I am a dedicated Georgist and believe in the cause on moral and pragmatic grounds. Despite this, I fully recognize our primary policy objective, the Land Value Tax, is notoriously difficult to explain in terms of its economic efficiency.

So for this post, I’m going to go in depth into the very nature of taxation, deadweight loss, and simply general welfare economics, to explain the economic advantages of a land value tax.

Supply and Demand

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Almost everyone has seen this graph before, and while people have a general idea of what it entails, there are some specifics which must be explained first.

First, let’s look at the Demand curve.

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As the price decreases, more buyers are attracted. At 100$ per unit, you attract 0 buyers, at 90$ per unit you attract 1 buyer, at 80$ per unit you attract 2 buyers, etc. etc. The cheaper an item, the more people will want to buy more of it. This is the Law of Demand.

We are going to look at Consumer Surplus here. At Quantity=5, we have attracted 5 sales, at 50$ per sale.

Now imagine these are 5 different people: one was willing to pay 90$ for 1 unit, one was willing to pay 80$ for 1 unit, one was willing to pay 70$ for 1 unit, etc.

But the price here is constant at 50$, so the person who was willing to pay 90$, now has a surplus value of 40$ from this interaction.

***Another way of reckoning this is if it’s one person, who simply has a “decreasing marginal utility,” the idea in economics that a consumer will demand each additional unit of a good less than the one prior.

If I drink one soda, I get a level of satisfaction. If I drink two sodas, i’m happier overall, but the second soda adds less joy than the first. (With some goods, the declining marginal utility may only occur after one or two units have been consumed) At some point, each additional soda I have will not increase my happiness, as my demand is saturated. (The exact calculations determine the slope and shape of the Demand curve, but for simplicity we’re using Y=-X+100)***

consumer surplus.png

In either method, we see that the end quantity:price, allows for a consumer surplus to occur, as shown to the right.

That is the extra added value all consumers are getting from the transaction set at this price.

Quantity * (y axis points)/2 (to find the area of the triangle)

5*(100-50)=250/2 = 125

Consumer Surplus Value = 125

Next, let’s move to the Supply Curve.

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When the price is 0$ per unit, producers have no incentive to produce. When the price is 10$ per unit, producers want to produce 1 unit. As the price increases, so does the willingness to produce. This is the Law of Supply.

Now we are going to look at producer (supplier) surplus.

When the price is at 50$ per unit, producers have the incentive to produce 5 total goods. Any more, and the producers have judged that there is a better trade off for my time (this depends upon supplier preferences, but here we have an easy y=10x formula to work with).

producer surplus.png

The suppliers were willing to produce 1 unit for only 10$, but now for that first unit they will receive a price of 50$, as will each following unit they produce. At Q=5, they are unwilling to produce more lest a price increase incentivize that trade off in opportunity cost to occur.

And so a Producer Surplus now appears.

Quantity * (y axis points) = x/2 (to find the area of the triangle)

5*(50-0)=250/2 = 125

Consumer Surplus Value = 125

When combined, they look as such:

total surplus.png

And so the total surplus value is 250.

Now, if you know the Supply and Demand curves, you can find the equilibrium market price and quantity, as well as the surplus value these transactions give to producers and consumers alike.

With that understood…

Taxation

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Let’s pretend there is a 20$ per-unit tax put upon whatever good we are analyzing here. We can analyze this from either demand or supply perspectives, but it comes out the same, but for simplicity’s sake I’ll explain suppliers. The supplier will have to pay 20$ now to the gov’t for each good it produces as a tax, but it will raise the price on consumers, in order to pass off the burden of the tax slightly.

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For suppliers, this means that to produce 1 good, not only do they need the original 10$ per unit incentive, they need an extra 20$ to make up for the tax increase.

With the supply curve adjusted above in red, we see an intersection with demand at Quantity produced = 4 units. To help with the math in just one second, I have drawn blue lines to show where this corresponds in terms of price, although the market price will now be 60$ per unit after this tax is increased.

The government tax was 20$ per unit, and we know production is at Q=4 now, and so we Screen Shot 2019-07-31 at 3.41.26 PM.pngcan thus prove that the space between P=40 and P=60 on the Y-axis represents government revenue from the tax; (60-40)*4=80.

Meanwhile the small triangle outside this rectangle, to the right of Q=4, represents the deadweight loss due to the tax, where consumers and producers decided it was best not to engage in the market, and so economic activity in total declined.

taxation.png

Here we see:

  1. Blue: Consumer Surplus
  2. Red: Producer Surplus
  3. Green: Government Revenue
  4. Black: Deadweight Loss

Consumer and Producer Surplus = 80 each (down from 125 each).

80*2=160+80(gov’t revenue)=240.

As we know the original amount was 250, we can determine the total economic deadweight loss to be 10.

All good? Because now you have seen how a per-unit tax works, and its effect. There are many sorts of taxes that can tax consumption directly, or tax production directly, and many other various different taxes in not just the good market, but labor market as well.

But we are focusing on the good market for now, and we are finally moving to the final stage.

Land Value Taxation

The LVT has two distinct features for what we need to consider now.

First, land is fixed in supply. What we see is what we have, you can’t take land from Texas and transport it to California, you can’t hide it overseas, it is in quantity (size) and location, fixed.

Second, the LVT itself is a value tax, that applies to the total value of land, which is itself an assessment by market forces.

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With those two considerations (which I will explain further along the way), we can continue.

Notice in this graphic, we have a fixed Supply at 5. Now that’s the total amount of Land which Landlords (henceforth referred to as Suppliers), are willing to Supply. Remember, Land cannot be produced, and this affects our welfare economics immensely.

First, we see the Consumer and Producer Surplus:

land welfare.png

 

Now, let’s test a 50% Land Value Tax. But first, we must assess the value of the land. Currently we have Q=5 (consider this for individual plots controlled). We also have P=50. So the total Land Valuation by the market to be 250$. Notice that the land valuation is not the same as surplus value from the transactions

  • Consumer Surplus: 125
  • Supplier Surplus: 250
  • Total Surplus: 375

(Also important for our example, we are looking at a specific region, not all of America, or all of Earth. This is merely applying a tax onto these specified plots).

So let’s put our tax rate at 50%. This will yield 125$ in government revenue, but instead of shifting the supply curve as in the earlier good market, we find that the entire burden of the tax falls upon the Supplier.

LVT welfare 1.png

 

  • Consumer Surplus: 125
  • Supplier Surplus: 125
  • Gov’t Revenue: 125

Now I’m sure many immediately are asking “why doesn’t the Supplier just raise price?” or for real life, “why won’t the landlords just raise rents?”

After all, that is how the tax burden works for value taxes: the tax is paid by the Producer/Supplier, and then some of the burden of the tax is passed off in a price increase. Some Consumers exit the market, and deadweight loss appears.

If the producer simply absorbs 100% of the tax burden, and doesn’t increase price, *we have no deadweight loss, and we have no tax burden on renters/consumers*

But let’s analyze a price increase, to see if it will work for the Supplier. Can he get away with passing costs off? Assume the price is now raised to 60$.

LVT Welfare 2.png

Now since the price is 60$, Demand has decreased to Q=4.

The new Land Valuation is 240$ (previously 250$)

And so we see the 50% Land Value Tax (on the owner of the land) is 120$, down from before!

However, notice that Supplier Surplus is now 120 (previously 125) and Consumer Surplus: 80 (previously 125). This is because despite 5$ fewer in taxes, the change from a PricexQuantity of 50×5=250 went to PricexQuantity 60×4=240. The decline in Quantity is more powerful than the raise in price, and decline in overall tax.

Add it up, and we see 120+80+120=320, down from the original 375 Total Surplus Value.

What happened to the right of Q=4? The land still exists, but nobody was willing to pay for a 5th unit at the new higher price at 60$, and Landlord have simply forsaken the land to avoid the tax. Nobody will buy, so they have a 50% tax on land that gives them no profit, so it’s all in the red. An important aspect of LVT: unproductive land still has market value, and a tax on unproductive land will incentivize productivity. Either that, or the landlord must forsake the land, and let the market take over (now the people who might leave the market on the Demand side might become landlords themselves and pay the tax directly). In the end, it’s a deadweight loss from the price increase: and most of it belongs to the Supplier.

So should the Supplier raise prices?

  • Consumer Surplus Value: 125  —> 80
  • Gov’t Revenue 125 —> 120
  • Supplier Surplus Value: 125 —> 120

(The Supplier Surplus Value if they keep holding onto the land nobody is buying — the deadweight loss — is a 50% tax of the 55$ value of land that went off the market, but without any profits since nobody is buying. Ergo Surplus value drops another 27.5)

Raising the price will harm the Supplier more than if the tax is simply absorbed entirely.

You can recreate this with any tax rate, and try to raise the price as high as possible: and no matter what, the best course of option for any given tax rate, is for the Supplier to take the blow.

In conclusion:

In response to a Land Value Tax, Landlords will serve to maximize their own best interests, and absorb the entirety of the tax, meaning no deadweight loss occurs, and renters have no tax burden to worry about.