California's Proposition 13 has had a wide range of undesirable effects. Among
them is the tendency for people to remain in homes that are too big for or
otherwise unsuited to their current needs, while others who seek such homes
must build them somewhere on the fringe. Also, people who no longer need to
be close to their work are incentivized to remain in those choice sites, while
those who do need access to those workplaces must commute long distances. If
the market were permitted to work, housing prices in California would be much
lower and more people would live closer to their work.
While it is often true that the prospect of earning
capital gains is what induces new investment to be made, applying further
rate cuts to real estate gains cannot be expected to spur much new
construction activity under present fiscal institutions. Clearly a “capital” gains
tax cut cannot cause the production of more land; land (as distinct
from capital improvements) is made by nature, not by the landowner.
As to buildings, more of the tax benefit would go to speculators in
existing capital than to investors in construction and renewal. We
also doubt that a further rate reduction is likely to accelerate real
estate turnover by reversing a “lock-in effect.” Turnover
is strongly affected by depreciation rates. In periods of rapid write-offs
-- most strikingly during the 1980s, when real estate could be written
off faster than in any other period -- buildings tend to be sold
as soon as they are depreciated. The 1986 reforms reduced the incentives
for this rapid turnover, but the principle is clear: When depreciation
rates are high, there is a powerful tax-induced incentive to sell a
building when it is fully depreciated.24 The basic motivation
at work, of course, is to avoid taking investment returns as taxable
income. Investors prefer to declare as much of their income as possible
in the form of capital gains, which are taxed later and at a lower
rate. Read the whole article
Normal yearly turnover in the U.S.
land market is 3-4 percent of parcels, and much less than 3 percent of
value (because small parcels turn over faster). Most of even that
small turnover is zero-sum, buyers being financed by sales of what they
owned before. Net movement of money in or out of land is a small percentage
of total value turned over, and a minuscule share of total land value. ...
There would be no land gains if land rent were to be 100 percent
socialized, and if the market expected it to remain so. In practice
those circumstances are unlikely, and some would consider them undesirable:
the easiest and most accurate way to appraise rent is by monitoring the
market in land titles.
When land and/or minerals are "ripening" over an extended period of
ownership, a property tax during the ripening period can be shown to collect
exactly the proper share of the increment, but only under ideal conditions.
First, the market and the foresight of market agents must be so perfect that
value rises roughly along a curve of compound interest. Second, tax assessment
must follow that perfect market closely.
In practice even rough perfection is, alas, rare. A gains tax is a
good way of "mopping up" excess rent that escapes the basic rent tax. It
can also be very productive of revenue: in Taiwan the land gains tax raises
four times as much as the basic land tax, partly because the gains tax is
always based strictly on current sales data. The land tax should be based
on current sales data as well, to be sure, but in Taiwan and many other jurisdictions
it often is not.
This writer recommends announcing at time of privatization, and regularly
thereafter, that landowners should expect a high tax rate, 80 percent or
more, to be imposed on land gains. It should be contrary to public policy
for land to attain a value based on expected future resale. Possessory interest
with allocation to highest and best current use, and not land speculation,
is the desired emphasis.
Instead of being made illegal, resale gains should be closely monitored
to audit the system of rent collection. Gains are evidence that basic rent
taxes are too low or that market agents expect them either to fall or to
fail to keep up with rising rent. A rise in gains is an early warning to
view the land tax administration with alarm and move swiftly to correct it.
Experience shows that buyers quickly acquire a mental vested interest in
collecting rent and avoiding taxes based on what they paid, or others are
now paying, for land titles.
A problem with gains taxes is the "lock-in effect." Holders with surplus
land may refuse to sell to avoid tax. A gains tax may be very high, however,
without a serious lock-in effect, when coupled with a high ongoing rent tax.
The latter compels owners to dispose of surplus lands. Indeed, the "ripening
cost" theorists believe it forces premature sales for conversion to new uses.
If there is any merit to their rationale we should favor strengthening the
lock-in effect. So should they, as a litmus test of their rational consistency
and constructive purpose.
The greatest cause of the lock-in effect of the capital gains tax in
the U.S., however, is not the tax itself but one of its major loopholes:
the ability to avoid it via the step-up of basis at time of death. There
should of course be no such provision, which is a kind of negative inheritance
tax mainly benefitting heirs who have done nothing to deserve it. Legacies,
devises, gifts and other transfers without arm's length consideration should
trigger valuation and tax. So should death itself, when property has to be
valued anyway.
Land gain should be defined as the excess of net sales price over depreciated
cost basis. An administrative problem to note and solve is the manner of
recording capital outlays and their depreciation, in the (presumed) absence
of a general income tax.
A supplemental tax on land transfers is desirable as a tool of disclosure.
It should be based on gross value of lands transferred (not just gain, and
not just equity). Many American states have such taxes, at very low rates,
simply to supply data for land assessment. While rates should be nominal,
penalties for perjury should be severe: the public has a right to know how
much others are getting for its property.... read the whole article