Everyone knows that federal debt may be "monetized" when bought by banks, and the papers are full of the effect of federal deficits on the money supply. Here we are victims of another perceptual bias. Now as defaults accelerate and the system starts to crumble, we suddenly become aware that most of what banks have been monetizing in recent years is not federal debt at all but, rather -- real estate! Anyone wanting to predict the future of money and banking had better be expert on land valuation because that is what it is now all about.
In 1933 Professor Herbert D. Simpson of Northwestern University told the American Economic Association that the banking collapse was an echo of the real estate collapse, and there was none to deny what none could hide, much as some wanted to. Homer Hoyt drew on Simpson and also adduced much more evidence on the subject in his monumental 100 Years of Land Values in Chicago, 1833-1933. Hoyt found the same cause producing banking collapses also in 1837, 1857, 1873, and 1893. Philip Cornick's Premature Subdivision and its Consequences records the same process in New York State in the 1830s and 1920s. Homer Vanderblue's articles on "The Florida Land Boom" show banking expansion and contraction being led and driven by boom and bust in land values.
One of the crimes of the Chicago School has been to stuff all that down the memory tubes of history. Lloyd Mints in his History of Banking Theory pillories and stigmatizes those who have warned against letting land I values be monetized, and many "mainstream" economists dutifully cite him. In Friedman and Schwartz bank expansion and collapse depend on the ideologies and personality quirks of Fed Governors, with all else following along.
Don't you believe it! A giant Chicago bank that did now survives only by virtue of the largest federal bailout in history. The world's largest, our own California pride The Bank of America, is declaring its first losses since The Great Depression. Our whole financial system stands on the brink of disaster or socialization for one main reason: overextension of defaultable loans on the collateral of real estate values whose determinants and trends the bankers obviously did not understand. During the joyride 1976-81 loan officers just plain projected unearned increments into the misty future, farther than the eye could see. It was only a dream, but the ensuing nightmares are real. How much safer we could all feel today had they had more exposure to good solid research in land valuation.
Not all land is allocated all the time to its highest and best use. Whether through ineptitude, somnolence or surfeit of wealth, some landholders doze on their assets. It is often the tax assessor, simply doing his job according to law, who awakens them.
The landholders' first reaction is to attack the assessor, a vulnerable official who does not enjoy the intimidating sovereign power over individuals' total lives and assets and income that Congress has delegated to I.R.S. agents. But the assessor is only doing for a public purpose what corporate raiders like T. Boone Pickens and Carl Icahn do for private profit: ferreting out latent values in misallocated land, to make the market work better. And in this land of free enterprise we are all supposed to believe in market decisions -- except, of course, when we lose the decision.
The raiders get attacked too, but they need no defense from me. Chicago, naturally, has risen to claim they are simply improving resource allocation. The claim is half true, which is all Chicago needs. But only Heaven protects the poor working assessor and the law he administers, which mandates impartial uniformity in assessment -- or did before preferential assessment came into legislative vogue with never a peep from The Midway.
Income taxation presupposes accurate valuations of land for the simple, basic reason that depreciation is deductible and land is not depreciable. What with accelerated cost recovery of building investments, and even investment tax credits for certain kinds of buildings, the allocation of basis between land and improvements becomes increasingly critical.
Of course the cost of a new building is not that obscure a figure. But I can show you mathematically that the major loss to The Treasury comes not from the first round of accelerated cost depreciation but from the re-depreciation of resold buildings by new buyers. And this is where the slippage comes, when the secondary buyer is allowed to depreciate land by undervaluing it, thus allocating land value to depreciable building value.
How do they do it? With all its terrifying powers the I.R.S. fumbles this one. In practice, according to I.R.S. manuals, the non-depreciable portion is not land value in the absolute: it is what the local tax assessor says is land value. There follows a heavy total pressure on assessors to undervalue land relative to buildings. The situation is analogous to that in our States in the ancient times now dimly remembered when there were heavy state property taxes based on values determined by local assessors. The situation led to competitive underassessment, which in turn led to state boards of equalization to solve the problem.
Today it is a federal problem. Local assessors help their constituents avoid federal taxes by overvaluing depreciable buildings relative to non-depreciable land. That is today's version of competitive underassessment, one that may only be solved by some sort of national agency charged with valuing land, or monitoring local assessors who do.
This article is an excerpt from an invited paper presented at the Assessment Workshop cosponsored by USDA-ERS-NRED and the International Association of Assessing Officers, Chicago, IL, June 25-26, 1985. The paper was published in Almy, Richard R., and T.A. Majchrowitz (eds.), Property Tax Assessment (Chicago: U.S. Department of Agriculture, International Association of Assessing Officers, and The Farm Foundation, 1985), pp. 91-109. The whole paper will be published daily in increments over this week and part of next week. This is excerpt 2 of 9.
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MASON GAFFNEY first read about the economist Henry George when a high school junior. After he served in the Pacific during WW II, this interest led him back to get a Ph.D. in Economics at Berkeley, where he tried to meet his teachers’ skepticism and apathy with a dissertation, Land Speculation as an Obstacle to Ideal Allocation of Land. Since then he has published many books and articles on land use, economics, taxation, and public policy. He has been a Professor of Economics at several Universities; a journalist with TIME, Inc.; a researcher with Resources for the Future, Inc.; the head of the British Columbia Institute for Economic Policy Analysis, which he founded; an economic consultant to several businesses and government agencies; and a frequent speaker on economic topics, domestic and foreign, and in political campaigns. He has been Professor of Economics at U.C. Riverside since 1976. For more information, visit his website at MasonGaffney.org