Taxing land value can lower the cost of living
The rent is too damn high
The number one cost for Canadians is housing. Be it in rental or mortgage payments, the percentage of Canadians’ incomes that are being eaten up by housing costs are ever-increasing and, for many, already unaffordable. We can reverse this trend, lowering the price of housing and ensuring Canadians have more cash equity but to do this we must replace the systemic incentives and accompanying aspirations that push housing prices ever-higher. We can accomplish this by disincentivizing these behaviours through a land rent which could lower taxes and return cash dividends to Canadians.
What is causing this?
Explanations of limited supply and increased building cost do not come close to explaining the explosion in the value of homes witnessed in the past several decades. Indeed, evidence indicates that the current housing crisis was driven by speculation rather than a supply shortage[1]. Rather, the answer to why housing is becoming more inaccessible is simple. Places to live are becoming more expensive because they’re incentivized to. The majority of Canadians are home owners and are deeply invested in the idea that their home should appreciate significantly; that it is an investment asset – a retirement plan. This belief, and the behaviours that it drives (for instance, paying more than you believe a home to be truly worth because you think it will only go up in value) are the main drivers of increased prices.
Homes lose value over time. They depreciate and require a lot of investment to maintain their value. Land however, increases in value because people are willing to pay some amount every year to use it i.e. to live or to conduct some economic activity there. As the economy becomes more productive, supporting infrastructure built and public services added, more people and businesses can make better use of land thus increasing its value. For instance, an empty lot in downtown Toronto is worth more than an equivalent parcel of arctic tundra because the community and infrastructure that surround it enable the land to be more economically productive. That value that someone is willing to pay for the use of land is called ‘rent.’ It is important to note that this rental value exists even if the owner is the one using the land. Land therefore has an annual return – it can generate this rent for the owner every year by charging others or using it themselves. As the economy grows and the productivity and value of what people can do on land (i.e. all economic activity) grows, so too does the rent that land generates. This is what primarily dictates the price of land; how much rent it will generate in the years to come.
Our homes and the housing market have become subject to this dynamic. The knowledge that increasing rents will drive increasing prices has fuelled a desire to use and purchase homes, not merely as a place to live, but as a vehicle for wealth creation, and we have created a tax system to support this. Unlike any other investment asset, the increase in value of our homes is not taxable. This makes houses the perfect place to park wealth and justifies incurring enormous debts to acquire a home in the first place. More and more of our incomes are therefore being spent on ever higher mortgages necessary to acquire a home in the first place and the rents that are charged to non-owners[2].
For most Canadians who own their homes, it can be hard to see just how damaging this dynamic has become. Despite the fact that their home values (and wealth) are increasing, it does not necessarily benefit them and can instead leave them ‘house poor’[11]. For instance, even if home values double, it is hard for those who themselves live in their property to realize this value. Indeed a 30 year mortgage a 6% would see the owner pay for the property twice over, with the total interest paid equaling the principle making it extremely difficult to realize any gains due to the property’s appreciation. As long as you still need a place to live, it's almost impossible to “cash out” because other properties will have increased in price commensurate with your own. Instead, what this means for most Canadians is a lifetime spent paying a sizeable amount of their income on mortgage payments.The result is Canadians on ever-larger mortgage debts, collectively paying nearly $33 billion in interest payments every year [12] while housing grows unaffordable to an unacceptable number of our neighbours, and we all face an increased cost of living. Indeed Canada has the highest price-to-income ratio for housing, of any of our G7 peers while more than 1 in 8 Canadians are in unaffordable housing. At the end of the day, even if high prices mean that existing land-holders experience a net increase in wealth, they do so at the cost of a higher cost of living and a reduced spending power.
This dynamic continues because it does benefit some, particularly the banking industry that helps fuel and perpetuate these behaviours. Housing prices are dictated in large part by the access to credit that will fund housing purchase: in other words, the price in a very real sense is whatever a bank is willing to lend against. This alone would not be problematic as defaulting mortgages would provide a check on the incentive to extend more credit, however mortgages are supported by taxpayers, whose government is deeply invested, through insurance and other programs, in ensuring Canadians’ mortgages do not default. This creates a cyclical dynamic wherein private credit (money) creation from banks can drive up housing prices, which are then used as justification and collateral to extend even more credit and further bid up land values.
Aside from increasing unaffordability, the attractiveness of land as an investment is also funneling wealth away from productive investments like stocks or bonds, hindering our economy. Why would you invest in a new business that produces things, employs people and creates prosperity, when a larger house will return you more?
Putting a number on it
According to Statistics Canada has shown a growth in land values of 8.3% per year since 1990[4]. However this figure hides a great deal of complexity and precisely how much land rents (and land values) grow are difficult to determine. Not all of this 8.3% growth is directly attributed to price appreciation, with some of the aggregate price increase due to new land entering into commercial, agricultural or housing use; nevertheless the figure provides an estimate of the market conditions driving higher land volumes i.e. agricultural land being developed into residential plots. Globally, over the past 70 years, housing as an investment has returned an average of 7% annually[3] with about half of this, 3.5%, being attributed to property appreciation.
Estimates from similar economies like Australia and Vermont have also demonstrated similar growth with rental values estimated as around 5.5%[5],[6].
Changing who collects the rent
What if speculating on land was not so profitable? What if instead, land was treated similar to a utility where we are charged for how much we use, like water and electricity, as opposed to land as a commodity that can be hoarded, speculated upon and inflated? If we charge a levy just below the price growth rate of land, land value would still grow but at a rate far less then other investments stocks or bonds. For instance, if the housing prices in Canada appreciated at 6.5%, we could charge an annual land rent of 5.5%.
Suddenly, there would be no more, state-backed easy money to be made in the housing market. There would of course still money to be made in real estate, by building new inventory, managing rental properties, renovating to sell, modernizing, and all the associated services; however, the incentive to speculate, hoard and park wealth in homes would disappear. This would shift how people make money in the housing market and realign profits with honest, value-adding work, work that improves our quality of life and creates better, more livable homes and communities for Canadians.
Lowering the price of housing and growing the economy
As the largest component of property values, the price of land is largely responsible for dictating housing affordability. In 1990, the value of all domestic dwellings in Canada was $564 billion while the land underneath them was valued at $290 billion. Today that dynamic is reversed: all dwellings are valued at $3.589 trillion while the land underneath them is valued at over $5.066 trillion [4].
Charging rent on the value of land could significantly lower the cost of housing and have wide-ranging economic benefits. This shift would drastically reduce the amount of money people are willing to spend investing in housing speculation, and instead shift the market incentives to better accommodate home-users rather than home-investors. Like any significant carrying cost, a levy on the value of the land would be capitalized into the market prices; buyers would be willing to pay less since they are also purchasing the associated land rents. Evidence from around the world substantiates this relationship. In Denmark, changes to local government boundaries shifted the tax authority and corresponding rates that were levied by local municipalities on land overnight[7]. As a result, housing prices fell in areas where land tax rates increased as the market immediately and fully prices in the new costs of ownership. Similarly, those areas which experienced an effective rate reduction saw property values rise proportionally as the market previously accounted for the future tax burden in the net present value of the property.
Reducing the incentive to hold land has the further benefits by significantly increasing the cost of holding vacant or underused land. This allocation issue has been explored extensively in theory[8] with research models suggesting a land rent would promote increased density and less sprawl in urban areas. These effects are compounded when the collection of land rents is accompanied with a reduction in property taxes (or taxes based on the value of structures on land). A case study of these impacts can be found in Pennsylvania where such a shift occurred. A city which shifted property taxes away from improvements and towards land saw significant increase in construction, renovation, and densification as well as a reduction of vacant or underused land compared to its control peer[9].
Finally, it can be argued that too much capital is tied up in real estate with over 76% of Canada’s national wealth tied up in real estate [13]. By reducing the revenue potential for landholders, thereby driving prices down, capital would shift to investments offering higher returns. With all this money out of the housing market, prices, debts, and rents would no longer rise at their current rates. Over the long term, as it was gradually introduced, it could wipe hundreds of billions of dollars of debt off the over $2 trillion dollars currently owed to Canadian banks, keeping more money in people’s pockets to spend and invest in the real economy.
The impacts of more efficient land use and more capital availability might be even more wide-ranging. The possibility of replacing inefficient taxes with, as Milton Friedman put it, “the least bad tax,” more productive land use, better land allocation and more available capital for productive investment; taken together promise significant economic benefits that would likely result in higher wages and a reduction of economic inequality[10].
Returning the rent to you!
Many Canadians, homeowners and renters alike might balk at the idea of a new way to fund government, but there are two important considerations. First, this levy is money that homeowners are already spending, albeit in less visible ways, as a result of the current system through their increased mortgage payments. With the adoption of a land value tax, the price of land would drop and thus the price, mortgage and interest payments associated with it. Schwerhoff notes that under a regime with a high land tax rate, the reduced mortgage obligation should be commensurate with the new land rent taxes, “Individuals would thus have to purchase the value of a house, but instead of paying interest on the credit for the land purchase, they would pay land rent taxes to the government. This means that homeowners have an unchanged stream of payments to make, but the total amount of credit would reduce significantly."[14] Renters too already incurring this cost as their rent has three components: the rental value of the land, the rental value of the structure and a profit margin for their landlord. Because the rental value of land falls in accordance with an increase of land tax rates, they too should see no change to their cost.
Second, by charging this ‘land rent’ we can collect and spend this value rather than having it disappear into the balance sheets of banks. We can in fact return these fees to all of us, in reduced taxes or cash rebates, not only reducing the cost of living but increasing our available incomes!
[1] https://betterdwelling.com/the-canadian-real-estate-bubbles-supply-shortage-myth-is-unraveling-bmo/
[2] https://www150.statcan.gc.ca/n1/pub/71-607-x/2018016/cpilg-ipcgl-eng.htm
[3] Felix, B., 2018, Housing; The Best Investment in History (On Paper). Global housing geometric mean returns (1870-2015; 1950-2015): 6.61%; 7.10%. Canadian national average housing returns (1980-2017; 2012-17): 5.64%; 7.13%
[4] Ibid. UBI Works Analysis here: Canada Land Value Time Series (1990-2022).
[5] Vermont Green Tax and Common Asset Project (University of Vermont), 2008, Valuing Common Assets for Public Finance in Vermont.
[6] Prosper Australia, 2013, Total Resource Rents of Australia: Harnessing the Power of Monopoly, p. 19
[7] https://www.zbw.eu/econis-archiv/bitstream/11159/1082/1/arbejdspapir_land_tax.pdf
[8] https://www.emerald.com/insight/content/doi/10.1108/eb028593/full/html
[9] https://openresearch-repository.anu.edu.au/bitstream/1885/116245/1/URU%20No.%2013.pdf
[10] https://www.sciencedirect.com/science/article/abs/pii/S0264837717304076
[12] https://www.fsco.gov.on.ca/en/understanding-mortgages/Pages/mortgage-business.html
[13] https://globalnews.ca/news/4775685/canada-national-wealth-real-estate/
[14] https://onlinelibrary.wiley.com/doi/epdf/10.1111/joes.12340