Home > Economic policy > Must try harder, Part 2

Must try harder, Part 2

August 6th, 2012

According to standard economic theory, the least distorting of all taxes is a land tax. This point can be pushed too far – for example, most land is improved to some extent, and that may be capitalized into land values. Nevertheless, given the financial difficulties of state governments, their failure to make use of this revenue source is an indictment, especially since they impose much more distortionary taxes on transactions involving land, such as transfer duties. All states exempt owner-occupied homes and primary producers from land tax, while taxing land sales and purchases across the board. The effect is to benefit existing landowners (except owners of rental housing) at the expense of new home-buyers and tenants.

It appears to be beyond the realm of political possibility to change this, but a government facing a supposed financial crisis, and looking for luxury items to cut, could start with land tax exemptions. As you might expect, Queensland has both a high threshold ($600 000) and a low rate (1 per cent increasing gradually).

None of the usual justifications for Queensland’s low tax effort apply here. Land tax exemptions do nothing to attract business to Queensland. They are a straightforward handout to landowners, mostly wealthy households with investment properties.

Unsurprisingly, this handout attracts zero critical attention from the Commission of Audit which states “Queensland has historically maintained a competitive taxation environment compared to other states.” This is entirely wrong as it applies to land tax. Since land is immobile, there is nothing competitive about low rates of land tax.

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  1. J-D
    August 6th, 2012 at 12:15 | #1

    I am more than happy to take the word of economists about what economic theory says, but I know that I have seen the view expressed by other people, some of whom may have been economists, that inheritance taxes are the least distorting taxes, so I’d appreciate anything that helped to clarify this discrepancy for me.

    (I’m not saying this because I’m pushing for inheritance taxes in preference to land taxes. To me, both inheritance taxes and land taxes sound like good ideas, but I say that in ignorance of economic theory on the subject.)

  2. Dan
    August 6th, 2012 at 12:27 | #2

    @J-D

    Perhaps introducing inheritance taxes will boost life expectancy. Rational agents, and all that.

  3. John Quiggin
    August 6th, 2012 at 12:35 | #3

    If people value bequests the same as own consumption (arguably should be true at the margin) then a bequest tax is just as distorting as an income tax.

    OTOH, if you think of bequests as a residual mistake, arising when you die before you’ve spent the kids inheritance, then taxing them is non-distorting

    I suspect truth is somewhere in between

    @Dan – the US had a one-year period recently when inheritance taxes were anomalously high (or maybe low). I’m told that there was an observable effect. If I have the story right, rich people hung on to the end of that year, or maybe gave up the ghost before the tax rate rose (I can think or more mechanisms for the second case than the first).

  4. TerjeP
    August 6th, 2012 at 12:35 | #4

    I’d support a shift to land tax if it was revenue neutral. However whatever tax you use to extract produce from producers there is no getting around the fact that you are extracting produce from producers. And whilst land can’t be moved the place of production, along with many factors of production, most certainly can be.

  5. Uncle Milton
    August 6th, 2012 at 13:28 | #5

    Given the influence of Gold Coast and Sunshine Coast property developers in the LNP, I don’t think the Newman Government is going to be taxing land any time soon.

  6. August 6th, 2012 at 13:30 | #6

    The current land tax is more then enough for me. It’s almost enough to put one off owning a house.

    However, council rates manage that. Rates are also far more arbitrary.

    A stiff inheritance tax will lead to less production. A visceral instinct is to produce something to give the kids a start. If that is taken away, then why bother working beyond a certain point. Thus making the entire nation poorer.

  7. Freelander
    August 6th, 2012 at 13:44 | #7

    The bias toward homeowners is greatest toward those who own their homes outright because those with a mortgage cannot claim interest payments against taxable income.

  8. August 6th, 2012 at 13:54 | #8

    @ Uncle Milton, valid point. And you’ve identified what is quite possibly the only positive thing about the Gold Coast!

  9. Uncle Milton
    August 6th, 2012 at 13:58 | #9

    @Steve at the Pub

    “A visceral instinct is to produce something to give the kids a start.”

    @SATP, if you die at 80, you kids will probably be around 50. Their “start” will have been decades earlier.

  10. August 6th, 2012 at 14:13 | #10

    @ Uncle Milton. But the youngest half dozen or so may well be newborn!
    That boast aside, the point is the same. If one cannot pass something (beyond a few framed photos & minor jewellery) to their children, then half the work we do has no point.

    The history of death duties & how the collection of them was applied, in this country is not a happy one.

    Additionally, it favours the big end of town & hampers individuals. Corporations don’t die.

  11. Freelander
    August 6th, 2012 at 14:24 | #11

    Death duties work because so many think they can take it with them.

  12. August 6th, 2012 at 14:30 | #12

    I find myself in the same boat as Steve at the Pub. Having lived in Finland where they have this wretched concept and having seen that my family have had to take out loans to be able to afford to get the property of their own parents (and no we’re not talking uber rich here, just ordinary folk) I can’t get what alternative dimension the people come from who say that it does not distort things.

    While I support the social contract for taxation I would expect something from the other end of the contract (that is the government) to perform their duties at the most efficient and cost effective level possible. Since this is seldom proven to be the case (and there is no competition to get my services elsewhere) I think minimising the taxes is the best way to keep them in check.

    If the rest of you are so fond of paying taxes please by all means pay mine.

  13. August 6th, 2012 at 15:05 | #13

    There was a recent suggestion in NSW that a levy to fund emergency and fire services etc could be in the form of a small broad based land tax. Interesting given that Costello recommended a flat levy per property which was said would be progressive because of multiple property ownership.

    However, the land valuation system is not as robust as many imagine fpr such as strata units which is why both Gold Coast and Brisbane have controversial rates schemes for higher rise buildings where valuatioins are no embedded in the land.

  14. August 6th, 2012 at 15:07 | #14

    It’s worth considering land tax reform, but it’s not right to say that tax cuts are a “handout”. You are in effect saying that not being robbed is the same as somebody giving you a gift.

  15. August 6th, 2012 at 15:55 | #15

    If the goal is to get people to work harder, then taking stuff off them can be a very successful way to do that. Personally I think the goal should be a good life for everyone, but then I am weird.

  16. Freelander
    August 6th, 2012 at 16:56 | #16

    The goal is to make other people work harder and it seems the one percent have achieved that goal.

  17. Ernestine Gross
    August 6th, 2012 at 17:33 | #17

    While it may be interesting from theoretical perspective to investigate which tax is ‘distorting’ and which is not and in what sense, I have never subscribed to the belief that non-distorting taxation is an important argument. The reason for my contrarian position is that the analyses often, if not always, is based on the assumption that there is a market solution which has desirable properties (eg a Walras equilibrium which has the property of being Pareto efficient) and the aim is to take a little bit of ‘wealth’ away from the market pie such that the relative prices are undisturbed.

    But if there is one characteristic that is constant in the series of booms and busts in just about all markets,, then it is the observation that relative prices are ‘wrong’. The need for internalising externalities (eg carbon emissions) is another obvious indicator that ‘all prices are wrong’.

    Starting from the premise that we live in a world where monetary prices are ‘wrong’, leads me to consider that one important role for taxation is to disturb (‘distort’) the actual monetary prices.

  18. Dan
    August 6th, 2012 at 17:48 | #18

    @John Quiggin

    Haha, no kidding!? Please let me know if you come across a reference.

  19. Bryan Kavanagh
    August 6th, 2012 at 18:23 | #19

    As an economist, Ernestine will understand that, unlike other taxes, an ad valorem tax on land values is a rent, and therefore non-distortionary, because it’s in the nature of a rent. Other taxes can simply be passed on in prices; rents cannot. No matter how hard you try.

    John Quiggin’s onto something here.

  20. Ikonoclast
    August 7th, 2012 at 00:08 | #20

    @Ernestine Gross

    I find myself partly agreeing with Ernestine here, although still some way from 100%. Let me approach it with some other thoughts first.

    1. Is not a key problem with respect to state taxes and state outlays (compared to federal taxes and federal outlays) the problem of vertical fiscal imbalance?

    2. “Currently in Australia, the Commonwealth government raises greater tax revenue than the state and territory governments. This vertical fiscal imbalance is remedied by Commonwealth grants to states and territories of Australia.” – Wikpedia. I think it should be amneded to say “greater tax revenue relative to standard outlay committments” or something like that.

    3. Is not the granting of GST receipts to the states (after adjustments for horizontal fiscal imbalance) the main grant mechanism?

    4. In this grant (or set of grants to all states) along with other Commonwealth to State grants still insufficient to cover standard, customary or typical state outlays?

    5. If federal grants are insufficient, I assume this is at least partly where the pressure arises for states to levy other fees, taxes and charges.

    6. Could not the federal government obviate all need for said state fees, taxes and charges by (for example) raising income tax and and/or GST by the right overall amount and distributing the necessary grants accordingly?

    7. Would this consolidation not be more efficient as many disparate and distributed collection mechanisms would obsoleted and two established collection mthods with economies of scale would do the entire job?

    8. Would states accept this as it would it hand entire defacto control of the overall size of state budgets to the Commonwealth? (This is the huge blowfly in the miracle ointment.)

    9. Given that the logically acceptable is not politically and parochially acceptable (how often that is the case!) then must we not at least propose the next logical fall back strategem?

    10. This would be for the states to levy one ubiquitous, standard, economy of scale tax which would appear to be land tax as Prof. J.Q. proposes.

    * * *

    More generally, it seems that one of the most difficult things to achieve in practice in the modern democratic nation state is a simple, effective and equitable tax policy. I think it’s worth following the logic from an obvious starting premise.

    1. If government is necessary then taxes are necessary.

    If government is necessary then resources are necessary to carry out the functions of government. If government is democratic, the people essentially contract the government to carry out the functions required from government and public administration. This contract has the broad character of a socio-political contract and a financial contract. It is implicit that a proportion of the people’s production must be allocated to underwrite the operations of government.

    2. Prima facie it is most logical to tax income only and to tax it directly. This would include deemed income from lazy assets.

    In the real economy what is in effect being taxed away from the private individual is a proportion of access to real goods and services via financial transactions. The direct financial analogue of this loss of access to a proportion of real goods and services is loss (via taxation) of a proportion of the income used to privately purchase goods and services. Income may come from personal effort or from ownership of income producing assets. The source does not affect the prima facie principle. It is most logical to tax net income and to tax it directly as this both mirrors and facilitates the appropriation of a proportion of production. This is without making a judgement on whether income tax rates should be flat, progressive or of some other configuration.

    3. If there were one level of government, there would be fewer temptations or rationales to stray too far from this principle. Broadening the tax base and overcoming compliance issues and loopholes might be one rationale. Implementing Pigovian taxes might be another. Ensuring more of a user-pays principle might be a third. Mentioning these possibilities does not imply endorsement or otherwise.

    To give an example of how multiple levels of government create further temptations or inducements and rationales for taxing beyond income taxes, we can consider some issues of state and local government. The existence of vertical fiscal imbalance (skewed against state and local government in contemporary Australia) and already mentioned in my previous points can induce state and local governments to implement other taxes, fees and charges. The costs of providing specific services (roads or garbage collection) can induce state and local governments to implement specific taxes, fees or charges (the distinctions become blurred) on an approximate user-pays principle.

    4. Thus a simple prima facie principle, that it seems most logical to tax income and to tax it directly, becomes shattered and compromised in the collision with reality, the conflict with political and administrative complexity, expediency and other levels of rationalisation and justification.

    5. Tax policy also needs to work in logical conjunction with social wage payments (welfare and public services) and social and economic objectives.

    We can identify some key principles here.

    - Genuinely redistributive social wage payments might be justified in some cases.
    - Churning (taxing to redistribute back to much the same demographic) has no justification.
    - Social wage, subsidy and tax deduction policies should not push in the opposite direction of tax policy and particularly not against Pigovian taxes.
    - Pigovian taxes themselves might be justifiable in some cases.
    - Anti-Pigovian subsidies can have no justification.

    Finally I would push the weak version of Ernestine’s contrarian hypothesis and not the strong version. That is to say, yes relative prices of the free market are sometimes very wrong (even spectacularly wrong on occasion) and maybe a bit wrong quite often but they are not always wrong about everything. Because the system already has inherent distortion and unstable cycles that is no reason to introduce more and more egregious distortions via blatantly distorting taxes or anti-taxes (subsidies). Two anti-taxes or subsidies spring to my mind in this context, namely negative gearing and fossil fuel subsidies. Those two are my bêtes noires and pet hates.

    However, where the distortions are modest and debateable and lost in the noise of many other distrortions than yes I think Ernestine’s point is quite valid. A moderate distortionary character in a tax might be ignorable if, for example, it is cheap and easy to collect and adminster and imposes low compliance costs on businesses and/or workers.

  21. John Quiggin
  22. Ernestine Gross
    August 7th, 2012 at 08:55 | #22

    It is not quite clear what is ‘standard economic theory’. But one standard theoretical model has a linear price system such that normalised relative prices (weights) add to 1. In this case, if 1 price is ‘wrong’ then all other prices are wrong.

  23. August 7th, 2012 at 08:58 | #23

    @John Quiggin A tax on land values has the most minimal compliance cost of all and is the least distortionary. States have the power to tax land, but choose to do so on a restricted basis. Yet they beg the federal government for financial assistance rather than use their own taxing powers. This lack of responsibility and accountability is one of the reasons we have the feds patronisingly collecting the GST for them and delivering it back. Ken Henry is quite correct: if the states won’t use a more equitable and broad-based land tax, maybe we need a federal land tax to be delivered back, GST-like, to the states.

    If we ignore economic theory for the moment to take a practical look at what’s happening around us, we can thank an exploded property bubble for to the financial collapse the world is now experiencing. Perhaps the unwinding of property taxes over the last 40 years (viz, Whitlam undertaking to fund half local government revenue where once municipalities funded themselves from council rates: this was replicated in the USA by those states that followed California’s notorious Proposition 13), the abolition here of state and federal death duties, etc., is not unrelated to tax regimes over-taxing labour and capital and undertaxing land giving all the wrong signals?

    Let’s not ignore the obvious in understanding why world economies are grinding to a halt.

  24. Fran Barlow
    August 7th, 2012 at 09:41 | #24

    @John Humphreys

    You are in effect saying that not being robbed is the same as somebody giving you a gift.

    Taxation is not inherently comparable to theft. Assuming one sees the regime as legitimate or the compulsory levies as reasonable in all of the circumstances then it’s simply rhetorical to describe these as “theft”. Theft entails the deprivation by one party of an asset or privilege to which another party has a compelling claim. How one determines what constitutes “a compelling claim” is an entirely cultural question, yet you assume the argument settled without argument, presumably on “libertarian” grounds. That’s a petitio principii fallacy.

    I put to one side the fact that the rebates of revenue from levies don’t go entirely to the same people so some people are indeed getting (at least in part) a gift.

  25. Dan
    August 7th, 2012 at 09:44 | #25

    @John Quiggin

    Haha, wow! Thanks!

  26. Ikonoclast
    August 7th, 2012 at 12:05 | #26

    @Fran Barlow

    I have been able to find some common ground with libertarians in economic matters; for example on the issue of avoiding tax churn which is taxing and returning to the same demographic. A fair bit of this does happen with middle class welfare. A fair bit also happens with business taxes and rebates. Businesses and landlords can receive various egregious subsidies like negative gearing and fossil fuel subsidies. On the other hand they are forced to pay rather absurd and anti-pigovian taxes like payroll tax. Remove all the churning I say.

    However, I cannot accept the libertarians’ and fellow travellers’ almost pathological* aversion to virtually ALL taxes, to virtually all redistributive, welfare and equity policies, of properly costing negative externalities and of a significant mixed economy and regulative role for properly constituted democratic government. The strands of libertarianism oppossed to these principles I can never and will never accept.

    * If the phrase “almost pathological” is too strong I should say this. I find the minarchist libertarian position solipsistic** in philosophical, moral and socio-economic terms. Also minarchist libertarianism demonstrates a general failure, in my view, to understand the set of ideas contained in the moral philosophy of enlightened self interest or else badly misjudges how to promote enlightened self interest and the greatest good of the greatest number in constitutional, representative democracies. Minarchist libertarianism uses a specious chain of reasoning and specious sets of claims, all refuted by masses of empirical evidence, historical and current, to claim that extreme libertarianism and lassez-faire market systems lead to the most moral, efficient and equitable outcomes.

    ** colloquially: the notion that only the self really exists or only the self really counts.

  27. Freelander
    August 7th, 2012 at 12:31 | #27

    Interesting. Was the plug pulled early? The date of death falsified? Did the departing thoughtfully leave early? Or was their speedy passage assisted?

  28. J-D
    August 7th, 2012 at 14:14 | #28

    Thank you for the clarification.

    I won’t pretend I’m now completely clear on the issue, but at least I’m clearer than I was, and probably as clear as I’m ever going to be without learning a lot of economic theory. So I’m grateful.

  29. Fran Barlow
    August 7th, 2012 at 15:39 | #29

    @Ikonoclast

    I have been able to find some common ground with libertarians in economic matters; for example on the issue of avoiding tax churn which is taxing and returning to the same demographic.

    In theory, I’d agree. Taxing and returning to exactly the same folks makes no sense. Taxing and returning to very similar groups makes not much more sense. In practice though, I’m not sure that transactions of this kind are common or account for very much of of the revenue movement within economies like Australia’s — though they may well be more common in Scandinavia. It seems as if there’s a lot of socially horizontal redistribution from people without children to people with them which is not quite the same though perhaps objectionable on other grounds, outside, perhaps, of basics such as education and health.

    Businesses and landlords can receive various egregious subsidies like negative gearing and fossil fuel subsidies. On the other hand they are forced to pay rather absurd and anti-pigovian taxes like payroll tax.

    All landlords/businesses get negative gearing but only a handful would pay payroll tax or get fossil fuel subsidies in the usual sense. Really though, bearing in mind that the states essentially duplicate functions that could be carried out at lower marginal cost by the commonwealth, the issue is not merely how to raise levies more efficiently and effectively but how to avoid administrative duplication and fragmentation.

    I’d be OK with landtax. I’d also be OK with phasing out the deductibility of “dirty energy” from income and withdrawing rebates. I’d also be happy to have a broader consumption tax than we have now and have it at 12.5% providing that the extra funds were directed at services of especial value to the bottom three quintiles and means/asset tested to ensure that that was who benefited. I’d also charge for road usage on at least the main connecting roads, based on TARE, accident, compliance and skill profile of the driver, road contention and tailpipe emissions etc. and trade that for CTP and registration and fuel excise. The revenue from that could then be fed into better public transport, heavy rail freight infrastructure, urban consolidation and so forth.

  30. TerjeP
    August 7th, 2012 at 17:00 | #30

    Ikonoclast – stay focused on the points of agreement. It will prove more fruitful. Disagreements about welfare and redistribution probably have more to do with means than ends.

  31. Bruce Bradbury
    August 8th, 2012 at 13:47 | #31

    It looks like the ACT govt is moving in the right direction with an increase in land tax matched by a decrease in conveyance duty http://www.treasury.act.gov.au/TaxReform/Index.shtml

    Re: Uncle Milton @ #5: I’m surprised that the real estate industry hasn’t been lobbying _for_ this policy change. Less conveyance duty is sure to increase the volume of property transactions, which will increase business for them.

  32. Chris O’Neill
    August 11th, 2012 at 23:25 | #32

    I think it’s worth pointing out Land Values Research Group for their analyses of land taxation.

    Basically, most of the value of a particular piece land has arisen from processes other than the efforts of the owner of that land. i.e. they accrue capital gain in excess of their effort (if any). Not only do the owners acquire capital gain without effort, it usually isn’t taxed very much. This represents an enormous tax concession which, if removed, would allow the lowering of economically harmful taxes such as income tax.

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