Property surtax the fairest way to fund services

Tax land ahead of productive capital or labour, say Joshua Gottlieb and David Green.

The B.C. government recently introduced a new property surtax that has proven controversial. Critics argue that it’s unfair, regressive, and will force homeowners to sell. But the surtax is one of the best ways to fund public services. It’s as economically efficient and fair as any tax increase can be.

This “school tax” costs residential property owners $200 per $100,000 of property value, but only on the part of the value above $3 million. It rises to $400 per $100,000 on the value above $4 million. The owner of a $4 million home pays $2,000 annually, or just 0.05 per cent of the home’s value.

Yet this tax has generated militant opposition.

To fund public services, governments should seek the best way to raise revenue. Which taxes should we increase, and which should we lower?

Economics provides a compelling answer: We should tax “economic rents.”

To understand this idea, consider an investor with $4 million. One option is to buy land. This would increase demand, and thus the price of land. But the higher price doesn’t change the amount of land available. In populated areas, nearly all land is used for business or housing, so this investment can’t change total economic output. It only makes the previous landowners richer. Owning land when demand increases is like holding a winning lottery ticket — it generates a return without doing anything productive. This is called an “economic rent.”

Alternatively, the investor can hire scientists and buy machinery to produce novel medical devices. Unlike land, the amount of machinery in the economy fluctuates. When demand for products goes up, so does demand for productive capital. That drives up the price of machinery, so manufacturing firms build more machines, which increases output.

Labour has this same feature. When wages increase, more people work.

Investors deciding between land and capital care about their personal returns. But society as a whole benefits if the investor chooses productive capital, increasing economic output.

So we should tax land rather than productive capital or labour. The amount of land is fixed so land taxes don’t reduce productivity. In contrast, taxing capital or labour reduces use of these inputs. In addition, taxing land lowers its return relative to productive capital. This encourages investors to buy productive capital instead, growing the economy.

The surtax is efficient, but is it fair? It changes payoffs after people made investments, which can feel unfair. But fairness arguments on the other side outweigh that concern.

First, the school tax captures returns to pure luck. In general, taxing the proceeds of effort — such as your salary — is less fair than taxing luck. So the school tax is fairer than the new payroll tax of two per cent included in the same budget, which affects successful businesses and workers.

Second, a surtax on houses worth more than $3 million fits perfectly with the idea of progressive taxation. Opponents highlight sympathetic retirees who spent $40,000 on a house now worth $4 million. They have earned $3.96 million and the capital gains are untaxed, an enormous advantage that renters are denied. While these owners may have low incomes now, they can defer the tax until the house is sold. Taxing this gain is not regressive.

Third, this tax mitigates the transmission of inequality across generations. Vancouver’s wild real estate market has produced some incredible windfalls, which can be bequeathed tax-free. Simultaneously, renters struggle to find basic housing. If this tax reduces the inheritance of real estate wealth, it helps equalize opportunity.

One of us is a homeowner and one a renter, so we empathize with people who see this tax — like any tax increase — as unfair. But the efficiency and other fairness arguments are compelling, so we favour the surtax.