Saturday, March 03, 2012

Taxes II

I recently read this article in which Samuel Brittan argues for a tax on land, and quotes Winston Churchill
Roads are made, streets are made, services are improved, electric light turns night into day, water is brought from reservoirs a hundred miles off in the mountains - and all the while the landlord sits still. Every one of those improvements is effected by the labour and cost of other people and the taxpayers. To not one of those improvements does the land monopolist, as a land monopolist, contribute, and yet by every one of them the value of his land is enhanced. He renders no service to the community, he contributes nothing to the general welfare, he contributes nothing to the process from which his own enrichment is derived.
I am no expert on Georgism, but I am intrigued.

Bryan Caplan, however, doesn't like it.
There's just one problem: While the Georgist tax has no effect on the incentive to pump discovered oil, it has a devastating effect on the incentive to discover oil in the first place. Suppose you could find a $1M well by spending $900k on exploration. With a 99% Georgist tax, your expected profits are negative $890k.
I am nor persuaded by Bryan's argument. The company will look at the total profits which it can make by investing in finding and developing the oil field.

First, it will pay a higher tax on the land it owns, but since it will no longer be taxed on the profits it makes from extracting, refining, and distributing the oil which it finds, it is not clear that its total profits will be any less.

Second, it is not the case that the company's profits from oil exploration are higher in the absence of the land tax: what would be paid as land tax would instead be paid to the landlord. The effect of the Georgist tax is to transfer rent from the current owner of the land to the State. Whether this is a good thing or not is debatable, but the tax is not paid by the company which finds the oil nor the one which develops it, and will not affect their incentives. Note that this is Ricardian rent, and not simply money rent, though the two could be the same.

To be clearer about this, consider a company which is thinking of buying some land outright, where it is confident that it will find oil. It will take the land tax into account when deciding whether to buy the land (just as it would take sales tax, etc into account today). The effect of the land tax will be to reduce the price which the company is willing to pay for the land, and so will in effect be paid by the current owner of the land. The landlord will sell to them if what they can pay is more than he could make from the user with the next best use of that land. If the land tax did not exist, the company would pay more, and the landlord would be end up richer. But the person with the second best use of the land would also be willing to pay more, and so the landlord's decision would not be affected by the tax!

Finally, as a couple of the commentators have pointed out, there is a fatal problem with Bryan's argument: the model which he says cannot work in theory already works in practice.
Or do you think that when Western oil companies rock up in Saudi Arabia, that the Saudis don't make them pay every cent for the value of the land/natural resources? The Western oil companies just get to keep the additional profits made by extracting, refining, shipping the stuff.
and (italics added)
I invite you to check out the world of actual oil and mineral exploration, this happens all the time. Very seldom will a party of oil/minerals exploration not have to negotiate with a private/government party who will extract as much rent as they can, and the stuff still gets out of the ground with a profit for the exploration party.

The author mistakes 100% of the rent for being 100% of the value of, in this case, oil. It's not, it's what the exploring party will bid to profitably extract it.
Bryan argues that we should be taxing negative externalities instead. The windfall gains made by the landlord because of the efforts of others is a positive externality which blesses the landlord alone, and this is what the tax is meant to recover.

Ricardian Rent is an amazingly subtle concept. I only understood it properly after I read Tim Harford's The Undercover Economist. I am not an expert on taxation, and it could be that I have got something wrong, but I really doubt it. I think it is much more likely that his ideological preferences caused Bryan to rush to judgement.

Edit: Gulzar's comment below, and his op-ed are well worth reading.


Derek said...
This comment has been removed by a blog administrator.
gulzar said...

i agree rajeev. just two more points

1. this land tax could be seen as a tax on negative externalities. as the experience of recent years in many indian cities show, investments in land, fuelled by property bubbles, have led to massive resource misallocations which in turn inflated the bubble further. seen this way, a land tax helps contain the negative externalities arising from such misallocation and resultant bubbles.

in fact, there are other negative externalities that i have outlined in this op-ed

2. a land tax, far from discouraging people to search for better uses of existing land, would actually encourage people to search for greater value addition/capture from that land so as to maximize returns/cashflows from the land. in fact, it would promote entrpreneurship and more economic activity instead of people merely holding on to land as a speculative investment asset class.

Rajeev Ramachandran said...

Agree with both points, Gulzar. And thanks for the links.
Since i have recently been arguing for idleness, i should count your second point *against* the land tax. :-)