“In general there is not, perhaps, any one article of expence or consumption by which the liberality or narrowness of a man’s whole expence can be better judged of than by his house-rent.” (WN, V.ii.e.7)

Thus far this week, we have seen Adam Smith’s four maxims of taxation (see here) and his tax treatment of agriculture (here), but what about residential real estate? That is, what about houses? Should one’s primary residence be taxed, and if so, by how much? As it happens, Smith explores “Taxes upon the Rent of Houses” in the third and last subsection of Article 2 of Chapter 2 of Book V of The Wealth of Nations (WN, V.ii.e). But Smith’s tax treatment of houses is not just about housing; it’s really about taxing the rich, making them pay their fair share of taxes:

“The luxuries and vanities of life occasion the principal expence of the rich, and a magnificent house embellishes and sets off to the best advantage all the other luxuries and vanities which they possess. A tax upon house-rents, therefore, would in general fall heaviest upon the rich; and in this sort of inequality there would not, perhaps, be any thing very unreasonable. It is not very unreasonable that the rich should contribute to the public expence, not only in proportion to their revenue, but something more than in that proportion.” (WN, V.ii.e.6)

Simply put, “house-rents” should be taxed, and since the rich devote a greater share of their income to housing — i.e. because the rich have bigger and fancier houses than the common people — it is “not very unreasonable” that the rich should pay more in property taxes. In addition, Smith argues that to the extent high property values are the result of good government, it is only fair that the direct beneficiaries (the rich) pay more in taxes:

“Ground-rents, so far as they exceed the ordinary rent of land, are altogether owing to the good government of the sovereign, which, by protecting the industry either of the whole people, or of the inhabitants of some particular place, enables them to pay so much more than its real value for the ground which they build their houses upon; or to make to its owner so much more than compensation for the loss which he might sustain by this use of it. Nothing can be more reasonable than that a fund which owes its existence to the good government of the state should be taxed peculiarly, or should contribute something more than the greater part of other funds, towards the support of that government.” (WN, V.ii.e.9; my emphasis)

But how would property taxes be calculated? What if a rich family already owns the house they live in? How would their “house tax” (so to speak) be calculated? The Scottish scholar addresses these logistical questions as follows in Paragraph 8 of this subsection:

“The rent of houses might easily be ascertained with sufficient accuracy by a policy of the same kind with that which would be necessary for ascertaining the ordinary rent of land [i.e. a formal public registry where leases are recorded]. Houses not inhabited ought to pay no tax. A tax upon them would fall altogether upon the proprietor, who would thus be taxed for a subject which afforded him neither conveniency nor revenue. Houses inhabited by the proprietor ought to be rated, not according to the expence which they might have cost in building, but according to the rent which an equitable arbitration might judge them likely to bring if leased to a tenant.” (WN, V.ii.e.8)

In other words, house taxes should be based on fair market values, on the rent a house would have obtained if it were put on the market.

Now, before proceeding any further, however, a crucial clarification is in order. Although Smith is clearly in favor of taxing the rich, he would probably be strongly opposed to a “wealth tax”. To see why, recall from my previous post Smith’s opposition to property taxes based on land values. I could be wrong, but I suspect that Smith’s critique of property taxes based on land values applies with equal force to most, if not all, proposed “wealth taxes” of our day: a wealth tax would have bad incentive effects, would invite government corruption, and would be arbitrary and unfair.

Nota bene: I will proceed to Adam Smith’s appendix for Articles 1 and 2 of Part 2, Chapter 2, Book V in my next two posts.