Why Land Tax Has the Potential to Be the Best Tax, and How We Can Reform It
A look at reforming the Queensland land tax
Introduction
Land tax (also known as land value tax) is an interesting case in tax policy, with economists strongly in favour of it - while the general public either dismissive or neutral about it - regardless of the contemporary discourse on the housing crisis. This post attempts to bridge this gap, while also explaining issues with the current implementation and some proposals to reform the tax, with a main focus on the Queensland (QLD) state land tax.
Overseas, land tax is a policy that is championed by many tax reformists and economists, but in Australia we've had state and territory level implementations of it near country wide, with only the Northern Territory exempt. [1]
What is a Land Tax?
In general, land tax is a tax on the unimproved value of land. This means that landowners have to pay recurring tax on their land which does not include the value of any property or anything else that is on the land. In other countries, property taxes are often imposed rather than land taxes, which discourages landowners from developing their land. A majority of economists agree that switching the tax burden from improvements on land to the unimproved value of land will enhance land development incentives and substantially boost economic growth. [2]
Research has observed these development incentives, with one notable study that found that switching the tax burden to land encourages land development, reduces urban sprawl and reduces land speculation. [3]
Besides incentivising land development, land tax has another massive positive component, in which it is most well known for - its efficiency. Tax efficiency can seem complicated through use of economics jargon, but its efficiency is intuitive and poses its efficacy as a revenue source.
Efficiency of Land Tax
Most people agree that taxes are important for some functions of the government, there is much disagreement over which taxes should be imposed, for reasons ranging such as efficiency or equity concerns.
Efficiency in this context refers to the amount of goods produced in a market relative to the consumers' desire for that good, with the goal being an optimal alignment of both.
Note: To reduce complexity, I'm not incorporating costs or benefits incurred by third parties (parties not involved in the transaction of the good) as part of efficiency. Although this absolutely is taken into account normally, such as a tax on cigarettes having the ability to actually increase efficiency in the market.
For example, a tax on pencils (for some arbitrary reason) would cause inefficiency:
Pencils are similar to most typical goods, when the price of pencils increase, firms are more eager to produce pencils and increase quantity produced.
This tax would increase the price consumers pay for pencils, decreasing the quantity demanded by consumers.
The tax also decreases the price received by firms, decreasing the quantity produced.
The tax burden falls on both producers and consumers and if this tax was not imposed, quantity produced and demanded of pencils would be higher, at a level where it's aligned with each other
Therefore, the tax distorts the market, causing inefficiency - this is also called 'deadweight loss'.
A portion of tax policy analysis is concerns regarding efficiency, with complicated justifications for imposing certain taxes. You could even make an argument for taxing pencils on the grounds of the environmental impact (use of wood in production), but that is beyond the scope of this post.
Now, a tax on land would not cause inefficiency:
Land is very different to most typical goods, when the price of land increases, the amount of land produced does not change and is fixed - as it's impossible to create more land.
This tax would not increase the prices consumers pay for land, with the quantity demanded by consumers remaining neutral
This tax does decrease the price received by producers (landowners), but does not change the quantity produced
The tax burden falls completely on landowners, the landowner supplies the same amount of land regardless of price and thus unable to adjust the supply to pass on any of the tax to consumers
Therefore, the tax does not distort the market, with the government able to raise revenue with no increased inefficiency - this tax does not create a deadweight loss.
The theory backing up the efficiency of a land tax is very sound, but unfortunately there isn't an overwhelming amount of empirical evidence showing large efficiency effects. [3] This is due to a few reasons, such as very few countries having a land tax, low tax rates for countries that do have a land tax, and other issues with the implementation such as not taxing all land or properly calculating the unimproved value of land. Political reasons are the main culprit as to why these taxes have had undesirable implementation, as it is difficult to politically sell the case for such a broad and high tax (as with most good tax reform).
Equity of Land Tax
Another prominent component of tax policy analysis is equity (fairness), the distributional effects of the tax. This can broken into vertical equity and horizontal equity, with the former concerning fairness in tax paid/transfers received relative to income and the latter in equal treatment of taxpayers.
For example, a tax would be vertically equitable where the total amount of tax paid increases with the taxpayer's income (progressive tax) compared to a flat tax that doesn't increase with income (regressive tax).
Studies such as Plummer, 2010 indicate that within residential properties, a land tax is more progressive than property taxes, but also finding significant variation in effective tax rates amongst taxpayers in equal groups, promoting and violating the principles of vertical equity and horizontal equity, respectively. [4]
However, the Plummer study is just comparing one instance of a switch to a land tax from a property tax. A land tax may be more or less progressive depending on both wealth inequality and the portfolio composition of households. [5] For example, if as individuals become wealthier, the proportion of their total wealth that is tied up in housing decreases (which has been observed in data), a land tax may be regressive as lower wealth individuals have more of their wealth tied up in their house.
Even if the land tax is directly regressive, the outcome can be progressive, with the tax revenue raised by the land tax used to afford a cut in income taxes or cash transfers to lower income households. One model demonstrates how implementing both a high land tax and reducing income tax substantially benefits low income households, slightly benefits middle income households, and increases the tax paid by high income households - making the tax switch progressive. [6]
Land tax directly taxes economic rents, making land both an efficient and fair tax base. Economic rent is the excess payment made to a factor of production or resource above the amount that is necessary to sustain the current use of the factor (or to entice the use of the factor).
It is essentially excess profits that can't be eliminated by competition, economic rents can arise for multiple reasons but the key reason here is due to scarcity, the fixed supply of land. It's worth noting that the reason isn't solely natural scarcity, but also scarcity of land through zoning laws - specifically urban land. These economic rents are unearned revenue for the landowner because it is not the result of any productive effort by the landowner.
Land Tax in Australia
Land tax has been around in Australia for a very long time, starting in 1910 with the introduction of a federal land tax, which was then abolished in 1952, with nearly all of Australia adopting a land tax at the state & territory level overtime. [7] The move from federal level to state level land taxes likely helped administration costs, with differences such as land tax rates between states having very low efficiency costs due to the immobility of land.
The Land Tax in Queensland
Focusing specifically on QLD's implementation of the land tax, it has many components that complicate the land tax structure.
The taxable value of land owned in QLD is what determines the rate of land tax. Land valuation is calculated annually by the State Valuation Service and the method they use for calculating land value is different depending on if the land is zoned as rural or not (rural-residential doesn't count as rural zoning). Rural land is valued using unimproved value, the measure of value I've been referring to this entire post - only taking into account the land itself without any improvements.
Non-rural land is instead valued using site value, which includes the value of the land but also taking into account improvements to the land that is used to improve the physical nature of the land or prepare it for development. [8] The rationale for site value is that these improvements have merged with the land over time because they have become permanent, don't require maintenance, and for all practical purposes became invisible since merging with the land. [9]
Taxable value in QLD used to valuate all land through unimproved value, but this was changed following recommendations in both the Chalk Report (1989) and the Smith Report (1990), citing better accuracy and ease of valuation to switch to site value. [10]
The value base used for calculating land value must reflect highest and best use. Highest and best use of land reflects the value of land at its potential highest use, regardless of its actual current use. Site value is sufficient to achieve this using vacant land sales, as vacant land sold on the market will reflect its potential highest and best use, resulting in an efficient value base. [11]
However, with the development of highly urbanised locations where vacant land sales with a similar purpose are not available, valuations are more often than not based on improved land sales that are adjusted to exclude the value of the improvements. This can make it so site value can be potentially inaccurate when using land sales to value land where improvements are not comparable or the location is not relevant, which compromises the economic efficiency of taxing the highest and best use of land. [12]
Moving to tax rates, the structure of QLD's land tax is quite progressive. For an individual, the land tax rate that a landowner needs to pay depend initially on if the total taxable value of land owned is over $600,000, with marginal tax brackets to apply a higher rate to individuals with high total taxable value of land as shown below:
Additionally, if the land is used as the landowner's home - a primary place of residence - it is completely exempt from paying any land tax. [13] This means the land tax is only applied to investment and commercial property land over the threshold, which does significantly limit the tax base. The rates are also quite low particularly at the lower value end, as an individual investor with a total taxable value of $680,000 would have to pay $1,300 annually. Although, for land owned by companies, the tax-free threshold is only $350,000 and all the marginal tax brackets have significantly higher rate.
Furthermore, it's crucial to point out there are also land taxes at the local level, they are just called 'council rates'. [14] At least with the Brisbane City Council, the local land tax is pretty similar to the state land tax, except that it does apply to landowners' homes at the local level, substantially increasing the tax base. [15]
Queensland Land Tax Reform and Policy Proposals
The QLD land tax is much smaller than desired, even compared to other Australian states, collecting less than half as much in land tax revenue per capita as New South Wales or Victoria. [16] Even stamp duty (transfer duty) collected over 2.5 times the revenue that land tax did in the 2022-23 budget, with the QLD government receiving $1.77 billion from land tax and with stamp duty collecting $4.72 billion in revenue. [17]
The Australia's Future Tax System Review (also known as Henry Tax Review) was commissioned by the Rudd Government to guide tax reform, written by economist Ken Henry. The first three recommendations are from the Henry Tax Review.
Recommendation 1: The land tax should be levied on as broad a base as possible to promote efficiency, particularly by removing the primary place of residence exemption
The primary place of residence exemption causes distortionary tax incidence, passing land tax on rental properties through to renters as higher rent - abandoning some of the efficient properties of an optimal land tax in theory. This is because in a housing market where land can be used for rental or owner occupied housing, unequal land tax treatment through only taxing the former results in a decrease of supply of rental housing, as some rental investors seek higher returns elsewhere, increasing rents. [18] Removing this exemption is one of the key land tax reforms, and would significantly increase efficiency. The primary place of residence exemption should be removed, to eventually move to a land tax structure that includes all land, to achieve the benefits of adopting a broad-based land tax.
With housing prices being a substantial contemporary issue, a broad-based land tax would also see a reduction in land values from the tax being fully imposed on landowners. [19] The paper goes on to estimate the decline in real land values as a result of an expected decrease in net income due to cost of the land tax (capitalisation), with the average plot of land declining in value by 5%, with a decline of 12% for land in and around the CBD. This estimate is conservative as it doesn't take into account the effect from eliminating stamp duty, further decreasing house prices.
Recommendation 2: Stamp duty should be phased out overtime and eventually abolished, while increasing land tax at the same time to raise the lost revenue
A deep-dive into stamp duty is beyond the scope of this post, but stamp duty is a tax on transactions such as buying or selling a house. Stamp duty is an incredibly inefficient and inequitable tax on land. Its inefficiency stems from significantly hampering housing mobility by discouraging transactions of property, distorting the process of efficient allocation of housing to its most valuable use. [20] Additionally, it discourages people from changing their place of residence as personal circumstances change. It's also inequitable because people who need to move more frequently have a greater tax burden, regardless of their income or wealth.
While the efficiency rationale for abolishing stamp duty is there, it generates such a large volume of revenue that it is not replaceable with revenue from an increased land tax in the short term. [21] Therefore, the transition will require a progressive phase out over a period of 5 to 10 years. It's important to be aware that there is plenty of room for the QLD land tax to expand and substantially increase revenues, as it currently only applies to around 20% of properties, with the below chart showing how even at the highest threshold it is only 1% of the effective tax rate.
Recommendation 3: To tax more valuable land at higher rates, land tax rates should be set at increasing marginal rates that are based on the per-square-metre value of the land, with a tax-free threshold exempting low-value land
Land tax rates should be based on the value of a given property, rather than the total taxable land value to not discriminate between different owners or uses of land. This can be achieved by basing the tax-free threshold on the per-square-metre value of the land, ensuring most agricultural and other low-value land are exempt from the tax. Additionally, the element of progressivity can be kept by imposing higher rates of land tax for higher per-square-metre land value.
One paper demonstrated how a broad-base land tax that subjects all land to the tax would leave the boundary of cities and their density unaffected. However, they examined that if agricultural land is exempted, the land tax would reduce urban sprawl by increasing density, decreasing size of dwellings, and increasing height of buildings. [22] This would also decrease commute time, while increasing house prices and rents in the city. The same paper also compared impacts of a land tax with progressive marginal rates based on per-square-metre land value (proposed in the Henry Tax Review) to a regressive land tax with a flat rate. The progressive land tax was found to concentrate the tax burden on relatively well-off communities, with suburbs that are closer to the CBD and are relatively affluent having the most expensive land, bearing the highest tax burden.
Recommendation 4: The basis of value used for assessing land value for the land tax should move from site value to Capital Improved Value
As mentioned earlier, the current site value valuation process with a lack of vacant land sales and reliance on improved land sales is potentially inaccurate. If the land value doesn't reflect its highest and best use, the tax will be economically inefficient.
An alternative measure is the Capital Improved Value (CIV) which involves two elements: site value and the added value of improvements, with the base being taxed either on the combined value or separating tax rates on each component (site value taxed higher due to inelastic supply). CIV can reflect the highest and best use by valuing all improvements to reflect the highest and best improvements to the land with the value regularly reassessed. These values could be derived from sales of land with recently completed improvements. [23]
Moving to the CIV instead values land based on recent improvements in the same location, rather than based it on hypothetical improvements or existing improvements which are not highest and best use. The CIV therefore would reflect highest and best use, maintaining economic efficiency as the decision to undertake building improvements does not affect their tax burden. [24]
Conclusion
By demonstrating the effectiveness of a land tax, and the current issues with the QLD land tax - I've painted a relatively straight forward path to reform. A significant issue for countries are administrative constraints to valuation or implementation of a land tax - but we already have it all mostly set up. It just takes getting the public on board with land tax reform, committing to sound economic principles, and spending a whole lot of political capital to get this much needed tax reform done.