Georgism, in theory

Last year, Astral Codex had a series of interesting posts on Georgism. The claims felt very counterintuitive to me, so I dove into it until I could at least sort out the theory. And I emerged with a better understanding, which I think would be useful to share here.

Key points:

  1. In theory at least, Georgism is correct that a land tax will not cause rents to rise.

  2. Land will become cheaper to buy, and there will be more pressure to use it in an economically viable way.

  3. The economy as whole will benefit.

  4. However, a land tax will not cause rents to fall, either. Indirectly, the better economy may cause them to rise, in fact.

For those who are deep into economic models, you can see a Georgist land tax as causing a deadweight loss in a situation of perfectly inelastic supply—ie no deadweight loss at all, and all the tax will be paid by the inelastic supplier. For a longer explanation, here’s the rest of the post.

Marginal rents and taxes

Adage: If you want less of something, tax it.

Quick quiz: if you tax cars, does their purchase price go up or down?

Well, if you put a sales tax, paid when the car is bought, then the price will go up. If you put a road tax, paid every year by the car owner[1], then the price will go down (since it’s now more expensive to own the car, hence less interesting to buy it in the first place).

Second quiz: suppose you have a nice community of a hundred renters, in identical homes. The rents are reasonable, and everyone renting is much happier to live here than anywhere else. What will happen to the rents?

They will rise, of course. As long as everyone renting prefers to live here than anywhere else, then they will continue to stay here even as the rents rise. And so, rise they will. And they will continue to rise until… until someone living here finds them too high, and moves away. At that point, they stop rising[2]. So the rent price is determined by the person who is just on the edge of moving away. In economics, this is what they refer to when they talk about the “marginal buyer[3]”: the gal or guy who thinks “this is not a very good deal; I could go either way on it”. That unsatisfied marginal renter is the one that determines the price.

And, once the prices have reached this level, the landlords can no longer raise rents. Maybe I pay €1,000 for a rental that I value at €1,500. Then the landlord might be tempted to charge me, say, €1,250. But if they do so, then I can just go to another landlord and offer them €1,125, which they will accept. Because of this, my landlord will not raise my rent. If we ignore transaction costs and moving costs then the same will happen if my landlord increase the rent to €1,002: I’ll offer another landlord €1,001.

So if my landlord wants to have anyone in their house at all, they have to price it at €1,000, like everyone else[4].

What happens if we charge a yearly tax to all the landlords in the community? Well, some of them will decide to move out of the rental business, there won’t be as many rental properties, rents will rise and...

Ok, what happens if we charge a tax to all the landowners in the community? Then landlords won’t move out of the rental business, as that doesn’t gain them anything. And they can’t raise rents. Those are still determined by the marginal renters: if the landlords increase rents, their properties will stand empty.

Ok, so rents won’t rise. What about land prices? These will fall. Just as with road tax example above, if owning land is less profitable, then it will be less expensive[5].

I haven’t said anything about the level of this yearly tax. You don’t want it so high that the landowners just abandon their land; but any amount below that will do. This is where the “ground rent” tax comes in: over the long term, the amount you can tax without causing people to abandon their land is based on the value of the land if there were nothing build on it.

Georgism in theory

If you’re like me, then at this point in the argument, you’d be highly suspicious. The argument seems to work, as far as it goes, but the conclusion is very counterintuitive. What is the trick that makes the magic happen?

One “trick” is that, in the tradition of spherical humans on airless frictionless infinite planes, we’re making simplifying assumptions and assuming everyone is rational, informed, and that there are no transaction costs. And I’m going to mainly keep that assumption, because I want to see how Georgism could possibly work in theory, which is already counterintuitive enough, before worrying how it works in practice.

So, if I did the argument above with, say, car rentals, then it would be false. Even if I raised a road tax paid by any car owner, then car rental prices would go up (everything else being equal). Why? Because there would be fewer car rentals available. Why? Because there would be fewer cars. Why? Because cars are less valuable to own and won’t sell for as high a price, so people will produce fewer cars.

And that’s where land differs. Georgists often say that land is special because you can’t make any more of it. Another way of looking at it is that you can’t make any less of it. You can tax it to whatever extent you feel, without causing any of it to disappear. As long as you tax the land itself, and not any development, change, rental, or anything associated with the land, you’re good.

In another universe, where cars were indestructible artefacts left by a long-dead alien civilization, and you could reclaim land from the sea at trivial cost, the equation would flip. Georgism would apply to cars and not to land.

Georgism doesn’t hurt OR help rents

This brings me to the most surprising part of my analysis. When people talk about it, Georgism often seems to have a moral dimension, contrasting the lazy rent-seeking landlord with the oppressed tenant. And while land taxes would hurt the landlord, they wouldn’t help the tenant at all.

Why? Because the supply and demand argument runs in reverse. A land tax will not make landlords raise rents, because the supply is constant and the demand is unchanged. But it won’t make them lower rents… because the supply is constant and the demand is still unchanged.

So Georgism won’t help tenants directly. It would help the economy, by redirecting taxes from inefficient sources. It would help governments raise revenues and hence provide services without distorting the economy. But it would not lower rents. In fact, if it makes the area more economically viable and a better place to live, it will end up raising rents, because the demand will rise.

So if you want to reduce rents, all the usual methods apply – remove restrictions on land use, encourage higher density housing, and all that jazz. Georgism is not a shortcut through that problem.

  1. ↩︎

    Real road taxes are only paid if the car is used, but we’ll ignore that detail here.

  2. ↩︎

    Unless someone else moves in and is willing to pay the increased price.

  3. ↩︎

    Marginal renter, in this case.

  4. ↩︎

    This is the picture for identical properties. For non-identical properties, it’s more complicated, but ultimately is still the marginal buyers that determine the rent levels. If everyone is very happy with their rents, those rents are too low, and will rise.

  5. ↩︎

    You might think that, with rents the same but land prices falling, more renters will instead buy rather than renting. But remember that this property now has a yearly tax on it: it’s cheaper to buy, but more expensive to live on. The effects will tend to cancel each other.