does a land value tax have zero or negative deadweight loss?
i was recently reading the wikipedia article on optimal taxation theory, when i came across an assertion that land value taxes (LVT) have not zero deadweight loss, but actually negative deadweight loss.
Economic theory suggests that a pure land value tax which succeeds in avoiding taxation of improvements could actually have a negative deadweight loss (positive externality), due to productivity gains arising from efficient land use.
You own a downtown lot that is used for parking. Your income is $250,000 per year, and there is no land tax, so at a discount factor of 10%, your lot is worth $2.5 million for parking. But someone would give you $10 million as a building site. That is the market value of the land. You expect that price to rise by 10% per year, so you understand your full income to be $1.25 million. If you sell, your income from the sale price will be $1 million per year. Best to hold.
Now implement a land tax at a rate of 10% of the value of the land. The value of the land falls to $5 million, with taxes of $500,000 per year. Your 10% price gain, in this example, just offsets your taxes, so your net profit (parking plus price gain minus taxes) is $250,000 per year. But if you sell the land for $5 million, then, at the assumed discount rate of 10%, your income is $500,000. Now, because of the land tax removing half the income from speculating, it is best to sell.
i found this example to be a bit confusing, so i radically simplified it as follows.
You own a parcel worth 2.5M to you, but worth 10M to someone else, and you expect a future positive externality receipt (e.g. a gold meteor lands on your property, you strike oil, Google builds new offices nearby, etc.) with an NPV of 1M (an NPV analogous to the more complicated expectation of 10% growth in your example). So really, that other party should pay you 11M (the 10M they think it’s worth to develop, plus the price of that meteor that’s going to land on your property). But they don’t know/believe that 1M, so they’re only willing to pay you 10M right now. So you’re just going to wait until the meteor lands next year, and then sell it to them for the full 11M. But there’s economic loss here because the property went undeveloped for that full year.
So then the question is, who’s right? If the other party is really confident they’re better at predicting the future than you, then they can just “short” the property. You sell the land for a future payment of 2f — e, where f is the actual future value and e is your expected future value (add in standard 0.3% to 3% shorting fees of course).
tideman agrees with this in theory, but suggests that such an esoteric financial instrument might not exist in practice.