Land and Property Tax

Ram Singh

Lecture 3

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Locations and Investments I

A location is characterized by
Amenities such as quality of roads, transport and other facilities,
streetlights, law and order, greenery, etc.
These locational facilities in our model are captured by a vector a.
Let us assume the vector of amenities can be indexed by a single
number, a.
Take a property of land area L
Value of land depends on a
For given L and K , the value of the house will also depend on a.

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Locations and Investments II

Suppose, value of a property is can be expressed as:

V = p(a)K α L1−α

where a is locational advantage of the property

p(a = 0) = 1, p′ (a) > 0

The OP for the landowner is: The maximisation problem of the landowner :

max p(a)K α L1−α − rK

x

The FOC yields:

1

∗ αp(a) 1−α
K (a) = ( ) L
r

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Locations and Investments III
Let
t p be tax rate (per-unit) of property value
Now, the OP of the landowner becomes:

max{ (1 − t p )p(a)K α L1−α − rK }

K

The FOC yields:

1
αp(a)(1 − t p ) 1−α
K ∗∗ (a) = ( ) L
r
The tax collected is given by

T P (t p , a, L) = t p p(a)K ∗ α L1−α

Clearly, for given a,

K ∗∗ (a) < K ∗ (a)

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Locally Funded Public Good I

In view of the above:

when there is no tax and no public amenities, i.e., t p = 0 = a
1
α 1−α
K ∗ (a = 0) = ( ) L
r

Suppose:
Govt provides a but this is funded by property tax
Let g(a) be the cost of a, i.e., t p p(a)K α L1−α = g(a)
The governement first provides a and then recovers g(a)
This gives us:
1
αp(a)(1 − t p ) 1−α
K ∗∗ (a) = ( ) L
r

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Locally Funded Public Good II

Question:
How does K ∗ (a = 0) compare with K ∗∗ (a)

Is K ∗ (a = 0) >=< K ∗∗ (a)?

When should a government fund local public good with local taxation?

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Land Value Tax I
Henry George propounded the idea of land value tax (LVT)
Under LVT, THE Tax obligation is t L L
Under the LVT, the maximisation problem of the landowner looks like :
max p(a)K α L1−α − rK − (t L )L
K

The FOC for optimization yields :

α 1
K L = p(a)( ) 1−α L = K ∗
r
Clearly,
the investment K L equals its efficient level K ∗ .
The LVT is superior to Property tax
The tax revenue is given by
T L (t L , a, L) = t L L

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Land Value Tax II

Consider
two localities- 1 and 2 with different locational advantages, a1 and a2 ;
a1 > a2 . So p(a1 ) > p(a2 ),
two parcels of same size - one in each locality
tiL as land tax rate in locality i
Surplus accruing to landowners in the two regions are:

π1 = p(a1 )(K α L1−α ) − rK − t1L L

π2 = p(a2 )(K α L1−α ) − rK − t2L L

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Land Value Tax III

The optimization exercise of the landowners in the two regions yields:

αp(a1 ) 1−α
1
K1∗ = ( ) L
r

αp(a2 ) 1−α
1
K2∗ = ( ) L
r
It can be seen that π1 (K1∗ ) > π2 (K2∗ ). (You can see this from the Envelop
theorem)

The payoffs to the owner are:

π1 (K1∗ ) = p(a1 )(K1∗ α L1−α ) − cK1∗ − t1L L

π2 (K2∗ ) = p(a2 )(K2∗ α L1−α ) − cK2∗ − t2L L

If t1L = t2L , we have π1 (K1∗ ) > π2 (K2∗ ). The outcome can be non-progressive

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Land Value Tax IV

Consider t1L and t2L such that:

π1 (K1∗ ) = p(a1 )(K1∗ α L1−α ) − cK1∗ − t1L L = 0

π2 (K2∗ ) = p(a2 )(K1∗ α L1−α ) − cK2∗ − t2L L = 0

That is, the tax rates are given by:

t1L > t2L (0.1)

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Property Tax and Non-distortionary corruption I

Assume
p(a) = 1, for simplicity
V denotes the true value of the property
the owner can under-report by putting in value hiding activities
V R be the reported value on which tax is paid.
b denotes the bribe for under-reporting the property value;
V R is a decreasing function of b; the owner is successful in hiding value
equal to u(b) = V − V R (b)
V̄ be the minimum value on which tax is to be paid.

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Property Tax and Non-distortionary corruption II

Ignoring V̄ , the optimisation problem for the taxpayer/landowner now

becomes :
max K α L1−α − rK − t p V R (b) − b, i.e.,
b,K

max K α L1−α − rK − t p (K α L1−α − u(b)) − b, i.e.,

b,K

max (1 − t p )K α L1−α − rK + t p u(b) − b,

b,K

It is easy to see that

the optimal choice of activity level under corruption K c remains the same
i.e., K ∗∗ = K c .
The FOC with respect to the level of the bribe is t p u ′ (b) = 1.
Question: What is the effect of V̄ on the reporting behaviour?

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Nash-bargaining over the bribe I

Assume
the taxpayer can under-report by bribing the assessor
V R be the reported value on which tax is paid.
V̄ be the minimum value on which tax is to be paid.
Nash bargaining over bribe
In case of disagreement, the owner has to pay tax on the true value
Surplus from negotiations= Sum of agreement payoffs - Sum of
disagreement payoffs
Disagreement payoffs
Inspector: Zero
Owner: V − t p V

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Nash-bargaining over the bribe II
Agreement payoffs
Inspector: bribe b
Owner: V − t p V R − b
So Surplus from negotiations=

[V − t p V R − b + b] − [V − t p V ] = t p (V − V R )

Each agent gets half of the surplus, i.e., :

(1/2)t p (V − V R )

What value V R will maximize gains for the parties?

Exercise
Set up and solve the optimization problem for the owner. Compare the
investment level K with the first best level.

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