Bayard, who is not totally anti-LVT, came up with this one:
"... what I see as a genuine problem with LVT [is] the other side of the "free rider" effect so often highlighted on this blog (e.g. railway company spends millions of pounds opening a new station and everyone in the vicinity benefits from the increased land value without having to do a thing).
This happened in a town near me, where a run-down market town was transformed over a few years into a thriving, happening place by the efforts of a group of shopkeepers and other traders. They invested their time and money and suffered reduced profits to build the place up and, for a while, reaped the reward. Then, of course, rents in the town started to rise and so business rates went up, and much or all of the increased profit disappeared in the higher rates.
Or, to take a more extreme example, on many landed estates in the C18th and C19th, it was not worth the tenants doing anything to improve their farms, as the resulting increase in revenue would be entirely clawed back by the landlord in increased rent. "
To understand why this isn't a 'genuine problem', you have to:
a) be able to distinguish truly earned income (from running in or working in a business) from land rental income. It is then a case of matching the costs of running a business with the costs of owning land, and
b) be aware of market forces and the effect of competition.
1. The C18th and C19th landed estates issue is easily dealt with, of course there was little or no incentive for tenant farmers to improve their farms, but that is because they were expected to bear the costs of improving the land out of their earned income, while the extra income from the improvements was collected by land owners. In a free market, it would be the land owners who pay for the improvements and recoup the cost by charging higher rents, in the same way as most landlords are happy to pay for decoration and repairs to the housing they own as long as the extra rent they can collect it more than covers the cost.
2. If all the shopkeepers in Bayard's example were tenants, then the same logic applies. It is quite probable that the extra rents and Business Rates soaked up most of (call it two-thirds of) the extra profits they could earn, but for an owner-occupier shopkeeper, the extra Business Rates is only about a third of that two-thirds, so they were still massively ahead of the game; part of their extra profits were truly earned and part were simply because they happened to own land in an area where 'everybody else' is paying for improvements.
3. Then we have to remember the impact of free-market competition:
i. Let's assume that there are ten hairdressers in the area, all open 9-5 six days a week and there is demand for a hundred thousand hair cuts a year, so that's 4.0 hair cuts per shop per hour during normal opening times or 10,000 hair cuts per shop (2,500 hours x 4). And let's call it £10 per hair cut.
ii. Now, maybe one hairdresser is keen to earn a bit extra and opens an hour earlier and stays open an hour later to snaffle the early morning and late evening trade and his gamble pays off. The average number of hair cuts per hour now falls to 3.9, our entrepreneur does an extra 2,000 hair cuts a year (3,100 x 3.9 minus 2,500 x 4.0) and earns an extra £20,000 and all the other hair dressers notice that they are now only doing 9,750 hair cuts a year (2,500 x 3.9), suffering a loss of income of £2,200 each (figures rounded).
iii. If the other hair dressers are just as keen, then they will all extend their opening hours accordingly, until they recapture that lost income, and they will keep extending their opening hours as long as the extra income is sufficient to pay their earned income or wages for being in the shop (whether actually cutting hair or just waiting for customers). If they all open an hour earlier and stay open an hour later, then on average they end up doing 3.22 hair cuts an hour and they all end up doing 10,000 hair cuts a year (3,100 x 3.22) and earning the same amount of money. Who gains from all this competition - the customer, of course.
iv. Clearly, there is an upper limit; there is no point opening at five o'clock in the morning or staying open until midnight, because very few people want to have their hair cut at such an inconvenient time. But the fact that competition only helps the individual hairdresser in the short run and benefits the customer in the long run - when gains are competed away - is the whole argument in favour of free competition.
4. The same applies to collective efforts done to improve the whole area, whether this is paid for by the shopkeepers or the local council doesn't matter. If one high street becomes relatively more attractive, then sure, the people on that street will earn extra income, part of which is earned (supplying goods and services) and part of which is unearned (the fact that their premises are now in a more favourable location).
5. For sure, a full-on LVT would soak up the bulk of the unearned element, and the earned element would be entirely untaxed (under full-on LVT there is no income tax or VAT), but does this discourage groups of shopkeepers from getting together to improve their area? No, of course not - because the extra LVT is still a lot less than the overall extra income!
6. Furthermore, by and large, one high street's gain is another high street's loss. Shopkeepers in the unimproved areas will see that their takings and profits fall, and so the rental value and hence LVT bills also fall, but because the fall in LVT is less than the fall in takings and profits, they end up worse off. So what is their best strategy? It is of course to try and improve their area to recapture some of that lost trade.
7. With the hairdressers in example 3, they all extend their opening hours and end up with the same income as if they'd formed a cartel and restricted opening hours and customers end up with a better deal, as they can pop in before work or after work etc. it would be the same with the shopkeepers in an unimproved area near the improved area; the only way to claw back that trade is to do the same improvements, which boosts their income at the expense of all other areas (including the already improved one).
8. Sooner or later (hopefully) most or all areas will become improved and the incomes and rents will settle down to the old level - but we'll end up with much nicer high streets, longer opening hours etc etc. Or perhaps, once most areas are improved, they will end up snaffling all the trade that was formerly spread over a wider area, so they are using land more efficiently and the last couple of areas become marginal for shops and so we can use these for housing or something else.
9. I suspect that shopkeepers seldom make co-ordinated collective efforts to improve their area (there would still be a free rider problem - the minority of shopkeepers or owners of vacant premises who do not contribute will still benefit), in which case the local council is in the same position as the C18th and C19th land owners from example 1 or a residential landlord. The landlord knows it's worth putting in new carpets for £500 every three years if he can get £200 a year extra rent. But he's no incentive to fit brand new Persian rugs every year at a cost of £1,000 because tenants won't pay that much extra. We end up with the optimum quality carpets in rented flats.
10. If the council can spend £x million on providing more free car parking spaces, sweeping the pavements, having more bobbies on the beat, putting up Xmas decorations, having more benches or wider pavements, getting more bus services etc, and knows that this pushes up rental values so that the extra LVT income is >£x million they will do it. But there is an upper limit to what is worth spending money on, an extra fifty parking spaces might be a no brainer, and an extra hundred might be better than fifty, but there is no point in buying up and knocking down buildings and then losing the LVT therefrom in order to provide a thousand free car parking spaces.
11. And there is also competition between councils in the same way as there is competition between hairdressers (from 3) or different groups of shopkeepers (from 8). And however you argue it, we are still far better off taxing land values rather than earned income - not least because taxes on earned income increase the cost of carrying out the improvements in the first place, i.e. those improvements are normal earned income from the point of view of the car park builders, street sweepers, policemen, Xmas decoration installers etc and if these people have to pay income tax, it pushes up the market clearing price for their services.
