http://www.econ.vt.edu/tideman/liberals.pdf

T. Nicolaus Tideman*

Introduction

Both for reasons of social justice and for reasons of economic efficiency, site value rating deserves a continued place in the programme of the Liberal Party.

The case for site value rating in terms of social justice is founded on two understandings: first, that the value of land in the absence of economic development is the common heritage of humanity, and second, that increases in the rental value of land arising from economic development and government expenditures should be collected by governments to finance those activities. What is meant by "land" is the unimproved value of sites and the value of extractable natural resources such as North Sea oil.

While there may someday be institutions capable of implementing a recognition of land as the heritage of all humanity on a worldwide basis, in the absence of such institutions each nation should implement a recognition that land within its boundaries is the common heritage of its citizens. This is accomplished not by making the nation a gigantic Common or by instituting government management of all land, but rather by requiring all persons and corporations that are granted the use of land to pay a fee or tax equal to what the rental value of the land they control would be if it were in an unimproved condition.

The case for site value rating in terms of economic efficiency is founded on the fact that a tax on resources that are not produced by human effort is one of the few sources of government revenue that does not reduce incentives for people to be productive. Two other revenue sources that have this virtue are taxes on other government-granted privileges such as exclusive use of radio frequencies and taxes on activities with harmful consequences, such as polluting the air. An economy will be more efficient if revenue sources that do not diminish productivity are employed to the greatest possible extent before any use is made of taxes that impede productivity.

What makes a tax efficient is that the amount of tax that is due cannot be reduced by reducing productive activities. When incomes are taxed, people can reduce the amount of taxes owed by working less. They do so, and the productivity of the economy falls. When houses are taxed, people can reduce the amount of taxes owed by building fewer house and smaller houses. They do so, and the housing shortage worsens. But when the unimproved value of land is taxed, there is no resulting diminution in the quantity of land. Thus taxes can be levied on land without diminishing the productivity of an economy. And shifting taxes from other, destructive bases to land will improve the productivity of an economy.

Subsequent sections explain in more detail these social justice and efficiency arguments for site value rating, describe procedures for implementing such a tax system, and explain why a variety of potential objections are without merit.

The Social Justice of Site Value Rating

In primitive societies, land is generally regarded as not ownable. No one made the land, so how can anyone own it? Ownership generally originates in conquest. In England, titles to land originated in the claim of William the Conqueror to own all the land because he was king. He granted to dukes, earls, etc. the right to collect rent from designated territories in exchange for their promises to fulfill various obligations to him. In the seventeenth century the nobility succeeded in removing all of their obligations to the crown, but they retained their rights to land. A substantial part of the great inequality in wealth in the United Kingdom can be traced to ancient patents of nobility that granted rights to collect rent.

One highly visible consequence of allowing land rents to be privately appropriated is that young people find it nearly impossible to buy houses. The price of a "house," in the Southeast of Britain at least, is primarily the price of land. If the rent of land were collected publicly, the price of land would be inconsequential, and the price of a house would be the cost of the materials and labour that went into building it. It should be recognized that if the site value of land were taxed, the payment of such taxes would make it more expensive to live in large cities than in small towns, but young people would be better able to afford it because other taxes would be reduced, and the mortgages to which people would need to commit themselves would not be nearly as great.

The justice of collecting the rent of land can be generalized to the justice of collecting a fee for any privilege that governments grant to some individuals and not others. The value of the special privilege for a few that is entailed in planning permission would be recouped automatically in collecting the rental value of land. A version of social collection of the value of privilege occurs in the present government's auctioning of ten-year broadcast licenses. For the same reason that people are justly required to pay for broadcast licenses,

• individuals who have the exclusive use of desirable number plates should pay annually for that privilege.
• Airline companies with exclusive landing rights should pay annually what other airlines would be willing to pay for such rights.
• People who have fishing rights that are denied to others should pay annually according to the value of those rights.

Private appropriation of rent and other privileges makes it necessary for governments to look elsewhere for revenue, with the consequence that even persons with very low incomes are required to turn over part of what little they earn to the state. In justice we ought to allow everyone, but especially those whose earnings are lowest, to allocate what they produce as they themselves choose.

The three sources of land rent, the gift of nature, public services and community development, lead logically to the justice of three distinct taxes on land. The gift of nature is primarily the agricultural value of land, but also the value of natural resources and the extra value of land near rivers and harbors that arises because such land represents good places to put cities whether or not cities are presently there. This component of the rental value of land should be collected nationally and used to support a guaranteed income for all citizens. The part of land value that arises from public services is justly the income of the community that provides those services. When private individuals and firms undertake activities that raise the rental value of surrounding land, the value thereby created should justly be awarded to those whose actions create it.

If site value rating is used only to finance local public services and to reward private activities that raise the rental value of land, the resulting reductions in other taxes on commerce and housing can be expected to raise the rental value of land by enough that land will retain most of its present sale value, and there will be no issue of compensating the existing owners of land. On the other hand, if the full rental value of land is collected through site value rating, then the sale value of unimproved land will fall to approximately zero. The sale value of houses will fall to the value of the houses themselves. Do the owners of land deserve compensation for these reductions in the market value of their wealth?

First, it should be pointed out that the average taxpayer will pay the same tax as before, but in a different form. Site value rating will be substituted for some combination of income taxes, excise taxes, community charges, property value rates, and other taxes. A person should not complain about a change in the form of the taxes he pays if the total is the same. The above argument would be sufficient if every individual paid the same total tax after the change, but of course this will not occur. To some extent, increases in the sale value of capital will offset decreases in the sale value of land. This occurs because, by a removal of taxes from capital, site value rating will greatly increase the private returns to capital. This will generate a massive flow of capital toward any nation or region that reduces its taxes on capital. But such flows cannot occur instantaneously, and before they are completed the reductions in taxes on capital will raise the value of capital. In general, young persons will benefit more than older persons from a move to site value rating, because they tend to own less expensive plots of land if they own land at all, and they have many years ahead of them to benefit from reduction in other taxes. Those who are yet unborn will benefit most of all, because their birthrights to equal shares of the provenance of nature, as well as to the product of their labour, will be recognized. Net financial losses will tend to be greatest for older persons. Their houses will fall in sale value. They will be required to pay annually the rental value of the land on which their houses sit, without as much in reductions of their income taxes, and with fewer years ahead of them to reap tax savings. On the other hand, they will have less concern about providing for their children, because houses will be much easier for their children to acquire. Further offsetting any claim to compensation would be any past unearned profits that potential claimants had made on ownership of land.

In some circumstances, a claim for compensation would have merit. If a person had purchased a title to land from the government just before the introduction of site value rating, that person could reasonably claim compensation from government action that eliminated the value of his purchase. Even if a substantial amount of time has passed, it can be argued that a government should not be permitted to eliminate by legislation the value of an asset that it has sold. On this basis, anyone who owned land that was at one time purchased from the government would have a reasonable claim on a return of the (inflation adjusted) price for which the land was purchased from the government. A claim for interest on the purchase price could not be sustained, however. The use of the land since the time of purchase offsets the interest that could otherwise be claimed.

What of land that was at one time granted by the crown without payment for the title, and land that has risen substantially in value since it was purchased from the government? The government is not obliged to provide compensation for these losses from general tax revenues, because the source of these losses is the mistaken belief that private appropriation of the rent of land can be just. It cannot. The present generation of taxpayers should not be required to pay for this mistaken belief on the part of their forbearers. On the other hand, every person who has sold land in the past has fostered, to his profit, the mistaken belief that the rent of land can justly be privately appropriated. On this basis, all past profits from the sale of land, and all inheritances based on such profits, with accumulated interest, can be appropriated to provide compensation for those whose land falls in value to less than they paid for it, upon introduction of site value rating.

It is possible that the administrative cost of such an undertaking would be so great as to make it infeasible, while at the same time its moral justice was recognized. On this basis one can justify a "capital levy," a one-time charge on all capital in the nation, to provide compensation for those who lose from the introduction of site value rating. The justification of the capital levy would be that the amount of capital that a person owned was the best readily available indicator of past gains that a person had made from the sale of land.

One activity that is sometimes thought to be unfairly affected by site value rating is farming. To a substantial extent, this concern reflects a misperception of the relation between urban and rural rents. The vast preponderance of land rents are urban. Also, it is important to remember that the basis of site value rating is the unimproved value of land. Much of what farmers do increases the value of land in ways less obvious than buildings. Site value rating of agricultural land should be applied on the basis of what the rental value of the land would be in a completely overgrown condition. But there is an important element of validity in the argument of farmers that they are treated unfairly by site value rating. When site value rating is used to finance public services, farmers can justly say that their land does not benefit from public services in the way that urban land does. Indeed, it has been said above that public services should be financed from the increase in land rents above their value in the absence of economic development. Site value rating of agricultural land, and of the pre-development value of urban land, has as its basis the idea that provenance of nature is the common heritage of all citizens. If we wish only to finance local public services and to reward activities that increase surrounding land rents, then the agricultural value of land, and the pre-development value of urban land should be excluded from the tax base. These should be taxed only when the nation is prepared to accept, and be bound by the consequences of, the principle that the provenance of nature is the common heritage of all citizens.

The Efficiency of Site Value Rating

Where justice requires that the value generated by land be shared equally among citizens, efficiency requires that land be managed by persons, individually or in firms, who receive the benefits and bear the losses of the management decisions that they make. Thus efficiency requires secure private titles to land. But secure private titles are consistent with requiring title holders to pay the rental value of land to the public treasury on an annual basis. That is, secure private titles are consistent with site value rating. Site value rating is economically efficient because it is not, like other taxes, a public appropriation of a part of what is produced, but rather social collection of the value in alternative activities of naturally or socially generated resources that are appropriated by individuals. Site value is not produced by the owners of sites. It is what is there before they begin to use sites.

Site value rating embodies the principle that people are allowed to keep what they produce and must pay annually for the value of the naturally occurring and socially created resources they use. This principle can be extended to take account of individual actions that have noticeable effects on the rental value of land surrounding that which individuals use themselves. When land is used in such a way as to raise the rental value of surrounding land, as by providing parking near a commercial center or by providing improvements that are beautiful to see, the person who creates that value should receive it. Correspondingly, when people use land in such a way as to lower the value of surrounding land, by generating noise, noxious smells, air pollution, or unsightly views, they should be charged according to the reduction in the rental value of the surrounding land that results from their activity. The opportunity to be paid for adding to the value of surrounding land will generally make land more valuable. And the requirement to pay for harmful consequences of land use will tend to inhibit such uses of land.

The whole practice of planning should be replaced by a system of charges for harmful consequences of land use and payments for beneficial ones. Planning is motivated by a concern for the harmful consequences that can result from land development. But the resulting restriction in land development makes planning permission all the more valuable to the few who receive it, with the result that vast fortunes are made by contriving to appear to have, in one's person or in one's projects, whatever attributes are regarded as attractive by those who grant planning permission. With so much money at stake, it is virtually impossible to avoid bias. A recognition of the impropriety of the large gains from receiving planning permission leads planning bodies to be ever more strict about granting it, and the result is ever higher prices of homes, to the detriment of first-time buyers.

When there are harmful consequences of land development, these are generally manifest in lower rental values of land near the land that is developed. The effort that is now devoted to determining whether to grant planning permission should be spent instead on identifying the magnitudes of the harmful consequences of development. Then everyone who wishes to develop land, and everyone who has title to land that is already developed, should be charged those costs. Those who have land that is adversely affected by development would be compensated automatically through the reduction in the rates on their land.

It has sometimes been alleged that if site value rentals were taxed, the owners of sites would simply pass the taxes on to the users of sites. Such assertions generally come from a serious misunderstanding of economics. An economic understanding of payments for the use of land presumes that negotiations between owners of land and potential users, over the terms on which land is to be used, are conducted on the basis of each side doing as well for itself financially as its position permits. Owners rent land for the most they can get, and if one potential user is not prepared to pay what the land is worth, then the owner will find someone else who is prepared to pay that much. There are, nevertheless, two ways in which site value rating could result in higher payments for the use of land.

• One way is that there could be individuals who rent land for amounts less than what the market will bear. If there are such individuals, they would be able to raise the rents they charged, to at least some extent, when they were required to pay site value ratings.
• The second way in which higher payments for the use of land could come about from site value rating is that if site value rating is accompanied by reductions in other taxes, as it ought to be, then these tax reductions would make land more valuable. Where this occurred, rents paid for the use of land would rise. But this does not constitute "passing a tax on." There is no guarantee that the amounts by which rental values would rise would correspond to the site value ratings. And in any case, if land were taxed according to its full rental value, all of what owners of land now collect in rents would be collected by the government.

Another objection sometimes raised against site value rating is that it would make leisure uses of land, such as golf courses, impossibly expensive. There are two parts to the answer to this objection.

• First, people who wish to devote land to golf courses do not deserve special privileges and the expense of other members of society. Any person or group that wishes to use land for a golf course should be free to do so, provided that they are willing to compensate the rest of society for the smaller amounts of land that will be available to everyone else because they want a golf course. And the rental value of the land that is used for the golf course measures what is owed to the rest of society.
• The second part of the answer is that to the extent that golf courses raise the value of surrounding land, it qualifies for receipt of the increase in the rental value of surrounding land that results from the use of the land as a golf course.

The extraction of minerals requires special treatment under site value rating, because this activity reduces the value of the heritage of future generations. For mineral deposits that can be expected to be fully depleted within a few years, the sensible thing to do is to auction the right to deplete the resource fully, subject to rules about restoration of the site when extraction is complete. Future generations should be compensated by investing the proceeds in such a way that all generations share equally in the value of the extracted resource.

For deposits that can be expected to last a generation or more, one must be concerned about whether future generations will be content with the financial arrangements that are made. For these cases, it is best to have deposits developed by joint public-private enterprises, where costs are shared in the same proportions as benefits, so that future generations cannot complain about their heritage having been sold for a song.

In the same way that mineral extractions reduce the value of land for future generations, so can the subdivision of land into small parcels. Once land has been subdivided, it is extremely expensive, if it is possible at all, to reassemble it for projects that require large sites. Reassembly, and the economic growth that it permits, can be facilitated by a "self-assessed property tax." Under such a tax, each owner of property is required to specify a price at which he or she would be willing to sell the property, and anyone who wishes can buy the property at that price. A person who was required to sell would be permitted to remove anything he or she wished, so that compulsory sales would be initiated only by persons or public bodies that wished to redevelop land. The appropriate tax rate would be a fraction of a per cent per year, so that people would find it financially feasible to assess their land a prices that would fully compensate them for being required to relinquish it.

The general principle that is applied in site value rating is that everyone pays for the naturally created and publicly created resources they use. There are a number of ways in which this principle can be extended. Where driving in crowded cities adds noticeably to the travel costs of others, there should be charges corresponding to those costs, provided that the administrative costs of implementing such a system are not so great as to outweigh the benefits of resulting improvements in traffic flows. Activities such as the consumption of alcohol that have socially adverse consequences should be taxed according to the costs of those consequences. Public services--gas, electricity, telephone, water, sewerage, transportation, etc.--whether publicly or privately owned, are best financed by a combination of charges on users and charges on land. Each user should be required to pay the addition to costs that results from serving him or her. The component of costs that is not covered by such charges on users can be recovered by collecting the increase in land values that comes from provision of public services.

How Valuations would be Made

Before describing the valuation process, which employs auctions, it is useful to discuss the concept of a "second-price auction." A second price auction is one in which each bidder submits a single sealed bid, and the object is sold to the highest bidder at a price equal to the second highest bid. Second-price auctions have the advantage of making bidding simpler and more straight-forward. In an ordinary sealed-bid auction, in which the highest bidder pays what he or she bids, bidders are induced to under-bid strategically, not revealing the full value to them of the auctioned item, so that they can obtain it at a more advantageous price. This incentive for strategic underbidding is eliminated by a second-price auction. With a second price auction, a bidder who bids less than the object is worth saves no money as long as he or she is the highest bidder, and if the bid is low enough not to be the highest bid, the object is lost to another bidder. Nor is over-bidding beneficial. Either it makes no difference, or it results in the object being bought at a price of more that it is worth to the bidder. Thus honest statements of the value of the thing being auctioned are in the self-interest of bidders in second-price auctions. By a similar line of reasoning, when a contract is to be let to the lowest bidder, honest statements of the lowest price at which a party is willing to do the work can be obtained by letting the contract to the lowest bidder at a price equal to the second-lowest bid. There are two efficiency advantages to second-price auctions. Bidders do not have to spend resources trying to compute their strategically most advantageous bids, and because bids represent accurate valuations, the winning bidder is the person who values the object most, or can truly do the work at the lowest cost. It might seem that the amount received by the seller would be smaller in a second-price auction. However, the higher bids that result from removing the incentive for strategic under-bidding approximately offset the reduced returns from charging only the second-highest bid.

In the proposed system of site value rating, valuations would be made by property market professionals, who would be rewarded according to the accuracy of their valuations, as revealed by occasional auctions. An administrative agency would divide territory into blocks of a convenient size and take bids for valuation of all sites in a block, with the valuation contract going to the lowest bidder, at a price equal to the second-lowest bid. The valuer would provide a formula that could be used to compute the value of any site in the block, taking into account such features as size, proximity to shops and transportation, width of the street on which the property was located, and any other objectively measurable attributes that were thought to be related to site values. The actual payment to the valuer would be reduced in proportion to the average inaccuracy of the valuations, as revealed by subsequent auctions of some of the sites.

When a site was auctioned, it would be under a rule that bids would represent offers of payment for use for the first year. The person who obtained the site would have the option of using the site into the indefinite future, upon payment of future rent, which would be determined by the results of future auctions of similar sites. The site would go to the highest bidder, at a price equal to the second highest bid. An administrative agency would purchase property with obsolete structures, demolish the structures and auction the vacant sites to determine the accuracy of the rating formulas.

When those who rated sites included in their formulas proximity to particular privately owned sites, that would be evidence that the activities on those sites had positive or negative effects on the rental value of surrounding sites. The effects of the activities on those sites could then be computed, and appropriate subsidies or charged placed on the activities that generated the effects.

A separate valuation process would be used to estimate the value of all land in the nation in the absence of economic development. These estimates would be checked by occasional auctions of unimproved agricultural land far from cities. The results of this process would be used to implement a redistribution of pre-development rent among localities, based on the principle that predevelopment rent should be shared on an equal per capita basis. The implementation would occur through a clearinghouse, where each locality received a credit equal to the product of its population and the national per capita predevelopment rent, and each was debited for the pre-development rent within its boundaries.

Conclusion

Site value rating must be the foundation of any system of public finance that is to be fair and efficient. The virtues of site value rating come from adherence to the principle that before we consider taxing people on what they produce, we should collect for public purposes the product of nature and the value generated by the provision of public services.