The UK economy is beset by three compounding problems: no growth, a high deficit and a constricting straightjacket of regulations. I posit that a reform to land-use planning, partnered with a land-value tax (LVT) substituted for business rates and council tax, offers a potential solution to all of these.
The unique merits of a land-value tax have pressed on the minds of economists for over 200 years. Economics has taught us how to analyse taxes against the criteria of efficiency, equity and revenue raising potential. The taxes most heavily applied in the UK today succumb to the theory of the second best: for example, income tax damages efficiency by perverting labour supply decisions; business rates distort firms’ input decisions, such that scarce resources are misallocated and final goods are not produced in the least-cost way. The key driver of inefficiency in both cases is the responsiveness of the payer, or the elasticity. High elasticities imply a greater distortion and greater efficiency loss.
In accordance with the sacrifice principle of Mill and others, an equitable tax system is one in which the utility burden is equalised across payers. By this criterion progressivity is desirable. Revenue raising potential is a function of the size of the tax base and the ability to avoid or evade.
The LVT is an annual levy on the underlying value of land. What is on top, whether it’s residential housing, a factory or wheat is of no importance, so that an empty plot of land next to a plot with a mansion on are valued the same ceteris paribus. This value is derived from the amenities and infrastructure which surround it, or Ricardian economic rent monies accruing not by virtue of work or returns to capital but by virtue of exclusive rights over the land’s use, or ownership. As described by Henry George in 1879, and more recently by the Institute for Fiscal Studies in the Mirrlees Review, this value is borne out of community effort, rather than individual effort, and therefore its returns should properly be redistributed back to that community.
Since the supply of land is finite and fixed, it is perfectly inelastic. This means that economic decisions are unaffected by the tax and that the incidence coincides with the legal payer (landowner). When a landowner builds a swimming pool on his plot its value increases but his LVT payment remains unchanged; when a public swimming pool is built a short walk away and the value of his plot increases, so does his tax liability. There is no efficiency cost.
One ‘wrinkle’ as the IFS puts it, is that land-use planning laws mean a plot designated agricultural is worth considerably less than a plot designated business (over £2.4m less according to IFS estimates). But this presents a big opportunity. A recent IEA report showed how planning restrictions have led to a chronic shortage of affordable housing and a pernicious degree of intergenerational inequality. The Centre for Economic and Business Research has shown that if house building could be increased by 300,000 units a year between now and 2015, GDP would increase by five percentage points and rents would fall by 11%.
Relaxing planning restrictions would lead to a rebalancing of land designations towards their most profitable use, namely residential housing and business. This would lead to a fall in house and business property prices as supply increased, and windfall gains to land owners. A concurrent LVT would capture some of those gains. As the tax base is observable and fixed, neither avoidance nor evasion is possible, making collection cheaper. Substituted for other distortionary and inequitable taxes such as council tax and business rates, LVT could also increase efficiency. Paired with an overhaul of the antiquated system of land-use planning, it would boost growth and ease budgetary woes.