The Need For a New Economic Paradigm
|January 9, 2007||Posted by Christopher Thacker under Archive, Progress Report, The Progress Report|
How Economic Systems Really Work
The Need For a New Economic Paradigm
We are pleased here to present a paper by Chris Thacker. It is far longer than the average article at The Progress Report, but we want to give our readers the full presentation and you will find a lot of good food for thought here. Please let us know your reactions. The failure to understand the unique qualities of land is a key cause of both the boom-slump business cycle and the wealth gap in a free market economy, and only by understanding land while regulating it properly with a land value tax can these two flaws be eliminated from the free market economy.
Abstract: Economics is undoubtedly one of the most important studies the human race can investigate. The world has scarce resources necessary for human life, and if the human race wishes to live on a peaceful planet then the human race must ensure an economically sustainable resource system prevails.
Today’s economics is shameful. Poverty is rampant, political leaders bow to a fistful of dollars, and economics has earned the painfully true title: “The Dismal Science.” Where is the “…liberty and justice for all” as promised in the American pledge of allegiance to the flag? Perhaps the pledge should have the following words added: “Someday, so help me God.” The general public has become disillusioned with government and public policy. Furthermore I am convinced most economists do not understand economics. If all the world’s economists were lined up in a row and asked the same question none of these “experts” would agree on a solution, or even agree on what is the root problem.
Few have ever asked “Why?” Why ask why? Only by understanding “why” can society find the root cause of its toilet-flush-like decline and propose a long term solution to long term troubles. Otherwise politicians will propose short term political “band-aids” which will last long enough to get through the next election. Surely something better exists. Maybe someday society will find a better understanding of economics. …Someday, so help me God.
During the past two centuries, a new phenomenon has emerged which has radically and permanently transformed society: free market capitalism. Birthed by the writings of famous classical economic philosophers such as Adam Smith, the free market economy now is finding its way around the globe. The results have been dramatic increases in wealth to individuals and governments.
According to classical economists such as Adam Smith, whom many economists consider the “Father” of Capitalism, all wealth can be divided into three parts, each arising from its respective source: land yields economic rent, labor yields wages, and capital yields interest. Such division of wealth is often referred to as the functional distribution of wealth (www.henrygeorge.org). Land rent is created by nature and society while wages and interest are created by individuals (www.henrygeorge.org). Functional wealth distribution should not be confused with personal wealth distribution as often happens. For example profit, which is the ultimate goal in a free market economy, is a matter of personal wealth distribution. Profit is personal, not functional distribution of wealth because it involves the return to all three of the factors of production in any combination (www.henrygeorge.org). These consistent definitions will be significant in the below analysis.
Despite such amazing increases in wealth, the free market economy has had numerous struggles since its inception. As book critic Geoff Forster noted in the Autumn 1999 edition of Land and Liberty (9), even though the western capitalistic style works more efficiently than socialism or communism, it involves two basic weaknesses: a) the boom-s1ump-boom cycle; and b) the growing gap between rich and poor.
What is the cause of these two fundamental flaws in an otherwise efficient resource allocation system? The answer can be traced to an open letter by dozens of economists to Mikhail Gorbachev in 1990-1991, urging him to create a public finance system where “…the rent of land be retained as a source of government revenue” (www.taxreform.com.au/russian.htm). The letter reaffirms that a market economy will greatly enhance the people’s lives, “but there is a danger that you will adopt features of our economies that keep us from being as prosperous as we might be. In particular, there is a danger that you may follow us in allowing most of the rent of land to be collected privately.” As noted in the letter some market economies collect only a small portion of land rent, which results in “…unnecessarily great use of taxes that impede their economies — taxes on such things as incomes, sales, and the value of capital.”
Exactly why did these economists urge the leader of the USSR to pay special attention to land values? The answer would be, according to Wylie Young, author of Antidote for Madness, that land has unique qualities when compared to labor and capital (Young 9). An American economic philosopher named Henry George clearly brought this matter to the public’s attention over one hundred years ago (www.henrygeorge.org) and proposed a “Single Tax” on all land value to better regulate the unique qualities of land in a free market economy. Before further analysis an explanation of these differences must be given. The failure to understand the unique qualities of land is a key cause of both the boom slump business cycle and the wealth gap in a free market economy and only by understanding land while regulating it properly with a land value tax can these two flaws be eliminated in the free market economy.
First, land is not produced by anyone therefore it has no production cost, while labor and capital are produced by someone thus always having a production cost (Young 9). Secondly, referring back to the Gorbachev letter as to why land has unique value, “The first is the inherent productivity of land, combined with the fact that land is limited. The second source of land value is the growth of communities; the third is the provision of public services.” Next, land values increase sometimes by hundreds or thousands of percentage points beyond the starting point but labor and capital never appreciate so rapidly and in fact labor and capital often lose value over time (Young 12-13). Another difference is if taxed high enough land actually becomes cheaper for people to buy, whereas taxing labor and capital in any amount always increases their respective costs (Young 12-13). If taxed high enough the rent land yields will remain the same but prices can stabilize or decrease (Young 9). In regards to taxes land is unique in that taxes on land cannot be shifted to other people while taxes on other items are always shifted to other people, the final result being the consumer paying a higher price than necessary (Young 9). By “shifting” Young means passing the burden of the tax on to the consumer in the form of higher prices. Consider this example from the Americans for tax reform web page (www.atr.org/taxbites/bread.htm): In 1995 nearly 30 different taxes existed on a simple loaf of bread. In 1995 the average cost of a loaf of bread was $1.09 and 31% of that, or $0.35 was pure tax.
Land is particularly different from capital (especially buildings) with regards to taxation. If a tax on capital increases and a tax on land decreases the price of both will increase (Young 20), which makes productive investment difficult. If a tax on capital decreases and a tax on land increases then the price of both will decrease, (Young 20) which makes productive investment a feasible option for investors and developers. With such difference, especially regarding taxation, one can reasonably conclude it is unscientific to treat land in the same manner as labor and capital. Land deserves a special focus in the economy.
The business cycle has been commonly accepted as a necessary evil of a properly functioning free market economy. Nothing could be further from the truth. Throughout capitalism’s history this disruptive phenomenon has devastated markets and numerous remedies have been applied. Yet, by the end of the twentieth century these cycles still damage global economies as they have in the past. Many possible causes have been studied but “One economic process has hardly been studied at all, and that is land speculation” (Booms & Slumps). The destructive cycle can be traced to mismanaged land markets due to two unavoidable facts all economists agree on: a) land is fixed in supply and b) land is needed for all production (www.henrygeorge.org).
First, recall that land values (i.e., rent) can rise hundreds or thousands of percentage points while labor and capital can not. Thus, land value can easily outpace the value of wages and interest, with the result of limiting new construction. Why would new construction be limited? If land sites become too expensive to build on then construction workers receive less profit due to their unexpected higher costs of developing. Higher costs result in less profit. The construction workers work elsewhere or do not work at all.
Secondly, non-construction businesses also suffer in cycles and are closely tied to land values as well. As rents increase beyond the ability of wages and interest to catch up “Businesses that rent their premises also get squeezed by rising rents” (www.henrygeorge.org). Common sense will explain the higher the costs any business incurs the greater risk of failing. With land values able to rise so rapidly in comparison to other factors, time is not on the side of the business owner.
Consider what Young has to say: “As the business cycle spirals upward they watch the price of land steadily increasing until toward the end, when people begin talking about a possible depression, they realize that the inflation of land values was making it all but impossible to buy sites for homes or storage” (52).
Does Young’s statement have any relevance to the real world or is it simply an unfounded theory? Advocate Fred Harrison has an answer. By turning to Fred Harrison’s book, Power in the Land, one will find during the mid to late 1970s “Most Californians reinvested their housing profits in more real estate, adding to the price spiral,” (254) and during the same general time frame in L.A. “… some locally owned businesses in the downtown area were being shut down by skyrocketing lease rentals and land costs” (254). In the late 1970s and early 1980s, a recession struck California.
Next, a focus on nonproductive investments is needed to further understand the role of land in the business cycle. The term “nonproductive” refers to any business activity where land or some other scarce natural resource is bought and held indefinitely for “”cashing in” at a higher price. Simply put “”Landowners will ‘site-sit’ and wait, if they believe future development will be much more gainful than development for the current market” (www.henrygeorge.org). Since land value by itself will increase faster than many other economic factors a shrewd investor will gain more profit by selling at a future date in anticipation of as yet unrealized gains instead of fully developing the land at current market conditions (www.henrygeorge.org). Land prices then rise. Recall land is needed for all production. If businesses cannot afford land what will happen to production? If more profit can be realized in “nonproductive” investments as opposed to productive investments which option will a shrewd investor pick?
A costly example of nonproductive investments can be found in recent US history. During the 1970s and 1980s, the Savings and Loans market grew rapidly. Despite the transparent accounting system in place many investors were able to manipulate “…the savings and loan industry to exploit the land market,” (Land and Liberty, Autumn 1999,9) which eventually cost the US taxpayers nearly $500 billion via US government intervention (Land and Liberty, Autumn 1999, 9).
Fourthly, one must consider how land affects banking and credit. Often builders need to borrow money to buy land, “…even though the price is too high, gambling that future rises in rents will let them repay the loan” (www.henrygeorge.org). If the rent increase materializes then the builders will continue to work. However, if the rents fail to rise, or fails to rise quickly enough, the builders risk going bankrupt. Land values may rise quickly but they cannot rise forever.
Furthermore as land values change, so do the requirements for receiving a bank loan. Classical economist John Stuart Mill had written “. .of a tendency of lenders, when legitimate demand for loans dries up, to ‘lower the quality of credit’ by accepting high-risk loans they would have spumed before” (www.henrygeorge.org). If the loans are not repaid then the capital is wasted, leading to gigantic financial collapses like those experienced by Charles Knapp, Charles Keating, and other famous business barons (www.henrygeorge.org).
Does any of this economic theory relate to the modern financial world? Yes. The trouble with land and the banking credit industry can be linked to a phenomena termed “asset bubbling.” An asset bubble is an unsustainable rise in the value of any asset, although the term usually refers to stock and land prices. Trouble always follows a bubble’s decline, or bursting. Bubbles have been documented throughout history, as The Economist states: “Time and again, in many different countries, property prices have moved in extreme cycles, often forming speculative bubbles that later burst, damaging the whole banking system” (October 2, 1999, 86). Why should anyone care about bubbles? According to The Economist, the answer is very straightforward since,”When a bubble bursts, it can cause severe economic and financial harm. Rising asset prices encourage excessive borrowing by firms and individuals,” which increases the pain experienced during a recession (September, 25, 1999, 14). The borrowing and spending becomes unsustainable. Japan will serve as the major example in the following demonstration.
Since 1990, Japan has performed dismally. Profits are down, debt has increased, and little structural change has occurred. As Wall Street Journal writer Peter Landers writes in the Wall Street Journal, “…there’s hope that Japan will break out of this box. Capital markets are growing, the labor market is loosening, and real estate, well, therein lies the challenge” (January, 24 2000, 1). Japan has become a recent victim of the asset bubbling phenomena leading to a major “slump” in the boom-slump cycle. The Economist states “In Japan, share prices and property prices increased more than fourfold between 1981 and 1989″ (September 24, 1999, 19). In 1990 the bubble burst. To intervene in Japan’s land market would be unpopular with voters. If land prices were “unshackled” the short-term effect would be numerous corporate bankruptcies. Nevertheless as the Wall Street Journal article suggests “…if the challenges to liberating the property market are greater, so are the potential benefits. One thing Japan’s ‘lost decade’ of economic malaise has proved is that nothing drags down an economy more than an immense stock of idle land and living dead companies tethered to it via banks that extend dud loans with property as collateral” (January 24, 2000, 1).
All of these economic factors and data, when linked with land, points to a close relation between land and the boom slump cycle so common in today’s markets. Land is the key factor.
The other flaw of the modem free market economy is the wealth gap, i.e., a disproportionate share of wealth flowing into the hands of an ever-shrinking minority. The wealth gap has been commonly accepted as a necessary evil of a properly functioning free market economy. Nothing could be further from the truth. Young contends: If land is privately owned but carries little or no taxation the economic power of the landowner inevitably grows faster than the economic power of the landless (Young 33). Perhaps Young would agree with Adam Smith when he stated “Every improvement in the circumstances of the society tends, either directly or indirectly, to raise the real rent of land, to increase the real wealth of the landlord, his power of purchasing the labour or the produce of the labour of other people” (Incentive Taxation, February 2000, 4). US Census figures, as stated in Business Week, show “…the gap is still stuck at the highest levels since the Great Depression…” (October 18, 1999, 158), and it should be of interest to note in the USA only 3% of the population owns 97% of all privately held land (www.henrygeorge.org). Is the wealth gap a problem for the USA? Is land a factor?
Wall Street Journal writer Jacob Schlesinger quotes US Treasury Secretary Lawerence Summers saying America’s wealth gap “… is a problem. ..” (Wall Street lournal September 13, 1999, 1). Schlesinger’s article continues, “From bigger cars to higher tuition for the best schools, the richer rich will ratchet up prices for everyone else. ..” since marketers naturally target wealthier individuals. For an example consider the San Francisco Bay area where “… a middle class family earns about 33% more than the national average,” writes Schlesinger, “but has to pay up to four times the national average to buy a home because of intensely competitive bidding from freshly minted millionaires” (Wall Street Journal, September 13, 1999, 1).
In an ABC news web story titled “Poverty’s Persistent Face” at abcnews.com the article states “While the wealthy grow steadily richer riding the stock market surges, millions of working Americans grope for their infinitesimal share of the boom.” Schlesinger corroborates this statement by pointing out in 1997 the top 10% of invested households held approximately 73% of America’s net worth (Wall Street Journal, September 13, 1999, 1). As an important side note, land rent is often accounted for in different fashions, for example “… it figures largely in returns to stocks and bonds” (www.henrygeorge.org). Anyone doubting the significance of land rents in the stock market should note, “More than half of all corporate earning are generated by real estate and real-estate related activities” (Incentive Taxation, August 1999,3). In fact corporations commonly include land rents in their profits which “…can be steady or rising even when the marginal rate of return on capital is falling” (www.henrygeorge.org). Land rent, which is often accounted for in different fashions, gradually concentrates into the hands of fewer people.
What does rent do to the other factors of production? Land rents “squeeze out” room for wages and interest. Land rents are linked with the wealth gap since it is “… the Law of Rent that regulates the never-ending competition for land” (Young 23). The Law of Rent is an economic theory that can be used to decipher why land rents play such a crucial role. A formal statement of the Law is as follows: “The rent of any given piece of land is fixed by the excess of its productivity over the poorest land in use” (Young 23). In other words, the difference between the highest value land and lowest value land is rent.
Take this simplified example of the Law of Rent (Young 26-27). Assume four different types of land exist. The yielding potential of plot A is 100 units. Plot B yields 60 units. Plot C yields 30 units and Plot D, which is the least productive, yields 10 units. A person may define “units” in whatever term he wishes (i.e., bushels, dollars, etc.. .). Assume the labor and capital applied to each plot is the same. Ultimately the only difference among the four plots of land is their natural productive limit with 100 units being the highest and 10 being the lowest. According to the Law of Rent the “‘rent” for plot A would be 90 units. The 90 units is achieved by simple math: the highest available is 100 units, the lowest available is 10 units. The difference between the two is 90 units. Following the same principle the “‘rent” for plot B would be 50 units and for plot C, it would be 20 units. Plot D is unique. Plot D is the lowest producer so plot D is called the marginal producer. The “rent” Plot D yields is zero since ten minus ten yields zero. Thus, plot D would yield no “‘rent” because it is the “poorest” land in use. No excess exists. This monopolistic oriented Law of Rent allows the landowner to collect any created wealth above the bare minimum. In the above example 10 units is the bare minimum. Thus, the total land rent from the above example would be 160 units (90+50+20) while only 40 (10+10+10+10) units remain for wages and interest.
Essentially land, according to the Law of Rent, has the capability to squeeze wages and interest out of the picture. Land due to its unique qualities is a natural monopoly, which is why it can command such a high portion of created wealth. Recall the three functional distributions of wealth: land yields rent, labor yields wages, capital yields interest. Now imagine a “wealth pie” divided into three equal sections (www.henrygeorge.org). As production increases so does the need for land, thus so does the rent. Since land is limited by nature but labor and capital are not the landowner can demand the excess over the marginal producer. As the rent increases quicker than wages and interest, it takes a bigger slice of the pie. However, since labor and capital need each other in production these two factors will always attempt to find equilibrium in which case neither factor claims a distinct advantage (www.henrygeorge.org) since both need land to produce.
Does this little heard of economic law have any relevance in the modern financial world? According to a Business Week special report, “The economic boom is raising rents faster than the incomes of many low wage families, causing a severe urban housing crunch” (October 18, 1999 158). On page 4 in the August 1999 edition of Incentive Taxation, a 1990-95 study is extracted from America’s Real Estate stating that residential land prices are outpacing inflation. Recently consumer advocate Ralph Nader announced “These are boom times according to GDP and executive stock and news reports that things are better, but there is a huge disconnect between this and the majority of people” (Groundswell March-April 2000, 12). America has a twenty percent child poverty rate, continues Nader, which is higher than any other Western nation while “The majority of workers are making less today when adjusted for inflation than in 1979″ (Groundswell March-Apri1 2000, 12). As stated earlier as rents increase less room is available for wages and interest. Land, due to its unique qualities, is again at the root of the problem.
Having established the significance of land in these two fundamental flaws of modern free market economies, it is now time to discuss the importance of taxation. Henry George, mentioned earlier, had already discovered the connection between land and the two modern day flaws of our free market system over one hundred years ago. As opposed to the modern “broad-based” tax strategy employed by governments today Henry George advocated what was referred to as the “Single Tax,” which is commonly called land value taxation (www.henrygeorge.org). Under a broad-based tax strategy the government levies myriad taxes on any item it deems worthy of taxation. The idea is to spread the burden of taxation as widely as possible. Unfortunately, a broad based tax still burdens production and makes items more expensive for consumers. Under a Single Tax system of public finance, the government’s main revenue source would be a tax levied against the rent flowing from land and natural resources. A Single Tax plan does not burden production and makes items cheaper for consumers, as will be observed shortly.
Throughout his book, Young outlines the Georgist economic paradigm. First, all land and natural resources are to be assessed at 100% market value and this 100% assessment will be used as the tax base as opposed to the selling price. Market value and selling price are two different entities when dealing with land, as “An increased tax on land value reduces the price of land but not the rent” (i.e., market value) (Young 16). Additionally assessors should be professionally trained and held up to the most professional and ethical standards. Assessors should be critiqued and their statistical methods and results should be made public. Unfortunately in the USA, politics often interferes with this procedure. Many states in America already legally require assessors to assess land at full market value but very few ever do, even though it is a legal requirement (Young 103). Such law breaking is rampant throughout the country’s states yet assessors remain unpunished and unaccountable.
Additionally, as Fred Harrison explains throughout his book, the land value tax should be administered within the free market framework of capitalism. Socialism and Communism are inadequate due to the extensive regulating nature each system imposes upon the market. A free market framework would also make a better distinction between earned income (wages and interest) and unearned income (rent). Under a land value tax plan the earned income belongs to the individual who created it while the unearned income belongs to society, i.e. the government.
A land tax is an ideal tax. The land value tax offers many advantages other taxes lack. Classical economists like Adam Smith defined four rules a tax should obey. First, a tax should bear as lightly as possible on production. Second, a tax should be easy and cheap to collect, and fall directly on the ultimate payer. Third, a tax should be certain in its existence and amount. Lastly, a tax should bear equally to prevent giving any special interest an advantage.
A land tax fits all four categories (www.henrygeorge.org). First, a land tax does not affect production in any way because land is not produced. Land is already created. Remember land has no production cost. By increasing taxes on land value a government can decrease taxes on other items. Secondly, a land tax is easy to collect compared to other taxes on items such as income, imports, and sales. Income, imports, sales, and so forth are mobile tax bases and can very often find offshore tax shelters, be underassessed, or not be assessed at all.
A tax based on land values is easy to collect. Land cannot be hidden and in some American states it is only necessary for assessors to follow the law to obtain a true full market value assessment. A land tax also falls on the ultimate payer, unlike many other taxes. Remember a land tax cannot be shifted to other consumers but a labor or capital tax is always shifted to other consumers. Third, a land tax is very certain in its existence and amount. Under a land value tax only the land is taxed. The tax is certain in its existence. The land is assessed once a year at full market value. The tax is certain in its amount. Lastly, a land tax prevents groups from exploiting tax loopholes. Under the current US tax code countless loopholes exist and different taxes have different rates under different circumstances. A land tax can eliminate such confusion. A person either owns land or he does not. No gray area exists. If he does, he pays the tax. If he does not he pays no tax. Only those holding land and other natural resources would be singled out for the land value tax.
This point, as well as many others, is a point Professor Richard T. Ely questions. During the early 1900s on towards the Great Depression Ely’s numerous works in land economics became among the most influential in forming US land and tax policy (Andelson 314). As one of the original founders of the American Economic Association, Ely had broad reach into many facets of the US federal government and academia (Andelson 313). Often referred to as the “Dean of American Economics” (Gaffney 99), Ely’s economic opinion was highly valued. Ely’s economic expertise and influence was so highly valued that in 1927 he was introduced to US President Calvin Coolidge with the following words: “Mr. President, here is Professor Ely, Dean of American Economics. If anything is wrong with the country it must be his fault” (Gaffney 99). Two years later the stock market and economy collapsed, officially ushering in the Great Depression in America. Despite this question mark over Ely’s economic expertise and influence, many of his arguments against the adoption of land value taxation are the chief arguments used in today’s modern financial world against the Single Tax. His name still carries great weight. However his critique of Henry George’s land value tax proposal is extremely faulty and weak, as will be demonstrated.
“On what ground,” Ely proclaims, “of justice or ethics shall the landowner be singled out for taxation?” (Andelson 320). Ely raises a common criticism of the land value tax: It seems extremely unfair to burden landowners with such a heavy tax to support state functions. Although at first glance the argument appears to have merit, closer inspection will reveal a fundamental flaw. Instead, Ely should have asked: On what ground of justice or ethics shall the landowner be singled out for private collection of socially created wealth? Recall land rent is a value created by nature and society, not by anyone individual or group of individuals. Land rent is an unearned income. The land value tax on these rental values is “… merely the public appropriation of a publicly produced phenomenon. ..for public purposes” (Andelson 322). The land value tax gives back to the community what the community creates. Furthermore, under a land value tax all taxes on earned income such as wages and interest would be abolished or at the very least severely reduced. Land value taxation lets individuals and corporations keep their own privately earned incomes while letting society keep its own publicly created wealth. What could be more just and ethical than reaping what you sow?
To provide an alternative tax philosophy Ely adamantly supported the progressive tax philosophy (Andelson 320). Contrary to the progressive tax philosophy which is based on an “ability to pay” principle, the land value tax is based on a “benefits received” principle (www.henrygeorge.org). The reason is very simple. Land ownership gives one tremendous claims to benefits created by nature and society. For occupying these benefits and thus preventing others from the same beneficial use the landowner pays an equal money amount to the government. Unlike an “ability to pay” tax a “benefits received” tax does not hurt production. An “ability to pay” tax makes no distinction between earned income (wages and interest) and unearned income (socially created land rent values). A “benefits received” tax does. Furthermore an “ability to pay” tax on a person who only collects earned income would violate Adam Smith’s first rule of taxation because it burdens the person’s production (www.henrygeorge.org). The “ability to pay” principle is not only unjust but also economically counter productive.
Since the Single Tax plan would generate its revenue from only one source a logical question arises: Is a land value tax able to raise enough money to fully fund a functioning government? The answer to such a question can be found in The Henry George Theorem written by Dr. Joseph Stiglitz, former Senior Vice President of the World Bank. Dr. Stiglitz, writes Fred Harrison, shows land rent is sufficient to pay for public services in the urban sector (Land and Liberty Spring 2000, 20). Interestingly nearly 25 years earlier in 1975, History Professor Steven Cord at the University of Indiana, Pennsylvania, conducted a study and “… was able to conclude that in 1982 a 100% tax on US land values would have reaped about $1,020 billion. This sum was nearly double all government revenues” (Harrison 200).
Enter Ely’s next complaint of land value taxation. With so much emphasis on land, Ely claims, a land value tax would certainly lead to socialism or communism by nationalizing all available land (Andelson 320). Such a serious accusation is unfounded. A land value tax plan allows for private ownership of land but not private ownership of land rent. The difference between the two is critical. The right to physically use land remains untouched. However, the private appropriation of publicly created rent is prevented. Additionally a land value tax plan is designed to work in a free market economy, thus allowing for private ownership of capital for maximum efficiency while encouraging competition. Socialism and Communism do not allow free market privatization and competition. A land value tax does.
Recall the letter to Mikhail Gorbachev mentioned earlier. Over two dozen economists, some Nobel Prize winners, urged Gorbachev to socially collect land rent instead of allowing the rent to be privately collected. Clear reasoning for socially collecting the rent is presented in the letter: “First, it guarantees that no one dispossesses fellow citizens by obtaining a disproportionate share of what nature provides for humanity. Second, it provides revenue with which governments can pay for socially valuable activities without discouraging capital formation or work effort, or interfering in other ways with the efficient allocation of resources. Third, the resulting revenue permits utility and other services that have marked economies of scale or density to be priced at levels conducive to their efficient use” (www.taxreform.com.au/russian.htm).
The first reason is understandable: if the tax is levied high enough, then holding land from productive use would become too expensive to sustain in the long run. The second reason given corroborates the economic fact that a tax on rental income does not alter the supply of resources, hence a land value tax would not have any harmful impact on productive investment. The third reason shows that a land value tax will have the effect of creating an efficient system of public finance for all involved.
A tax on land values offers a unique opportunity to use market forces to shape the economy. Under a land value tax “…the owners of vacant or underused land will be encouraged to use it properly or sell it to those who would use it properly and pay the tax. This will tend to increase the amount of land available and thus prices will tend to stabilize or fall” (Land and Liberty Spring 2000, 19).
Under a land value tax the boom-slump business cycle would gradually disappear. By stabilizing land prices rents will be within an affordable reach for developers without having to borrow excessive money. Rent will not put such a burden on construction businesses. Visit the Japanese boom-slump example given earlier. This damaging phenomenon was birthed by unusually high land prices. Were a suitable land value tax administered in Japan, land would have had a large tax liability with the consequence of pressuring landholders to “use it or lose it” instead of waiting to see if future development would yield more profit than present development. A properly sized and properly administered land value tax would have prevented the asset bubble from ever forming by striking at the root cause — land. Without the formation of the asset bubble Japan’s banks would have been less likely to make ridiculously risky loans to clients who needed to borrow money to pay for inflated land prices.
A land value tax would greatly affect the wealth gap too. Visit the American wealth gap example given earlier. Young contends “Our failure to tax land value to the extent that we should is the chief reason that wealth has become concentrated in fewer and fewer hands” (Young 22). If rent, which is created by nature and society, is collected by the government instead of private individuals the result would be a decrease in the number of people enriching themselves by nonproductive asset holding. Recall profit includes the returns to all three factors of production. Rent would no longer be a part of personal profit; instead, the value would go to the government. Taking rent away from profit reduces the incentive of a landholder to hold land and wait for the value and price to rise. Only wages and interest would remain for the private sector. If rent, which grows more rapidly than wages or interest, is collected by the government far less profit could be made by holding vacant land or underused land since all that will be left for the person to collect would be wages and interest. Nonproductive investments would become unprofitable.
In the letter to Mikhail Gorbachev, the economists emphasize a “danger” in the private collection of land rent. As long as rent is privatized, asset bubbles will have an opportunity to emerge. As long as rent is privatized, an imbalance of wealth distribution will exist. The Law of Rent will always take advantage of the marginal producer, meaning everything created above the minimum output could easily be claimed as rent. The never-ending quest to privately collect rent fuels the business cycle and the wealth gap. As long as socially created rent is privatized, governments will resort to collecting earned income such as privately created wages and interest to pay for state functions. Since the share of the wealth pie that wages and interest retain can be easily restrained by the rapidly rising rent, this earned income taxation policy seriously reduces the market’s overall efficiency.
Although his ideas are over one hundred years old, Henry George’s “Single Tax” philosophy is gaining global attention and credit. On the other side of the Atlantic, Europe is beginning to consider alternative tax philosophies. Facing the realities of the modern free market economy, “the European Commission is coming to realize that Europe needs to step outside conventional fiscal wisdom. It is studying the benefits of untaxing people’s wages and savings, and raising revenue from resource rents” (Land and Liberty Spring 2000,3). Meanwhile the United Kingdom is awakening to the possibility of adopting a Georgist paradigm of rent taxation. In a letter to Single Tax advocates, Fred Harrison notes in 2001 Britain is expected to lose approximately 10 billion British pounds due to Internet commerce (letter from Fred Harrison). The letter also notes that a September 2, 1999 editorial, The Guardian suggested “…to shift the burden of taxation towards taxes that cannot be shrugged off (like land value taxation)” to alleviate the economic loss (letter from Fred Harrison).
In the USA a lobbying group known as Get America Working! is campaigning against payroll taxes. Over time payroll taxes have increased from 2% of Federal revenues to 34% and the group argues “…that cutting that tax would ‘leverage the largest economic improvement’” (letter from Fred Harrison). Unlike many tax cutting advocates who fail to provide an alternate tax base, Get America Working! stated in a letter to the Financial Times regarding the payroll tax: “It has driven up the cost of using people and allowed the only other primary ingredient in the economy, natural resources (land, energy, and materials), to carry a lesser load. Since people and natural resources are competitive substitutes, this tax-driven accidental price shift underpins much of America’s huge hidden unemployment” (letter from Fred Harrison). Get America Working! further claims by shifting the burden away from wage taxation and towards rent taxation hiring people would be “…roughly 30% more attractive” (letter from Fred Harrison).
In addition, Nobel Prize winner in economics Dr. Herbert Simon professes: “Assuming that a tax increase is necessary, it is clearly preferable to impose the additional cost on land by increasing the land tax rather than to increase wage tax” (Incentive Taxation June 1999,4).
Thus far the presented data points to a significant, yet overlooked, connection between land and the economy. For further study of the Single Tax’s effectiveness one can look to several striking examples instead of just theories and quotations. A few striking examples follow, although many more exist throughout the world.
Consider the case of Southfield, Michigan (Young 103), a suburb near Detroit. Southfield had many vast vacant acreages “…and these had been ridiculously under assessed for years” (Young 103). Judge James Clarkson, who was mayor during this time, implemented a land value tax himself. Clarkson ordered the land to be assessed at full market value, which greatly disturbed several landowners since the land “…was ripe for development and was being priced at fabulous heights. ..” (Young 103). The full market value assessment for taxation soon paid off because “With higher assessments the vacant land brought substantially lower prices and several large firms bought land and erected fine buildings to serve as headquarters” (Young 103).
On a statewide scale the idea of taxing land more and other items less has been successfully implemented in Pennsylvania. As cited in Incentive Taxation; writers Anthony Downs and Knighton Stanley wrote in the Washington Post “This seemingly modest reform [a building to land property tax shift] enabled Pittsburgh, Scranton, Harrisburg, and a dozen smaller cities to keep housing costs down, and renew and revive blighted neighborhoods. These activities, in turn, unlocked job opportunities” (Incentive Taxation September 1999, 4). The two authors are referring to Pennsylvania’s “Graded Property Tax Law” which allows cities to tax land values more than building values.
The property tax shift has been successful in Pennsylvania’s cities and “…there are now at least fifteen studies showing that in all cases, spurts in new construction and renovation follow the two-rate adoption. 15 out of 15 is not so bad…” (Incentive Taxation February 2000, 2). In particular Harrisburg, Pennsylvania provides a compelling case. In the early 1980s Harrisburg was the “…second most distressed city in the United States … under the Federal Distress criteria” (Incentive Taxation, October 1995,4). Harrisburg Mayor Stephen Reed states “Since then, over $1.2 billion in new investment has occurred here, reversing nearly three decades of very serious previous decline” and further states the general tax shift towards rent and away from capital “has been and continues to be one of the key local policies that has been factored into this initial economic success here” (Incentive Taxation October 1995, 4). Since the city started to actively implement a land value tax, Harrisburg, Pennsylvania has become one of America’s fastest growing cities and “…the city features the two rate property tax in all its promotional literature” (Incentive Taxation February 2000,2).
Earlier in the century on the western US coast California experimented with a land value tax to create its famous irrigation districts. Before the governments levied a land value tax large parts of California were underused by wealthy cattle owners (Harrison 223). Harrison writes “The districts created their networks of irrigation canals out of money raised through a tax on the value of land,” and that the change “…did not come through political controls, land appropriations and arbitrary bureaucratic allocation. The free market provided the framework, and the tax on the value of land stimulated the action” (223). After levying the tax the nonproductive land speculation ceased “…and California’s pre-eminent role in US agriculture began during that period” (www.henrygeorge.org).
None of these situations can compare to an example at the national level. Nevertheless, a poignant nationwide example does exist. In 1957, when Denmark’s legislature issued a law “…to implement the taxation of increase in land value, land speculation ceased, and Danish inflation fell to below 1% — even though employment and wages remained high!” (www.henrygeorge.org). In 1960 a new government came to power and overturned the 1957 law “…and land speculation started up again — as did inflation” (www.henrygeorge.org).
Another interesting case occurred in Australia. The American Institute for Economics studied a building to land tax shift of greater Melbourne during the late 1940s. Some municipalities followed the shift while others did not. As expected those cities which taxed land more experienced “…marked increases in building construction” compared to those cities which taxed land less (Incentive Taxation July 1999, 4). The study’s conclusion states explicitly: “The findings of the study suggest that the exemption of improvements from taxation deserves the consideration of leaders in communities of the United States and elsewhere” (Incentive Taxation July 1999,4).
With such suggestive theory and data is it any wonder “…eight recent American winners of the Nobel Prize in Economics have endorsed the principle of land value taxation…” (Incentive Taxation July 1999, 4)? Although the relation between land and the economy may not be the only cause of the boom-slump business cycle and the wealth gap, the relation is a key factor worthy of further investigation. Land is significant in the economy. Land’s significance is undoubtedly underestimated in the modern free market economy. A failure to understand the unique qualities of land in a modern free market economy is a key cause of both the boom-slump business cycle and the wealth gap and only by understanding land while regulating it properly with a land value tax can these two flaws be eliminated from the free market economy. Ultimately all production depends on readily available land. If rent is privately collected then rapidly rising land rent will continue to create damaging business cycles and a widening wealth gap while governments resort to collecting more wealth from earned income sources. Another recession is in the making while the wealth gap grows larger. Clearly, a need for a new economic paradigm exists.
1) ABC News web site. “Poverty’s Persistent Face.” Accessed at ~.abcnews.go.com on 10-4-99.
2) Americans for Tax Reform web site, www.atr.orgitaxbites/bread.htm Accessed on 1-20-00.
3) Andelson, Robert and Cord, Steven. “Ely: A Liberal Economist Defends Landlordism.” Critics of Henry George. Ed. Robert Andelson. London: Associated University Press, 1979. 313-325.
4) Booms and Slumgs — Their Cause and Cure. London: Henry George Foundation.
5) Gaffney, Mason and Harrison, Fred. The Corruption of Economics. London: Shepheard-Walwyn Ltd, 1994.
6) GroundSwell, March-Apri1 2000, Volume 13, No.2, 12.
7) Harrison, Fred. Power in the Land. New York: Universe Books, 1983.
8) Harrison, Fred. “Real Time.” September 2nd 1999. Letter from Centre for Land Policy Studies, United Kingdom.
9) Henry George Foundation web site, www.henrygeorge.org Accessed on 8-26-99.
10) “Hot Property.” The Economist, October 2nd 1999, 86.
11) “Hubble, Bubble, Asset-Price Trouble.” The Economist, September 25 1999, 13-26.
12) Incentive Taxation, news bulletin: Columbia, MD 21045. Columbia, MD: Center for the Study of Economics, 1995 (October), 1999 (June, July, September, November), 2000 (February).
13) Land and Liberty, Spring 2000,3, 19,20.
14) Land and Liberty, Autumn 1999, 9.
15) Landers, Peter. “Japan Opens Door For Investment.” Wall Street Journal, January 24 2000, front page.
16) Schlesinger, Jacob. “Wealth Gap Grows; Why Does It Matter?” Wall Street Journal, September 13 1999, front page.
17) Special Report — Inequality and Poverty in America. Business Week, October 18 1999, 158.
18) Tax Reform Australia Inc website, www.taxreform.com.au/russian.htm Accessed on 10-1-99.
19) Young, Wylie. Antidote For Madness. New York: Robert Schalkenback Foundation, 1976.
What’s your opinion? Tell your views to The Progress Report!