How Does Land Value Tax (e.g. Georgism) Decouple Lease Transfer From Improvement Transfer?

Question

In theory, a land value tax (e.g. Georgist single tax), works by the government replacing property taxes with leases on land, as an incentive to invest in property improvements. This obviously works when the owner of the improvement is the holder of the lease on the improved land. However, if the land value increases, and the rent on the lease does not, the holder of the lease, in effect, privatizes the positive network externalities of others' improvements. Therefore, it is necessary that the lease not fix the rent payments for the duration of the lease and, instead, dynamically adjust them to collect (thence distribute as a social good) the increased land value.

At some point a lease holder may be unable or unwilling to pay the rent, causing a lease transfer. If his improvements are mobile, he can pull up stakes and move them. However buildings are typically fixed improvements. Hence there can occur a decoupling of ownership of a fixed improvement from the ownership of the lease on the underlying land. This would appear to be a theoretic problem with the LVT, since the new owner of the lease's right to improve the property would be constrained by the prior owner's use of the land in the form of fixed improvements.

How does LVT theory deal with this decoupling of land lease from improvement ownership with land lease transfer in the absence of improvement ownership transfer?

Answer 1

In practical terms the leaseholder will need a certain degree of certainty over her future rent payments on the lease to be able to make the investment. That’s why leaseholds often have long durations (in Germany typically 99 years). At the end of the lease the buildings become property of the freeholder. Depending on the jurisdiction the freeholder may have to compensate the leaseholder for the building. That is why leaseholds typically specify which type of building is permitted. Also the limited lease duration limits the ability of the leaseholder to actually benefit from the positive externality because her investment is already made; neither can she liquidate the increased land value at the end of the lease.

If the lease were permanent and subjected to real time land value taxes the leaseholder would have little incentive to invest. This would be equivalent to a one-year rental contract in which the tenant has a perpetual option to renew but the landlord can adjust the rent each year. It would be hard to convince someone to make a significant investment under these conditions. A solution may be for the leaseholder to buy insurance against excessive land value tax increases. But I have not heard of this in practice.