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Winner's Curse

Nic Tideman:   The Case for Taxing Land
I.  Taxing Land as Ethics and Efficiency
II.  What is Land?
III.  The simple efficiency argument for taxing land
IV.  Taxing Land is Better Than Neutral
V.  Measuring the Economic Gains from Shifting Taxes to Land
VI. The Ethical Case for Taxing Land
VII. Answer to Arguments against Taxing Land

There is a case for taxing land based on ethical principles and a case for taxing land based on efficiency principles.  As a matter of logic, these two cases are separate.  Ethical conclusions follow from ethical premises and efficiency conclusions from efficiency principles.  However, it is natural for human minds to conflate the two cases.  It is easier to believe that something is good if one knows that it is efficient, and it is easier to see that something is efficient if one believes that it is good.  Therefore it is important for a discussion of land taxation to address both question of efficiency and questions of ethics.

This monograph will first address the efficiency case for taxing land, because that is the less controversial case.  The efficiency case for taxing land has two main parts. ...

To estimate the magnitudes of the impacts that additional taxes on land would have on an economy, one must have a model of the economy.  I report on estimates of the magnitudes of impacts on the U.S. economy of shifting taxes to land, based on a mathematical model that is outlined in the Appendix.

The ethical case for taxing land is based on two ethical premises:  ...

The ethical case for taxing land ends with a discussion of the reasons why recognition of the equal rights of all to land may be essential for world peace.

After developing the efficiency argument and the ethical argument for taxing land, I consider a variety of counter-arguments that have been offered against taxing land.  For a given level of other taxes, a rise in the rate at which land is taxed causes a fall in the selling price of land.  It is sometimes argued that only modest taxes on land are therefore feasible, because as the rate of taxation on land increases and the selling price of land falls, market transactions become increasingly less reliable as indicators of the value of land.   ...

Another basis on which it is argued that greatly increased taxes on land are infeasible is that if land values were to fall precipitously, the financial system would collapse.   ...

Apart from questions of feasibility, it is sometimes argued that erosion of land values from taxing land would harm economic efficiency, because it would reduce opportunities for entrepreneurs to use land as collateral for loans to finance their ideas.  ...
Another ethical argument that is made against taxing land is that the return to unusual ability is “rent” just as the return to land is rent.  ...

But before developing any of these arguments, I must discuss what land is. ...

The way that land speculation can worsen economic efficiency is by giving land the greatest value to those who make the most foolish overestimates of the rate at which it will rise in value.  The result is that much land is owned by people who have paid more for it than can ever be recovered from its use.  This is an example of a phenomenon that economists call ‘the winner’s curse’.  The general description of the winner’s curse is that when a thing of uncertain value is sold to the highest bidder (or a contract is let to the lowest bidder), the person who wins the thing by bidding highest (or lowest) will suffer the curse of having paid too much for it (or bid too low).  The winner’s curse arises commonly in such arenas as bidding for oil leases and construction contracts.

The effect of the winner’s curse in the land market is that those who attach the greatest value to land are persons who believe that it would be unprofitable to invest in improvements to the land, because it will soon rise rapidly in value, and any improvements constructed now would be sacrificed when the higher value of land was realized.  Thus, in land speculation, the winner’s curse produces the social cost of an artificial scarcity of land for current use. ...

Since land speculation can, in theory, either improve or worsen the efficiency with which land is used, it is an empirical question as to which effect predominates.  While no conclusive evidence is available, there are reasons for believing that the winner’s curse is more powerful than the beneficial speculative withholding of land.  The first reason is casual empiricism.  As one looks around cities, it is easy to find places where vast amounts of barely improved land surround islands of intense development.  It commonly happens that land near very tall buildings has been occupied for many decades by one- or two-storey buildings, or even by nothing more than a paved car park.  This cannot be efficient.  There would have been time to fully depreciate substantial buildings while owners have been waiting for the right time to develop land.  The inefficiency of leaving such land underused is the social cost of the winner’s curse.

There is little evidence of inefficiency from premature land development.  If there were such evidence, it would take the form of recently constructed buildings being demolished for more extensive development, or possibly, in less extreme and less obvious cases, new development surrounded by recent, substantially less extensive development that could have been just as extensive as the new development if only the developers had waited a little longer.  Examples of the first type of evidence are quite rare.  Examples of the second type would be easy to miss, but still there seems to be no reason to suppose that they represent a problem of efficiency as widespread as the problem of indefinitely deferred development induced by the winner’s curse.

The second reason for believing that deferred development induced by the winner’s curse is more of a problem than premature development induced by a lack of foresight is that the latter problem can more easily be resolved by new markets.  If land should come to be taxed so heavily that people stopped speculating in land, and if it then transpired that people often lost money on their investments in developing land because they underestimated the rate at which land values would rise, then there would be a potential private market for good predictions of the rates at which land values would rise.  A person who could foresee future rises in land values (a good speculator in today’s markets) would have a comparative advantage in selling insurance against a rise in land values, and hence in land taxes, that would make current development unprofitable.  Thus, in making land speculation unprofitable, land taxation would redirect the energies of those who believed they could predict rises in land values, away from buying and holding land that they believed would rise in value, and toward selling insurance against rises in land values where they believed that there would be none.  People would be discouraged from building where land values were foreseen to rise rapidly, by the unavailability of reasonably priced insurance against rises in land taxes.  Thus the potential development of a market for insurance against rises in land values makes it unnecessary to maintain land speculation as a mechanism to secure efficient deferral of development.  The benefits of eliminating the inefficient deferral of development that is caused by the winner’s curse can be secured without foregoing the benefits of redirecting development, based on private knowledge of where land values will rise rapidly. ... Read the whole article

Nic Tideman: Land Taxation and Efficient Land Speculation

An additional social cost of land speculation was elucidated by Harry Gunnison Brown (1927). He pointed out that when it is possible to profit from land speculation, land will tend to be acquired by those who have the most extreme beliefs about how much it will rise in value, and that such beliefs will generally be more optimistic than is warranted. Economists have given the name "winner's curse" (Milgrom & Weber, 1982) to the phenomenon that those who bid the most tend to bid too much. The winner's curse can cause the whole land market to become dominated by persons with extreme beliefs about future rises in value, creating an artificial scarcity of land for current use, as those who have land wait for illusory future opportunities. The winner's curse is thereby shifted to society. ... read the whole article



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Wealth and Want
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