Want growth? Scrap income tax and introduce a location tax

If we want to stimulate growth and tax people more fairly, we should replace income tax with a 'location value tax', says Merryn Somerset Webb. Here's how it would work.

A few weeks ago, I wrote about my lunch with a reader Nicholas Dennys - in London and repeated a story he told me about Martians and space dust, which was meant to exemplify the idea behind a land or location tax. I have been meaning to return to the subject so apologies for having left it so long. You can read the original posthere: Why a Martian would never manufacture in Britain,but I also want to run through some of the rest of our conversation for you.

The main point behind a land or location tax is that, in general, the price you pay for a property or piece of land (ie, the value the market gives it) is not about the land itself, but about where the land is. A house sitting on a piece of land might cost more or less the same to put up in Wales and London, and as a structure, be worth the same in both places.

But the house in London still sells for 20 times the one in Wales because of the wealth of activity around the land on which it sits. The community, the infrastructure, the buses, the airports, the schools, the hospitals, the ease of doing business the price you pay for the land is a function of all these social rather than private goods. As Nick puts it, "the mud beneath our feet is only worth what it is because of what goes on around it".

This suggests that the value of a piece of land should perhaps be divided into two. The first part should be the value of whatever sits on the land (its houses, sheds, factories and the like). The second should represent the value given it to buy the surrounding civilisation (its 'location value').

There is a neat little example of the existence of location value in today's FT. According to letter writer Charles Bazlinton, when a bypass is built around a town, residential property values in that town will rise by an average of 15% as a direct result.

This 15% uplift in capital values- which is effectively a 15% rise in the location value of the properties - accrues instantly to private property owners in the town. But given that the bypass will have been paid for by everyone's taxes, why does it make sense that one group of people (freehold property owners) should make money out of it when everyone else does not?

From this comes the idea that the 15% uplift should be shared out among the community as a whole via a property value tax or a location value tax (LVT). That way, something the community has provided benefits the community rather than just the private landowners within the community.

This makes a kind of moral sense. But there is another argument for an LVT the idea of excess burden or the deadweight loss of taxation. It refers to the amount by which a country's potential GDP is reduced by the distorting effects of various sorts of taxation -effects that are stunningly high.

Our own Treasury puts the excess burden of taxation at around 30p per pound of tax collected. LVTs are thought to have very low excess burden or possibly none at all. A recent reportout from the OECD (Tax Policy Reform and Economic Growth) made the point that, of all the four categories of tax (property taxes, consumption taxes, personal income tax, corporate income tax), property taxes are the least harmful to an economy.

"Income taxes have larger effects on firm and household decisions than (most) other taxes and therefore create larger welfare losses ceteris paribus." Recurrent taxes on immoveable property are the "least harmful" tax in that they distort rational economic behaviour the least. "A growth orientated tax reform would therefore shift part of the tax burden from income to consumption and/or residential property."

There is even a very good argument to be made that an LVT is not just neutral but stimulative, in that land taxes work to shift investment out of property and into 'higher return activities'. A proper LVT could also be stimulative in that it might bring marginal land back into use.

Consider a derelict inner city site and a would-be start-up business. The business might find that it can afford to fund its costs of labour and capital, but not the endless taxes imposed on that labour and capital. However, under an LVT system, this wouldn't be so much of a problem: the location value of land no one else wants is low to non-existent and so would bethe taxes. The result? A new business and a marginal area brought back into the community.

The main and the best objection to a location tax is that we have so many taxes already. This is quite right and we are utterly opposed to new taxes being introduced without old ones being dumped.

There wasa good letter in The Times on this matter from James Lewisohn earlier this week. In it he noted that, while it sounds like a good idea to shift the UK tax system away from income and towards wealth, and in particular, unearned wealth via increased taxes on property, the truth is that the UK "already taxes wealth and greatly so: at 40% UK inheritance tax is among the highest in the world, and vastly above Scandinavian rates".

As a Dane, for example fictional detective Sarah Lund, may incur regular and relatively high property taxes on an annual basis. Yet, should her mother pass away in suspicious circumstances in seriesthree of The Killing, "she will pay no more than 15% in estate tax".

Her counterparts in Norway and Sweden will pay much less: "in Sweden a simple 0%". A location tax may be a great idea (or not please discuss below). But for it to work, it would have to come instead of, rather than on top of, all our hundreds of other taxes.

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