Thursday, March 1, 2018

Henry George and Affordable Housing

Philip Bess has an article in American Affairs about the benefits of a land value tax (LVT), which was the idea that led to the fame of 19th century thinker Henry George.  There are a lot of interesting thoughts on urban development in the article, and I generally agree with the points made.

Reading the article triggered some thoughts regarding the land tax and housing affordability.  One of George's conclusions, which Bess refers to, is that having a near 100% land tax (which, effectively, is confiscation of unimproved land, but not the improvements and structures, by the government) would prevent speculative bubbles and would improve housing affordability by removing speculative value from the property.  Here is an interesting description, from the article, of how land ownership would look under a comprehensive LVT:
Land speculation would be impossible because only the use of land would have economic value. In turn, though, an LVT would also benefit land titleholders who would not pay tax on improvements to their land or productive activities undertaken thereon. And why would anyone sell land? One would not sell land to make a profit from the sale (which would not be possible), but rather to relieve oneself of a tax liability. That which one cannot or will not use one cannot own save for a fee. “Ownership” of land extends no further than an entitlement to the use of land, and that which an “owner” cannot use he must pay for or “sell” to someone else. “Buying” and “selling” land under a single tax regime therefore assume slightly different meanings than in ordinary discourse because what is really transferred is a land liability equal to land value—a liability virtually no one would accept if they did not plan to use the land.
George focuses on land banking and speculative ownership which is based on expectations of capital gains.   Here, I think my recent work on the housing bubble might add food for thought to this topic.  The point I have frequently made about analysis of the bubble is that there is a sense of attribution error in human nature deep enough to infect the academy. ("I bought a house in Phoenix in 2005 because I was tired of having my rent jacked up every year in LA, but I had to overpay for it because there were thousands of greedy speculators in the market at the time.")  I rarely see homebuyer expectations framed in terms of the present value of future rents.  Usually, especially during the bubble, they were framed in terms of expectations of future home prices.  Removing rental income from the mental framing of home values causes us to exaggerate the effect of speculation as a process unmoored from intrinsic present values.  I think this is the case regarding the idea that a LVT would eliminate land speculation or price volatility.

First, in terms of affordability, I would like to point out that ownership, first and foremost, is a rent hedge.  A Georgist tax would be a pretty harsh Darwinian imposition on homeowners.  California has Prop. 13 because rising home prices meant that older owners with limited incomes were faced with rising property taxes.  A Georgist LVT would impose that tax at a maximum level.  There would be no rent hedge.  It would be the antithesis of tenants rights.  If you couldn't pay the rising tax on a valuable property, you would have to move out.  George sees this as an advantage, and there are benefits to it.

One benefit would be, as a second order effect, that more housing development would be induced because developers would outbid less productive owners and build more improvements on the land, which they could profit from.  So, maybe where current building restrictions are the cause of high prices, this would solve the affordability problem, and little old ladies wouldn't be faced with rising taxes in the first place.

But, the first order effect would be to remove an important source of stability that is fundamental to ownership in our current system.

So, back to my point about speculation and price volatility, if price volatility is unmoored from the fundamentals, then it would be reduced.  However, if price volatility is related to fundamentals (the rental value of a home) then it would not.

Imagine an owner in an untaxed system vs. one in a system with 100% LVT.  Let's say the structure is worth $200,000 and the land is worth $200,000.  It has an annual rental value (after expenses) of $20,000 - $10,000 from the structure, $10,000 from the land.

Untaxed, a buyer pays $400,000 cash and there are no further transactions.  Under the LVT, a buyer pays $200,000 plus an annual $10,000 tax.  We might  imagine that they invest their other $200,000 in a long term fixed income security that pays $10,000 annually.  So, for the buyer, the transaction is essentially the same.  They need $400,000 to own the house.

Now, what if there is a market expectation that the land rental value will grow by 2% annually because of its location?  All the numbers above are the same, but in year two, the tax would be $10,200 instead of $10,000.  So, now, in order to perpetually control the property, the buyer would need enough savings to pay the initial $10,000 tax, and to grow by 2% each year.  So, the buyer would need to pay $200,000 for the house and save $280,000 to cover the taxes.  So, the total "price" would be $480,000.

Now, since rising rent is a liability for the owner, owners would still want to hedge that risk, just like they do today.  So, we might imagine that banks would offer a service.  They might develop a security that they sell, sort of like an annuity.  They would say, "Pay us a set amount, and we promise to make the LVT payments on a property in perpetuity."  So, now, the buyer would go to the bank, pay them $400,000.  The buyer would own the home and the bank would handle the LVT, so the owner would have no further expenses.

And, if the local housing market became valuable, and there was an expectation that land values would rise 2% annually, the bank would still sell the same security, but they would require a payment of $480,000.  And, if someone wanted to buy the property, they would have to purchase that annuity from the current owner, also at $480,000.  If we think of speculators betting on future rental value rather than betting on short term price increases they expect to reverse (presumably after they sell), then there is no difference in that changing value.

(edit: Changing interest rates would also affect the value, just as they do today.  And, of course, we could further imagine that buyers fund their initial payment for the annuity by getting a loan with a 30 year fixed amortization.)

(edit #2: Upon further thought, even unmoored speculation could happen with those annuities.  So, maybe my distinction between fundamental and unmoored speculation isn't that important.  Everything would basically be the same, except that since the government has taken a long position in the land, which it doesn't have in the untaxed version, for these instruments to work, the bank has to have a short position on the land, which is what the promise to pay the tax is, which it doesn't have in the untaxed version of the story.)

So, we can imagine that, to the extent that home values reflect capitalized future rental value, there really is no difference between the taxed and the untaxed market.  I differ from George on these two points.  (1) I think he, like most observers do, overestimates the significance of unmoored speculation on home prices, and (2) by removing a device for capitalizing future rental values, he can imagine that the value doesn't exist.  But, future rent or tax changes have an effect on current owners whether we imagine that they can hedge them or not.

21 comments:

  1. You kind of gloss over what I always saw as the primary benefit, if not the entire purpose, of a LVT. "So, maybe where current building restrictions are the cause of high prices, this would solve the affordability problem, and little old ladies wouldn't be faced with rising taxes in the first place." I think you might be on to something with the bank capitalization of rent payments and such, but if an LVT allows enough new construction such that the nominal rental expectation is 2%/year instead of 4%, wouldn't that have a big effect on broader affordability? It's not 'speculation', its altering the fundamentals.

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    1. Yes. I didn't mean to gloss over it. I meant the post to be an aside to the broader idea. Not an encyclopedic review of it. I think you are correct, although I'm not certain how all the effects would play out from the basic premise that under LVT owners would prefer their land to have less value, all else equal.

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  2. Perhaps of note is that in the state of Texas authorities reserve the right to apply property taxes at highest and best use. I am not sure how much political correctness or corruption goes on in the application of such property taxes, but it is an interesting idea.

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  3. > A Georgist tax would be a pretty harsh Darwinian imposition on homeowners. California has Prop. 13 because rising home prices meant that older owners with limited incomes were faced with rising property taxes. A Georgist LVT would impose that tax at a maximum level. There would be no rent hedge. It would be the antithesis of tenants rights. If you couldn't pay the rising tax on a valuable property, you would have to move out. George sees this as an advantage, and there are benefits to it.

    The usually way around the little old lady objection is distribute the proceeds from the LVT equally amongst the citizenry. Thus only people who use more than the average are net payers. The little old lady in a small house might be a net receiver (and if she were a net payer, she's not the little old lady someone needs to worry about).

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    1. But, the idea that the property would be put to its highest use necessarily means the owner is displaced. I think in any system, there has to be some room for that, but it tends to meet public opposition.

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    2. The highest use is not some objective criterion, but determined by what people are willing to pay.

      In some sense, the profit motive already gives peope the incentive to put their properties to the highest use even without lvt.

      An lvt-financed basic income gives people the ability to just declare by fiat that them occupying an average place is its highest use. They just have to burn all their basic income on it. (Thanks to wealth and income inequality, the median place is actually quite a lot cheaper than the average place, so most people will save quite a bit on net.)

      (As an aside, monopoly suppliers' profit motive should drive them to cut costs. But in practice principal-agent problems mean that competition's threat of eliminating a weak company drives cost cutting / productivity a lot more efficiently than mere concerns for shareholder value.)

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    3. That's all true. I'm just saying that forcing people out of their homes because the rental value changed while they lived there is very politically unpopular. That's why high cost places end up with rent control and prop. 13. People vote for the opposite of what you are proposing. Any solutions to the supply problem will have to minimize that type of displacement, though there will need to be some.

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    4. Yes, that's definitely a political problem. But coupling a tax to change behaviour (like lvt or a carbon tax) with equal distribution of proceeds to citizenry should make them much more palatable?

      Especially with lvt it's nice, because all those "evil" rich foreign oligarchs buying up luxilu condos will pay for grannies basic income.

      (You can even put the 'housing assistance' part front and centre: say that everyone who uses less than the average value in land will get an assistance paid for by the people using more. Ie talk about net transfer instead of tax vs payout? But that might sound too socialist for Americans, but perhaps not for Californias? I don't know.)

      But definitely: yes, political palatability is an important part here.

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    5. The problem now is that in some cities your neighbors won't let you sell your property to its highest potential use. Solving that problem solves the problem. I don't see the value in talking about a policy that pushes people out of their homes to do that. If we are anywhere close to getting that far politically, the housing problem will have already been solved.

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    6. Have you seen the 'Why are there NIMBYS' paper? (https://www.google.co.in/url?sa=t&source=web&rct=j&url=https://www.dartmouth.edu/~wfischel/Papers/00-04.PDF&ved=2ahUKEwjdtNTD4tHZAhXLyLwKHRuvAFoQFjABegQICRAB&usg=AOvVaw2bEALY0T1_-pVpIOu1dx68)

      The author doesn't draw the conclusion, but the paper strongly suggests that an LVT would reduce NIMBYism, and thus help with local housing policy. (And in general has a good mechanism for how NIMBYism and housing restrictions feed each other.)

      For home owners the LVT gives them just exactly the same economic incentives, as if the government was holding a large equity share in their land, ie the same situation as renters face with their landlords today. People paying market rates of rent don't get kicked out usually. (Though they might gripe about how high it is, but that's mostly due to supply restrictions.)

      But yes, in a country where housing supply works, the LVT doesn't do anything for housing supply. (Duh.) The opportunity to untax labour and capital is still pretty big, though.

      Historically, there have been some attempts at land tax. Hong Kong might be the most successful one. Australia seems like a bust, apart from some positive developments in Canberra recently.

      So just like open immigration and free trade or free banking, lvt seems like one of those eminently sensible things every economist can agree on that seldom gets implemented in public.

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    7. Yes. I basically agree. I'm just poking the idea around the edges. I agree that it seems like a good way to raise taxes.

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    8. Oh, definitely. And I agree totally with your scepticism about Georgist claims about lvt avoiding crisis, 'harmful' speculation and recessions. LVT is great, but doesn't cure cancer or give everyone a puppy..

      The market monetarists have a better handle on the economic cycle. And funny enough, once you have stable nominal spending, the remaining small fluctuations would probably reasonably well explained by the Internet-Austrians, but nobody would care much. Just like nobody cared much about the implosion of the American housing industry before that happened before recession. That is nobody apart from your valiant efforts at retrospective economic archaeology.

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    9. There is also the possibility of "deferral": withholding the tax against the "poor widow" who is land-rich, but cash-poor", and then collecting it when she finally moves on or sells the property. This will decrease the resell value by imposing a high back tax, but so what? The poor widow is gone and the next owner can put the land to its highest use and not be taxed for improvements.

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    10. Scott, no need for the taxman to get involved in that. That's just a 'reverse mortgage' that the private sector already offers.

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  4. As an arithmetic curiosity, the absolute value of the LVT doesn't matter too much---market land value will adjust so that no matter the LVT no more than 100% of the yearly rent gets taxed.

    You can work that out relatively easily. By an arbitrage argument without LVT we have:

    land price * interest rate = land rent

    With LVT we get:

    land price * (interest rate + lvt rate) = land rent

    Assume that interest rate, land rent and lvt rate are fixed and solve for land price:

    land price = land rent / (interest rate + lvt rate).

    Then you can answer questions like: what's the percentage of land rent that goes to lvt payments?:

    (lvt rate * land price) / land rent = lvt rate / (interest rate + lvt rate)

    And that ratio never goes above 100%, even if lvt rate goes above 100%.

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    1. In practice with low prevailing interest rates of eg 1%/a an LVT rate of 9%/a will already capture 90% = 9%/(1%+9%) of land rents.

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  5. Henry George's "Progress and Poverty" put the argument in magnificent prose, demolishing all the arguments still put forward today against capturing land rent. However, David Ricardo, Adam Smith and JS Mill also said we need to tax away land rents if all other markets are to function properly. Doesn't a tax regime favouring rent-seeking against real wealth creation explain what occurred in 2008, and make their case in spades?

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  6. Bryan, if you follow this blog a bit, you can see that there's lots to "what happened 2008".

    Unless you are talking specifically about an inadequate tax system (indirectly?) causing tight money?

    People here are rather sympathetic to the argument that taxing land rent would help with policy, too, but it's not a panacea.

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  7. So much wailing and gnashing of teeth over the possibility that some landowners might find it too difficult to pay for what they are taking from the community, and might consequently decide to move to a location better suited to their needs and means. Oh, the humanity! Look: if you don't want to pay for the bread you take from the bakery, you don't take it. Simple concept, no? Well, the same goes for the access to publicly provided services, infrastructure, opportunities and amenities that the landowner takes from all who would otherwise be at liberty to access them. He is depriving everyone else of the locational advantages of that site, NONE of which he provides. So on what basis, exactly, is the landowner more entitled to continue taking from the community than a tenant who is subject to eviction by his private landlord unless they pay for any increased locational advantages that the community, not the landowner, creates? Indeed, the private landlord is far less entitled to demand that publicly created value from a tenant than the community that creates it is to ask the landowner to repay what he is taking from that community.

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    1. Good points. Interesting way to put it.

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