Tax Policy for Optimum Production

Harry Gunnison Brown

[Reprinted from the American Journal of Economics and Sociology,
Vol. 24, No. 1 (January, 1965), pp. 7-8]

WHEN THE ADVANTAGES are pointed out of exempting from taxation buildings and other man-made capital, and getting the necessary revenue by increasing the rate of taxation on land values, the objection is sometimes raised that such land value taxation violates the principle of taxing on the basis of "ability to pay." How can one get such an objector to consider any other principle relevant to tax policy? Perhaps the most effective way is to show him that our present tax system certainly does not conform to the principle of "ability to pay" for which he is arguing.

To illustrate clearly both why such an objector insists that land value taxation fails to conform to the ability theory and also wherein our present real estate tax policy fails to conform to it, we shall assume that each of four owners of real estate owns a building lot of equal size and the same shape as the other three, and on the same side of the same street. None of the lots is a corner lot or has any other advantage (or disadvantage) as compared to the other three. And each lot, we shall suppose, is worth $20,000. The four owners are John Doe, Richard Roe, Paxton Poe and Mortimer Moe. However, John Doe's lot is vacant; Richard Roe's lot contains a one-story building worth $20,000; Paxton Poe's lot contains a three-story building worth $60,000, and Mortimer Moe's lot contains a four-story building worth $80,000. The objector to a land value tax policy contends that Moe has the greatest ability to pay (having the most valuable building, which yields the largest rentals), that Poe has the next greatest ability to pay, that Roe has the third greatest ability to pay and that John Doe has the least ability. And since land value taxation would tax each of the four owners the same amount, our objector calls it "unjust"; whereas our present real estate tax system taxes our four owners in due proportion-or so he assumes!-to their respective tax-paying abilities and hence is "just."

But Mortimer Moe's property is mortgaged to a lender for $90,000, and under our present real estate tax system, Moe, whose net ownership is the least, has to pay the most in taxes. How, therefore, can anyone who objects to land value taxation as not being in proportion to "ability," consistently defend our present real estate tax system?

Suppose now that in the city or town where these four men own this property, buildings and other man-made capital are exempted from taxation and a land value tax system is adopted. In that case the net yield of capital to the investor would certainly be greater. Hence, if John Doe were thereafter to borrow $80,000 and use the sum to construct an $80,000 building on his vacant lot, he would receive a higher net yield from the building than would previously have been possible. And since he would have had to borrow, to be able to have the building, not more than $80,000, he would clearly now be better off than Moe, who was -- and is -- in debt $90,000. Likewise, Richard Roe (for example) might borrow in order to add another story to his one-story building.

When such facts are thoroughly understood by the objector who has so emphasized the idea of "ability to pay," he will perhaps be willing to admit that a really good tax policy must give attention to incentive. Our present local tax policy, which encourages speculative holding of good and needed land out of use, which discourages building, keeps rents high, breeds slums, increases the cost of acquiring ownership of a home, discourages establishment of industries in a community, and keeps down the productivity and the earning power of labor, is definitely not a good tax policy.