Taxation and Economic Development in Free Cities

How a Free City pays for itself

Nation-states tax income, consumption and capital because those are the flows a sovereign can reach. A city that has to attract its residents starts from the other end: what does this place cost to run, and who will pay that willingly? Three answers recur across the movement.

The first is the flat rate with a ceiling. Próspera’s charter sets an effective income tax of around five per cent on individuals and roughly one per cent on companies, puts the maximum rates in the founding document rather than in an annual budget, and commits to capping total public revenue at 7.5 per cent of the zone’s economy. The second is land. Henry George’s argument that land rent is the one thing worth taxing resurfaces in Próspera’s land value tax and in Estonia’s property tax, which falls on the land and not on the buildings placed upon it. Hong Kong runs the largest version of all: nearly every plot is leased from the government, and selling those leases has helped fund an unusually light tax system since the colony’s founding. The third is the plain fee. The Cayman Islands operate a functioning government with no direct taxation whatsoever, financed by registry, licence and work-permit charges alongside import duties. Ciudad Morazán does the same thing on a single site, where nothing is sold and everything is leased, so the rent simply is the revenue.

Competition as the mechanism

Why any of this should produce better government was set out by Charles Tiebout in 1956. Where many small jurisdictions offer different bundles of services and taxes, and people can move between them, residents reveal what they actually want by choosing, and a government that misprices loses its base. Spencer Heath and Fred Foldvary pushed the argument further with the proprietary community: an owner who supplies the streets, the security and the courts and recovers the cost through ground rent has a direct financial stake in governing well, because bad governance shows up straight away in the value of the land.

Special economic zones are the nearest thing to a natural experiment. UNCTAD counted roughly 5,400 of them across 147 economies in 2019, and the best of them have transformed regions: Shenzhen went from a modest border county in 1980 to one of the largest urban economies in China.

Where the competition happens now

Tax competition is no longer mainly a contest of headline rates. The OECD’s global minimum tax tops large multinationals up to fifteen per cent wherever they book their profits, and automatic exchange of account information has made cross-border financial privacy a thing of the past. What remains is competition on everything else: how quickly a company can be registered, how long a building permit takes, whether the courts work, and whether the rules will still be the same in ten years.

That plays to the Free Cities argument rather than against it. A jurisdiction whose only offer is a lower number was selling arbitrage. One that can genuinely run a city for less, and show what the money buys, is selling governance. The Foundation has used Carmel, Indiana as a benchmark for what that might look like in practice, at roughly $1,370 per resident per year, around half what comparable American cities spend, achieved through design and coherence rather than through any special legal status.