Taxes on Buildings and Land in a Dynamic Model of Real Estate Markets

Henry George’s single tax on land is an elusive concept to implement, because land is occupied by a variety of buildings or is undeveloped. Land value is undefined since the value of the land lying under buildings is difficult to estimate and does not correspond to real market value. Therefore, it is hard to find taxes that are accurately related to land value and, hence, to the ability to pay and still satisfy George’s axiom. Static models unrealistically pretend that all the land is available in the market at all points in time. To properly treat dynamics, a generalized perfect-foresight model of real estate markets solvable by simulation is presented. Using a version of this model stripped-down to its bare essentials, the effects of the conventional ad-valorem property tax and of an ad-valorem tax on undeveloped land are analyzed. We show a new result that the conventional tax speeds up the demolition-reconstruction cycle, shortening the life span of buildings and thus resulting in excessive use of structural capital over time, while a tax on undeveloped land has the opposite effects. We then turn to the application of the dynamic simulation model to the optimal taxation problem adapted to real estate markets. In this problem a different tax rate is levied on each type of undeveloped land and each type of building to meet a desired revenue goal, recognizing the different price elasticities of demand and supply for these assets. The formulation is designed to calculate deadweight losses associated with such optimal taxation schemes.