We have argued in this chapter that it is difficult to find taxes that are efficient—i.e. taxes that do not give rise to a deadweight loss. Economists have long pointed to one exception to this proposition: taxation of land.
A: Suppose a particular plot of commercial land generates approximately $10,000 in income for its owner each year into the foreseeable future.
(a) Assuming an annual interest rate of 10%, what is the most that you would be willing to pay for this land?
(b) Now suppose the government announces that, from now on, it will impose a 50% tax on all income derived from land. How does your answer regarding how much you would be willing to pay for this plot of land change?
(c) If you currently own this land, how are you affected by this tax? Is there any way you can change your behavior and avoid some portion of the tax; i.e. are there any substitution effects that might arise to create a deadweight loss?
(d) If you currently don’t own this land but are about to buy it, how are you affected by the imposition of this land tax?
(e) True or False: Regardless of whether the current owner of the land keeps it or sells it tome (after the announcement of the tax), the current owner effectively pays all future taxes associated with income from this land.
(f) In light of your answers above, how is this example of an efficient lump sum tax?
B: Consider the more general case where a particular plot of land yields $y in annual income.
(a) What is the value of this land assuming an interest rate of r?
(b) Now suppose the government announces a tax rate t (with 0 < t ≤ 1) that will be levied on income obtained purely from land. What happens to the value of the plot of land?
(c) Who is affected by this—current land owners or future land owners?
(d) Suppose the government decides to set t = 1 —i.e. it announces that it will from now on tax income from land at 100%. What happens to the price of land?
(e) Defend the following statement: A 100% tax on income from land is equivalent to the government confiscating land and asking for annual rental payments — with the present value of all future rental payments equal to the previous price of the land.