“The attention of the sovereign can be at best but a very general and vague consideration of what is likely to contribute to the better cultivation of the greater part of his dominions. The attention of the landlord is a particular and minute consideration of what is likely to be the most advantageous application of every inch of ground upon his estate.” (WN, V.ii.c.18)

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Remember Adam Smith’s stinging critique of landlords way back in Book I, Chapter 6 of The Wealth of Nations: “Landlords, like all other men, love to reap where they never sowed, and demand a rent even for the natural produce of the earth.” (WN, I.vi.8)? Well, landowners are not just economic parasites; they are also an important group of potential taxpayers — so important that Smith begins his substantive survey of taxation in Article 1 of Part 2, Chapter 2, Book V of his magnum opus (“Article 1”) with landlords.

[Nota bene: Smith’s general emphasis on landowners should come as no surprise, especially since agriculture was still the most important economic activity of his day. Here, I will explore the first two subsections in Article 1: “Taxes upon Rent” (WN, V.ii.c) and “Taxes which are proportioned, not to the Rent, but to the produce of Land” (WN, V.ii.d). I will turn to the third and last subsection of Article 1, “Taxes upon the Rent of Houses” (WN, V.ii.e) in my next post.]

But instead of asking, How much taxes should landowners pay?, Smith asks a different question. He asks, How should a landlord’s overall tax liability be calculated? (a) On the actual amount of rent the landlord is able to collect from his farmer-tenants, (b) on the overall value of his land, or (c) on the amount of crops his land is able to produce? Smith’s general answer to this key question is crystal clear: don’t tax the crops or value of his land; tax the rent instead. (The meme pictured below is therefore false and misleading.) More specifically, Smith provides three reasons why land taxes should be based on the landlord’s stream of income or rents:

REASON #1: INCENTIVE EFFECTS [1]

To begin, Smith explores the incentive effects of land taxes. His verdict is that a tax on the value of one’s land might be counterproductive because such a tax might deter the landlord from making any improvements to his land:

“The discouragement which a variable land-tax [i.e. a tax based on the value of land] might give to the improvement of land seems to be the most important objection which can be made to it. The landlord would certainly be less disposed to improve when the sovereign, who contributed nothing to the expence, was to share in the profit of the improvement.” (WN, V.ii.c.18)

Ditto taxes on crops, such as tithes:

“The tythe … is always a great discouragement both to the improvements of the landlord and to the cultivation of the farmer. The one cannot venture to make the most important, which are generally the most expensive improvements, nor the other to raise the most valuable, which are generally too the most expensive crops, when the church [or the government, in the case of a tax on the produce of land], which lays out no part of the expence, is to share so very largely in the profit.” (WN, V.ii.d.3)

In other words, if a landlord or one of his tenant-farmers invests extra money and labor to increase the yield or output of their crops, the tax collector (or the church in the case of tithes) will take a share of this increased output without having contributed to the landlord or tenant-farmer’s initial investment.

So, what about a tax on rents? Although Smith throws some shade on the famed Physiocrats of France for their “metaphysical arguments” (WN, V.ii.c.7) in favor of taxing rents, the Scottish scholar devotes most of Article 2 explaining why a tax on rent is “less bad” (so to speak) than the alternatives. See below.

REASON #2: INVITATION TO GOVERNMENT CORRUPTION [2]

According to Smith, a tax based on land values or on the amount of crops (i.e. the produce of the land) would invite government corruption in one form or another. Consider, for example, a tax on crops, especially one that must be paid to tax officials “in kind”:

“The servants of the most careless private person are, perhaps, more under the eye of their master than those of the most careful prince; and a public revenue which was paid in kind would suffer so much from the mismanagement of the collectors that a very small part of what was levied upon the people would ever arrive at the treasury of the prince.” (WN, V.ii.d.7)

Ditto a tax on land values:

“A land-tax assessed according to a general survey and valuation, how equal soever it may be at first, must, in the course of a very moderate period of time, become unequal. To prevent its becoming so would require the continual and painful attention of government to all the variations in the state and produce of every different farm in the country. The governments of Prussia, of Bohemia, of Sardinia, and of the duchy of Milan actually exert an attention of this kind; an attention so unsuitable to the nature of government that it is not likely to be of long continuance, and which, if it is continued, will probably in the long-run occasion much more trouble and vexation than it can possibly bring relief to the contributors.” (WN, V.ii.c.26)

In other words, a tax based on land values would require tax officials to conduct a general survey and valuation, but how accurate would their valuation be? If you were an 18th-century landowner, would you really trust the government to accurately assess the value of your land? Why wouldn’t the government inflate its value in order to squeeze more tax dollars from you?

REASON #3: FAIRNESS [3]

But Smith saves his best argument for last: a tax based on the value of land would, in the end, be arbitrary. Why? Because the Herculean task of trying to figure out the true value of all the land in a kingdom inevitably requires the exercise of discretion by government officials, and this discretion is likely to be abused. (See WN, V.ii.c.27.) A tax on the landlord’s rent, by contrast, is much more easier to figure out and is not subject to the whims of government officials.

Likewise, although a flat land tax or tithe (e.g., 10% of crops) appears to be equal and fair, the effect of such a tax would have an unequal impact on landowners. Why? Because the cost of cultivation varies wildly between land plots. On rich land, a farmer can easily pay a portion of the produce and still make a profit, while on poor land, that same land tax could wipe out his profit. (See WN, V.ii.d.2)

THE BIG PICTURE

For Smith, the main job of the government is not to micromanage the activities of landlords and his farmer-tenants. Its role is to legalize freedom, to allow landlords and farmers “to pursue their own interest in their own way and according to their own judgment”:

“The principal attention of the sovereign ought to be to encourage, by every means in his power, the attention both of the landlord and of the farmer, by allowing both to pursue their own interest in their own way and according to their own judgment; by giving to both the most perfect security that they shall enjoy the full recompense of their own industry; and by procuring to both the most extensive market for every part of their produce, in consequence of establishing the easiest and safest communications both by land and by water through every part of his own dominions as well as the most unbounded freedom of exportation to the dominions of all other princes.” (WN, V.ii.c.18)

In short, the role of the government is to open markets and promote production. The tax system should therefore be consistent with these goals, not undermine them! (To be continued …)

[1] Cf. Adam Smith’s first maxim of taxation: “The subjects of every state ought to contribute towards the support of the government, as nearly as possible, in proportion to their respective abilities; that is, in proportion to the revenue which they respectively enjoy under the protection of the state.” (WN, V.ii.b.3)

[2] Cf. Smith’s insightful discussion of transaction costs in Paragraph 6 of Part 2 of Chapter 2 of Book V of The Wealth of Nations. According to Smith, a given tax is bad if “the levying of it may require a great number of officers, whose salaries may eat up the greater part of the produce of the tax, and whose perquisites may impose another additional tax upon the people.” (WN, V.ii.b.6)

[3] Cf. Smith’s second maxim of taxation: “The tax which each individual is bound to pay ought to be certain, and not arbitrary.” (WN, V.ii.b.4)