Taxes on the
Sale Value of Land
A tax on the sale value of land, or "ad
valorem" tax, is a recurring (e.g., annual or monthly) tax
proportional to the price at which the land would sell. Ad
valorem taxes on land have been praised by many economists for the
fact that they do not impair incentives to use land productively. The characteristic
of an ad valorem tax that keeps it from impairing incentives to
produce is that, when such a tax is properly administered, the amount of
the tax is independent of any action taken by the taxpayer. Whatever course
of action maximizes the wealth of a taxpayer before a tax is levied also
maximizes his or her wealth after the tax is levied (apart from income effects,
which do not entail allocative distortions). A taxpayer can reduce the taxes
he or she pays by selling the land, but the new purchaser will acquire a
tax burden of the same magnitude. The total of taxes to be paid is independent
of any reshuffling of land titles among taxpayers. For this reason, ad
valorem taxes on land, like taxes on the rental value of land, are capitalized
into the purchase price of land and entail no economic distortions.
A tax on the sale value of land is very much
like a tax on the rental value of land, but with a somewhat different incidence. If
land is not taxed, its sale value in a market in which the participants foresee
the same opportunities can be described as the present value of future net
returns, discounted at the market interest rate, r,
when the land is used in such a way as to maximize those returns. The effect
of an ad valorem tax at an annual rate of t is to increase the annual
holding cost of a dollar's worth of land from r to r + t. Thus the value
of a site in the presence of a tax at a rate of t is computed by discounting
future returns at a rate of r + t. The sale price of a site with a net return
of x per year falls from x/r to x/(r + t), so the tax takes the fraction
t/(r + t) of the pre-tax value. Thus for land that is not changing in value,
an ad valorem tax at a rate of t is equivalent to a tax at a rate of t/(r
+ t) on the rental value of the land.
If the net return from the use of a site is not constant but rather grows
from an initial value of x at a rate of g, then the sale value of the site
in the absence of a tax is x/(r - g). When the tax raises the annual holding
cost to r + t, the sale price becomes x/(r + t - g). The fraction of value
that is taken by the tax is t/(r + t - g). For example, if the tax rate is
4% and the interest rate is 8%, then the tax takes 1/3 of the value of a site
that is not growing, but 40% of the value of a site whose return is growing
at 2% per year. When paths of returns through time cannot be expressed as simple
growth rates, it continues to be true that, other things being equal, a site
with relatively more attractive future prospects will bear a higher proportion
of current taxes under a tax on the sale value of land than under a tax on
the rental value of land. Thus an ad valorem tax falls more heavily on land
that might be the object of speculation than on other land. It thus tends to
discourage speculation more than a tax on the rental value of land does. Otherwise,
its effects are the same as those of a tax on the rental value of land. There
is an upper limit of 100% on the feasible rate of a tax on the rental value
of land. There is no such upper limit on the feasible rate of an ad valorem tax
on land. The tax could be 10% per year or 10% per day or 10% per hour, with
the sale value falling as the rate rose. In the limit as the tax rate of an ad
valorem tax approaches infinity, the tax approaches a tax that takes 100%
of the rental value of the land.
An ad valorem tax is administered by having assessors who estimate
the sale value of land. When tax rates are modest, it is easy enough for assessors
to do this by monitoring sales of land that is vacant or has only structures
that are about to be demolished. However, if the rate of an ad valorem tax
is very high, then the influence of inherent value of land will be overwhelmed
in prices by idiosyncratic features of transactions between particular buyers
and sellers. Assessors would need to rely on processes in which sale prices
were linked directly to taxes. These could be either auctions, where participants knew that the
auction result would be used to set the tax for a specified period, or options,
where potential uses of land offered specified payments for any site meeting
certain standards. Because ad valorem taxes on land have no distorting
effects, they neither retard nor advance the timing of land development in
a world of perfect information. This has been denied by Shoup (1970, p. 38-39),
Bentick (1979, pp. 861-63; 1982) and a variety of other writers who have followed
them. The tax that Shoup and Bentick analyze, however, is not an ad valorem tax,
but rather a tax whose base is the present value of the future net income that
is expected to result from the plans for a site. Thus a change in the plan
produces a change in the tax bill, generating an incentive for inefficient
changes in plans (Tideman, 1982). ... read the whole article