CDAE 61 Assignment 11:
1.
(10 pts) Property taxes in most cities in the US are on both the land itself and on
any improvements to the land, such as buildings. Using graphs, explain how a tax
on buildings creates a deadweight loss for the economy (ignore for the time being
the negative externalities associated with building). What is the impact of such a
tax on building maintenance? Explain the impact of removing such a tax on
construction. What would be the impact on slums?
Strange as it sounds, a tax on buildings does affect renters while a tax on land
does not. This is because the supply of buildings shows some elasticity (i.e. when
the price goes up, quantity built goes down).
Removing the tax actually leads to increased maintenance and increased supply of
all buildings, high end and low end. The higher the value of the property, the
greater the pressure to increase the value of the building. Slums earn the lowest
rent of any buildings. If the building owner improves them when buildings are
taxed, she gets both higher taxes and higher rent, which offset each other. In the
absence of a building tax, the owner would collect higher rent without paying
higher taxes. Supply of housing would increase however, so rents in general
would go down. Since no one wants to live in a slum, they will be the last
buildings to be rented. If they can’t be rented, the landowner pays land tax but
gets no income from the land. The landowner therefore has an incentive to
upgrade the slums even she can’t extract higher rent.
A tax on buildings shifts the supply curve upwards by the amount of the tax, thus
reducing the supply from Q1 to Q2. As a result, the price shifts upwards from P1
to PC2. The price received by suppliers shifts downwards from P1 to PP2. The
deadweight loss is the economic surplus, or combined producer and consumer
surplus, lost to the decrease in production. The money transferred to government
is not considered a loss by itself, but a drives a wedge between what the consumer
would be willing to pay for another unit and what the producer would be willing
to provide it for. It would be possible to base a building tax on ecological
footprint, say, as a proxy for the impact of the building on ecosystem services, in
which case it would be a Pigouvian tax internalizing a negative externality, thus
eliminating a deadweight loss. It would also create incentives for R&D into
sustainable building technologies.
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Repairs increase the value of and building and hence taxes, so a building tax is a
disincentive for maintenance, leading to suboptimal maintenance. Shifting a tax
off of buildings would theoretically increase their supply and maintenance. If a
slumlord improves his properties under current law, his tax burden goes up.
Without the building tax, a slumlord could fix up buildings, which would allow
him to charge higher rent (for a better quality property) without paying higher
property taxes.
2. (10 pts) Preferably using a graph, explain why a landlord cannot pass on a land
tax to renters. Remember the relationship between elasticity and who pays taxes.
The definition of rent in economics is 'unearned economic profit'. It is above and
beyond normal profit. Rents have been increasingly far faster than inflation for
many years in Burlington and elsewhere in the US, and the landlords are earning
more and more without doing any more work.
Assume that Burlington increases the land tax by the amount shown below. If the
landlord tries to increase rents by the amount of the tax, supply will exceed
demand, and the property will go unrented. Faces with a land tax and no rent to
pay it, the property loses the landlord money. Shse will either lower the rent so
that he can at least pay the tax, or sell the property to someone who will rent it or
use it. Theoretically, a land tax could be so high that it drives the price of land to
zero, and still the landlord could not pass it on. If the landlords wants to raise the
rent to more easily pay the tax, she will have to improve the quality of the
apartment. In that case, the renter is paying for the productive activities of the
landlord. With a high enough tax, the government captures all the rent and the
landlord none. The landlord still makes a fair return on her labor and capital
(normal profits) but earns no economic profit, the expected outcome in a market
economy.
3.
(5 pts) What is the dead-weight loss of a tax on land?
There is no dead-weight loss from a tax on land, as land has perfectly inelastic
supply (when demand is perfectly inelastic, there is also no deadweight loss). The
change in output from a taz is 0.
4.
(15 pts) Explain the impact of shifting property taxes from total property value
(land plus buildings) to the land alone on:
a. The deterioration of inner cities
A vacant lot or one with a burned out, run down building would now pay the
same tax as on a fancy office building, but would generate no money with which
to pay the tax. The owner would therefore either invest productively in the land,
or else sell it to someone who would.
In addition, with a tax on buildings and land, as buildings decay, tax revenues
goes down. A lower tax base reduces the ability of government to provide basic
public goods, such as roads, parks, libraries, good schools, police, etc. leading
those who can afford to to move away, accelerating urban decay. If the tax is on
the land alone, the city retains a stable tax base.
b. The costs of housing rental in cities
Not able to leave lots vacant or decrepit, landowners would build housing with
which to earn income. The shift in supply supply would drive down the cost. As
poor people spend much of their income on housing, this should have a positive
impact on distribution. To maintain revenues, landlords would have to improve
quality, in which case they should receive a fair return on their investments.
c. Urban sprawl
The incentive to build on land would increase proportionate to its value (and
hence tax). Urban land is thousands of times more expensive than rural land, and
hundreds of times more so than suburban land. With only a finite amount of
resources for building, this shift in incentives would presumably lead to more
urban building and less suburban and rural building, which would reduce sprawl.
More building in cities would reduce the cost of living in the city, leading to a
change in quantity demanded (a movement along the demand curve). With better
maintenance of buildings and more job opportunities (from forcing urban land
into production), cities would become more pleasant, and there might be a shift in
demand for city living as well, further reducing sprawl.
Land taxes would also pay for more green space in cities. Currently, if a city
builds a park, neighboring land values increase. The land tax allows the city to
capture this increase in value, which in many cases would be sufficient to pay for
the park. A high land tax drives down the price of land, which make it easier for
cities to buy land for parks too.
High quality public transportation also increases the value of land, and can
similarly be paid for through a land tax.