Monday, 27 February 2017

The Laffer Curve of Land Value Tax

The principle that deadweight losses act as gravity on government revenue is uncontroversial. The top graph below is familiar and shows the effect of taxes on factors that are produced by human effort. Like income or added value. 

However, this doesn't apply to taxes on the scarcity value of natural resources. In the bottom graph, straight line A shows the effect of a land value tax where markets are perfect. That is a market where we all rent our property from a landlord.

Curve B shows the effect of the alleviation and elimination of deadweight losses, area C, due to the fact owner occupiers can impute their rent (thus over consume immovable property).

But what would happen to revenues after more than a 100% tax was applied to the rental value of land? How would you extend that line? Please share your thoughts.

Mark W adds: It's a straight line up to 100% with no Laffer Effects. At rates above 100%, first it would discourage new development, which might reduce the total tax base in the long run. Once the rate was so high that it exceeded the total rental value of land and buildings then people would abandon them, so total revenues would decline. It's not difficult to know where the 100% limit is, as long as land and buildings are being sold for rebuild cost/value or more, you haven't exceeded 100%. We can argue and bicker over what the rebuild cost/value is, but if similar buildings are being sold for similar amounts wherever they are - ignoring buildings in areas with zero land value - we know that we haven't exceeded 100%.


James James said...

It would start to eat into the capital component, resulting in a reduced supply of buildings and reduced maintenance.

The rate of increase of revenue would start to decrease, and eventually total revenue would decrease. It's even possible that total revenue might fall below that of a 100% land tax, because a reduced supply of and quality of buildings could decrease the desirability of the area/country.

James James said...

I'd like to see a thorough analysis of the consequences of imposing different tax rates on residential and commercial property, as we do.

Ben Jamin' said...


It would make land values in some areas turn negative, reducing the value of immovable property. Whether this would lead to less construction over all, I'm not sure.

Mike W said...

Very interesting post and previous (non crisis) thread below.

I have never considered using the Laffer Curve to explain the merits of LVT. There is no curve down problem after 50%, as drawn by Laffer, with LVT, as you explain.So I certainly agree with you that a pure LVT tax is described by Line A in the second model.

As to the shift B, C and your question (tax beyond 100%) - I will keep reading this thread and no doubt learn something new.

Ben Jamin' said...


Yes, it's a tricky one. For a start what sort of "land" are we talking about? People can move, oil fields cannot.

There are all sorts of assumptions that could lead to different results.

ontheotherhand said...

Net emigration of businesses and people would increase if they are both unable to extract more from the location value in the UK than it enables them to produce. e.g. if the maximum competing retailers can make from a site available on Oxford Street is £1m, and the LVT is £1.1m, then nobody will open the shop. It's the equivalent of certain streets where even the charity shops can't make it worthwhile with their business rates exemption and zero rent.
The rational thing for all players to do would be to sell all property, which now carries a negative return. All loans secured on property would be worthless, because their is no incentive to avoid repossession. National economic activity would shrink, making the location value of the UK less attractive, meaning LVT would reduce over time.

Ben Jamin' said...


You are assuming an open economy. I believe economists prefer a closed economy for modelling purposes, as it reduces the variables.

After all, the whole World will be LVT only one day :)

But, yes, I think this is a question of what happens to the margin of production.

ontheotherhand said...

Good point PJ. In a closed system people would consume less location if possible both by shutting down businesses that require location, and by crowding into shared homes. If the banks don't want to repossess and hold the LVT obligation, does land then revert to The Crown?
If LVT collection and spending was kept local, then councils would have an incentive to invest in infrastructure to maximise location desirability and maximise LVT receipts. At some point such investments would be a misallocation of investment at a national level though because the return is 'subsidised' by the right to extract more than 100% LVT. e.g. every council puts in heated cobbled streets

Ben Jamin' said...

@ Mark W

" At rates above 100%, first it would discourage new development, which might reduce the total tax base in the long run. Once the rate was so high that it exceeded the total rental value of land and buildings then people would abandon them, so total revenues would decline. "

I'm not so certain. Wouldn't it be in everyones interests to re-locate to marginal ie 0% LVT areas? Of course, you'd then be back to where you started.

In the real World, I'm sure people would accept a limited amount of negative land values, but I wonder how the actual theory would be applied to that graph?