The case for a land value tax

The real estate bubble will not burst anytime soon, but capital is being hit as nothing new is created

January 26, 2014 01:08 am | Updated May 13, 2016 12:22 pm IST

MYSORE, 04/08/2008: Horizontal expansion of Mysore is consuming large tracts of agricultural land. Photo: M. A. Sriram

MYSORE, 04/08/2008: Horizontal expansion of Mysore is consuming large tracts of agricultural land. Photo: M. A. Sriram

In a feudal society like India, land ownership has always been a source of wealth and power.

While the traditional feudal class has largely faded out, post-Independence, especially in the last decade, real estate prices have soared to vertiginous heights, bringing realty back to the centre stage of the Indian economy.

The fall in property prices in 11 out of 15 major Indian cities in 2013 as compared to 2012, has created a feeling that the overheated real estate sector is showing signs of correction. Some have gone on to speculate that this might be the sign of an impending real estate bubble- burst. But bankers see no reason to be worried as the Indian realty sector differs from that of developed world in many ways.

First, the mortgaged property’s market value is more than its book value as up to 50 per cent of the value of a property is paid by the buyer in “black”, and banks lend only by book value. So the sector can absorb considerable downward correction. Secondly, a major share of the investment in real estate is in undeveloped land, which is not financed by banks. Finally, money is parked in this sector usually to evade taxes, and this flow of unaccounted funds is not likely to slow down anytime soon.

It is a tragedy that the same factors which make this sector immune to a meltdown, are bleeding our economy. Black money, whether earned legitimately or siphoned off from government-spending, is getting sucked into a vortex of shady land deals, which provide not only anonymity but assured returns. It creates artificial scarcity, jacking up land prices for end-users. Moreover, it creates an incentive for the builder-politician nexus to delay clearances to residential or commercial building projects of individuals or communities without political patronage, leading to a mushrooming of irregular colonies, with non-existent infrastructure such as water lines and sewerage.

It has created a new feudal class of landowners which extracts a rentier’s income from the economy without adding any value. The overdeveloped real estate sector is worthless for India’s balance of trade, as construction projects, even if world-class, cannot be exported. Even if the real estate bubble does not burst, capital is still being destroyed and nothing new is created.

This is the neo-liberal blind spot which fails to see the Physiocrat’s wisdom of recognising that productive work is the only source of national wealth.

However, the productive work, the value added to the economy, is all that most modern economies tax. Real estate, on the other hand, gets its value from location, mostly a result of public utilities like transportation, water, electricity and drainage tending it, and jobs, schools and hospitals in its vicinity. All of this is financed by the community, either as taxes if built by the state, or as user-fees if built privately. So modern taxation is a clear case of taxing private wealth while doling out public wealth to a select few — those who are first-comers, inheritors, cronies or plain lucky.

The logical solution to this aberration would be to tax land at its value. The so-called land value tax was an idea considered by Adam Smith in The Wealth of Nations , but most famously and fervently advocated by George Smith. Ever since the 1868 Meiji restoration in Japan, it has been used in many parts of the world, as in the U.S., Australia and Hong Kong. It has been dubbed ‘the least bad tax’ by Milton Friedman as it does not lead to allocative inefficiency. From Paul Samuelson to Joseph Stiglitz, it has many supporters in the economists’ fraternity. Michael Hudson is a vocal proponent and he has suggested it for China as a way to avoid the fate of debt-ridden Western economies.

Land value tax, when applied to non-agricutural land, might turn out to be the game-changer. It will end speculative land hoarding and bring down prices for the end-user. The money saved thus will be spent on other commodities, increasing consumption and give the economy a boost. It will free a lot of undeveloped land close to cities, which can be developed by state or private players. These developed colonies will be affordable to lower income families which have been spending considerable sums for unapproved land till now.

This will provide the government revenues to develop urban infrastructure. Mining companies, which find it more profitable to squat on natural reserves sensing a rise in mineral prices, will not do that once they have to pay annual tax on the value of the mines. They will have to mine it to earn revenue to pay tax, or choose to return it to the government. Unused prime urban land, of closed mills for example, will be promptly returned to the government for the same reason.

This tax may not replace all other taxes, as Paul Krugman concedes, but may be a one-stop solution to all that ails realty sectors.


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