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A lot of people are skeptical of the idea that a Ricardian tax program on land and natural resources can finance the kind of government we need. I’ve outlined – in some detail – why this isn’t the case but some prominent voices, like Paul Krugman, disagree:

But [Henry George – late champion of land taxes – has] been out of favor for decades, especially in graduate schools. Economists are trained to ignore him. Paul Krugman came to Berlin in 2008, right when the subprime crisis had started to rumble, and I asked his opinion of Henry George. He squinted and tried to remember the name of the book. “Uh — Progress and Poverty I think is the [main text]?”

“That’s right.”

“Well, look. Believe it or not, urban economics models actually do suggest that Georgist taxation would be the right approach at least to finance city growth. But I would just say: I don’t think you can raise nearly enough money to run a modern welfare state by taxing land. It’s just not a big enough thing.”

The context was health care. “We’re having enough trouble trying to make sure we repeal the Bush tax cuts,” Krugman added, “and trying to shift to a completely different base of taxation is just not going to be on the table.”

When we’re talking about revenue positive tax reform, it’s useful to understand a) from what activity and b) from what individual the marginal tax dollar is generated. In a welfare maximizing system, the answer to (a) would probably be something very bad for the world like carbon and the answer to (b) would be Bill Gates. More generally, we should first tax activities that harm the world – like global warming – before we tax activities that help the world – like working. Similarly, we extracting a marginal dollar from the rich is vastly less welfare inefficient than doing so from the poor.

Most of the time, these guiding principles are in tension with each other. A tax on externality-generating activities – like a levy on gas, carbon, or natural gas – tend to disproportionately hit the poor. Likewise, a tax on the rich usually comes from what we would usually consider “good” – like returns on human or capital investment.

Land is a big exception*. Land – like almost any other store of value – is disproportionately owned by the rich. (Remember, land excludes value added property, so democratic ownership of houses across flyover country doesn’t make as big a difference as you might imagine). And while land isn’t “bad”, per se, because its ultimate supply is perfectly inelastic there is no welfare loss in its taxation (granted, there are no welfare gains either, unless it offsets an even worse tax).

(*Another notable exception might be congestion taxes in cities which fall on the people who take cabs or private cars instead of public transportation. In other words affluent tourists and the local elite).

Some people I’ve talked to don’t grasp the idea that land is inelastic. They tell me that companies will stop “improving” land for more productive use. It’s always surprising how confused people are about the idea of land. By definition land is unimprovedI don’t want to tax people who’ve built nice buildings on land or, for that matter, even deforested dense areas for efficient development (though I’d support anti-deforestation laws for entirely different reasons). That’s why property taxes are dumb.

But I want to disarm some misconceptions. When Paul Krugman says “Land is just not a big enough thing” he’s echoing a broadly held, and to some extent true, belief. In 1980, Paul Samuelson wrote:

Historically, pure land rent has become a declining fraction of GNP and NNP.

Ironically, 1980 was an important, if gradual, turning point:

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These figures – land rent share of income – are, for reasons I’ll get to later, quite a bit underestimated. But for now I’m more interested in the rate of change. After secular decline during the postwar expansion, land rents have increased not just in value, but in proportion, to the incomes of the wealthiest.

The biggest reason for this is, I think, the steep rise in inequality over the same time period. Conceptually, this is a pretty sensible argument. As mass affluence increases, as it did between 1940 and 1970, demand for consumer luxuries – like fridges, air conditioners, and garments – grows quickly. But as incomes of the median workers stagnate, while those of the rich grow precipitously you see a shift in demand to zero sum goods – or land.

Think about it, beachfront property, Manhattan penthouses overlooking Central Park, and second homes in Aspen have all increased rapidly in value in the Inequality Era. That’s because as the number of people who can afford luxury products has grown substantially, so too has the dollars chasing said land.

This is a pretty informative thought experiment. Land plays a big role in all of the products in the set of goods exclusively afforded to the affluent, and especially rich. While second homes and penthouses are a great example at the primary level, think about Ski Resort owners. If you want to Ski properly – that is on the Alps or in Colorado – those fake, manmade hills won’t cut it. You need a real mountain. The former is capital, and the latter is land. And boy do rich people love their Winter Chalets on the Swiss Alps.

Once you realize that land value is the most pristine of luxury goods – fake beaches are below the rich – the potential of land taxes becomes immediately apparent.

Now, you might be wondering after all this, if only 3-4% of the richest 1%’s income is land, there’s no way a total reform can include land values only. This is correct insofar as its ambiguity. The moral and logical extension of a land value tax would include similar levies on minerals, Internet domain names from common language words, and imputed rents from “middle America”. More importantly, there’s reason to believe this figure is understated, as discussed here. The last paragraph here is conspiratorial nonsense, but Fred Foldavary gives some pretty good reasons to believe that land rents are underestimated.

Part of the problem is because the United States pursued a program of broad home ownership – along with the fact that many affluent people own only one, expensive home without renting a second one out – so-called “imputed rents” become an important part of the picture. To calculate GDP, the government uses all kinds of tricks to estimate what you would have paid to live in your house had you not owned it. Even an average of $700 a month for everyone taxed at 50% yields a very significant sum. (Especially noting that the rich are easily paying the equivalent of $5,000 a month).

Granted, going back to the tradeoff between objectives of an optimal tax system, this would also “hit” many middle-class Americans.

There’s another critical point about taxing minerals. Many think about this from the point of profit from production without considering the consumer surplus from cheap consumption. That is, because most of us – especially the rich – would (if we had to) pay way, way, way more for a gallon of gas than we do, we’re rentiers each time we pay at the pump less than we would have. Because otherwise it would have been the company’s profit which is clearly rent.

Now, it’s important to note that a disproportionate amount of fossil fuel consumption should be attributed to the rich (just look at how much they fly, and in fancy business class configurations too!) That means their rent extraction from cheap fuel is orders of magnitude worse than the average American’s.

Note this argument has nothing to do with the environmentally-efficient price of carbon: we only note that minerals are a scarce, primary resource whose rents should be treated as land, and correct for the fact that most people would pay more for the average unit than we do. This is a very non-trivial point. Once you stipulate that not only the taxes, but consumer surplus, from minerals can be taxed under Ricardian principles, there is a gold mine of untapped tax revenue. Just look at the sales of America’s oil and gas sector. Along with land, and maybe a small levy on income earned above $1M we can finance a big government (25% G/GDP) with sensible tax policies.

Here we tease an important tension. A minerals tax (in reality what should be a carbon tax, but I’ll refrain from using that language here to divorce this conversation from environmental concerns) would disproportionately hurt the poor, as it is regressive, even if the rich disproportionately abuse the cheap fuel. This is a classic case where p(a|b) is very different from p(b|a). The best way to deal with this is to still heavily tax minerals – coal, oil, natural gas, etc. – but to provide a very progressive government spending system.

I want to summarize the most important part of this post as treating consumption of minerals as crucial a component of rents as profiting from the sale thereof. This adds another inefficiency beyond the environmental cost to even just innocently buying a gallon of gas. If we all used gas equally this wouldn’t be a problem, but we don’t, so our collective benefit should be socialized.

This is a particularly shocking problem if you think about how much the rich would actually pay for a gallon of gas (or unit of coal and natural gas burned if you’re of the Elon Musk class). For someone earning $500,000 a year or more, $20 a gallon would hardly seem like too high a reservation price. (After all, people in Europe earning well below that figure pay over half that). And what of air transport? This can’t be replaced with efficient, clean travel anytime soon.

The conversation on rents from land and minerals in this time of inequality has to begin. We might not be able to achieve all of our progressive goals with only a land value tax, but once we implement taxes on that principle the revenue is not trivial. Paul Krugman is unfortunately correct that this has all but disappeared from the Neoclassical, mainstream graduate schools. But I would expect the average consumer microeconomist to understand the rent from simple consumption better than anyone else. 

People like Paul Krugman can make this debate real in a matter of minutes. There is nothing utopian, idealistic, or useless about doing what Hal Varian’s Intermediate Microeconomics would tell you to do.

P.S. The name for this post comes, of course, from David Ricardo who first (or at least most prominently) advanced this argument:

It was from this difference in costs [between productive and unproductive land] that rent springs. For if the demand is high enough to warrant tilling the soil on the less productive farm, it will certainly be profitable to raise grain on the more productive farm. The greater the difference, the greater the rent. 

P.P.S. I plan to write some more on the evolution of economic thought regarding land. Some of the crispest writing on land rents comes from the classical greats like Ricardo or Henry George years after that. In any case, the modern arguments for land taxes usually come from the extremely utopian libertarian wing which makes a great argument but does alienate support from the “mainstream”. A lot of what Ricardo wrote doesn’t apply today, and mechanism of rent-seeking certainly manifests itself in subtler ways than before. But it is time to bring land and mineral taxes back into the heart of mainstream progressive discussion: something even the wonkiest seem hesitant to do.

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Really. As I was moving into college we, unfortunately, had to keep a car in Philadelphia for quite a few days. And the whole ordeal reminded me how much I hate private parking lots. This is just another Georgist rant, so if you’re not into land inequality and inefficiency feel free to ignore it.

First, profits owners earn from parking lots is the purest form of rent in the modern world – because it’s all land. At least some of the money you pay to lease an apartment is value added by the owner – the building, insurance, and basic upkeep come to mind. But the parking lot owner does absolutely nothing. Of course, most modern lots are nicely paved, but most people don’t care about that. Roadside lots are paved for cars to drive on – not to park on – and 99% of us wouldn’t pay a cent more for a lot that’s paved as opposed to one of grass, gravel, or dirt. Therefore the entirely arbitrary initial distribution of land determines all profit earned by a few lucky landowners that do absolutely nothing to take your money.

But private parking is also a socially inefficient good, as it is a de facto tax on public transportation. Their existence lowers the opportunity cost of driving, which itself requires more land. Path dependency and positive feedback between private driving and parking creates a deeply inefficient city promoting rents not only landowners, but wealthy citizens.

Since roads are usually a public good, it’s difficult to tease out who earns the rent. But we know that rents are earned any and all times the initially primary land isn’t distributed equitably, so the benefit from public roads accrues almost exclusively to those who drive the most.

Who drives in New York City? Well most people take the subway. But any firm on Wall Street provides its entry level analysts a driving service – or at least pays for cab fare. And surely you’ve seen at least one or two black limos. I’m going on a limb and guessing that like me, most of you and America can’t afford one of those. For this reason, public parking for which the price is undervalued can be just as bad: it disproportionately benefits those who already own cars.

And cabs are used by more affluent residents who for god knows what reason won’t take the subway, or tourists. Tourists are almost always affluent Americans or wealthy foreigners. Why on Earth do we want to subsidize their experience on American land?

All of this is to say, that even if we need parking lots, the government should nationalize them all, and progressively distribute all profits. Sure richer people will drive more, but that should be offset by extremely progressive distribution of profits. All urban streets should be converted into public toll roads – preferably with a monthly pass that is proportional with the exponential of car size.

In the long run, demand for paved roads and parking will fall which will allow efficient entrepreneurs to build office space and public entertainment. Something actually good for society.

This also frees space for buses, which are a sadly under appreciated form of public transportation.

It’s become vogue for us liberals to hate on Goldman Sachs. But at least these guys, ostensibly, add value and provide crucial services. That idiot who owns a parking garage does not. Rents exist: socialize them.

In almost every “run” there is. I’m making this post a) because of its relevance to my recent calls for steep land value taxation which was of (relatively) high interest and b) because Paul Krugman and Noah Smith beg to differ. (How often does a not Very Serious Person get to disagree with Krugtron, after all?)

There are obviously strong theoretical reasons to believe that land prices correlate well with population. Probably the simplest argument is a rising demand on a perfectly inelastic supply. More intricately, David Ricardo argued that an increasing working class would steadily increase the demand for grains increasing rents earned on fertile land, thereby the net present value of all future returns and hence the price.

In America, Henry George – perhaps not coincidentally after a failed attempt at finding gold – angrily argues for land taxation in his Progress and Poverty, not with arguments too far from what the classical economists made or what you might hear today.

Smith thinks it’s all about agglomeration:

In other words, New York City real estate is high-priced because New York City is an agglomeration of economic activity. It is not high-priced because an increasing number of people are being forced to live in New York City. That isn’t even the case! No law makes people cram themselves into NYC (except in that Kurt Russell movie!); you are legally free to move out to North Texas and get a nice ranch. People choose to live in the heart of New York City because of the economic (and social) opportunities offered by proximity to all the other people living there. So they’re willing to pay lots for land.

Krugman piggyback’s on Smith’s point and also notes that the city can always spread out into unused land:

Even if people want to stay in existing metro areas, they can hive off “edge cities” at the, um, edges of these metro areas, so that the relevant population density — the density that makes land in or near urban hubs expensive — might not rise even if the overall population of the metro area goes up.

And we have data! Via Richard Florida, new work by the Census (pdf) calculates “population-weighted density” — a weighted average of density across census tracts, where the tracts are weighted not by land area but by population; this gives a much better idea of how the average person lives.

Together, they make a strong argument that only in the longest of runs (and perhaps not even then) when a city can grow in size no more, is land price truly a reflection of population constraints. The logical conclusion of this eternally long run wouldn’t be far from America – the whole thing! – becoming a city state.

But there are a few important problems with the argument, mostly Krugman’s suggestion that the city can just “hive off”. The city is not a discrete blot as much a diffused core. The agglomeration economies then derive from the ability to commute efficiently to a well-recognized center. Now note, not all cities are monocentric, and polycentric models exist. Most business activity and, hence, economic output happens in the immediate vicinity of these centers. Indeed, variations of density can differ by over an order of magnitude and land prices in the core may be over 30 times that in the “hived” peripheries.

But cities are limited in the extent to which they can expand. A highly-developed rapid transit system with a commuter rail allows for cheap and quick commuting. As a new working paper notes:

This raises the issue of population density. When we compare cities cross- sectionally, at the same time but across different sizes, we tend to find that larger cities are denser. Nevertheless, in the United States and increasingly all over the world, we also find many modern urban forms, and especially many low-density large cities, such as Atlanta or Dallas. Are these lesser cities than the West Village that Jane Jacobs knew, or the walkable towns that Smart Growth planers advocate? The perspective of cities as interaction networks tells us how all these urban forms can co-exist: the spatial extent of the city is determined by the interplay between interactivity and the relative cost of mobility. When it is possible to move fast across space, cities become much more diaphanous and are able to spread out while preserving their connectivity. It is in fact the diffusion of fast transportation technologies, especially now in developing world cities, that is allowing them to spread out spatially, sometimes faster than they grow in terms of population (32). This, of course, creates possible vulnerabilities. For example, if the cost of transportation relative to incomes suddenly rises (e.g. because it is tied to oil prices) then cities may not be able to stay connected, leading potentially to a decrease in their socioeconomic production rates. Ideas for shrinking cities that have lost population apply the same ideas in reverse.

From the same paper (Bettencourt, 2013) we get confirmation of something I suspected earlier. There’s a greater flaw with assuming land prices aren’t causally related with population in the short run, but agglomeration economies. Population causes agglomeration. (This is theoretically and empirically founded). That is, on a log-log scale of population and income, the slope is about 1.13. Or a doubling of population increases total income by 113%. People get disproportionately richer. More money is chasing the same land because more people are chasing the same land.

This means land prices do associate well with population, in fact it’s about a 50% increase in rents for every unit increase in population:

There are two important consequences for general land use considerations. First, the price of land rises faster with population size than incomes. This is the result of per capita increases in both density and economic productivity, so that money spent per unit area and unit time, i.e. land rents, is expected to increase by 50% with every doubling of city population size! It is this rise in the price of land that mediates, indirectly, many of the spontaneous solutions that reduce per capita energy use in larger cities. Cars become expensive to park, and taller buildings become necessary to keep the price of floor space in pace with incomes, thus leading to smaller surface area to volume, reducing heating and cooling costs per person. These effects may also create the conditions for public transportation to be a viable alternative to automobiles, even when the price of time is high. Thus, larger cities may be greener as an unintended consequence of their more intensive land use. Policies that increase the supply of land per capita or reduce transportation costs (such as urban renewal), while addressing other problems, will tend to create cities that are less dense and that require higher rates of energy consumption in buildings and transportation.

Smith argues that agglomeration effects are path dependent, and that theoretically if land use restrictions were implemented there could be a chance that agglomeration would decrease and hence price would fall.

He’s right about most of it, but I take a much simpler view of agglomeration:

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In other words, it’s all the population. And by the way, the figures are pretty similar across the world (that’s actually what I’m working on for India). Read the paper if you want to convince yourself this just isn’t coincidence.

Smith talks about technology, but then oversimplifies the idea that there’s always unoccupied land nearby. The farther I have to drive to get to the center, the more I pay for gas and the more wages and leisure I sacrifice in commute. Transportation technology can mitigate this to an extent, after which point a city is largely stationary. Krugman’s point that the average American lives in sparser city today is well-taken, but also simplistic. We have more medium-sized cities than ten years ago. We don’t have more Chicago’s than ten years ago.

It’s kind of like saying “the average person in a medium or rich countries today is poorer than he was ten years ago”. That’s because a bunch of people just entered that “medium” category. But we don’t have a new America or Norway. In fact, it’s noted that initial urbanization happens in what happened to Delhi or Mumbai a few decades ago, but after a point the drive comes from the new and small places that are now classified as “cities”.

In any case, Smith’s point is actually causally linked with population. It always has been, and always will be.

P.S. Also read Bill McBride on why land prices will rise as population.