Reihan Salam’s solution to the approaching “fiscal cliff” is to raise more revenue without increasing marginal rates.
How is that possible?
According to Salam, Congress could simply close loopholes and cap deductions. Since the rich are the ones exploiting most of these loopholes, doing this would, according to Salam, effectively place the burden on them instead of low and middle income earners.
Simplifying the tax code and closing income tax loopholes sounds like a reasonable plan. Doesn’t it? In the words of Peter Drucker, “there is nothing so useless as doing efficiently that which should not be done at all.” Income taxes by their very nature are arbitrary and complex. Sure, they can be somewhat simplified, but they can never truly be made transparent and salient. It’s difficult to get large numbers of Americans to understand and actively push for specific and principled measures for closing these loopholes, even if they agree with this in principle. Once again, that’s due to a poor understanding of the connection between justice and the dynamics of taxation. There isn’t a heck of a lot of motivation to learn about these dynamics either. After all, taxes are boring! People are too busy squabbling over crumbs.
Most taxes limit economic activity, i.e. they decrease productive incentives. If solar panels are taxed, what happens to their price? Obviously, it increases, hampering solar panel production. If people are taxed for working, that decreases the incentive for working. However, there is one tax that actually increases productive incentives more than would otherwise occur without this tax. Isn’t that strange?
It goes by the moniker land value taxation. Instead of taxing people for working, exchanging, or building, it only taxes the value of land. Land values rise as a result of increasing population, public infrastructure, and economic development in general.
Imagine an empty lot in the middle of a city. If taxes on buildings, wages, sales, etc are lowered and the tax on land values is increased, lots like this one will be put to use. If you own this particular lot and you are taxed in proportion to its market value on a regular basis, you won’t want to hold it idle as a financial drain. If you are not going to use it, you will be more inclined to sell it to someone who will – creating opportunity for entrepreneurs.
Don’t forget though that adding to your ability to produce income on this land is the fact that other taxes on productive activity are decreased. The total revenue collected by the government is the same. Taxes are just shifted from productive activities to land speculation instead, generating revenue without harming the economy.
“Pure land rent is in the nature of a “surplus” that can be taxed heavily without distorting production incentives or impairing productive efficiency”
Samuelson and Nordhaus, *Economics*, Twelfth Edition, McGraw-Hill Book Company, p. 605
Many people believe that income taxes, corporate taxes, or most other types of speciously redistributive taxation are fair because high income earners have the ability to pay more. The plight of the poor is far more important than the misgivings of the rich, but income taxes simply do not redistribute wealth in the way supporters believe. It is precisely because we need a more fair and prosperous society that this point must be made.
These taxes are indirectly shifted onto low income earners. They play into pre-existing power structures instead of addressing the fundamental causes of inequality. They act as a circuitous sales tax, making life harder for low income people by decreasing employment opportunities, and increasing the costs of goods and services across the board.
Furthermore, the progressive income tax does not adequately draw a distinction between adding wealth to the economy and amassing wealth produced by others. Why should behaviors which produce wealth be taxed as much as those that serve no productive function?
Land value taxation captures a value that is created by society as a whole. It leaves earned income untaxed, capturing what economists call “rent” for revenue instead. Rent-seeking is a term economists have used for centuries, often to describe behavior aimed at obtaining varying definitions of “unearned income.” It owes its etymology to landed aristocrats abusing peasant farmers through charging rack-rent.
Rent seeking is still highly prevalent in the modern world. When a government builds roads, it increases land values near the roads. Those roads are built with taxpayer money. Why then should nearby landlords, and the banks who finance them, get to pocket values created by everyone’s tax dollars? Instead, why not tax a portion of the increased value of that land and use it to recover the cost of building the road? The road could be self-funding, or actually achieve a return on investment. A land value tax accomplishes this.
Taxation based on benefits received is fairer than taxation on merely the ability to pay. It is a more principled way to collect revenue that can help foster prosperity. It also satisfies the “ability to pay” attribute of progressive taxation that many liberal-minded folks agree with. Those who have benefited via increased land values, and can thus charge higher rents and selling prices, have a greater ability to pay taxes as well. Those who hold land in a high value financial district for instance should pay more than those who hold low value land on the outskirts of a city. Since the tax is levied as a rate applied to the *value* of land, the total tax paid rises and falls in proportion to a particular site’s value.
Poor people usually rent. Under land value taxation, working class renters need not pay any taxes at all. Landlords can not pass on land value taxes to tenants the way income taxes are pushed onto others. The fact that the tax ultimately falls on landlords has been a universally accepted concept in political economy from the time of Adam Smith to the present.
“Ground-rents are a still more proper subject of taxation than the rent of houses. A tax upon ground-rents would not raise the rents of houses…”
— Adam Smith , The Wealth of Nations, Book V, Chapter 2
Land value taxation is transparent, and much less vulnerable to tax evasion. In some places, land values are already made publicly available online in easily interpretable land value maps. Everyone sees the same map and tax information. Whatever a given landowner pays should be similar to what adjacent landowners on similar land pay. Taxes can’t be made much more transparent than that.
Large corporations avoid taxes by moving overseas, but they can not take land overseas. Thus, fraud is curtailed, and honest people are on equal footing with everyone else. Even economists of libertarian and anti-tax persuasions, such as Milton Friedman (see 13:44-13:49), have supported land value taxation for this and a multitude of other reasons.
Absentee US landlords, living in other countries, are able to extract rents from a community without contributing anything to that community in return or even paying much income tax. The people living there created those land values. Land value taxation restores that value to the community.
Income taxes, especially payroll taxes, are highly regressive compared to the land value tax. They also hurt economic activity. The land value tax promotes activity.
Instead of inspiring boredom and resentment, we need to start switching to a land value tax. We must stop squabbling over crumbs and use the land value tax to vastly increase the size of the economic pie and ensure fair distribution. These two goals go hand in hand.