.

Pull 1 to 4 together, and the easiest way to reconcile these countervailing effects is :
Year 1 = income £100 = living costs £80 + £20 on rent.
Year 2, income = £102 = living costs £81 + £21 on rent…
This reaches an upper limit where income = £150 = £100 living costs + £50 on rent, and at that stage the economic/political pressure is to redistribute land wealth a bit (rent caps, social housing, mortgage caps, more construction, selling off social housing or overt redistribution via the tax system etc), so our owner-occupier with income of £150 does not worry about the rental value of £50, he can spend all £150 on living costs and this gets the average down again.

5. If you reduce taxes on earnings/profits, you get more business activity, more employment and more competition, so the unit price of goods you can buy for your net wages goes up. There are three more or less opposite conclusions to be drawn from this:

a) The cost of a normal, basic living standard goes down, so the amount going into rents goes up.

b) Currently, an average family can choose to rent a home with an extra room for £2,000 a year. That means they have to cut other spending by £2,000, so they sacrifice a new car every ten years. If the cost of a new car halves, then the opportunity cost of an extra room doubles. So rents might go down accordingly.

c) People might accept the split between spending on goods and services and on rent and simply consume correspondingly more 'other stuff' leaving spending on rent unchanged. So the basic, minimum living standard goes up in material terms but not in £-s-d.

6. As wealth rises, luxury/status/positional goods become more and more important. Location is the most pristine positional good there is. So if there is more money chasing a fixed supply of land/location, rents and prices go up. The fact that they cost more enhances their signalling power so does not dampen demand. This affects the top of the market more than the bottom, to be fair.

7. As a tie-breaker, we agreed that half the increase in net wages would flow through into higher rents i,e, higher land/location values. This is now a circular calculation:

a) For example, current land/location values are £240 bn a year, of which (say) £80 bn is collected in tax (council tax, business rates, SDLT, IHT, CGT and so on). Total taxes on earnings/profits are £400 bn (income tax, VAT, NIC, corporation tax). So we can collect £240 bn in LVT, an increase of £160 bn and reduce taxes on earnings/profits by £160 bn to £240 bn. That means net wages/profits to be spent on rents are £160 bn higher.

b) So land/location rents increase by half of that = £80 bn. We can then increase LVT by £80 bn and reduce taxes on earnings/profits by another £80 bn from £240 bn to to £160 bn.

c) That means net wages/profits are £60 bn higher and half of that £30 bn goes into higher rents etc…

d) By the time we get to iteration #8, which I did on a spreadsheet rather than boring you with it, LVT receipts would be £400 bn and taxes on earnings and profits would be a modest £80 bn, which means a flat income/corporation tax of (say) 10%.

e) Then we can factor in the loss of deadweight costs. The economy will grow considerably as taxes on earnings/profits are reduced, as a very modest and conservative estimate, by 20% over the transition period = £200 billion a year. Again, let's assume nearly half of that goes into location/land values, giving us the last £80 bn we need to get rid of even a token 10% flat income/corporation tax.

Job done, sorted.


Lola said...

Intriguingly I'd got to the full on LVT + 10% 'income tax' tax shape, but by a different route. I just assumed that there was a reason for tithes. That is in the middle ages and before land rents plus tithes were THE taxes. And since it was then all a bit amateur they'd have had to be working on what worked. And tithes were paid to the Church, that is the social services of their day.
In which case, by extension under full on LVT + 10% IT you would shut down the welfare state as such, pay out CI, and everyone would go back to friendly societies or whatever with the government doing Law, Military, and safety net back stop.

What goes around comes around.

Antisthenes said...

You have convinced me that LVT would bring enormous benefits and solve many intractable ones we currently have. However how do you convince the public that it in their best interests. I believe that is an obstacle you are never going to overcome.

PS I have no objection to you pulling me up on my grammar etc., but I believe you are only fighting a losing battle. I am aware that my English usage skills leave a lot to be desired but the level I have reached is as far as I am ever going to get at my age. I did know I should have written en mass not on mass it was just one of those lapses that old people and others suffer from.

Mark Wadsworth said...

L, or do a short cut and just say £480 billion total, knock off 1/4 for LVT on business premises = £360 bn from housing. Total selling price of UK housing currently £6,000 billion. £360 billion divided by £6,000 bn = 6% on current selling prices. Collect that via PAYE, job done. For an average working age household, that will be much the same as their PAYE deductions alone, and the Employer's NIC/VAT saving is a bonus on top. There'll be winners and losers from this, but once people have shuffled round a bit, it will be the new normal.

Anti, I am a pedant because I like annoying people. Don't worry about it.

As to the politics of the LVT shift, that is the tricky bit. What we YPP are trying to do is rally the obvious winners (working age, working private tenants) to the cause by doing the YPP flat tax app (see sidebar) that shows them how much better off they would be and appeal to their naked self interest. So far it isn't working, but hey.

Bayard said...

"So far it isn't working, but hey."

Two possible reasons for this:
1) people are nervous of having a tax they will have to pay whether they are working or not. No matter that these people are tenants, they are almost without doubt, aspiring owner occupiers concentrating on the golden years after they have paid off their mortgage.
2)as aspiring homeowners, they want a magic money tree of their very own, not a system that puts an axe to the whole forest.

Ben Jamin' said...

The only thing I would add is a) rents have been taking up a greater share % GDP b) positional goods are also more important as affluence rises. Location being the most pristine positional good there is, IMO.

I therefore say that the likelihood of all bad taxes being replaced with Land, other economic rents and some Pigouvian Taxes is almost dead certainty.

Plus all the cost savings on top.


I think that's right.

Land ownership is the ultimate security blanket. But the costs are enormous.

Taking away that blanket with an LVT is as hardcore as Capitalism gets. It's ironic the LVT is most hated by those on the Right.

Mark Wadsworth said...

BJ, I sort of covered (a) at 4. but your (b) was one of the illegible ones! I'll have to add it in.

Can you remember any more?

Apart from that, agreed. Of course "LVT would raise enough to cover all government spending" because "all government spending" is a moving target anyway. Could be anywhere between 30% and 50% for a democratic, first world country.

Bayard said...

"Taking away that blanket with an LVT is as hardcore as Capitalism gets."

Perhaps you should talk to someone in the life insurance industry of the cost of a financial product that would allow you to build up a fund whilst paying your LVT over, say, a 25 year period, at the end of which the fund would be turned into an annuity that paid your LVT until you died, an LVT mortgage, if you like. What capitalism takes away, capitalism can give back.

Lola said...

B. Oo yes. I know let's call that an endowment policy...

Mark Wadsworth said...

Bj, the citizen's dividend/LVT personal allowance is your comfort blanket.

B, no need for insurance. Pensioners get the roll up and defer option and you could have short term exemptions for the short term unemployed between jobs. Only 3% of the working age population is short term unemployed.

L, saving is a good thing, but earmarked saving is a bit daft. It's good to have a cushion which you can then use for whatever emergencies turn up.

Random said...

"saving is a good thing, but earmarked saving is a bit daft. It's good to have a cushion which you can then use for whatever emergencies turn up."
What's that you say?
Yes, but if you have that cushion, someone else has to be living *above* their means. By accounting identity. :b

Mark Wadsworth said...

R yes of course. I have expounded on this at length. "Saving" is merely spreading consumption more evenly over your lifetime, so "dis-saving" is just as important. As a second issue, one man's saving can either represent another man's dis-saving or borrowing - or that household saving could go into business investment.

Lola said...

MW. I was being ironic..

Mark Wadsworth said...

L, yes of course, but you reminded me of a more general point.most of these mis-selling debacles are when somebody is tricked into thinking he is saving or paying for something specific (endowment mortage, pension, PPI). You get little or no mis-selling with general savings 'vehicles' like PEPs, Tessa's or ISA's.

Piotr Wasik said...

B, "they want a magic money tree of their very own" - that's what I often hear, people want to "invest" and enjoy the profits. they don't care if I tell them that if they win, somebody else loses which is a very toxic race. maybe point them to some simple calculations that this "magic money tree" has become way too expensive now? I don't know the exact figures, but my gut feeling is that the moment they get it, they will have overpaid for it a lot. ah, and leasehold money trees are not forever.

Random said...

That's one reason.
There are two other reasons for saving. People save because they want to be seen as clever (look at me, with lots of saving and no debt!) and because they are scared (this one espc in recessions.)
These cause a "paradox of thrift" as much as "consumption smoothing."
Humans like to hoard money irrationality

Random said...

So Mark when is Bill Gates going to spend his billions of $. Lot of consumption smoothing going to happen then ;)

"I have expounded on this at length. "Saving" is merely spreading consumption more evenly over your lifetime, so "dis-saving" is just as important. As a second issue, one man's saving can either represent another man's dis-saving or borrowing - or that household saving could go into business investment."
That used to be the case until New Labour came to power. Then some weird weird shit started to happen. Espc after dot com bubble burst, households have been dis-saving and corporates saving, the opposite of what you think. The trends have continued today. UK sectoral balances here:

Bayard said...

"B, no need for insurance. Pensioners get the roll up and defer option and you could have short term exemptions for the short term unemployed between jobs."

I wasn't really thinking of insurance, it's just that life insurance companies usually handle annuities, which this product would more closely resemble. In the good old days, if you took out a mortgage in your mid-twenties, you could have paid it off by the time you were in your early fifties, no need to wait until you retire.

Graeme said...

I suggest the big problem is totally illogical. At least one of the major parties is committed to having a high level of corporation tax because companies are just evil.... And the apologists for this insanity are on record as saying that lower corporation tax in exchange for higher receipts of other tax is not a defence. Cf Soapy Jo Maugham or the Murph monster. Thjey would only settle for LVT if it meant a greater take of Corp tax.

Mark Wadsworth said...

PW, the magic money tree is still going great guns in London and the south east, but the magic money tree elsewhere in the UK has only just about beaten inflation over the last ten years.

B, insurance, assurance, pensions and annuities is all the same thing. The maths is the same, it's all about compounding and discounting and probabilities and so on.

And in practice they are the same too. You give a company regular amounts of money on the basis of some whizz bang forecasts and glossy brochures, they take half of it in fees and charges and then when you need the money, they find an excuse not to pay out what you were promised.

G, the lefties hate LVTers because we want to reduce taxes on income and profits. The right-wingers hate LVTers because we want to tax land/location and other monopoly values. As long as we are being shot by both sides, we know we are on the right track.

Lola said...

MW @ 08:11 - Third para. That is not always true.

Bayard said...

Mark, OK, how about this:

The value of a house is its ability to generate a rental income, whether you are an owner occupier avoiding paying that rental income by renting to yourself or a landlord looking to rent the property out. If part of that rent is converted to LVT, it is very easy to arrive at a amortised cost for the LVT in perpetuity by the same process that establishes the purchase value of the house. Thus the cost of buying a financial product that would pay the LVT in perpetuity is also easy to establish. This product could be attached to the house and be bought and sold with it. You could even raise a loan to pay for it when you buy the house. Theoretically, the house plus product should cost no more than the house would cost without any LVT. It's like tax farming in reverse.

Mark Wadsworth said...

B, yes, you could do it that way. In terms of financial maths it would be perfectly possible. Provided the insurance companies don't shaft you.