The series on 'LVT and land values', that was running in this group during November and December 2006, has provided some interesting points of view but there still seems to be a degree of uncertainty in some cases, and quite rightly so. It is a complicated subject and a bit like a mobile in the air - tug on any part and everything else changes position!

How can we get back to the basic principles? As a new and clean start the title has been altered and I will attempt a new road map.

Note: This is not an introduction to LVT nor a sales promotion, but an attempt to arrive at a deeper understanding. Your discussion on any of the points raised will be most welcome. Please give the concept number/s in the subject line.

[Attached are four diagrams and some tables that will be referred to later]

Concept 1

Most of you have seen photos of the Land Value Model of Johannesburg produced by members of the School of Economic Science Johannesburg in 1972. This was based on the then latest Municipal Valuation Roll. The land values given were as close as possible to actual market prices at a set previous date. Many factual land or site values were available as checkpoints. This applied where buildings were purchased and demolished to make way for a new and larger construction. The cost of purchase / consolidation, demolition and rubble removal to obtain a clear site gave a factual price, or a value per square foot (meter). This value could be easily extrapolated to surrounding sites, taking into account other local factors.

The ratio of land values on CBD prime sites compared to residential sites, say 4km away, was approximately 500:1. On the outskirts of the city the ratio was approximately 1000:1.

Comparing these with the economic value of marginal land gave ratios of CBD 1000 000 : City Outskirts 1 000 : Marginal farming 1.

A recent study done by Peter Fennell of the School of Economic Science in London confirms the above as he gave a ratio for the UK of 1 000 000 : 1 on estimated land values.

In order to make any sense of these extreme differences in values in a diagram form it is necessary to use a log scale or truncated vertical scale (i.e. equal vertical division for 0, 1, 10, 100, 1000, 10 000 etc).

The 4 diagrams attached and the 3 diagrams given in my book 'That All May Live' (TAML) (1990) Chapter 5 are based on this concept.

Concept 2

Refer to diagram 1 attached (or TAML p.32) It is well understood by most Georgists that all taxes, no matter where applied, are shifted up into the rent area. Rent with an 'R' is used here for the Ricardian Rent, to distinguish it from rent of improvements.

Concept 3

Refer to diagram 2 attached (TAML p.33)

As I see it, there was no need to further define Rent in Ricardo's time or George's time. (This is a problem raised by Neil Gilchrist.)

In an effort to improve my own understanding, the term Rent was divided into two namely pre - tax and post - tax. This was found to be very helpful.

'Natural Rent' is used here to mean what the Rent would be in the absence of any form of taxation: direct, indirect or LVT.

'Economic Rent' is used to mean the amount left after all forms of imposts and taxation have been extracted by all levels of government, including tolls.

(Privatizing toll roads is effectively a gift by government at the expense of Land Rent and land values. This becomes significant when considering LVT.)

Concept 4

Refer to diagram 2 attached (TAML p.33)

The actual height and shape of the Rent curves will be affected by a number of factors. In general, as the economy grows and infrastructure and employment improve so the Natural Rent Curve as a whole will tend to rise. Security plays an important part and also the general health of the economy. Civil unrest will drop rent in the affected areas. The level of crime has both a short term and long term negative effect. At the end of a war there is a peace dividend in that Economic Rent increases and land values rise rapidly.

The quality of communication and transport can promote or decrease Rent on individual sites.

Ricardian Rent is based on the economic potential of each site according to its optimum permitted use. Any changes in consent use will have an immediate affect on Rent. Rent applies irrespective of whether the site is used or vacant.

Concept 5 - Effect of Taxes on Rent

Refer to diagram 2 attached (TAML p.33)

Different taxes can have vastly different effects on the amount that is subtracted from the Natural Rent value at any point on the curve and thus affect the Economic Rent curve.

Taxes on fuel and transport have a disproportionate effect on land furthest from the markets, supply points and cultural / educational facilities. Indirect taxes normally impact more on both labour and marginal land than on prime land.

Company taxes have the least disruptive effect near the margin where profits and taxes are low.

Amongst the worst taxes are 'General Sales Tax' (GST) or 'Value Added Tax' (VAT). These do not reduce to zero at the margin of production.

When first introduced and at each increase in VAT wages are soon increased by a similar amount to compensate the workers.

At each stage of production salaries and wages account for approximately 50% of the cost. This is progressively added to each subsequent stage as well as the cost of inputs, materials and services. The final product thus carries the full amount of VAT (14% in RSA) on its cost of production, as well as the final invoiced amount of VAT.

Thus cost of production in RSA = 114%
Add to this 14% VAT = 114 x 1,14 = 129.6 %
People on a fixed income could be paying an extra 29.6% on their purchases.

Although exports are VAT exempt (or refunded) they still carry nearly 14% on their cost of production or selling price. This puts exporters at a disadvantage in international markets.

Concept 6 - Price versus Rent

Market price should relate directly to the capitalized value of Economic Rent - but it does not normally under existing conditions of land tenure and taxation. There are three aspects to the price of land.

First is the capitalized value of Economic Rent. Capitalization depends on prevailing interest rates and inflation. Traditionally, with no significant inflation, when interest was approximately 5% per annum, Rent was capitalized over 20 years,. Recent studies have shown that on agricultural land the ratio has been approximately 4.5% (interest - inflation = + 5%. Slow moving markets can distort this effect.)

Secondly there is the speculative value of land and this can vary according to demand and supply in the market. This can be totally unreasonable as owners are either reluctant to sell their nest - egg or it may have sentimental value. A typical case some years ago was an asking price of R250 per hectare for a farm whilst the economic return on cattle ranching in that area was only R2 to R3 maximum per year per hectare.

Thirdly is the opportunity value, which raises its head when consent use is about to change or there is the possibility of a hold out when a major project still requires that particular site.

The aggregate of taxes applicable at any time or place will affect all three of the above values.

Concept 7 - Speculation versus Land Value

Refer to diagram 3 attached

Speculation results in much land being kept vacant and totally unproductive or under utilized. The present tax system encourages this anti-social behavior that is destructive to the overall economy.

The City of Cape Town Valuation Roll shows approximately 10 % of land as vacant. Municipal rates are only 1cent per rand or 1%. This is the only tax cost of keeping the land idle. So Cape Town has 10% less production than it could have, 10% less employment, 10% less consumption and 10% less paid into central and provincial government coffers. This does not include the cost of under utilization on other sites.

Looking at Diagram 3, since government is loosing more than 10% of revenue, it needs to increase taxation by over 10% (round figures) to achieve the same budget. Taking into account under developed land, the figure would be larger.

This could be lowering the Economic Rent by well over 10% on prime land and increasing to 100% when approaching the margin.

The margin is moved in by a further amount as shown in the diagram, resulting in further losses all round. Many of those who would have worked on 'A' quality land are forced to work on 'B' quality land and so on down. This also has the effect of reducing wages.

Demand for quality land increases at the same time that Economic Rent reduces because of increased taxation caused by speculation.

The final result on the price can be up or down.

Concept 8 - Change in Tax System

Refer to diagram 3 attached

Any introduction of a tax on land should be based on market values or, in time, market Rent; this latter is not an idea understood in RSA.

Any land tax must be offset by an equal reduction in total amount collected by other taxes, preferably a reduction in VAT or other taxes that depress the margin.

Over a fairly short period of years a Land Value Tax should replace all existing taxes.

When all existing taxes are repealed / eliminated, the Economic Rent curve in Diagram 2 will be restored to coincide with the Natural Rent curve.

In a separate study "Land Tenure: A Time Bomb Ticking in SA" (1991) it was shown that the area between the Natural Rent curve and the Economic Rent curve constituted approximately 70% of the total Natural Rent. i.e. the Economic Rent area is approximately 30% of total. From this can be deduced that under present conditions, before any improvements take place, it would only be necessary to collect 70% of the Economic Rent to achieve the existing budget.

When the 10% plus idle land starts paying LVT and the unproductive land beyond the Economic Margin (in diagram 2) comes back into production, the budget would show a surplus of some 20% or more.

Moreover the change in taxation would kick-start the economy, idle land would come into production and unemployment would rapidly reduce.

Concept 9 - Land Prices versus Interest Rates

Under current conditions bond interest rates have a direct effect on market prices.

Most home purchases rely on a 90% bond over say 25 years at about 10% per annum. The land portion of the purchase is about 35%. This is the last part of the loan to be paid off, over the last five years. For twenty years 10% of the land value is paid to the banks. This is Rent and should be paid to government. Even if government imposed a 10% tax on the land they would only be collecting half the Rent. Land prices would fall accordingly, to about half.

Land prices are presently influenced by interest rates on bonds, in addition to taxation. It would seem that speculative pricing is more pronounced nearer the margin. The residential market is influenced by ability to repay bonds and in some instances limited by law to a maximum monthly pay back relative to income. (At one stage in RSA the law limited this pay back to 23% of income.)

The prevailing bond interest rate thus had a strong influence on market prices. Changes in prime rate influenced the residential market to a large extent. In Pretoria, administrative capital of RSA, a large percentage of workers were government employed and enjoyed a subsidized interest rate. For a given salary strata they were able to purchase larger homes than their commercially employed counterparts. This also had the effect of distorting the residential property market compared to other cities.

Where does this lead us?

Accepting a total change to LVT, how would interest rates affect land prices? Again this is a complex matter.

Refer to diagram 4 (TAML p 39) The percentage of Natural Rent that is taken in taxation will determine the amount of Economic Rent left for capitalization. On the above referenced page in TAML it was recommended that not more than 80% be collected leaving 20% behind to establish realistic values.

Concept 10 A Thread of Reason

Our 'Mobile' is still highly mobile!
Everything keeps changing.
This is an attempt to tie it down with your aid.

From Concept 1 has been established that the ratio between Natural Rent on prime sites and marginal sites of equal size can be of the magnitude of one million to one.

Under prevailing conditions at any time the Natural Rent for any site would be the Ricardian Rent based on best permissible use. This would be a constant irrespective of how the site or land is used or not used.

For the purpose of this discussion Rent will be taken as a constant and given a value of 100. The division of this Rent will depend on a number of factors, mainly percentage taxation and interest on money.

Attachment 5 gives a series of tables setting out changes in taxation and interest as a percentage of Market Value of land only and how this in turn is affected by the changes. The final distribution of Rent is different as land Market Values change.

In Concept 8 it was suggested that only 70% of the Natural Rent needs to be collected in order to match the present budget. If this is increased to 80% the additional amount could be redistributed as a Citizens Dividend or Basic Income Grant to every citizen instead of present social security, with no strings attached. This will add to Natural Rent on most properties, but not beyond the margin.

With the above in view it is useful to study the attached tables to determine what conditions allow for approximately 80% of the Natural Rent to be collected by government as revenue. See column marked 'Tr' or Taxation as a percentage of Rent.

By printing the tables and highlighting the results nearest to 80 in this 'Tr' column it becomes interesting to see what changes in interest rates, 2nd column, do to market prices.

At this point a new and simple concept is introduced.

Concept 11. Let Market Value be a Stipulated Number of Years of Taxation on Rent.

Or let 'Tr' be a corresponding percentage of Market Value.

This would give a simple formula that is easy for everyone to understand. When you pay a certain amount for the land that will represent say five years of taxation. Alternatively, when you agree to pay say $100,000 for the land you are also agreeing to pay government 20% or $20,000 per annum in place of all other taxes. See Concept 8.

Table No 6 gives a suggestion on the phasing in of an LVT. This applies where the existing interest is 12% and needs to be modified for other starting points.

Reducing interest rate to 5% and increasing Taxation to 20% gives a land Market Value of five times the annual Rent or five years of taxation. This in turn gives government 80% of the Natural Rent and leaves 20% as Economic Rent.

Since other existing taxes will be progressively removed the total amount of Economic Rent will be fairly close to what it is at present. However the distribution will change.

It is estimated that where land is being put to good use the LVT will show a saving compared to the aggregate of present taxes. Under utilized land will be faced with a large increase in annual taxation.

Comparing graphs 2 and 4 shows that a large amount of land presently beyond the economic margin will be brought back into economic use when the tax system is changed.

If a Basic Income Grant or CD is introduced it will have the effect of lowering the base line in Diagram 4 and increasing all aspects of Rent, extending the margin still further.

There will be a great demand for labour and unemployment will reduce rapidly. The economy will expand and GDP will surge ahead.