Georgism is a social philosophy that combines liberty and equality. It is named after the American economist Henry George (1839-1897). In Georgist ethics, every person should have complete ownership of his body, time and labour. That implies that there be no restriction or imposed cost on peaceful and honest human action. In a Georgist economy, there would be no tax on wages, enterprise profits, goods or value added. Thus, if the Cayman Islands adopted a Georgist tax policy, there would be no import duties, work permit fees, tourist accommodation taxes, airport departure tax or stamp duties on the purchase of real estate and on mortgages.
Since land, including all natural resources, is not produced from human action, the Georgist concept of moral equality prescribes that all persons should receive equal benefits from land.
The benefit is measured by the market rent of land, the yield of the land in its highest and best use. The rent would pay for the public goods provided by government. Some of the rent could also be equally distributed to the people in cash. The rent of all land, including government-owned sites, would be tapped for public revenue.
The taxation of land rent is equivalent to the taxation of land value. If the rent does not change, then the relationship between the purchase price (p) of land and its rent r is: p = r / (i + t) where i is the interest rate (or capitalisation rate) and t is the tax rate based on p.
The economic effect of taxing land value or rent is that the rent stays unchanged, while the purchase price falls. The economic rent does not change, because the quantity of land is fixed, and the tax does not affect the demand to use land. Since both the supply and demand for land do not change, the market rent stays unchanged.
The economic rent of land is based on what the highest bidders would pay if there were an auction, not the rental that a particular tenant pays. Some landlords might collect less rent than the market would bear, in which case a tax on the land value could induce the landlord to raise the rental, but that does not change the economic rent. If a landlord charges less than the maximum he could charge, then, in effect, some of the economic rent is paid to the landlord, and the rest is kept by the tenant as implicit rent.
Since a tax on rent does not change rent, it does not raise the prices of the goods produced on the site. In contrast, a tax on goods raises the purchase price of the goods. This increase in price generates an ‘excess burden’ or ‘deadweight loss’, a loss of consumer well-being.
Consumers are hurt because they buy fewer goods, and because they obtain less net benefit from the goods after paying the higher cost. Replacing import duties with a tax on land would lower the cost of living.
The purchase price of land is based on the rent kept by the landowner. Thus, a tax lowers the purchase price of land. The price of any asset is also based on the interest or capitalisation rate. The yield of a bond, for example, if there are no taxes, is i*p, the interest rate times the price. Therefore, the price equals the annual yield divided by the interest rate. The same applies to land value.
Land rent is an economic surplus, income that remains after paying for labour and capital goods. That is why rent can be taxed without hurting the economy. The tenant is unaffected by who receives the rent, whether it is a landlord or the government.
Since rent is a surplus, even landowners are not burdened by a tax on land value, after the transition. Suppose, without taxes, a plot of land has a purchase price of $100,000. If the capitalisation or interest rate is 10%, the rent is $10,000 per year. Suppose also that the owner has borrowed the $100,000 and the mortgage interest is also $10,000. The owner receives $10,000 in rent and pays $10,000 in interest, and nets out to zero.
Now suppose the tax rate on rent is 100%. The price of land falls to zero, so there is no mortgage. The owner receives $10,000 in rent and pays $10,000 in taxes. Thus, the owner nets out to zero when there is no tax and also with a tax of 100%. The owner is no worse of even when all the rent is taxed, because the tax replaces the mortgage interest.
After the transition, everyone is better off, because the deadweight loss of taxation has been eliminated. Prices are able to do their economic job of efficiently allocating resources, as they are not skewed by the extra costs of taxes. The problem is the transition.
Cayman Islands landowners, like owners anywhere, obtain higher land value from the public goods provided by government, paid for by import duties and other taxes. Landowners thereby receive an implicit subsidy. Of course, as landowners, they would be worse off with a tax on their land value, even though as consumers they are better off not paying the higher cost of taxed goods. The transition can be facilitated by a payment of bonds to those who have net losses, for whom the gain from the abolition of taxes is less than the loss of kept rent. The bonds would be bought back as the economy grows and generates higher rent.
One question raised regarding a single tax on land value is whether the rent would be sufficient to pay for the costs of government. Data from Australia put its rent at one third of national income. With a GDP of almost $4 billion, and government spending of $600 million, if land rent is one third of income at about $1.3 billion, land rent can easily pay for the government expenses of the Cayman Islands. There is even a ‘Henry George Theorem’ in public finance analysis, which shows that in a community with an optimal provision of public goods, the land rent equals or exceeds the cost of the community’s public goods.
Many economists have come to the same conclusion as free-market economist Milton Friedman, who stated, “the least bad tax is the property tax on the unimproved value of land, the Henry George argument of many, many years ago”.
The concept of taxing land values for public finance is ancient. The Bible declares “the profit of the Earth is for all” (Ecclesiastes 5:9). During the 1700s, some French economists proposed an ‘impôt unique’ or single tax on land value. Land value taxation was viewed favourably by the classical economists, starting with Adam Smith, who wrote, “Ground-rents, and the ordinary rent of land, are, therefore, perhaps, the species of revenue which can best bear to have a particular tax imposed upon them.”
There are several methods of assessing land value or rent. One way is to calculate the replacement value of the existing improvements (unless they are historic), and then subtract the depreciation of the buildings. Then subtract the building value from the total property value. What is left is land value. For commercial property, one also can take the net income and subtract the return on the improvements (using some interest rate), the remainder being land rent. In some places there is vacant land that has a market price, and sometimes there are separate owners for the land and the improvements, for which data can be derived from leases and sales. The assessors then smooth out the neighbourhood land values, using maps.
The shift from taxing productive human action to collecting the economic rent generated by nature and communities is more than a fiscal reform. There is an ethical side to this reform.
One of the ongoing problems of social philosophy is the relationship of the individual to society. In conventional tax policy, there is an inherent conflict between the individual and government as the agent of society. Individuals want to benefit from the collective services provided by government, but the mechanisms for financing those services typically have used force against individuals and invaded their private lives.
The collection of land rent for public revenue reconciles the individual and the community. The community and its government no longer intrude into the individual’s private life and stifle his or her pursuit of economic well-being. The tax on land value is not a tax in substance, but only in the form of payments to government. In substance, the payment is a sharing of the benefits provided by community and nature, and a payment for the services that generate the value of the land. If this payment is not made by the landholder, the services become a subsidy, producing a value not returned to the community.
Public revenue from land rent is a necessary element of true free trade and a genuinely free market. An import tax and a property transfer tax intrude into transactions, adding friction that reduces the flexibility of an economy. The elimination of this friction and deadweight loss is made possible by land value taxation.
The obstacles to land value taxation are political. The current system benefits certain vested interests that will resist reform. But since the public at large will benefit from a shift to land value taxation, and since they greatly outnumber those obtaining privileges from the current system, the greater reason why this tax reform has not taken place is that the public has not been informed. Once citizens, taxpayers, consumers and voters understand the option of obtaining public revenue from land value or rent, then the logic of getting both greater efficiency and greater justice may well prevail.