Saudi Arabia Channels the Gracchi Brothers

Facing a housing shortage of 1.5 million homes, Saudi Arabia’s Shoura Council approved a 2.5 percent tax on undeveloped land in urban areas, according to Bloomberg. King Salman has the final say, but he gave initial approval in March.

Coincidentally, shares for development companies have fallen. It could be causation, and if so, it shows that even talking about land taxes wipes out speculation.

The article offers more than one assertion that the goal is overwhelmingly stimulative and not directly revenue-related. Oil prices have fallen substantially, and Saudi Arabia has no income tax, so it’s not getting the revenue it once did. It’s almost as though the government is being defensive about the whole thing.

Another goal is increasing “middle-class homeownership” over renting. In short, Saudi Arabia is facing the same problems the Roman Republic did after the Punic Wars: restless landless citizens. The populares, led by Tiberias, and later, Gaius Gracchus, tried to force land reforms, but they were murdered by the optimates. The optimates resisted later “land for loyalty” policies, but Roman generals embraced them, hence the empire. Land-for-loyalty a good strategy so long as the majority is mollified: Promise future rents to as many—but not all, and not equally—people as possible, and you can keep your superior cut.

As for the revenue the Saudi government can expect from the scheme, as always, remember three things:

(1) Gross rent is the independent variable,

(2) Gross rent is the independent variable, and

(3) Gross rent is the independent variable.

…Which means that the final assessed land value itself is an ephemeral number. It melts away as you tax it. The gross rental value is a real, periodic quantity, e.g. per year. (And if you complain it’s an imputed sum, I offer to buy the right to that flow value from you for $1.00 until death or transfer.) Thus, a parcel that rents at $100,000 annually will have a different land value depending on how much of it is taxed. This is not to say that capitalized land values are fictitious numbers or can’t be calculated. Rather, it just means that when the Saudi government says it’ll tax these vacant parcels at a 2.5 percent rate, you need to think it through more than if it were a just 2.5 percent tax on their gross rents.

For example:

Current assessed land value: $2,000,000

Capitalization rate, no taxes: 5.0%

Therefore, current annual rent: $2,000,000 x 0.05 = $100,000.

Now let’s add a 2.5% tax on the land value:

New assessed land value: $100,000 gross rent / (0.05 + 0.025) = $1,333,333.33 land value.

NOT: 2,000,000 x 0.0725. That’s wrong!

Land-value tax revenue (which will come out of gross rent!): $1,333,333.33 x 0.025 = $33,333.33.

Tax rate on the gross rent: $33,333.33 / $100,000 = 33.33%

The $666,666.67 in capitalized land value melts away because of the tax.

Consequently, although it sounds trivial, a 2.5 percent LVT turns out to be a huge amount, depending on the capitalization rate. The lower it is, the higher the tax revenue. I’m sure the Shoura Council knows this.

The other benefit of this arithmetic exercise is answering the question: How much building is necessary to escape the tax? Answer: Trick question. The answer has little to do with the numbers; it comes up even in U.S. cities when people talk about taxing vacant parcels. The easiest way to evade the tax, onerous though it is, is to put a small, halal hot-dog stand on the property. Okay, maybe you want to put a little more on there, but if real-estate speculation is your thing, expect minimal effort.

This explains why I favor full LVT over partial measures. Even if Saudi Arabia adopts the tax and the phase-in isn’t too long, it might not alleviate the housing crisis. But it sure beats being toppled by Gaius Marius or Julius Caesar.

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