A Critique of a Critique of Georgism
by Fred E. Foldvary, Senior Editor, 11 June 2012In February 2012, economist Bryan Caplan wrote “A Search-Theoretic Critique of Georgism” summarizing a working paper by him and Zachary Gochenour. This paper is interesting both because the authors deem Georgism important enough to critique, but also because the critics of geoism keep on having the same misunderstandings.
Bryan’s summary critique is that “A tax on the unimproved value of land distorts the incentive to search for new land and better uses of existing land.” This is false. By economic definition, what is “nature” is what is prior to human action. Land means natural resources, and the value of a natural resource is apart from the value added by human action. The economic rent of land is the market rental paid by a tenant minus the costs needed to put the land to its best use. Those costs include the search, analysis, and organization provided by the entrepreneur.
Caplan writes, “Imagine the long-run effect on the world's oil supply if companies stopped looking for new sources of oil.” It is a waste of time to imagine this, because a tax on rent would not have that effect.
Oil has a global market price, and the profit from oil extraction is the revenue -- the price of oil times the quantity sold -- minus the costs. The economic rent of the land containing the oil is the market value of the oil minus all the typical costs involved in extracting the oil. This is put into practice by a competitive leasing of areas containing oil to companies that explore for and extract the oil. When an oil firm bids a lease amount, the lease rent is its estimate of the surplus left after accounting for the typical costs of production.
Much of the production of oil, natural gas, and minerals comes from long-established sites. The exploration costs have long been amortized or paid for, and now the economic rent is the value of the resource minus the on-going typical costs, including the normal return on capital goods. There is no disincentive to explore new lands or to improve the productivity of existing operations, because a tax on economic rent only taps the surplus beyond normal costs.
Critics of Henry George have also made the opposite claim, that taxing most of the land rent would make companies extract water, oil, natural gas, and coal too quickly. If a firm has to pay a tax on the value of materials in the ground, they will extract it as quickly as possible. But that assumes a simplistic and foolish implementation of land-value taxation. These critics think that Georgists or geoists are fools who can’t even do the economic analysis that a student would do on the third week of his first economics course.
Properly tapping the economic rent of material land requires a sophisticated policy. A tap on that land value would include bids for leasing land and a lump-sum monthly tax on the estimated economic profit of the current extraction, based on the current price of the resource. The economic profit equals the revenue minus all costs, both explicit and implicit, including normal returns on assets. Possibly the economic profit could be zero, the operation providing only a normal return on the labor and capital goods.
The periodic lump-sum (a fixed amount of money) payment would provide an incentive to be efficient, since the marginal tax rate during that time would be zero, i.e. there would be no tax on extra profits, thus providing an incentive to minimize costs and maximize productivity. So the tap on the economic rent of oil extraction would not be based on the value of the oil reserve but on the anticipated surplus -- the leasing bid -- and on the economic profit from the extraction.
Caplan writes, “Suppose you could find a $1 [million] well by spending $900 [thousand] on exploration. With a 99% Georgist tax, your expected profits are negative $890 [thousand]. This is just another example of Tolstoy’s observation that nobody really argues against Henry George; these arguments are based on misunderstandings. The value of the land would be apart from the human action that costs $900,000. The $1 million of site value would be composed of $900,000 of capital goods and $100,000 of land. Evidently Caplan uses a physical definition of land, the physical oil, rather than the economic definition of land value, i.e. apart from the value of the human action needed to put the oil into productive use.
In their working paper on the same topic, Bryan Caplan and Zachary Gochenour write, “we have not complicated the models by differentiating between improvements and the land's ‘unimproved’ value. Information about the land can be considered an improvement in its own right.” Yes, information about land from search is capital good improvement, and the essence of George’s analysis is to differentiate labor and improvements from the value not provided by the title holder. By omitting the essence, the authors are beating up a straw man.
References Caplan, Bryan. 2012. “A Search-Theoretic Critique of Georgism.” Library of Economics and Liberty. To read more
Caplan, Bryan and Zachary Gochenour. 2012. “A Search-Theoretic Critique of Georgism.” Working paper. To read more
-- Fred Foldvary
Copyright 2010 by Fred E. Foldvary. All rights reserved. No part of this material may be reproduced or transmitted in any form or by any means, electronic or mechanical, which includes but is not limited to facsimile transmission, photocopying, recording, rekeying, or using any information storage or retrieval system, without giving full credit to Fred Foldvary and The Progress Report.
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