CLASS SUICIDE: How property owners bite the hand that feeds them
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By opposing taxes on unearned increases in land values, property owners block the financing of infrastructure that would increase their wealth and income.
Contents
1. The miracle of the land market
2. Five loaves and two fishes
3. Twelve baskets
4. A mutually profitable investment
5. Assets ain't assets
6. Taxes ain't taxes
7. Quick! Hide the loaves and fishes!
8. Seven plagues (and one remedy)
9. Conclusion
1. The miracle of the land market
If you are to share in the benefit of a public infrastructure
project, such as a new freeway or bus route or state school, you must
reside or do business in the area served by the project. For this
purpose you need access to the real estate in the area. Hence
the benefit of the project, as measured by the market, is the ensuing
uplift in property values in the affected area.
If the infrastructure project is worthy of funding, the benefit
exceeds the cost; so the cost can be covered by reclaiming only
part of the benefit through the tax system, leaving the rest of
the benefit is a net windfall for the owners of property in the
affected area, but without burdening other taxpayers. If the
reclaimed part of the benefit is greater than the cost of the
project (but still less than the total benefit), the project is a net
source of public revenue. This not only ensures that the project goes
ahead — so that the property owners get the ensuing windfalls
— but also allows cuts in other taxes for the benefit of
all taxpayers whether they own property or not.
N.B. The implementation of this funding mechanism does
not require any initial increase in tax receipts, and any
subsequent increases in tax receipts are due solely to
expansion of the tax base — not increases in tax rates.
2. Five loaves and two fishes
The funding of a public project through increases in property
values is attractive to property owners provided that the additional
tax payable on each property due to the project is less than
the benefit for the property owner due to the project. This
requirement is met by a form of site value taxation.
A site is a piece of ground or airspace, including any
attached rights to construct buildings on that ground or into
that airspace, but excluding any actual buildings. The value
of a site reflects the value of its location even if no buildings
(yet) occupy the site. So, to the extent that infrastructure
increases "property values" in a certain area, it actually increases
site values in that area.
The simplest site value tax or "land tax" is a per-annum percentage
of the (lump-sum) site value, payable by the owner of the site. If
the land tax has a threshold, the taxable value is not the
entire site value, but the margin by which the site value exceeds the
threshold. If the threshold is the site value at the time of
introduction of the tax (i.e. the "initial" site value), adjusted for
inflation, the result is a tax on the subsequent real increase
in the site value. If the threshold is reduced below the
inflation-adjusted initial site value, the additional revenue from the
land tax allows other taxes to be reduced or abolished on introduction
of the land tax. In particular, one can abolish existing recurrent
property taxes and set the threshold on each site so that the
new land tax initially replaces the recurrent property taxes
previously paid by the owner of that site; the threshold is
then called a site threshold because it varies from site to
site. Let's call this last arrangement an incremental land tax
(ILT).
An ILT reclaims only part of the benefit of an
infrastructure project, because the tax on a property does not
increase unless the site value does, and the site value does not
increase unless, in the judgment of the market, the owner is better
off in spite of the tax implication. While the same is true of any
holding tax on lump-sum site values, the ILT has the added feature
that property owners do not suffer any change in total tax
liabilities when the ILT is introduced.
As implied above, the ILT should replace all recurrent
property taxes hitherto imposed by the same government. These include
not only "land tax", but also any so-called fire levies or ambulance
levies that amount to de facto recurrent taxes on
property. The ILT should be allowed to be negative, so that it gives
some compensation to that minority of property owners whose sites are
devalued by planning decisions.
3. Twelve baskets
If the ILT is to be attractive to politicians, it must turn a
comprehensive range of infrastructure projects into net revenue
earners. Rational property owners will concur with this requirement,
because projects that earn more revenue than they cost are likely to
proceed, so that property owners are likely to get the associated
uplifts in land values. For property owners, the fact that
some of these projects could have been funded by other taxes is
a red herring for three reasons. First, the ILT allows more
projects to be funded. Second, a project that could have been funded
by other taxes still represents a net gain to property owners if it is
funded by the ILT. Third, when projects that would have been funded
by other taxes are instead funded by the ILT, those "other taxes" can
be reduced, and property owners in their capacity as general taxpayers
can expect to share in the benefit of that reduction.
4. A mutually profitable investment
From the viewpoint of property owners, the ILT is an investment,
and the uplift in property values is the return on the investment.
This return is already "net of tax" because the market takes the ILT
into account when valuing each site. So the ILT cannot render the
investment unprofitable.
From the viewpoint of the government, the cost of a public project
is an investment and the consequent increase in ILT assessments is the
return on the investment. The higher the marginal ILT rate (or the
fraction of sites subject to ILT), the greater the number of projects
that will pay for themselves through uplifts in site values, hence the
greater the number of projects that will actually proceed — and
the faster the rate at which old taxes can be reduced or abolished,
thanks to the surplus revenue caused by projects whose benefit/cost
ratios are higher than the minimum for a self-funding project.
Very conveniently, property owners also have an interest in
increasing the number of projects that proceed and the number of old
taxes that can be reduced or abolished. Of course there are only so
many projects that would pass a cost-benefit test, and only so many
old taxes to abolish. So, as the ILT rate is increased, there comes a
point beyond which property owners are losing more through higher ILT
than they are gaining through infrastructure and tax cuts. This
confirms that from the viewpoint of property owners, the taxation of
uplifts in land values can be too high. But it can also be
too low, as the current infrastructure crisis clearly shows.
Somewhere in between there is an optimum — for which every
rational property owner should be campaigning.
Unfortunately the behavior of property owners to date has been
less than rational. But before we can tell that story, we must
explain a bit of theory.
5. Assets ain't assets
Rivers of blood have been spilled over the ownership of the "means
of production" because these "means of production" are spoken of as a
single category, whereas in fact they fall into two
categories:
- Assets that taxpayers can neither create nor destroy nor
move out of the taxing jurisdiction are land-like
assets.
- The rest — that is, assets that taxpayers can
move and/or destroy and/or refrain from creating — may be called
(for want of a better analogy) house-like assets.
By this terminology, house-like assets used as means of
production include not only fixed structures, but also industrial and
commercial equipment (fixed or movable) and stock in trade. The great
classical economists from Adam Smith (1723–1790) to Max Hirsch
(1853–1909) called such assets capital. Because the
production of capital adds to the total wealth of humanity, and
because the profits from capital are an incentive to
produce it, humanity gains from the private ownership of house-like
assets and the private retention of profits derived therefrom.
Land-like assets include sites (not buildings), other
natural resources (which cannot be created by human effort), and
statutory monopolies and limited licenses (which can be created only
by governments, not by taxpayers). Returns on land-like assets, net
of the demands of labor and capital, are known as economic
rent [1]. From the viewpoint of
taxpayers, land-like assets cannot be produced, but can only be
acquired. Acquiring an asset that cannot be produced adds
nothing to the total assets of humanity. While the economic rent
received from a land-like asset may be partly contingent on the
application of labor and capital, it cannot be justified as an
"incentive" to apply that labor and capital, because it accrues to the
owner as owner even if the labor and capital are applied by
other parties. So the standard argument justifying the private
retention of returns on house-like assets is not applicable to
land-like assets.
6. Taxes ain't taxes
A holding tax is a periodic tax on ownership of an asset
— in contrast to a transaction tax, which applies to
(e.g.) changes of ownership.
All transaction taxes impede commerce. All taxes on house-like
assets reduce the incentive to produce capital. These effects hinder
production and therefore raise prices and feed inflation, increasing
the so-called natural rate of unemployment, which is defined as
the minimum unemployment rate that causes sufficient downward pressure
on wages to yield stable inflation. Central banks fight the
inflationary tendency by raising interest rates (or otherwise
restricting credit) in order to discourage consumption and hiring,
thus maintaining unemployment at the dismally-named natural rate. So
when the government decides to raise revenue from transaction taxes or
taxes on house-like assets, the central bank responds by creating
unemployment!
But holding taxes on land-like assets have none of these ill
effects provided that the taxes take no more than the economic rent,
which is not an incentive for production. Such taxes do not
impede commerce by penalizing transactions. And they cannot impede
production of assets, because they apply only to assets that cannot be
produced by the taxpayers. If the government raises revenue
exclusively from holding taxes on land-like assets, it
minimizes inflationary tendencies, allowing the central bank to
minimize unemployment.
Needless to say, the ILT is a holding tax on land-like assets.
7. Quick! Hide the loaves and fishes!
The campaign for holding taxes on land-like assets reached its
zenith in the writings and speeches of the American classical
economist Henry George (1839–1897), who advocated the public
appropriation of almost the entire rental value of land in lieu of
taxes on labor and capital [2]. When
George rose to prominence, economics was just becoming established as
a separate academic discipline. Landowners were well represented on
the trustee boards of prestigious American universities, whose
endowments, moreover, consisted chiefly of land grants. And there was
no academic tenure: professors who failed to do the bidding of their
paymasters could be fired without process or redress.
The counter-attack was swift, massive, decisive, and ridiculously
indiscriminate. The language of economics was deliberately
corrupted so as to conflate land with capital, economic rent with
profit, and acquisition with production, thus obscuring the
advantages of a selective tax on land-like assets [
href="#n3">3]. The fallacy of composition — that
what is good for the part is good for the whole — was accepted
as a valid argument whenever the part in question was a landowner. By
calling itself neo-classical economics, the new pseudo-science
masqueraded as the successor, though in fact it was the usurper, of
the classical tradition. Within a generation it became the new
orthodoxy.
A consequence of the fallacy of composition was that
macro-economics, in which profit is a cost of production and
the rent of land is a surplus, was displaced by
micro-economics, in which rent is a cost of production and
profit is a surplus. Thereafter, those who wanted to reduce economic
inequality by redistributing the "surplus" would attack private
profit, not private economic rent; in other words, they would
be socialists and communists, not mere "Georgists". The
consequences for property owners in Russia, China, and eastern Europe
were rather worse than those envisaged by Mr. George.
But even where the capitalist system of land ownership remained
intact, property owners suffered because the neo-classicists opposed
not only the full implementation of George's system, but all
reform in that direction, however modest it might be. In
particular:
- They opposed Thomas Shearman's "Single Tax", which was a
straightforward land tax calculated on "land price";
- They opposed the Ralston-Nolan Bill (U.S. House of
Representatives, 1920), which would have imposed a federal tax of a
mere 1% per annum on "the privilege of holding lands, natural
resources and public franchises" with a threshold of $10,000 (a
princely sum in those days);
- They opposed the concentration of local property taxes on land
values alone, preferring to tax the combined values of land and
buildings, and sometimes even claiming that the separate valuation of
land was not possible [4].
In each of these cases, the neo-classicists defeated a measure that
would have enriched property owners by encouraging the provision of
infrastructure. More generally, the neo-classical conflation of land
with capital undermines any system of taxation that
distinguishes between the two — including the ILT.
If property owners had known what was good for them, they would
have concentrated their efforts on:
- making a moral-philosophical case, or even a practical case,
for the sharing of publicly created value (e.g. uplifts in land values
due to public infrastructure) between public and private partners, as
opposed to the complete retention of publicly created value by the
government; and
- ensuring that any system for financing infrastructure through
uplifts in land values was implemented in such a way that taxpayers
were protected against losses in the transition to the new
system (as they are in the design of the ILT).
They might also have considered that, as owners of the most
important class of economic assets, they had an interest in being able
to get the right answers to economic questions, to which end it might
help if the science of economics were allowed to remain a science.
But they were not that smart.
8. Seven plagues (and one remedy)
Two consequences of property owners' unenlightened
self-interest have already been mentioned:
- The infrastructure crisis: Public projects and services
of which the benefit would exceed the cost are stalled because of the
alleged difficulty of meeting the cost.If the benefit exceeds the cost, how can it be difficult to cover
the cost? The excuse is absurd; but it is the "logical" consequence
of the neo-classical dogma that land values, which capture the benefit
of so much public expenditure, should not be a substantial
source of public revenue.
- Unemployment: Failure to raise sufficient revenue from
holding taxes on land-like assets necessitates other taxes that raise
prices and feed inflation. Central banks counteract the inflationary
tendency by raising interest rates in order to create unemployment,
which exerts downward pressure on wages.Needless to say, those who are unemployed are not engaged in
projects that enhance property values. Neither are they likely to be
bidding up prices at property auctions. Low wages have a similarly
depressing effect on spending power, hence property values.
Further consequences include the following:
- The rat race: Unemployment weakens the bargaining
position of employees, driving down their wages and conditions. Poor
prospects in one occupation drive some employees into other
occupations, where they increase the competitive pressure on
employees in those other occupations, driving down their
wages and conditions, and so on. Some employees or would-be employees
try to escape these pressures by starting businesses in competition
with employers, some of whom are then forced into alternative lines of
business, where they increase the competitive pressure on
employers in those other lines of business, and so on. To keep
their employers afloat, salaried staff must work unpaid
overtime, and those who cannot or will not do so are displaced by
those who can and will. Thus the unemployment rate sets a
benchmark level of stress that propagates through the entire
economy, affecting workers and bosses alike.Only the recipients of economic rent are spared. Therefore
everyone wants a slice of the economic rent, and the resulting
competition for land-like assets makes it harder to become a
property owner, even if the only property you want to own is your
place of residence!But if uplifts in site values are partly reclaimed through the tax
system and spent on public projects and services and cuts in other
taxes, everyone automatically gets a slice of the economic rent
— and not at the expense of property owners, because the
tax on uplifts takes only part of a benefit that accrues to property
owners in consequence of the same tax.
- Competing with speculators: As land is a limited
natural resource, an increase in total demand for land cannot be
offset by an increase in total supply. And indeed the effective
demand for land tends to increase due to population growth (which
increases the need for sites) and economic growth (which increases
capacity to pay for them). So sites tend to appreciate in real
terms [5]. This causes
speculative demand for sites as individuals and firms buy sites
in the hope of reselling them for higher prices, or try to save money
by early acquisition of sites that they intend to use later.
Speculation raises land prices because all buyers must compete with
the speculators. Worse, sites held by speculators are likely to be
unused or underused because the owners are not yet ready to use them,
or because the owners wish to avoid commitments that would fetter
their ability to sell at the most opportune times. This effect raises
not only prices, but also rents, as the affected sites are withheld
from both prospective buyers and prospective tenants.An ILT on a site encourages the owner to cover the tax liability by
generating revenue from the site — either by using it
productively or by selling or letting it to someone who will. This
makes rents and prices more affordable by strengthening the bargaining
positions of potential tenants and buyers.But such incentives are not always appropriate. An owner-occupied
residence, for example, does not generate a cash flow with which to
pay ILT. And because such a residence is already being used for its
intended purpose, the owner should not be forced to sell or let it.
Accordingly the ILT on an owner-occupied residential site should be
deferred until the next transfer of title [ href="#n6">6].Deferred ILT would greatly improve the "affordability" of homes for
first-time buyers. If owner-occupants can sell their old homes
without paying any tax, they can spend the entire proceeds —
including unearned capital gains — on new homes, and thereby
outbid first-time buyers who have no capital gains to spend. A
deferred ILT liability for sellers would strengthen the competitive
position of first-time buyers. Meanwhile the sellers would benefit
from the infrastructure funded by the ILT. To ensure that this
benefit is preserved and seen to be preserved, the deferral of ILT
should be interest-free, and the deferred ILT should be capped at some
fraction of the real increase in the site value during the period of
deferral.N.B. Increases in land prices and rents due to
infrastructure provision do not harm tenants and potential
buyers, because such increases reflect genuine improvements in
utility; they do not make it harder to buy or rent a site of
given utility. But they certainly increase the income and
wealth of the landlords and sellers. When these effects are combined
with the improved bargaining position of renters and potential buyers,
all the aforesaid parties become net winners; that is, the benefit of
the infrastructure is shared among all parties.
- Chasing our tails: It is sometimes argued that ordinary
home owners, who own no real estate apart from their homes, do not
gain from a rise in property values, because the higher selling prices
of their present homes are canceled by higher purchase prices of
alternative accommodation — and they always need somewhere to
live.That argument, as far as it goes, is valid when the rise in values
is due to general speculative demand [ href="#n7">7]. But it is not valid when the rise is due to
an infrastructure project serving the owners' locality, because in
that case there is no matching rise in prices of alternative homes in
other localities. Neither is it valid if prices in all
localities rise due to infrastructure, because in that case the rise
in prices of alternative homes is due to improved utility, and does
not imply a rise in price for alternative homes of given
utility.As ordinary home owners do not gain from general speculative demand,
neither do they lose if that speculative demand is dampened by the tax
system. But they still gain when the same tax system delivers
improved infrastructure.
- Bubbles and bursts: In a rational market, the
capitalized (or "lump-sum") value of a land-like asset is the
discounted present value of the future rent stream. (That is,
the capitalized value is the lump sum that would yield an interest
stream equal to the rent for the same risk, or the sum of the future
rental payments individually discounted for time and risk.) But
speculation tends to make the market irrational. When people
see prices rising, they want to buy into the market. In so doing,
they accelerate the rise in prices, inducing more people to buy in,
and so on, causing a speculative bubble — that is, a
state in which prices are decoupled from rents and are supported
solely by the circular argument that prices will continue to rise. At
some point the illusion becomes unsustainable and prices stop rising,
taking away the alleged justification for current prices, and so on:
the bubble bursts. This is obviously disastrous for investors
who buy at or near the top of the bubble. But eventually the natural
appreciation of land-like assets leads to a new bubble in the same
asset class. So the market for any land-like asset class, including
land itself, is cyclic.The ILT would require property investors to earn income from their
acquisitions in order to cover the tax, forcing them to consider the
tax implications before bidding up prices, and making it less
attractive to acquire land for speculation alone. These influences
would impede the formation of bubbles. To avoid bubbles is to avoid
bursts. Moreover, in a rising market, the ILT would produce a rising
tax liability counteracting the urge to "buy in"; and in a falling
market (if there were ever another falling market), the ILT would
produce a falling tax liability counteracting the urge to "bail out".
Thus the ILT would make property investment safer in the short term by
smoothing out bubbles and bursts — but more lucrative in the
long term by encouraging provision of infrastructure.
- Recessions/depressions: A bursting bubble in a
particular asset market has two counteracting effects. On the one
hand, it drives investors away from that asset class and, by default,
towards some other asset class that may also be susceptible to
bubbles. On the other hand, those who have invested heavily in the
collapsed market must reduce their expenditure, and some (most likely
those who have bought their assets with borrowed money) become
insolvent. As one agent's expenditure is another's income, and as one
agent's debt is another's asset, a chain reaction ensues,
reducing the funds available for investment in other asset markets,
possibly causing them to collapse, and so on. After an
isolated bubble-burst, the former effect tends to dominate;
thus the land burst of the mid 1920s led to a stock-market
bubble [8], and the stock-market
crash of 1987 led to a land bubble. But when that second bubble
bursts, the cumulative belt-tightening and bad debt tend to cause a
recession; thus the stock-market crash of 1929 led to the Great
Depression, and the land burst of 1989 led to the recession of
1990–91. The exceptional size and unique importance of the land
market mean that a bursting land bubble is the most reliable
single predictor of a recession [ href="#n9">9]; in particular, the global recessions of
1974–5, 1981–2, and 1990–91 were heralded by
bursting "property" bubbles, i.e. land bubbles [ href="#n10">10].To the extent that the ILT would avoid property bubbles, it would
avoid the ensuing bursts and recessions. By inducing public
investment in infrastructure, it would also help to lift the economy
out of recessions — including the one that we're about to have,
courtesy of the biggest global property bubble in history.
9. Conclusion
The infrastructure funding problem can be solved by means of an
incremental land tax (ILT) — that is, a site value tax with an
inflation-adjusted site threshold, the threshold for each site being
chosen so that the ILT payable on that site immediately replaces the
recurrent property taxes previously payable to the same government in
respect of the same site. By its nature, the ILT cannot raise more
revenue from any particular property owner unless that owner receives
a net benefit after tax.
The ILT on an owner-occupied residential site should be deferred
interest-free until the next transfer of title, and capped to some
fraction of the real increase in the site value during the period of
deferral.
On introduction of the ILT, all recurrent property taxes hitherto
imposed by the same government should be abolished. Other old taxes
should be phased out as fiscal conditions permit.
Notes
[1] The so-called "rent" of real
property comprises the rent of the land plus the hire of any
building(s) attached to the land; only the former is economic rent.
The so-called "rent" of a vehicle is not economic rent, but a return
on capital.
[2] Henry George (abridged
A.W. Madsen), Progress and Poverty,
href="http://www.henrygeorge.org/pplink.htm"
>http://www.henrygeorge.org/pplink.htm. See also (e.g.)
href="http://schalkenbach.org">http://schalkenbach.org,
href="http://hgclub.com.au">http://hgclub.com.au,
href="http://hgfa.org.au">http://hgfa.org.au,
href="http://prosper.org.au">http://prosper.org.au,
href="http://earthsharing.org.au">http://earthsharing.org.au,
href="http://lvrg.org.au">http://lvrg.org.au.
[3] M. Gaffney, "
href="http://homepage.ntlworld.com/janusg/coe/!index.htm"
>Neo-classical Economics as a Stratagem against Henry George", in
M. Gaffney, F. Harrison, and K. Feder, The
Corruption of Economics (London:
href="http://www.shepheard-walwyn.co.uk">Shepheard-Walwyn, 1994;
271pp.).
[4] Concerning this claim, note that:
(i) land is valued separately from buildings in all Australian
States; (ii) even in jurisdictions where governments do not
separate land values from building values for the purpose of taxation,
insurance companies manage to do the same thing for the purpose of
setting premiums and assessing losses; (iii) the valuation of
land, unlike that of buildings, is facilitated by spatial
continuity, i.e. the requirement that in the absence of
significant boundaries, the land value per unit area is a smoothly
varying function of position; and (iv) the mathematical
uncertainties in valuing land are minor compared with the legal
uncertainties in classifying transactions as taxable or non-taxable
under almost any other form of taxation.
[5] While one may claim that sites on
the city fringe remain affordable for first-time buyers on typical
incomes, this claim does not refer to a fixed group of sites. As the
city fringe moves outward while any given site remains stationary,
that site tends to become less affordable.
[6] Similar arguments can be applied to
sites owned and occupied by religious, charitable, or educational
institutions that do not simply "charge what the market will bear" for
their services. If such a site is nominally subject to deferred ILT,
but is never sold, then the tax never becomes payable and never
becomes a problem for the venerable user of the site.
[7] Indeed, the author has frequently
used the argument in that context.
[8] Most corporate shares are
partly backed by land-like assets. Moreover, the speed with
which shares can be traded, relative to the speed with which they can
be created and destroyed, makes their behavior land-like in the short
term. So share prices are susceptible to bubbles and bursts.
[9] A land bubble tends to be
accompanied by a construction boom (as buyers try to justify the
exorbitant prices paid for sites) and a consumption binge (as owners
borrow against inflated land values to buy goods and services). These
multiplier effects work in reverse when the bubble bursts.
Because of the long transaction times in the land market, a burst is
initially manifested as slower sales rather than lower prices,
allowing sellers and their agents to pretend that the market has
"plateaued" when in fact it has crashed. This state of denial worsens
the liquidity crisis that follows the crash.
[10] Concerning the theory that
recessions are due to high oil prices, suffice it to say that:
(i) there were recessions before there were oil shocks;
(ii) the recession of 1990–91 started before the oil shock
that allegedly caused it; and (iii) in the words of Alan
Greenspan, "we create these elaborate models for policy responses and
we put in oil prices [but] they don't create a recession in the
models" [answer to a question from the International Monetary
Conference (London, June 8, 2004), transcribed by Ashley Seager
and quoted in Fred Harrison, Boom Bust (London:
href="http://www.shepheard-walwyn.co.uk">Shepheard-Walwyn, 2005;
288pp.), p.65].
name="copy">Copyright © 2006 Gavin R. Putland ( href="http://grputland.com">http://grputland.com, href="http://grputland.blogspot.com">http://grputland.blogspot.com).
Permission is given to forward, copy, translate, and otherwise publish
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