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 Thünen'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.