What could be better than NO PROPERTY TAX??

Two things: (1) a property tax that motivates the government to?add?value? to your property; and (2)?a?property tax that boosts other people's capacity to pay for?your? property.

(1) Tax or commission?

If you engage a real-estate agent to sell your house, the agent will charge a percentage of the sale price as a commission. You accept this because linking the commission to the price is an incentive to get a higher price. But the incentive could be better targeted. A?simple percentage, meaning that the agent's income is proportional to the average price?multiplied by turnover, is as much an incentive to generate more turnover as to get higher prices. That's one reason why local real-estate agencies put junk in your letterbox saying that they recently sold a house in your suburb for some eye-popping amount and have you ever thought about selling yours? Not every price needs to be so impressive. Worse, getting (say) a 5% higher price takes rather more than 5% more work, causing a temptation to sit back, settle for turnover, and not strive too much over the price.

It would be better for you, as the seller, if the agent's commission were not simply a flat rate on the whole price, but a higher marginal rate on that part of the price which exceeds a threshold. And the threshold that most readily suggests itself is the price that?you? paid, which makes the agent's commission proportional to your?capital?gain. The higher marginal rate would serve as a stronger incentive to get a higher price but, due to the threshold, would?not? necessarily cost you more.

But why let the agent profit from inflation? Better still would be a higher-again marginal rate with a higher-again threshold equal to your purchase price?adjusted in line with the CPI, making the agent's commission proportional to your?real? capital gain. That would be the ultimate—from the owner's point of view.

Now here's the thing: Your real capital gain depends not only on what the agent does at the time of resale, but also on what?governments? do during your term of ownership. Moreover, it's quite possible to give governments that "ultimate" incentive to maximize your real capital gain. Indeed it's been done before, although not on the scale that would have maximized the benefit to property owners. From 1985 to 1999, Australia's Federal capital-gains tax (CGT) was levied at the full marginal rate on the?real? gain, giving the Federal Government an incentive to do things that maximized real capital gains—but only on those assets to which the tax actually applied; and because the taxable assets (not acquired before 1985, and not owner-occupied principal residences) were a small and scattered fraction of the assets that might appreciate due to government policy, the incentive was minimal and the benefit to property owners consequently diminished. In?2004, New South Wales introduced a so-called "vendor?duty" on property sales that had made a certain minimum capital gain—only to abolish it 13?months later. A?straightforward capital-gains tax would have been better for NSW property owners, especially if the State had beefed up the CGT and abolished the old purchaser?stamp?duty, whose revenue yield is more sensitive to turnover and less sensitive to real capital gains.

Indeed,?substituting a capital-gains tax for stamp duty? is surely the biggest no-brainer in tax reform. From a property owner's point of view, a?CGT not only enables and motivates the taxing government to do things that deliver capital gains, but takes only?part? of the gain, and is not payable at all unless and until you actually receive a gain. Thus a CGT, unlike a stamp duty, cannot turn a profitable purchase-resale cycle into a loss and cannot increase a loss. This in turn is one reason why a CGT has?less lock-in effect? than stamp duty. But there's a bigger reason: under a stamp duty, to "trade?up" more often is to pay proportionally more tax; but under a CGT, to "trade?up" more often is merely to pay tax in a larger number of smaller instalments. Of?course the lesser lock-in effect serves the?public? interest by allowing a more efficient allocation of addresses to owners. But even that benefit flows back to property owners because, other things being equal, a?more efficient economy has more capacity to bid up property values!

So why does stamp duty persist in the teeth of such an obviously preferable alternative? It?could be that because stamp duty is nominally payable by the buyer and CGT by the seller, the transition from the former to the latter would appear to cause a one-off disadvantage to the current owner. But that appearance would be illusory because, whoever nominally pays the tax, the market?prices it?in. A?more substantive objection is that if the seller is sitting on a big-enough capital gain, the CGT payable on the transaction under the new system will exceed the stamp duty payable under the old. If this situation is thought undesirable (notwithstanding the enviable position of the seller!), it?is easily addressed by transitional rules.

Commission for what?

Given that a capital-gains tax on property induces the taxing government to do things that deliver capital gains, what things are we talking about? In?the unlikely event that you don't know, google "follow the infrastructure" (with the quotes). There are two places in the economy where the benefit of a location-dependent service can show up in a price: the price of actually using the service, and the price of access to?locations? where the service is available—in other words,?property values. Thus the benefit of the service, net of user charges, appears as an uplift in property values.

So if (say) the State government, through a CGT on property, receives a certain fraction of each uplift in property values, then any State-funded?infrastructure?project whose cost/benefit ratio equals that fraction will pay for itself from the government's point of view, and any such project whose cost/benefit ratio is less than that fraction will?more?than? pay for itself from the government's point of view; and the untaxed portion of the uplift will be a?net benefit to property owners. Financial markets will turn the cost into a finite annuity, and the uplift in property values will cause an increase in CGT received per sale, which in combination with normal turnover will turn the benefit into an annuity with which to amortize the cost. And property owners whose properties do?not? rise in value are not lumbered with any part of the cost.

Nuts 'n' bolts

If the CGT is to replace stamp duty, the CGT rate is set so as to replace the revenue from stamp duty if infrastructure investment remains on its present trajectory—which it doesn't, because the CGT induces additional infrastructure investment, which is funded out of the ensuing expansion of the CGT?base? for the same CGT rate. This double benefit—replacing an old tax?and? increasing investment—is possible because the economy as a whole expands: the CGT closes a circuit of production that would otherwise be open.

This, by the way, is one reason why the CGT shouldn't try to distinguish between capital gains due to public infrastructure and capital gains due to other things: if?you don't tax capital gains that would have happened anyhow, you don't get revenue to replace an inferior tax such as stamp duty.

But why stop at stamp duty??There are far too many property taxes!? Most of them are less efficient than CGT in motivating governments to invest in infrastructure. Even if a tax is allegedly justified by uplifts in property values—like so-called infrastructure charges or rezoning windfall taxes—the CGT would do the job more simply and thoroughly. Property owners would be better off if all these property taxes were rolled into the CGT. Then there are?insurance?taxes, which are largely de-facto property taxes in that they are largely paid by insured property owners. Again, property owners would be better off if these were rolled into the CGT.

For that matter,?why stop at property taxes?? Non-property taxes,?by?definition, don't encourage governments to raise property values! And if all property taxes were replaced by CGT, the resulting incentive to invest in infrastructure might still be sub-optimal for property owners—in which case property owners would be still better off if still more taxes were replaced by CGT. Among Australian State taxes, the candidate that most readily comes to mind is?payroll?tax. If this too were replaced by CGT, not only would State governments have more incentive to invest in infrastructure, but the abolition of the tax on jobs would lead to economic growth, which would feed into growth in property values!

From property owners' point of view, it?is obviously possible for the CGT rate to be too high, leaving property owners without much of a share in the capital gains. But it is equally possible for the CGT rate to be too low or too narrowly based, starving infrastructure of finance, causing property owners to miss out on capital gains that they would otherwise get, and, by?default, perpetuating the existence of bad taxes that shrink the whole economy including property values. Somewhere in between there's a sweet spot.

What about affordability?

When property values rise due to improved infrastructure, the uplift in value represents improved amenity, some of which represents real savings to the occupants, especially lower travel costs for necessary purposes. The higher prices or rents look like a loss of affordability when viewed in isolation, but not necessarily when viewed against what the occupants can afford to pay or what they get for their money. Moreover a capital-gains tax, by?default, makes current income more attractive relative to capital gains, and therefore makes property investors more determined to fill their vacancies in order to realize their gains in the form of income. This strengthens the bargaining positions of prospective tenants, enabling them to get a share of the benefit.

It is trite but true that if we make a bigger cake, it is arithmetically possible for everyone to get a bigger slice. Infrastructure projects whose benefits exceed their costs make a bigger cake. How property owners get a bigger slice is obvious: the benefit of the infrastructure is shown in property values. The mechanism by which tenants also get a bigger slice is less obvious, but no less real: landlords become keener to get tenants.

There is, however, another property-tax reform that also confers benefits on both owners and non-owners, in such a way that the benefit to?non-owners is more obvious. This is the subject of the second part of my answer to the title question.

(2) The importance of affluent customers

It's no use having a tsunami of people who want to buy or rent your property if they don't have money to spend. Making property artificially scarce doesn't give them money to spend. If?they're going to earn that money, they're going to have to earn it?somewhere. Therefore if you're a property investor, you need your fellow investors to be hosting income-earning activity on their land—building on it, working on it, or housing people who build or work nearby—and not just hoarding it in the hope of capital gains. So, from your point of view, they shouldn't pay tax for occupying or using or letting their properties; but they should pay a bit whack if they're holding their properties vacant, or going through the motions of advertising for tenants but persistently failing to meet the market.

A?properly designed?vacancy?tax—applying not only to vacant properties advertised to?let, but also to vacant lots and unoccupied premises that are not on the market—motivates your fellow property investors to promote income-generating activity in order to?avoid the vacancy tax; and that income feeds the pool available to pay?you. But you can't have one rule for your fellow investors and another one for you! (Yes, I?said?avoid the vacancy tax. Imagine that: a?tax that's?meant? to be avoided!)

Now consider some other ways in which a vacancy tax helps property owners (other than incorrigible hoarders):

• A vacancy tax is good for homeowners with variable-rate mortgages because, being pro-production, it's?anti-inflationary, making the central bank more likely to?lower interest rates?and less likely to raise them. And of course the tax doesn't apply to your home, which by definition isn't vacant. (Incorrigible hoarders might pretend that a vacancy tax would somehow bite ordinary home owners, but the reason why might want you to believe that scenario is the very reason why it isn't believable: it?wouldn't be good politics!)

• A vacancy tax on one property is good for owners of surrounding properties because a neglected property tends to become a?nuisance that reduces the amenity and value of surrounding properties. It may get overgrown with grass and weeds, fall into disrepair, become an eyesore, attract rubbish, rats, snakes, squatters, drug dealers... Abandoned properties are a NIMBY issue! Indeed, vacancy taxes are also called?dereliction?taxes.

• In any locality, a vacancy tax on residential property is good for commercial property owners because it keeps nearby residential properties populated with prospective customers and workers.

• In any locality, a vacancy tax on commercial property is good for residential property owners because it keeps nearby commercial properties populated with employers and service-providers. It's?good even if you're a commercial property owner because it keeps nearby commercial properties populated with complementary businesses that will attract foot traffic to?your??property!

• If you're a property owner, you have interests not only as a property owner but also as a consumer, probably as a worker, possibly as an employer, and certainly as a general taxpayer. As?a consumer, you stand to gain from more competition in supply of goods and services as more commercial sites are vacancy-taxed into use. If?you're a worker, you stand to gain from?more?jobs—including?closer?jobs and?shorter commutes—from the same source. If?you're an employer, you stand to gain from greater availability of commercial premises from the same source. And as a general taxpayer, you stand to gain because?avoidance? of a vacancy tax requires economic activity, which expands the?bases? of other taxes, allowing their?rates? to be lower.

• If a vacancy tax, which encourages efficient use of land, is combined with a capital-gains tax, which pays for location-specific government services, the two together satisfy the chief rationales for property taxes and therefore help to make a case against any additional property taxes.

And of course a vacancy tax is good for?real-estate agents?because it generates more rental-management fees or—if owners decide to sell rather than let—sales commissions.

Affordable aspiration

It is hardly necessary to point out that a vacancy tax, by reducing property owners' tolerance for vacancies, strengthens the bargaining positions of prospective tenants and buyers. Indeed vacancy taxes were originally invented as an affordable-housing measure and are usually promoted in that context. I've even indulged in some of that promotion myself. In so doing, however, I?have been keen to emphasize that in view of the above benefits to owners, the competitive advantage conferred on tenants and buyers is not a zero-sum game. We?can have a property market in which owners are doing well?because? tenants and prospective buyers are doing well. Taxing locations?into use is another example of making a bigger cake so that everyone can have a bigger slice. And if no nation ever taxed itself into prosperity, that might be because no nation ever had the good sense to tax the obstacles to prosperity instead of the engines of it.

Moreover, the very fact that a vacancy tax enhances affordability is itself an advantage to owners in three ways. First, it's part of the?anti-inflationary? mechanism which tends to?reduce interest rates. Second, it addresses the equity side of the tax debate, making it easier to build the rest of the tax system for simplicity and efficiency, with benefits to property owners in their capacity as general taxpayers. Third, it's a substitute for that other purported affordability measure—rent control!—which is manifestly worse for owners because it does not raise the spending power of tenants and buyers, but rather suppresses aggregate spending power by reducing the aggregate supply of accommodation for productive purposes (taking down tenants and buyers in the process).

If the vacancy tax is apportioned to the value of the underlying land, the incentive to use a site productively is apportioned to its potential productivity. If?the threshold of "occupation" (for avoidance of the tax) is higher for higher zoning, the incentive to use sites productively becomes an incentive to use more productive sites?more? productively. This incentive, in combination with a capital-gains tax that induces governments to supply supporting infrastructure, becomes a potent driver of the creation of wealth; and wealth, as property investors know, tends to find its way into property values.