“Kinetic” means “in motion.” There is kinetic energy when you walk or drive a car.
Kinetic land rent is a flow of funds from a land tenant. Kinetic rent includes explicit rent, a transfer of funds from a tenant to a landlord, and implicit rent, the rent that an owner-occupant pays, in effect, to himself as also the owner. Kinetic rent can also be hidden, as when an owner of real estate pays mortgage interest, since the loan payment for the land originates in the land rent, paid from borrower to lender. Kinetic rent can also be explicit as a property tax on the land value or rent. Kinetic rent can also be part of the profit of an enterprise that owns its land.
Kinetic rent therefore includes visible explicit rent paid by tenant to landlord; hidden rent in the form of interest, profit, and taxes; and the implicit rent of an owner-occupant. These are all flows of value, thus kinetic.
Potential rent is value that would have existed, but has vanished because some force has imposed costs that make the location less profitable. Usually it is government that provides that force. For example, a sales tax increases the price of the goods produced or sold there, which reduces the quantity and the profit, so the entrepreneur bids less for kinetic rent, as the location provides less value. Similarly, an income or value-added tax, or a tax on the building, imposes a deadweight loss and reduces the kinetic rent.
Possibly the value-reducing force could consist of criminals who invade and steal property, or extract money with threats. But in this case, one could argue that government has failed to provide its prime service, security.
Another way that kinetic rent gets converted into potential rent is by changing the land use to a less productive enterprise. When government imposes a gross-receipts tax, for example, and a business cannot increase its price due to global competitive pressure, the firm shuts down, and is replaced by one which can increase its price. But if the first firm had maximized the location’s profit before the tax, the next one will provide less pre-tax profit and less product. For example, if a book store employing 25 persons is replaced by a gas station employing 3, the book store would provide more profit, but the tax has forced a shift to less employment, as the gas station is able to increase its price, operating in a local market. Mason Gaffney has called this the “quantum leap effect.”
If we seek to estimate the total amount of rent that could be collected for public revenue, we need to include both the potential and the kinetic rent. What is measured before the policy shift is only the kinetic rent. The potential rent is unknown, since even if the deadweight loss from taxation can be estimated, the quanta losses due to less productive land shifts is unknown.
If we seek to estimate the total amount of rent that could be collected for public revenue, we need to include both the potential and the kinetic rent. What is measured before the policy shift is only the kinetic rent. For example, the share of total income due to land rent in Australia has been calculated as a third of national income. But this is only the kinetic rent. The potential rent is unknown, since even if the deadweight loss from taxation can be estimated, the quanta losses due to less productive land shifts is unknown.
Most economists do not understand potential rent, because in school, the terminology they learned misled them. Economists call the surplus from production a “producer surplus,” making it sound as though the owners of firms, as producers, receive this surplus. But economists also recognize that in a highly competitive industry, the long run economic profit (after subtracting all costs, both explicit and implicit) is zero (leaving only normal returns on investment). Since the “producer” surplus is an economic profit, beyond all costs, this becomes a puzzle: how can firms make zero profit, when the industry has a positive profit? Few textbooks even ask the question, and only the most brilliant students see the puzzle.
The answer is that the “producer” surplus flows down to the input providers: land, labor, and capital goods. But if labor and the production of capital goods are also competitive, these have no surplus, and the “producer” surplus goes to land rent. Unlike labor and capital goods, the supply of land cannot expand to reduce the price and squeeze out the surplus. Since land is not produced, the surplus should be called a “non-producer” surplus.
In standard microeconomic theory, a tax on production reduces the surplus from consumption and well as production. Part of the surplus gets transferred to government; the “producer” surplus that gets paid as taxes is hidden kinetic rent. But, as recognized in standard theory, the surplus that disappears, due to the reduction in quantities produced and bought, and thus also the loss of profit, that loss of “producer” surplus is kinetic rent that has been converted to potential rent. The kinetic rent is no longer there, but has the potential of coming back if the tax is removed.
The removal of stifling taxation would convert potential rent into kinetic rent. When that rent is distributed to the people in cash, or spent to provide productive public works and services, that distribution generates kinetic rent. Tenants receive value from natural features, population, commerce, and public goods. Paying for public goods from rent does not reduce that value, the rent, but it does reduce the purchase price of land, as the title holder receives less net rent.
There is a theory in public finance called the “Henry George theorem,” which concludes that the cost of the optimal provision of public goods equals the economy’s land rent. But when the cost of the public goods is paid from wages or enterprise profits, then not only do wages and profits fall, but also the kinetic rent. The economy can only provide maximum kinetic benefits when it is allowed to use all its potential rent.
There is a theory in public finance called the “Henry George theorem,” which concludes that the cost of the optimal provision of public goods equals the economy’s land rent. But when the cost of the public goods is paid from wages or enterprise profits, then not only do wages and profits fall, but also the kinetic rent. The economy can only provide maximum kinetic benefits when it is allowed to use all its potential rent. Otherwise, as is the situation today, the economy has potential income not realized, and the consequence is poverty, unemployment, environmental destruction, and violent conflict. The potential prosperity we could enjoy requires the optimal use of the land, when there is no more potential rent, as all rent has become kinetic.
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FRED E. FOLDVARY, Ph.D., is an economist and has been writing weekly editorials for Progress.org since 1997. Foldvary's commentaries are well respected for their currency, sound logic, wit, and consistent devotion to human freedom. He received his B.A. in economics from the University of California at Berkeley, and his M.A. and Ph.D. in economics from George Mason University. He has taught economics at Virginia Tech, John F. Kennedy University, Santa Clara University, and currently teaches at San Jose State University.
Foldvary is the author of The Soul of Liberty, Public Goods and Private Communities, and Dictionary of Free Market Economics. He edited and contributed to Beyond Neoclassical Economics and, with Dan Klein, The Half-Life of Policy Rationales. Foldvary's areas of research include public finance, governance, ethical philosophy, and land economics.
Foldvary is notably known for going on record in the American Journal of Economics and Sociology in 1997 to predict the exact timing of the 2008 economic depression—eleven years before the event occurred. He was able to do so due to his extensive knowledge of the real-estate cycle.