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Deadweight Loss

Deadweight loss is a pitfall of most kinds of taxation, but not of tax that falls on land values.


Fred Foldvary: Geo-Rent: A Plea to Public Economists
Microeconomics textbooks explain the deadweight loss from taxation. They explain how the loss is lower with a more inelastic supply and demand. Professors have given thousands of classroom lectures showing that if the supply curve were perfectly vertical, there would be no deadweight loss. But they usually end the discussion by saying, “and so it is good to try to put such taxation on goods that exhibit relative inelasticity in supply or demand.” Some textbooks go on to say that, because the supply of land is fixed, the taxation of land rent has no excess burden. A few books point out that Henry George proposed such taxation. None that I have seen point out that Adam Smith and John Stuart Mill did, too.

Tideman et al (2002, 17) “estimate that the net gain (measured in real dollars of 2000), from shifting as much taxation to land as could be financed by collecting 90% of the land rent, would be $1308 billion or 14% of NDP in 2002 and $4,799 billion or 26.6% of NDP in 2042.” Even if only a fraction of government revenue shifted from the types of taxes we know today to a geo-rent tax, the efficiency gains could be really substantial.

The elasticity insight remains compartmentalized. In public finance textbooks, when the discussion turns to tax policies, the insight is rather neglected, and the idea of taxing land value is usually nowhere to be found. It is as though there were some medicine available that we know cures cancer, yet nobody takes it and no doctor prescribes it. Economists who study irrational behavior should take note.  Read the entire article

Fred E. Foldvary — The Ultimate Tax Reform: Public Revenue from Land Rent

... Even a relatively flat income tax imposes what economists call a “deadweight loss” or “excess burden” on society. Taxes on productive activity increase the price of labor or goods beyond economic costs, and so reduce the quantity provided. This reduction in production, income, and investment is a misallocation of resources. Resources are wasted because they do not go to where they are most wanted. We can reduce this excess burden by reducing taxes, but changing the type of tax can also reduce this deadweight loss. Economists recognize that if we tap for public revenue a resource whose quantity is fixed, the excess burden disappears. The tax does not reduce the supply and does not increase prices. ...

In Progress and Poverty (1879), his most important book, Henry George contended the ideal tax would most closely conform to the following conditions, similar to those of Smith:

1. That the tax bears as lightly as possible upon production, minimizing the excess burden or deadweight loss.
2. That the revenues be easily and cheaply collected, and fall as directly as may be upon the ultimate payers — so as to take from the people as little as possible in addition to what it yields the government.
3. That it be certain and visible, so as to give the least opportunity for tyranny or corruption on the part of officials, and the least temptation to lawbreaking and evasion on the part of the taxpayers.
4. That it be equitable, giving no citizen an arbitrary advantage or privilege, and in being consistent with moral principles. ...

Impact on production

It is widely understood that when something is taxed, we get less of it. As discussed above, this reduction in labor, production, and investment is called the “excess burden” or “deadweight loss” of taxation. Income taxation discourages work, sales and value-added taxes discourage consumption, capital gains taxes discourage investment, and real property taxes discourage building and improving property. Those taxes make the asset or activity more costly, which then reduces the quantity bought of the thing being taxed.

What makes land different is that its supply is fixed, and it is independent of human action. When land value or rent is tapped for public revenue, the land does not shrink, flee, or hide. ... read the whole document

Louis Post: Outlines of Louis F. Post's Lectures, with Illustrative Notes and Charts (1894) — Appendix: FAQ

Q46. How can it be possible that speculative land values cause business depressions when, as any business man will tell you, the whole item of land value — whether ground rent or interest on purchase money — is one of the smallest items in every business?
A. You overlook the fact that the item of speculative rent is the only item which the business man does not get back again. The cost of his goods, the expense of clerk hire, the rent of his building, the wear and tear of implements, are all received back, in the course of normal business, in the prices of his goods. Even his ground rent, to the extent that it is normal (i.e., what it would be if the supply of land were determined alone by land in use, and not affected by the land that is held out of use for higher values), comes back to him in the sense that his aggregate profits are that much greater than they would be where ground rent was less. But the extra ground rent which he is obliged to pay, in consequence of the abnormal scarcity of land, is a dead weight; it does not come back to him. Therefore, even if infinitesimal in amount, as compared with the other expenses of his business — and that is by no means admitted — it is the one expense which may break a thriving business down. Besides, it is not alone the ground rent paid by the business man for his location that bears down upon his business prosperity; the weight of abnormally high land values in general presses upon business in general, and by obstructing the flow of trade forces the weaker business units to the wall. It is not altogether safe to deduce general economic principles from the ledgers of particular business houses.

... read the book

Jeff Smith: Sharing Natural Rents to Sustain Human Society
To get rich, or more likely to stay rich, some of us can develop land, especially sprawling shopping centers, and extract resources, especially oil. While sprawl and oil depletion are not necessary, they are more profitable than a car-free functionally integrated city. Under the current rules of doing business, waste returns more than efficiency. We let a few privatize rent -- ground rent and resource rent -- although rent is a social surplus. As if rent were not profit enough, winners of rent have also won further state favors -- tax breaks, liability limits, subsidies, and a host of others designed to impel growth (20 major ones follow herein).

If we are to sustain our selves, our civilization, and our eco-system, we must make some hard choices about property. What we decide to do with rent, whether we let it reward our exploiting or our attaining eco-librium, matters. Imagine society waking up to the public nature of rent. Then it would collect and share its surplus that manifests as the market value of sites, resources, the spectrum, and government-granted privileges. Then we could forego taxing labor and capital. On such a level playing field, this freed market would favor efficiency -- the compact city -- not waste -- the mall and automobile. ...

Drawing their cue from the public, governments tolerate "rentention", the private retention of publicly-generated land values. Lacking this Rent, states turn to taxes. But to grow the economy, all governments -- left, right, or undecided -- hustle to stimulate development; they cut taxes and slop subsidies. Going beyond the call of duty, the state excuses producers' their routine pollution and limit liability, thereby cutting the cost of insurance. Companies that don't impose on nature, worker, or customer are not benefited at all but lose a competitive advantage. On this tilted playing field, one with the lumps of subsidies and the tilts of taxes, technologies lean and clean have a hard time competing as suppliers of materials, homes, food, rides, and energy. ...
Geonomics draws its power to predict and fix what ails economies by being grounded in reality. It holds to the notion that economies are not apart from but part of the embracing eco-system. As part of whole, economies self-regulate by the same natural feedback loops. The prey/predator cycle is mimicked by the pricing cycle, also known as the Law of Supply and Demand. This familiar pattern is found, too, in the Share Rent Cycle.
(1)  Getting more rent, people work less, so output drops.
(2)  Less output lowers land values and deflates the rent-share.
(3)  Getting less rent, people work more.
(4) More output raises site values and swells the rent-share.
(1) Again, ad infinitum.

Thus, production is put into balance with consumption and work with play. Geonomics yields a policy that's not at war with but aligned with nature as model. Perhaps the most central feature of economics is price. Price is to production what DNA is to reproduction, the guides to growth. Rather than distort price with taxes and subsidies, with license (so-called "externalities") and rent-retention, geonomics respects the integrity of price, allowing it to accurately reflect our costs and values, by sharing rent. Then economies ("geonomies") can operate without the deadweight losses of taxation and rent seeking. ...  Read the whole article

Bill Batt: Painless Taxation

Abstract
Real tax reform could do away with those taxes that are resented by the large proportion of our population. We could replace all taxes on wages and on interest by instead taxing economic rent. Rent is windfall income; it is income that arises not from the efforts of any person or corporation; it comes about as a surplus gain from common social enterprise. There is ample moral warrant for society to lay claim to that which it has created, as well as to that which no individual or party has earned. Analysis increasingly makes clear that economic rent in all its forms is far larger than official government figures indicate; in fact it is likely sufficient to supplant all current taxes on labor and capital (wages and interest) which are acknowledged to have so many negative effects. Recovering economic rent in all its manifestations by taxing its various bases actually can foster economic performance and yield other benefits that make it the natural source of revenue for governments. Such a tax is essentially painless. ...

Tax Principles

The starting points should be the lessons that have been learned over the course of the past three hundred and more years about what is a good tax. Most basic textbooks in public finance enumerate them in very clear form, and they constitute benchmarks against which to measure the soundness of any particular tax. They are listed as few as three or as many as eight such principles but little disagreement exists as to their substance, regardless of ideology or government. Most commonly enumerated are neutrality, efficiency, equity, administrability, simplicity, stability, sufficiency.[3] Tax theorists typically measure revenue structures according to any or all of these criteria: ...

Tax efficiency is much like tax neutrality, and is the measure of how much shifting of behavior it imposes, resulting in what is called "excess burden," or "deadweight loss" on the economy. Tax economists usually hold that the best taxes are those that are shifted little if at all. Because the elasticities (a technical word for the slope of supply and demand curves) of each are very different, a tax on land values and a tax on improvement values have very contrastive effects on economic choices. Using a tax base that has little or zero elasticity is the best way of assuring that taxes are not shifted. Zero elasticity is another way of saying fixed supply. ... read the whole article

Bill Batt: The Nexus of Transportation, Economic Rent, and Land Use

This means that taxing away land rent more relieves it from circulating through labor and capital, allowing those factors in turn to be more productive. Significantly, perhaps most importantly, the collection of land rent, on account of its inelasticity, incurs no deadweight loss like tax levies on labor and capital. The economy thus functions more efficiently -- i.e. with less drag and friction.

Lest one believe that this excess burden, or so-called deadweight loss, is a negligible drag on the economy, studies show just the opposite. One study calculates that it was equal to about 20 percent of the total US economy in the mid-1990s, annually at least one trillion dollars in lost output.(23) Put another way, a well designed efficient revenue structure would allow productivity to rise by that amount and effectively make our income that much higher. For Great Britain, the comparable figure was shown to be £400 billion annually.

Deadweight loss is a concept understood by economists but not by the general public. But this is likely to change as discussion about the merit of various taxation approaches is presented to the public. Nations in the European Community are now required to publish their calculations about the deadweight loss of the various tax schemes being reviewed, precisely because of the recognition of its importance as a factor of production.(24)

The one kind of tax where there is no deadweight loss whatsoever is that imposed upon an base with inelastic supply. Since land and some other elements of nature cannot be increased in quantity resulting in a completely vertical supply curve, no inefficiency is incurred by such a tax. Consider two cases of a tax commonly found worldwide on real estate. Because a real property tax is actually two taxes from the standpoint of economic dynamics -- the tax on the land component and the tax on the improvement component, each is considered here as a separate case. In the first case, the tax on the land component alone is illustrated. In the other case, the tax on the improvement component (i.e. the building) is shown. What happens?

The tax on land alone is completely capitalized in the market value of the land parcel and is not passed forward to the tenant. This is important, because when the roughly 1/3 of all American households that rent rather than own their own homes are removed from the burden of property taxation, it has the effect of making the land tax far more progressive. Those land parcels that do pay taxes are split between residential and non-residential titleholders. Even though the residential households are likely to constitute the overwhelming number of parcels in the tax base, they are likely to bear only about half the taxes paid, the remaining share borne largely by commercial sites. Agricultural parcels may in some instances represent a large area of land, but it is likely to be of far lower market value and represent less than five percent of the revenue paid. The land component of a tax on real property then is actually highly progressive. ... read the whole article


Bill Batt: Who Says Cities are Poor? They Just Don't Know How to Tax Their Wealth!

The Failure to Tax Rent

The performance of economies freighted by experience with conventional taxes is much reduced, as has been widely acknowledged. One Harvard study estimated that taxes on income exert a deadweight loss equal to a third of the amount that is collected, half if payroll taxes are included.[17] Sales taxes are equally as onerous. But taxing land, due to its fixed (inelastic) supply, has zero burden; it therefore has no encumbrance or drag on economic activity whatsoever. By reducing all the taxes on labor and capital and instead shifting the burden to various forms of land as a revenue base, it is possible not only to garner sufficient income for government programs but to relieve the market from the friction that slows its performance. Cities then get a double dividend by shifting to a land tax: downtaxing any form of labor and capital frees up its potential; uptaxing land value by the recovery of rent prompts its more intensive use. Revenue yield could even be increased in such a tax regime without much additional burden on homes. This is because underused landsites in the urban cores would feel the greatest increases.

It should be further noted that wherever tax burdens are first incurred they are ultimately shifted through the economy until they come out of economic rent.[18] By their initial imposition on other factors of production, however, they encumber the performance of markets and foster inequities among populations that is both inefficient and unjust. This is not difficult to explain: labor is responsive to the forces of market location, even if not always in the short run. People are always free to locate where burdens are less onerous, thus avoiding efforts to collect taxes when their labor is so targeted. Capital is even more mobile, especially so in the age of contemporary communication and wired transfers. By taxing capital a municipality is insuring that its investment base will be reduced. Only locations, and the rent that attaches to them, cannot be moved and are beyond escaping the reach of taxation. One can't take one's land to Cancun or Bermuda. ... read the whole article

Bill Batt: Stemming Sprawl: The Fiscal Approach

In addition, a tax on site value (that is, the collection of economic rent) restores moral principle to tax theory. By collecting rent on that value that is generated by the collective activity of the community, it offers the opportunity to relieve tax burdens on value that is generated by individual effort. Put another way, any value that individuals create by their own bodies and minds is left for them to keep; that which is socially created value is recovered by the community to pay for its collective purposes. "Tax what you take, not what you make," is one way to say it. "Tax bads, not goods," or "Tax waste, not work," is another way. At the heart of this approach is a very profound message: The earth is the common heritage of humanity; it belongs to everyone. That which grows out of our own personal efforts and ingenuity is ours to keep, and no part of it should be subject to taxation.[37] Taxes on income, sales, savings, structures, and things that come from the sweat of our brow can be replaced by taxes on land rent — which, when all forms of it are included, is revenue source that can fully pay for the full services of government and is nonetheless essentially burden-less to taxpayers.[38] What economists call the "excess burden" or "deadweight loss" of the current tax structure — by many calculations at least 25 percent[39] — is reduced to zero, thereby increasing our collective productivity by that amount That effectively makes us all 20 percent wealthier. ... read the whole article


Bill Batt: The Compatibility of Georgist Economics and Ecological Economics

A tax that is neutral is one that in no way alters the behavior of the markets by its imposition; that is people perform and make choices in the same way as if there was no tax at all.39 Because a tax on “land” broadly defined is inelastic, i.e., has a fixed supply, any tax on this base is completely capitalized in the market price of the land itself. It is, in effect, a tax on the land rent, or a recapture of the land rent by government in the name of society, just as the rent is a creation of that society.
39"The striking result is that a tax on rent will lead to no distortions or economic inefficiencies. Why not?  Because a tax on pure economic rent does not change anyone's economic behavior. Demanders are unaffected because their price is unchanged. The behavior of suppliers is unaffected because the supply of land is fixed and cannot react. Hence, the economy operates after the tax exactly as it did before the tax--with no distortions or inefficiencies arising as a result of the land tax." P. Samuelson and W. D. Nordhaus, Economics, 16th ed., p. 250.

A land tax is efficient because there is no economic distortion of market choices as a consequence of its neutrality. This means that there is no wasted economic behavior in the form of excess burden or deadweight loss typically associated with other tax designs. As an example of the inefficiencies of other taxes, for example, one might consider the altered behavior that occurs in consequence of the presence of the income tax or the sales tax. This deadweight loss in American and British economies has been estimated to be roughly 20% of the national domestic product in each nation. Put differently, were there no deadweight loss as a result of the tax structure, the society would essentially be 20% more productive — and 20% richer in the aggregate.40
40Fred Harrison (Ed.), The Losses of Nations: Deadweight Politics versus Public Rent Dividends, London: Othila, 1998, and Dale Jorgenson and Kun-Young Yun, “The Excess Burden of Taxation in the United States,” Journal of Accounting, Auditing, and Finance, fall, 1991. Harrison, et al. calculate that the deadweight loss of the current tax system of United States is a trillion dollars annually. Nicolaus Tideman et al. have modeled “The Avoidable Excess Burden of U.S. Broadbased Taxes,” in Public Finance Review (September, 2002), showing a “net gain of about $10,000 per worker (16% of NDP) in the first year, rising to $17,800 (23.7% of NDP) after 20 years for the most productive tax reform, which involves collecting 90% of the rent of land and using the income tax as a residual tax. When the sales tax is used as the residual tax, the gain per worker is about $3,300 less.” This and other work is summarized in “The Gains from Taxing Land,” in Geophilos, No.03(1) (Spring, 2003), pp. 56-60. See also Alan Durning notes that “Complying [with the personal income tax alone] takes Americans 5 billion hours each year. For every dollar raised, U.S. taxpayers spend nine cents obeying the law. Cheating is widespread; roughly one-fifth of income goes unreported.” Alan Durning and Yoram Bauman, Tax Shift: How to Help the Economy, Improve the Environment, and Get the Tax Man Off Our Backs, Seattle: Northwest Environment Watch, April, 1998. p. 17. This is further corroborated in Donald L. Barlett & James B. Steele, The Great American Tax Dodge (Boston: Little, Brown & Co., 2000), where the authors note (p. 23) that the proportion of U.S. taxpayers deliberately engaged in cheating on their income taxes now approaches “between one -third and one-half of the tax-paying population.”... read the whole article

Bill Batt: Comment on Parts of the NYS Legislative Tax Study Commission's 1985 study “Who Pays New York Taxes?”

The question still begs to be answered, “why tax land?” And what happens when we don’t tax land? Henry George answered this more than a century ago more forcefully and clearly, perhaps, than anyone has since. He recognized full well that the economic surplus not expended by human hands or minds in the production of capital wealth gravitates to land. Particular land sites come to reflect the value of their strategic location for market exchanges by assuming a price for their monopoly use. Regardless whether those who acquire title to such sites use them to the full extent of their potential, the flow of rent to such locations is commensurate with their full capacity. This is why John Stuart Mill more than a century ago observed that, “Landlords grow richer in their sleep without working, risking or economizing. The increase in the value of land, arising as it does from the efforts of an entire community, should belong to the community and not to the individual who might hold title.”33 Absent its recovery by taxation this rent becomes a “free lunch” to opportunistically situated titleholders. When offered for sale, the projected rental value is capitalized in the present value for purposes of attaching a market price and sold as a commodity. Yet simple justice calls for the recovery in taxes what is the community’s creation. Moreover, the failure to recover the land rent connected to sites makes it necessary to tax productive activities in our economy, and this leads to economic and technical inefficiency known as “deadweight loss.”34 It means that the economy performs suboptimally.

34. “Deadweight loss is the loss of producer’s or consumer’s surplus stemming from the price of a good being higher than marginal cost or to a tax that increases the cost. A lower quantity is purchased than would be the case without a tax or under ideal conditions, such as the elimination of artificial barriers to entry. (Fred E. Foldvary, Dictionary of Free-Market Economics. Northampton, MA: Edward Elgar Publishers, 1998. p. 103.) The attachment of economic rent to land sites means that a market of less than perfect competition exists, thereby engendering deadweight loss.

Land, and by this Henry George meant any natural factor of production not created by human hands or minds, is ours only to use, not to buy or sell as a commodity. In the equally immortal words of Jefferson a century earlier, “The earth belongs in usufruct to the living; . . . [It is] given as a common stock for men to labor and live on.”35 This passage likely needs a bit of parsing for the modern reader. The word usufruct, understood since Roman times, has almost passed from use today. It means “the right to use the property of another so long as its value is not diminished.”36 Note also that Jefferson regarded the earth as a “common stock;” not allotted to individuals with possessory titles. Only the phrase “to the living” might be subject to challenge by forward-looking environmentalists who, taking an idea from Native American cultures, argue that “we do not inherit the earth from our ancestors; we borrow it from our children.” The presumption that real property titles are acquired legitimately is a claim that does not withstand scrutiny; rather all such titles owe their origin ultimately to force or fraud.37

If we own the land sites that we occupy only in usufruct, and the rent that derives from those sites is due to community enterprise, it is not a large logical leap to argue that the community’s recovery of that rent should be the proper source of taxation. This is the Georgist argument: that the recapture of land rent is the proper – indeed the natural – source of taxation.38 ... read the whole commentary




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