Why investing in “land value” is evil
And how to fix the problem
Amali and Bimal
[The people and the transactions in this scenario are imaginary. But the numbers are based on real data, but significantly simplified]
In 2010, both Amali and Bimal have Rs. 20M in cash to invest.
Amali puts her money in a fixed deposit which pays 10% annual interest, every year.
Bimal uses the Rs. 20M to buy a plot of land in a remoter part of the Colombo District.
10 years later in 2020
Each year, Amali renews the fixed deposit at the same rate, after playing income tax on the interest, which is consistently 15%.
By 2020, Amali’s investment has little over doubled to Rs. 45M.
The average inflation rate during the 10 years was 7% per year. Hence, Rs. 20M in 2010 is worth Rs. 39M in 2020. Hence, Amali’s inflation corrected return on investment (ROI) is 1.4% per year.
Bimal is also a “passive” investor. He does nothing with the land. Instead, he asks a distant relative who lives near the land to “keep an eye on it”.
Bimal decides to sell the land in 2020. The property is on the market for a few weeks before he accepts an offer of Rs. 51M. Bimal pays 10% in capital gains tax (CGT) on the land, leaving him with Rs. 46M. Hence, Bimal’s annual inflation corrected ROI is 1.6%.
Why are these two investments different?
On the surface, these two investments look very similar. They have similar principles and similar ROIs. But dig a little deeper and we see that the two investments have important differences.
Amali realized some of the value of her investment every year. Her bank invested her money in some productive venture and returned some of the returns to Amali. Amali also payed income tax on this return.
Bimal, on the other hand, realized nothing until 2020. However, it is not like nothing happened to the land. The land 2.6xed in value in the 10 years. Part of this (2x) was due to inflation. The remainder (1.3x) was due to the market finding more productive ways to use the land — and hence asking more for it.
Ok. But what’s the problem?
Let’s go back to 2012, and enter Chaminda.
Chaminda wants to start a new organic vegetable plantation. Bimal’s plot of land is perfect for the venture. He offers Rs. 24M for the plot of land. But Bimal refuses, because he thinks that the land will be worth much more in a few years’ time.
Note, Rs. 24M will give Bimal roughly the same annualised ROI, as he ends up getting in 2020; but he still refuses Chaminda. And so, there is no organic vegetable plantation. And the plot of land stays barren for another 8 years.
This is why investing in “land value” is pure evil. People with a little bit of money can effectively kidnap and imprison a fertile piece of land and keep it completely unproductive; with no incentive to do otherwise.
So, what is the solution?
What if we made a small change to the CGT law?
We keep the 10% rate, but make it due annually, instead of on sale.
How do we do that?
Each year the market value of the land is assessed. On whatever appreciation, the owner must pay CGT.
For example, by 2011, the market value of Bimal’s land is Rs. 21.8M. His gains over the previous year are Rs.1.8M, and would have to pay Rs. 180K in CGT. By 2012 it the land would have appreciated to Rs. 23.7M, and Bimal would have to pay another Rs. 194K.
These tax amounts might sound large, but what Bimal is paying is for the opportunity cost of people like Chaminda. Other potential private owners who can make much better use of property than him.
Under such an incentive system, Bimal is far more likely to sell off the land to Chaminda for Rs. 24M, as opposed to keeping the land bare and pay non-trivial amounts of tax for it.
Generalising these ideas
I’m neither an economist nor a tax lawyer. So don’t take the quantitative numbers too literally.
But do consider the qualitative principle.
All of what I said still holds with very different income tax, CGT, land value and inflation scenarios. They also applies to all other investments which effectively leave the investment “barren” — like empty apartments.
Reasonable Exceptions
The existing CGT law has some important and reasonable exceptions. For example, if land is for your primary residence, then you don’t pay tax. These reasonable exceptions should remain.
Others, like exceptions for inheriting land, are somewhat questionable.
But doesn’t this punish private ownership?
Many might question, “Aren’t these ways for more money to flow from efficient private individuals to the inefficient state in the form of tax?”. I have two responses to that.
The net effect of this system is going to be “property flowing from inefficient individuals (like Bimal) to efficient individuals (like Chaminda)”. As a result, everyone, Bimal and Amali included can benefit.
My second response is, if you followed the math, the state still collects the same amount of tax.
Overall, people like Chaminda would love this. Instead of being forced to doing nothing, they get the resources (in Chaminda’s case land) they need for their entrepreneurial ventures.
The Bimals of the world wouldn’t hate it that much either. If you recall, Amali’s return was not very different from Bimal. If Bimal is lazy, he should just put his money in a bank without depriving the country of valuable resources.
The Biggest Inefficient “Private” Owner
The biggest inefficient “private” owner of land in Sri Lanka is the state.
As I said in Why we must “Abolish” Private Property,
Depending how you count (and counting is hard), the Sri Lankan state owns 50% to 90% of the country’s total property. So, JVP aside, the UNP and the SLFP (and their bastard progeny from both sides of the bed) have been effectively running a Communist State, where property ownership is centralised in the state.
For the Sri Lankan state (and all Communist States), de-jure “public property” is de-facto “private property” of those in power and their sponsors in the private sector. At best, a few scraps trickle down to the public.
The state must also pay CGT on its land portfolio. You can find details on how in the above article.
Capitalists of the world unite!
There are some religious bigots who think “Private Property is sacrosanct”. No one can violate that. These people are exactly that: bigots and cranks.
If we are true capitalists, we must put money and resources (like land) to work. We must make sure that property is in the hands of those who can make best use of it and we must create an incentive system to make that happen.
The “cranks” usually brand true capitalists as “socialists”, “communists” or worse. For these illiterate idiots, the only alternative to private ownership is state ownership. They don’t see that in an inefficient capitalism like Sri Lanka’s there are always better private alternatives to the existing private ownership, i.e., better private ownership.
We must win back capitalism from these cranks. It’s time for a revolution. A capitalist revolution!
Capitalists of SriLanka, unite! We have nothing to lose but waste and inefficiency!
I express some very similar principles in a far more abstract way in this article…
