It is a generally accepted principle that a tax on land values is capitalized, and that sufficient allowance is made in the purchase price that the burden of the tax continues to remain on the individual who owned the land when the tax was levied. An example will make clear how this principle is supposed to work. A man contemplates buying a farm, and calculates that the net income from its operation would be about $2,200, which, capitalized at the current rate of return on similar investments, say 5 per cent, would make the value of the farm $44,000. In these figures, however, he has neglected to take into account the annual tax of $200. When this is considered the annual net income is reduced to $2,000, which, capitalized, will give a valuation of $40,000 that the purchaser will be willing to pay. He keeps the additional $4,000 that he would have been willing to pay for the farm had there been no tax, to endow permanently the annual tax of $200. The seller, by being compelled to accept $40,000 instead of $44,000, has borne the burden of the $200 tax as long as it exists.
It is possible that the supposed purchaser of land may want to sell his purchase. He does not feel the effect of the tax as did the original seller. The income, less the tax, will still be the same, and the selling price will be the same as the purchase price so far as the tax is concerned. The tax has been paid year after year, yet the owner of the land has felt no burden of it. It is often asserted, therefore, that the burden of a tax remains upon the owner of the land at the time of the levy, and is burden-less upon all future purchasers. In other words, a tax on land values cannot be shifted to the purchaser.
Tax on Land Values. - It is generally believed that an increase in taxes on land values is often shifted by the landlord to the tenant through collecting a higher rent. A correct understanding of the nature of rents will reveal the fallacy of such thinking. Students of economics are familiar with the differential nature of rents. They represent a surplus which belongs to the owners of the better grades of land. Rent represents the difference between the return from these better grades of land and the return from that grade of land which it just pays to cultivate at the prevailing prices for the products from the land. This marginal grade of land has no rental, hence no capital value to be affected by a tax. Before a tax would lessen the amount of land under cultivation it would have to be 100 per cent of this rental surplus. A tax upon values, then, would have no effect upon the amount of land used for cultivation. The tax, on the other hand, in no way affects the demand for the products from the land, hence prices and the differential advantage, in rent, will remain the same as without a tax. Land is no more or less desirable to a tenant after a tax levy than before.
It may appear, sometimes, that the landlord shifts the tax in a higher rent charge. If, for some reason, the tenant has not been paying the full differential surplus, then it may be possible for the landlord to raise the rent and think he is shifting the tax. What he does, however, is to get more or all of the surplus which he should have been getting before because of the differential advantage of his land. The landlord, then, must bear the new tax, which makes the land a less desirable investment than it was before the tax was levied. Demand will fall off for this class of property, with a consequent fall in the price of land values. Again it is seen that the burden of such a tax once and for all falls upon the owner of the land at the time of the levy.
Specific Tax on Land. - A specific tax on land would have very different results. Here the demand and supply relationship would be changed, which would result in price changes through which the shifting of the tax could be accomplished. Suppose a new tax of $10 an acre to be placed on agricultural lands. The poorest land under cultivation, however, has just been remunerating capital and labor for the energy expended in production. Again the imposition of the tax makes the products no more desirable, and capital and labor cannot afford to continue to use this land, but will seek other fields where it will be properly remunerated. This action causes a decrease in the amount of products put on the market, with a corresponding rise in price. Through this price change the owners of lands which will continue to be cultivated will partially recoup themselves for the $10 an acre tax.
Tax on Nonreproducible Goods. - General taxes on non-reproducible goods have the same characteristics as taxes on land. They are capitalized by a prospective buyer and the purchase price is so modified that the burden rests on the owner at the time the tax was levied. A tax upon bonds previously exempt would be offset by a decreased selling price. Suppose, for example, there were no taxes on 5 per cent bonds, and that under this condition the bonds were selling at par. The government now places a tax of 1 per cent on this class of bonds, which reduces the return to 4 per cent. A purchaser will consider only such a figure as will bring him 5 per cent on his investment - that is, he will be willing to pay no more than 80 for perpetual bonds. The seller must take a 20 per cent discount because of the tax. A tax on such non-reproducible goods as pictures, curios, etc., would have the same effect. The levy of a tax does not increase the desire for the goods, the purchase price will be decreased, and the burden remain on the seller. If the tax were a local one, however, rather than general, it might be evaded by moving the goods. Herein lies one important difference between such goods and land.
From these apparent results of a tax on land and other nonreproducible goods, it appears from the standpoint of justice that such taxes should be permanent rather than temporary. Not all property changes hands within a given period. A temporary tax would be unjust to those transfers which were made while the tax existed, because the burden of future taxes would be saddled upon the transferor, while in a preceding or succeeding period of no tax the burden would be entirely different. The same principle applies to the taxation of inheritances. An inheritance tax should be permanent so the burden on inheritances made at different times will not be different.