Credit Market Imperfections, Urban Land Rents and the Henry George Theorem

This paper investigates the impact of the credit market on urban land rents and the implications for tax policy. We introduce two credit market imperfections in the canonical urban land use model: a borrowing cost and a down-payment requirement. We first show that both imperfections lower equilibrium land prices in the most attractive locations within a city. This downward effect is more likely to occur when land is scarce as well as when cities are large and endowed with inefficient transport infrastructures. However, only the down-payment requirement generates utility differentials among homogeneous households (symmetry-breaking). We further show that the Henry George Theorem, which posits that a confiscatory tax on land rents is sufficient to finance public goods, needs to be amended in the presence of credit market imperfections as aggregate land rents are lower than public expenditures. Depending on the nature of mortgage market imperfections, we derive optimal tax schedules.