What is land value tax?

When you buy a home, you must pay property tax on that home. But in many countries, and some parts of the United States, taxes are assessed on land rather than the real property located on the land.

Land value taxes place a tax burden on land owners, regardless of the buildings, personal property, and other improvements placed on the land. Economists dating back to Adam Smith generally prefer this progressive tax to property taxes because they do not hurt economic activity or discourage development and have been shown to reduce inequality.

Defining a land value tax

To expand on the brief definition above, land value tax levies a tax on the value of unimproved land itself, regardless of what lies on the land. It’s also sometimes called a location value tax, a point valuation tax, a site valuation tax, a split-rate tax, or a site-value rating.

Today, the land value tax is mostly used in Europe and Asia, although some cities in the United States also assess it.

Understanding land value tax

Land value taxes don’t eliminate property taxes, they just eliminate the assessment of structures and other property placed on the land. Most of the time, the land’s value is taxed at a greater rate than it would in a traditional property tax system because the total potential of land where a property sits is assessed, regardless of how the owner takes advantage of the land. In that sense, land in a thriving, desirable city would be assessed at a higher value than land sitting in the middle of the woods.

In a land value tax system, when owners build structures and make other improvements to the land, the land value does not change. Rather, changes around the land are more likely to impact how the land is valued, like the addition of new businesses or a public school nearby.

Both land value and property value are calculated by third-party appraisers, so the amount assessed depends on a current appraisal.

Split-rate property tax

Some local tax authorities in the US used a hybrid land value tax called the split-rate property tax, or a graded tax. In this system, both the land and the property on the land are treated as separate entities and taxed at different rates. 

Generally, the land is taxed at a higher rate, so if the owner wants to reduce the tax burden, they’re incentivized to develop the land to its greatest value. They’ll pay more taxes on the land, but the property’s market value or business generated should offset the taxes.

Pros and cons of a land value tax

Human societies have always valued land as a premium asset. For centuries, owning land has provided entry to exclusive privileges of society, from collecting tithes from people living on the land to voting rights. It has also been a fundamental driver of inequality in society.

Because land passes from generation to generation, it’s really more of a rental for current proprietors. Only the wealthiest people can develop land to its maximum value, which is why land value taxes are seen as a more fair way to determine tax liability. Regardless of changes to the land, the tax rate remains more or less that same year over year.

In a split-rate model that taxes both land and property, someone who has built a modest home on a high-value price of land won’t pay the same in taxes as someone who has used a land plot of equal value to build a mega mansion with a pool house and a guest house. Each would pay the same land value tax, but the mansion dwellers would pay a higher tax for the property on the land. 

In practice, land value taxes generally carry the following pros and cons:

Pros

• In a pure land value tax system, property owners can anticipate lower tax bills because they’re only taxed on land, not the property sitting on it. In a split-rate system, the wealthiest pay more as they build more.

• Land value taxes encourage development because empty land is taxed the same as optimized land. Owners are incentivized to get the most value out of the land (within zoning limits), which often promotes construction of much-needed housing.

• In a pure land value tax system, landowners are not penalized for making improvements to their land or property. In a hybrid model, most landowners won’t pay significantly more in taxes unless they’ve made extravagant changes.

Cons

• Land value taxes tend to collect smaller revenues for municipalities and counties, which can lead to reduced or inferior public services and infrastructure. (Or it may force the local tax authority to assess and collect more frequently.)

• Highly taxed parcels of land may change hands frequently as impatient investors want to improve land quickly and cost-effectively just to sell it before racking up a huge tax bill.