The Consumption of Land
by Fred E. Foldvary, Senior Editor, 29 April 2013Consumption has a more specific meaning in economics than in ordinary language and accounting. In national accounting, consumption means the purchase of household goods. When a person buys food, shoes, television sets, and cars, that is counted as consumption.
But in economics, consumption means the using up of economic value. That is the meaning in ordinary language when we say that fire consumes wood. When you buy food, it is not consumed until you have eaten it or until it spoils. A car gets consumed as it loses value from depreciation, due to the wear and tear and also as newer cars have the advantage of better technology, reducing the relative value of older cars. Services are consumed soon after or at the same time as they are produced.
Economics also has a specific meaning for investment. In finance, or ordinary language, the purchase of an asset is considered an investment, so one “invests” in stocks, bonds, and land. But in economics, investment means the production of capital goods, and also of human capital, that has market value. All produced goods are investments if they can be sold at a positive price. Capital goods are wealth that has been produced but not yet consumed.
Therefore a building is an investment, as is a car, a computer, and even a can of corn. Education is an investment in human capital. But land is not an economic investment, since it has not been produced by human action. Likewise, stocks and bonds are not economic investments. Stocks represent ownership shares in a business, including its investments in capital goods, but also as shares of its land value and human capital. Bonds are loans to enterprises or governments, some of which may be invested, but the funds might also be spent for consumption such as services.
Does land get consumed? Yes. The purchase of land is not consumption, but the payment of rent for the use of land is for consumption. The space itself does not get used up, and the natural materials in that space might not get used up. The space and materials are consumed as a flow of site services during time. That flow of services generates rent. Space provides the services of a place in which to put things, at a favorable location, and the use and enjoyment of a location. Every hour, the land provides a spatial service that is consumed while it is generated.
The same economics applies to land used for commercial purposes. That land too provides the services of location and spatial extension. The land rent is paid for that consumption. If the land is owner occupied, then there is an implicit rent equal to the explicit rent that would be paid by a tenant to a landlord.
In the US national income and production accounts, it is recognized that housing provides the same services to owner-occupants as to tenants of landlords. The rental value of housing is included in the gross national product. The services of residential land are included in national output. But the implicit rent of government-owned land is ignored. The rent of commercial land is not explicitly calculated, but is implicitly and imperfectly included in the income of landlords, in property taxes, in mortgage interest, and as part of the profit of landowning firms.
Those who seek to replace the taxation of income with the taxation of consumption overlook the consumption of land. They seek to tax consumption in the accounting sense, as the purchase of goods, rather than the economic sense. Their consumption tax properly excludes the purchase of land, but is biased in not also tapping the economic rent of land as consumption.
The taxation of consumption is equivalent to the taxation of production. If a service such as a hair cut is taxed as consumption, it is also taxed as production, as the barber is producing a better looking head of hair. If food eaten in a restaurant is taxed as consumption, it is also taxed as meals get produced from the ingredients and other inputs. If there is a sales tax on the purchase of a car, it has the same economic effect as a value-added production tax on the maker.
The economic difference between a tax on production and a tax on consumption involves saving and borrowing. When income is saved, consumption is postponed, and the saver received interest. A tax on the interest reduces the reward for saving and generally reduces saving. In contrast, when one borrows funds to buy an item such as a car, one pays interest, so a tax on the car increases the borrowing and increases the payment of interest. A tax on the purchase penalizes borrowing.
There is no good economic reason to promote or to inhibit either saving or borrowing. What is best for the economy is to tap non-labor production so that workers keep the value of what they produce and thereby have the maximum incentive to produce and invest, or else to engage in leisure if that has more value to them.
The non-labor production is the generation of land rent. We maximize social consumption by maximizing the land rent, while avoiding reducing the consumption of produced goods, including services and also including the service of leisure. We consume leisure by engaging in less labor, and we purchase leisure by giving up the wage that would be earned from labor during that time interval.
Those who seek to tax consumption to avoid taxing production should logically be in favor of tapping only land rent for public revenue, because the taxation of the using up of goods is equivalent to taxing their production. Thus the advocates of taxes on consumption have not thought it through. Once they understand that land is also consumed, they must either become advocates of public revenue from rent, or else admit they what they really seek is not the taxation of consumption, but the implicit subsidy of rent to landowners.
-- 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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