This article employs a real options framework to investigate the design of
taxation on both land value and development in a competitive real estate market. We
assume that developed properties reduce open space, and thereby harm urban
residents. However, ignoring this negative externality, landowners will develop
properties sooner than is socially optimal. A regulator can correct this tendency by
imposing a positive tax on development or a negative tax on land value.
Alternatively, the regulator can implement both instruments simultaneously, in
which case an increase in the tax rate on development will be accompanied by an
increase in the tax rate on land value, and vice versa.
