CityDAO Journal #6: Harberger Taxes on Land and Real Property - Initial Thoughts

Harberger Taxes are a set of incentives designed to ensure that the asset being taxed is always owned by the person who values it most. Harberger Taxes are useful for assets that derive their value, at least partially, from network effects (i.e., land, a billboard, or a hotel room). But for this article, I’ll focus on Harberger Taxes as applied to land, with a particular focus on its implications for housing. This specific application was popularized by the book Radical Markets by Eric Posner and Glen Weyl, who used the term “Common-ownership self-assessed tax” (COST), and partial common ownership to refer to a Harberger Tax system on land. More recently, the terms “self-assessed licenses sold at auction” (SALSA) and plural property have been used.

Harberger Tax Basics

A Harberger Tax on real property can be summed up in three principles:

  1. Every piece of property is continuously on sale with a publicly advertised price.

  2. The current owner sets the price (self-assessment), and if someone agrees to pay that price, then the current owner must transfer the property to them.

  3. To discourage ridiculously high self-assessment prices and encourage a truthful self-assessment, the owner must pay a tax to the government (or DAO) which is a predefined percentage of the self-assessed price.

Here’s a quick example to illustrate the idea.  Suppose a city sets the Harberger Tax at 10% of the self-assessed property value.  As the current owner, you can set whatever price you want.  You could set the price to zero if you don’t want to pay any tax at all, but you wouldn’t be the owner for long since the property is always on sale.   Alternatively, you might want to set a price to ensure that the property never sells, let’s say $1 billion.  No one would pay that price, but you’d have to pay 10% or $100 million in taxes every year. You’d realize eventually that it makes sense to pick a price that coincides with your true valuation of the property.  If everyone acts accordingly - assesses land and property according to their actual valuation of it - then the property always ends up in the hands of the person who values it most.

This is an extremely distilled version of a nuanced topic, and there is quite a bit of economic and intellectual history underpinning this approach. For more information I suggest reviewing the resources at the bottom, and specifically Chapter 1 from the book Radical Markets. But to sum up the origins of this theory, it’s essentially this: Economists hate seeing things go to waste (think of anytime you see a parcel sit vacant for years in a big city).  The desire to remove this inefficiency, combined with society’s frustration in seeing landowners do nothing with their property (when prospective landowners would readily buy it, invest in it, and create economic value for them and the city), led to various proposals of new tax systems culminating in the Harberger Tax.

Benefits of Harberger Taxes

Maximize Land Efficiency

Almost every major city in the United States has a housing affordability issue. Also, every major city has vacant land that has sat unused for years.  How can this be?  There are many factors that lead to vacant lots, but chief among them is that the property owner doesn’t have enough incentive to do something with the lot.  It is simply too easy for the property owner to hold onto the property, do nothing, and refuse to sell. With a Harberger Tax, these vacant lots would be put to use.

It would be too costly for the property owner to hold the property and pay the annual Harberger Tax and not do anything with it.  It would only make financial sense to develop it so that the property generates income, or sell it to someone who will.  The most obvious benefit is that it would incentivize housing creation, helping to increase supply and making housing more affordable. Exactly how many housing units would be built on a vacant property would be determined by project cost and prospective rent prices. However, it seems unlikely that a vacant lot that generates no income and still pays taxes every year would be better financially for the property owner than adding some amount of housing to the now vacant lot. Harberger Taxes ensure that every piece of land is being used to its maximum potential at any given time, and if it's not, someone else will buy it to ensure that it will.

No More Holdouts

Large public projects that require the coordinated purchase of multiple individual plots of land are another major beneficiary of Harberger Taxes.  A typical example is a high speed rail (as described in the opening vignette of Chapter 1 in Radical Markets) or other linear infrastructure project that needs to buy property along the proposed right of way.  Once owners find out that their property is in the right of way, they usually increase their asking price and hold out for more than their property is actually worth on the open market. The hold out works because the big project has already invested a lot and in the particular route, and thus the property owner can command a high price because they know it is difficult for the project owner to walk away.

This type of holdout can happen on a smaller scale too. For example, multiple townhouses on a block could be purchased by one new owner. The new property owner could demolish 10 adjacent townhouses and then combine the individual properties so that a larger apartment building could rise in its place. In this situation, a holdout can scuttle the deal, and prevent more housing from being built in cities - not because there wasn’t someone willing to build housing, but because of the inefficiency of the land sale transactions and the ability of one property owner to take advantage of the system. A Harberger Tax scheme pushes owners to be more honest about how much their home is really worth. This would be hugely beneficial for large projects, and, presumably, for the creation of public goods.

You CAN always get what you want

When you are looking to buy a home, at some point you may realize that the home you want is simply not for sale.  It may be for sale a year from now, but that is not helpful if you are trying to buy a home now.  At any given time, only a small fraction of the housing supply is for sale. There might be a house that's perfect for you, but you’ll never know because it wasn’t for sale at the exact time that you were looking to buy. Even more infuriating: maybe the family living in that perfect-for-you house doesn’t even like it that much, but that’s the house that was available when they were ready to buy, and now it’s good enough so they stay. This is terribly inefficient from an economic perspective.

A Harberger Tax scheme would solve this, because at any instant, every home is for sale. You may not be able to afford all of them, but availability won’t be the reason you can’t get your dream home.  So, if you’ve narrowed your search for homes to the perfect neighborhood that is equidistant between your work and your partner's work, and found the one home within that neighborhood that has the right number of bedrooms and bathrooms… then you can buy it! As long as you pay the price that is self-assessed by the current property owner.

Potential Problems with Harberger Taxes

Constant Threat of Displacement

Right now if you own a home and pay your mortgage every month (or better yet paid of your mortgage completely), you can feel pretty confident that you’ll never have to leave. But if you own a home in a city with a Harberger Tax? Well, you never really actually own the home (hence the term partial common ownership) and you might be forced out with just a few weeks notice.  Even if you pay your Harberger Taxes on time, as soon as someone agrees to pay the price of your self-assessment, you’d have to move out (within some reasonable time frame set by the city laws).  You could reduce the chances of this happening by raising the self-assessed price of your home, but it comes at the cost of increasing the taxes - essentially the monthly rent.  You’d probably opt for some number that will prevent most people from buying your home, but you’ll never be able to guarantee you can stay there forever. Living with that uncertainty would be really difficult and stressful. It might be 10 years before someone makes an offer, or it might be 10 days.

This fear of eviction and inability to feel settled would make a Harberger Tax tough to implement broadly across American cities. And even if it was implemented, we might expect to see a drop in health, well being, and productivity based on the growing body of research that suggests people under stress tend to perform worse academically, socially, and otherwise. This might be offset, however, by a Harberger Taxes’ ability to create more affordable housing. The stress that some people have today in finding any affordable home to live in might disappear completely in a city with a Harberger Tax.

Equity and Gentrification

Imagine a neighborhood that is 2 miles away from the urban core.  Early on in the city’s development, this neighborhood was not highly valued and therefore people with lower income moved in because that’s what they could afford.  Fast forward 10 years and the city has grown and the neighborhood is now more desirable.  Through no fault of their own, the current residents are likely to be displaced because they can only afford to pay a small amount in Harberger Taxes, and their self-assessment will be much lower relative to how new city residents value it.  It's a pretty classic case of gentrification, except Harberger Taxes amplifies it.  In “typical” gentrification, some homeowners are forced out because even though they’ve paid off their mortgage, they can’t afford the ever increasing property tax assessments.  Other homeowners are able to stay in place while the property appreciates, and if they have to sell they get an immediate windfall of cash from the ridiculously high price that their house now commands in the gentrified market.  With Harberger Taxes, the original low income homeowner would be forced out of their home the moment someone else values it more.  But there is no windfall, because they didn’t set the price at what the market valued, they set the price at what they could pay in annual taxes.

In a world with only moderate wealth gaps, Harberger Taxes would work nicely.  As your income grows, you move from one house to a new house that is a little bit better.  Suffer some kind of setback? No problem, downsize for a little bit while you recover.  But in a world with extreme wealth gaps, you could imagine very wealthy individuals who just DGAF and set exorbitant self-assessments because the exorbitant Harberger Tax is still nothing compared to their overall wealth. This example would have benefits; just think of all the public goods you could fund with this rich person’s taxes! But, while the rest of the middle class is carefully weighing their self-assessments and stressing about possible eviction, the rich can easily buy the best houses (entire neighborhoods?) and not think twice.

Ideally, when a property is owned by the person who values it the most, it also means that the property is being put to the highest and best use from the perspective of the city. The classic example here would be an enterprising individual who wants to generate income from the property, and then builds whatever will generate the most. If its housing then they build housing. If its a commercial office space, then they build office space. If you use the amount of income generated as a proxy for what the public wants (i.e. demand is high for housing, therefore the price that the owner can charge, and income generated is also high), then Harberger Taxes work nicely. If the property owner is extremely wealthy, however, they may value the property the most, but that might not translate into using the property for highest and best use from the city’s perspective. A caricature of this might be a mansion in Manhattan, next to Central Park and public transit, surrounded by high rise condo buildings. The mansion is great for the rich person, but really the city would be better off if the mansion were a high rise building where more people could benefit from the excellent location. The tax paid by the rich person would definitely offset some of the negatives here (with the tax revenue you could build a new transit line in another area of the city and create a new park), but the problem might simply pop up again in the new neighborhood.

Shift away from outright ownership

Today, when most people talk about owning property, they are typically referring to fee simple ownership, ownership of a property without limit of time. In a Harberger Tax city, you can still own a property (possess might be a better term), but your ownership has an expiration date. Maybe if Harberger Taxes were around long enough it would result in a cultural shift - towards a more fluid concept of home, and a change in what “owning” property means. But unless/until that happens, most people, at least in America, would really struggle with this shift.  Owning a piece of land - that’s yours forever and doing whatever the f*** you want with it - is a cornerstone of American culture.

The shift would certainly be hard, but even if it were accomplished, the shift away from outright ownership has its own drawbacks.  To paraphrase Aristotle, “People care best for things they own.”  If you have property that could be taken from you at any moment, you would likely think twice about whether you want to install a new deck; it might make sense for you to just switch to a new home.  Or, if you like the home, but know there’s a chance you won’t be able to keep it forever, you might decide to keep putting off a roof replacement, or getting the cheaper refrigerator instead of the upgrade that would last longer.  In theory, the constant deferred maintenance would result in the value of that property decreasing. Alternatively, if you bought the upgraded refrigerator then you should increase your self-assessment of the whole property by the difference in value between the upgrade and regular version of the refrigerator.  But, wow, it would be exhausting to have to perform this mental calculus any time you wanted to improve your home.

Why is this Interesting to CityDAO?

CityDAO Parcels as of September 18, 2022
CityDAO Parcels as of September 18, 2022

CityDAO ultimately aims at having multiple properties in real life on which to experiment. Right now,  Parcel 0 (owned by CityDAO) is purely conservation land.  But future parcels will allow some kind of development and housing, and will ultimately need a form of revenue to pay for the provision of public goods and carrying costs of the parcel. That’s where a Harberger Tax comes in. Most American cities today use some form of property or land tax to generate revenue, so the precedent is well established.  But existing taxation schemes, combined with traditional zoning systems, often fail to incentivize the development of property to its highest and best use.  Harberger Taxes offer an innovative way to raise revenue, promote development, and ensure that CityDAO real estate is being efficiently used.

CityDAO is already starting to consider the implementation of Harberger Taxes in a future parcel as part of CIP-100. Further experiments with a Harberger Taxes could help CityDAO workshop the idea and test policy questions like: Should Harberger taxes only be used to stimulate growth where it is not naturally occurring, or only in non-residential areas? To address issues of equity, should a quadratic formula be applied to the assets in a prospective buyer's wallet, or should people be limited to one buying one parcel in a Harberger Tax zone?  Operationally, who would ensure that citizens move out after their property is bought at auction?  Would CityDAO need its own law enforcement?  These are just a few questions to consider.

Further tests of Harberger Taxes would be well aligned with the idea of CityDAO as a grand experiment - as often articulated by Eric Gilbert-Williams, host of the CityDAO podcast.  Without having to subject all citizens to it, an experimental zone could help show what works and what doesn’t in the real world. And what we learn there can be applied to other CityDAO parcels, or other crypto cities as they develop.

Written by Nicholas Bonard (nicholas.bonard.eth). This article was made possible by funding from the Education and Research guild, and benefited considerably from discussion and feedback with its guild members.

Additional Resources:

Cover Image Credit: Mike Linksvayer, 2011. Vacant lot in Philadelphia, USA.

Book: Chapter 1 of Radical Markets

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