Site Value Taxes and the Optimal Pricing of Public Services

WILLIAM S. VICKREY (*) Introduction: Pricing Urban Services CITIES OWE THEIR existence to the presence of activities with economies of scale or density, and to transportation costs. With no transportation costs, activity would be scattered at random. With no economies of scale, all activity would be carried on in hamlets on a household scale to minimize transportation costs. In order to reduce transportation costs and take advantage of economies of scale, people live in dense settlements. Marginal Cost User Fees WITH BOTH ECONOMIES of scale and transport costs, it is efficient to organize economic activity unevenly over space, with cities being locations at which economic activity is concentrated. Decentralization of the efficient allocation requires pricing all goods and services, including public services, at short-run marginal social cost. The competitive free market is justified on the basis that it accomplishes this result for activities without economies of scale or where these economies are exhausted. For activities with economies of scale, pricing at marginal social cost will in general not cover total costs. A subsidy is then required if output is to be pushed to the point of taking full advantage of these economies. What should the source of the subsidy be? Here, I propose that the subsidy should be covered by a tax on site values--the value of urban locations. Marginal cost pricing of all goods and services, along with a tax on site values to finance the deficit of increasing returns activities, is both efficient and equitable. The mispricing of public services will reduce the potential benefits from urbanization. A subsidiary aim of this discussion is to examine how badly distorted the pricing of particular public services is in practice and what marginal cost pricing of these services would entail. Site Value Taxation IN ORDER TO permit marginal cost pricing of urban services, a subsidy is required to cover the fixed costs. The best source of that subsidy is revenue derived by taxing the rental value of land or sites. (2) That value is created in part by the very services for which the site value tax will pay. Taxes on site rents are therefore an efficient, equitable, and adequate method of subsidizing services that are priced at marginal cost. Site value taxation is nothing new. It is already a component of the property tax, which is actually two taxes in one. The property tax combines one of the best and one of the worst taxes we have. The portion of the tax that falls on sites or land values is the only major tax that is reasonably free of distortionary effects and is not intolerably regressive. The taxes on improvements and personal property are more difficult to assess properly. They impose excess burdens through undue discouragement of such investment. In the next section, I shall show how, under suitable assumptions, these urban site rents (over and above the rent on peripheral rural land) will be just sufficient, no more and no less, to provide the subsidies needed to supplement marginal cost pricing. Demonstrating the Principle with Models A Linear City Model In order to see why site value taxes are just adequate to subsidize urban services that are priced at marginal cost, let us consider a simple one-dimensional model. (3) Imagine a city laid out on a strip of oceanfront of uniform width. Imports can be landed and exports dispatched indifferently on any point on the frontage, but local (coastwise) transportation has a line-haul cost proportional to distance. Activities with economies of scale can be represented as having a fixed cost consisting of imports, variable costs consisting of imports, local outputs of other activities and land, all varying in proportion to output. If an activity wishes to increase the frontage it occupies, it will thereby increase the distance freight must be carried past this frontage, and require encroachment on the rural land at the edge of the city. …