Without tax revenue, the State would simply not have enough money to enforce laws, maintain the political system, or provide us with various public goods.

However, it would be a mistake to view taxes simply as a way of paying for things. When done right, taxation can also make markets more efficient, and people much better off as a result.

‘How Much?’ is the Wrong Question

An important part of this is the fact that what the government taxes matters just as much, if not more, than how much the tax is.

For example, when the government taxes the estates of the recently deceased, there is little to no adverse effect on productive activity.

Nobody is going to work less if their money will be taxed after their death, and their kids might actually be incentivized to work more!

On the other hand, when the government taxes something like income, people have less of an incentive to work and generate wealth, harming productivity.

Therefore, as a rule-of-thumb, when the government taxes productive activity or popular goods, it should focus on those things which won’t respond much to the tax.

This way, less productive activity is forgone, markets remain efficient, and optimal outcomes are achieved for consumers as a result.

A Good Tax Doesn’t Clobber the Poor

Additionally, a good tax is one that is progressive.

To someone with a low income, each marginal dollar is more valuable to them than to a rich person.

Consequently, in order to maximize welfare, a lower tax burden should be placed on the poor than on the rich: taxing large incomes at a higher rate, or taxing the things the rich consume more of, for instance.

The Three Things that Make a Tax Good

So, when we imagine a good tax, we should think of one that has: high revenue generating potential, a low effect on market efficiency, and a clearly progressive structure.

Without these things, the economic harms of the tax – the ‘deadweight loss’ – would likely mean that it would be counterproductive to overall welfare, and useless as a result.

A Tax to Rule Them All

Whilst there are many taxes that satisfy these core requirements, one, above all else, satisfies them better than the rest: The Land Value Tax (or LVT).

Put simply, an LVT is a tax on the unimproved value of land. ‘Unimproved’ means that the tax does not take into account the value of the things built upon the land such as factories, homes, or wells. This way, development is not discouraged.

Whilst plain on the face of it, the LVT is absurdly good at what it is designed to do.

Even Milton Friedman, a man not known for his love of taxes, called this tax the “least bad tax”.

But why?

No deadweight loss

Firstly, LVT generates little-to-no deadweight loss.

The supply of land, for all intents and purposes, is totally fixed: a country cannot produce more or less of it.

This means that, when a government taxes land value, the land can’t go anywhere and must continue to be used for productive activities in order to generate a profit.

To be absolutely clear, this is amazing.

A tax which creates no deadweight loss – no harm to economic productivity – is incredible; a true example of a free lunch.

This chart (wonkily) helps illustrate exactly how this works:

Due to the supply curve being vertical (supply of land is totally fixed), the tax does not change the equilibrium quantity and thus there is no decrease in productive activity.

The right people pay

Furthermore, notice who is paying for the tax.

Consumer surplus – the gain consumers receive when they pay a price lower than their value for it than a good’s true value – is unchanged after the tax is levied!

Therefore, all of the tax revenue comes out of the producer surplus.

Put in regular language, this means that land owners can’t pass on much, if any, of the cost of the tax on to renters; they must pay for it themselves.

Nothing not to like

In addition to LVT having no deadweight loss, then, it is also incredibly progressive.

Since the rich in America own most of the privately controlled land, it is them who will bear the burden, not the less well-off.

So, all in all, LVT completely satisfies the three criteria for a good tax we outlined. It has a high level of potential revenue generation; no deadweight loss; and is highly progressive.

Making Markets Better

As said previously, a key benefit of an LVT is that it generates no deadweight loss.

In fact, this actually understates an LVT’s potential.

Aside from being perfectly efficient, there is also reason to believe that an LVT would generate negative deadweight loss.

In other words, productive activity would increase as a result of the tax as opposed to simply being unaffected by it.

Undercover monopolies

Put bluntly, this is because land in America is not currently being put to use in its most productive capacities.

As Glen Weyl and Eric Posner point out in their radical liberal tract Radical Markets, land is quite often unique in its character and location.

Unfortunately, this fact gives landowners monopoly power, allowing them to charge prices far above what a competitive market would determine.

Due to this, land is often left underutilised for years while landowners wait idly for someone to pay the inflated monopoly price.

To give a sense of scale, Weyl has estimated that a reduction in this misallocation of land could potentially boost the annual output of the US by 1-5%.

Those numbers might look small, but since the size of the US economy is ~20 trillion dollars, a couple of percentage points is very substantial.

A free lunch for the public

Also, changing this through a well designed LVT would cost absolutely nothing. No extra spending, no debt, no nothing.

In fact, if government revenue was extracted from land values, big public goods spending programs could begin to pay for themselves.

Nobel laureate Joseph Stiglitz has shown that under often-met real world conditions, investments in public goods will increase land rents by at least as much as investment costs.

Thus, an LVT would make the provision of public goods such as public transit easier, which could make cities and towns across America more desirable and more green.

A fix for the housing crisis

Beyond public investment, an LVT could also spur an increase in private development by incentivising higher density housing and less urban sprawl.

This is because, with an LVT in place, it is costlier to own any given sized plot of land.

If you are an owner of some land in a major city like San Francisco or New York (where land is very expensive already) you will now have an incentive to lessen this cost by building as much housing as possible on your fixed plot, thereby maximizing potential revenue.

In turn, this would increase the supply of housing, lowering rents and the cost of living – helping to alleviate one of the major causes of sluggish economic growth and poverty: rent being too damn high for too many people.

Overall, an LVT would not only be progressive, but it would also dramatically increase the productive capacity of the United States.

Brass Tax

The introduction of an LVT, especially as part of a tax shift away from income and payroll taxes, could tackle so many of the issues facing our society today.

With an LVT, rampant wealth inequality would be tamed, perverse anti-growth incentives would be removed, rapidly inflating rents would be alleviated, and public investment spending would become cheaper.

The evidence in its favour is overwhelming, so only one question remains: why isn’t it already in place?