land rent

One weird old tax could slash wealth inequality (NIMBYs, don’t click!)

Nick Cowen Current Events, Economics, Law, Liberty , , , , , , , ,

yesnoimputedrent

What dominates the millennial economic experience? Impossibly high house prices in areas where jobs are available. I agree with the Yes In My Back Yard (YIMBY) movement that locally popular, long-term harmful restrictions on new buildings are the key cause of this crisis. So I enjoyed learning some nuances of the issue from a new Governance Podcast with Samuel DeCanio interviewing John Myers of London YIMBY and YIMBY Alliance.

Myers highlights the close link between housing shortages and income and wealth inequality. He describes the way that constraints on building in places like London and the South East of England have an immediate effect of driving rents and house prices up beyond what people relying on ordinary wages can afford. In addition, this has various knock-on effects in the labour market. Scarcity of housing in London drives up wages in areas of high worker demand in order to tempt people to travel in despite long commutes, while causing an excess of workers to bid wages down in deprived areas.

One of the aims of planning restrictions in the UK is to ‘rebalance’ the economy in favour of cities outside of London but the perverse result is to make the economic paths of different regions and generations diverge much more than they would do otherwise. Myers cites a compelling study by Matt Rognlie that argues that most increased wealth famously identified by Thomas Piketty is likely due to planning restrictions and not a more abstract law of capitalism.

Rognlie also inspires my friendly critique of Thomas Piketty and some philosophers agitating in his wake just published online in Critical Review of International Social and Political Philosophy: ‘The mirage of mark-to-market: distributive justice and alternatives to capital taxation’.

My co-author Charles Delmotte and I argue that for both practical and conceptual reasons, radical attempts to uproot capitalism by having governments take an annual bite out of everyone’s capital holdings are apt to fail because, among other reasons, the rich tend to be much better than everyone else at contesting tax assessments. Importantly, such an approach is not effectively targeting underlying causes of wealth inequality, as well as the lived inequalities of capability that housing restrictions generate. The more common metric of realized income is a fairer and more feasible measure of tax liabilities.

Instead, we propose that authorities should focus on taxing income based on generally applicable rules. Borrowing an idea from Philip Booth, we propose authorities start including imputed rent in their calculations of income tax liabilities. We explain as follows:

A better understanding of the realization approach can also facilitate the broadening of the tax base. One frequently overlooked form of realization is the imputed rent that homeowners derive from living in their own house. While no exchange takes place here, the homeowner realizes a stream of benefits that renters would have to pay for. Such rent differs from mark-to-market conceptions by conceptualizing only the service that a durable good yields to an individual who is both the owner of the asset and its consumer or user in a given year. It is backward-looking: it measures the value that someone derives from the choice to use a property for themselves rather than rent or lease it over a specific time-horizon. It applies only to the final consumer of the asset who happens also to be the owner.

Although calculating imputed rent is not without some difficulties, it has the advantage of not pretending to estimate the whole value of the asset indefinitely into the future. While not identical and fungible, as with bonds and shares, there are often enough real comparable contracts to rent or lease similar property in a given area so as to credibly estimate what the cost would have been to the homeowner if required to rent it on the open market. The key advantage of treating imputed rent as part of annual income is that, unlike other property taxes, it can be more easily included as income tax liabilities. This means that the usual progressivity of income taxes can be applied to the realized benefit that people generally draw from their single largest capital asset. For example, owners of a single-family home but on an otherwise low income will pay a small sum at a small marginal rate (or in some cases may be exempted entirely under ordinary tax allowances). By contrast, high earners, living in large or luxury properties that they also own, will pay a proportionately higher sum at a higher marginal rate on their imputed rent as it is added to their labor income. Compared to other taxes on real estate, imputed rent is more systematically progressive and has significant support among economists especially in the United Kingdom (where imputed rent used to be part of the income tax framework).

This approach to tax reform is particularly apt because a range of international evidence suggests that the majority of contemporary observed increases in wealth inequality in developed economies, at least between the upper middle class and the new precariat, can be explained by changes in real estate asset values. Under this proposal, homeowners will feel the cost of rent rises in a way that to some extent parallels actual renters.

For social democrats, what I hope will be immediately attractive about this proposal is that it directly takes aim at a major source of the new wealth inequality in a way that is more feasible than chasing mirages of capital around the world’s financial system. For me, however, the broader hope is the dynamic effects. It will align homeowners’ natural desire to reduce their tax liability with YIMBY policies that lower local rents (as that it is what part of their income tax will be assessed against). If a tax on imputed rent were combined with more effective fiscal federalism, then homeowners could become keener to bring newcomers into their communities because they will share in financing public services.

Rent isn’t a four-letter word

Nick Cowen Books, Economics, Liberty, Politics , , , , , , , , ,

download (3)

Inspired by the publication this week of NYU scholar Alain Bertaud‘s critical new book Order without Design: How Markets Shape Cities (MIT press), Sandy Ikeda‘s pre-book development series Culture of Congestion over at Market Urbanism, and London YIMBY, here is a note on housing reform.

Classical liberals see the economic solution to housing as relatively simple: increase supply to better meet demand. By contrast, the political economy of housing is almost intractably complex. The reason for this is that there are endless externalities associated with new housing: access to light, picturesque landscape, open space and uncongested roads just for starters. These gripes and grievances are the bread and butter of local politics. Unlike consumer product markets, housing cannot be disentangled from these social, political and legal controversies. A successful market-based housing policy must establish institutions that not only encourage housing supply growth but navigate around these problems while doing so.

Policy reform proposals that deliberately favour increasing owner-occupied single-family homes, as tends to be the focus among market liberals in the UK (and to some extent in the US), are currently self-defeating. As justified as they were in the past to achieve a more market-friendly political settlement, they are now a barrier to achieving plentiful, affordable housing. This is because every new homeowner becomes an entrenched interest, a potential opponent to subsequent housing development in their area. They impose more political externalities than renters. I propose we cut the link between support for home ownership and housing supply policies. This would free up policymaking to focus on expanding provision by all available market-compatible means.

This should include greater encouragement of institutional landlords, especially commercial enterprises. Commercial landlords have more incentive and capability to expand supply on estates that they own, while long-term renters (unlike homeowners) have an interest in keeping rental costs low. The lack of private firms dedicated to supplying housing in England compared to much of the rest of the world is startling and yet often overlooked even by friends of free enterprise.

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Natural Rights and Taxation

Fred Foldvary Law, Liberty, Philosophy , , , ,

A moral right is a correlative or flip side of a moral wrong. The right to have X means that it is morally wrong or evil to deny the holder from having X by stealing or destroying it. The right to do X means it is evil for others to forcibly prevent a person from doing X.

People have the natural right to do anything that does not coercively harm others, and the natural right to be free from coercive harm. Natural rights are based on natural moral law, as expressed by the universal ethic. By the universal ethic, all acts, and only those acts, which coercively harm others are evil. I and others have written on natural moral law, easily searched on the Internet.

A legal privilege is a special power or income granted to particular people because of their political status. A king is privileged because of his inheritance and laws regarding this. A slave owner is privileged to own another human being. There are no privileges in natural moral law, since one of the premises from which the universal ethic is derived is human moral equality, an equality of moral worth, implemented as equality before the law and equal legal rights.

In the Constitution of the United States, the 9th Amendment states, in its entirety, “The enumeration in the Constitution, of certain rights, shall not be construed to deny or disparage others retained by the people.” The other rights are common-law and natural rights. Therefore the U.S. Constitution recognizes natural rights, and all laws in the USA should be consistent with the 9th Amendment, although in practice, the 9th is ignored and not widely understood.

This brings us to two court cases. In Murdock v. Pennsylvania, 319 U.S. 105 (1943), the Supreme Court stated that a law requiring solicitors to purchase a license was an unconstitutional tax on the Jehovah’s Witnesses’ right to freely exercise their religion. The Court ruled that “The state cannot and does not have the power to license, nor tax, a Right guaranteed to the people,” and “No state shall convert a liberty into a license, and charge a fee therefore.”

In another case, the Court ruled similarly, that “If the State converts a right (liberty) into a privilege, the citizen can ignore the license and fee and engage in the right (liberty) with impunity.” (Shuttlesworth v. City of Birmingham, Alabama, 373 U.S. 262).

The principles behind the statements of the Court have to apply generally. The federal and state governments may tax privileges, but may not tax a natural right. Since people have a natural right to engage in labor for wages, taxes on wages violate natural rights and therefore the Constitutional rights recognized by the 9th Amendment. Taxes on trade and goods also violate natural rights, which is why state laws claim, incorrectly, that, when they impose a sales tax, they are taxing the privilege of selling goods. (For example, it is written that “California assesses a sales tax on sellers for the privilege of doing business in California.”)

If natural rights are violated by taxing wages, the same applies to the products of labor and the income from the products. Thus a person has the natural right to fully keep and trade produced goods and the financial counterparts as shares of companies and their incomes.

The U.S. Constitution does provide government with the power to tax. Article I, Section 8, states, “The Congress shall have power to lay and collect taxes, duties, imposts and excises.” The 16th Amendment restricts the income tax to being levied as an indirect tax, but otherwise did not alter or add to the powers of Article I.

There is an apparent contradiction. Article I empowers government to tax imports and goods, and other taxes, but the 9th Amendment prohibits taxing acts which are natural rights.

Clearly the founders did not oppose taxing as such. But the letter and spirit of the law have to go beyond the intents of the founders. The Constitution also did not explicitly outlaw slavery, despite its recognition of preexisting rights. When slavery was later abolished, this was in accord with justice as prescribed by natural moral law and the 9th.

If a parent says to a child, you may go outside and play, and also says, do not throw rocks at the squirrels, the permission to play does not imply that anything goes. Thus when the Constitution authorizes taxes, but then, in an Amendment, says, by implication as recognized by the Supreme Court, that government may not tax a right, then the power of taxation has been constrained.

The U.S. Constitution creates an imposed but limited government, and the founders recognized the need for revenues. The sources of government revenue boil down to two original sources: labor and land. There is human exertion, and there is what nature provides.

Since human exertion and its gains are a natural right, the only source left is nature’s resources, land. Thus the moral question is whether the ownership of land is a natural right. This issue is, of course, much disputed. In my judgment, the moral law of property is, “To the creator belongs the creation, and where there is no creator, the benefits belong to the people in equal shares.” The universal ethic is based on the premise, from the nature of humans being, as John Locke wrote, “all equal and independent,” the independence being that thinking and feeling occur individually.

The benefits of land are measured as its economic rent. Therefore, the rent belongs to the people, and by natural moral law, the individual right of the possession of land is conditional on paying the rent to the rightful owners, the people. A tax on land rent does not violate the natural rights of the title holder.

Although the rent really belongs to the people and not to an imposed government, since government is already an imposition, it violates natural rights the least when rent is used for public revenues to pay for public goods that generally benefit the people. The people receive the rent in kind rather than in cash.

If consistently implemented, the 9th Amendment, backed up by the Murdock case, implies that the income tax as well as excise taxes should not tax the right of labor and trade. The greatest challenge of humanity is to recognize the full spectrum of human natural moral rights.

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A similar article by me appears in progress.org as “Rights and Privileges”.

The Dangerous Inequality Meme

Fred Foldvary Economics , , , , , , , , ,

The inequality of wealth and income has become a meme loaded with danger. A “meme” is an idea that gets propagated like genes in biology. Economic inequality has long been a topic of interest, but during the past few years, and especially during the 2015-2016 American elections, the inequality meme has erupted into a major political issue among those who identify as progressive, liberal, and socialist.

The facts about inequality in the USA are clear. Since 1970, income inequality has increased. As national income has grown, most of the gains have gone to the rich. Average incomes have even dropped since the recession of 2007-2009.

During the 1800s, the first economist to analyze equality and inequality was Henry George. Karl Marx had touched on economic inequality by saying that the surplus from production was due to labor but was captured by the capitalist, the owner of the firm and its tools. Thus, the proletariat, the workers, stay poor and the capitalists get rich, creating inequality. But Marx and his followers focused on the conflict between labor and capital rather than the inequality.

Henry George pointed out that the surplus from production is not in wages, nor in business profits, but in land rent, which is a pure surplus, since land has no cost of production. George showed how land rent captures the gains from economic progress, creating the inequality in wealth and income between workers and the landowners. Competitive firms make normal profits, which has no surplus. Of course monopolies can capture surplus also, but the profits from entrepreneurship are a bonus to society, rather than a social problem, as entrepreneurs drive innovation and economic progress.

Unfortunately, when the classical economics of the 1800s turned into the neoclassical doctrines of the 1900s, both by design (in opposition to the Georgist remedy of taxing land value) and for mathematical convenience, land was dropped as an input factor, and mainstream economics became the two-factor production function Q=f(K,L). It is illogical that land rent gets included in the distribution of income in the return on K, but excluded on the production side, as the models are based only on the two inputs, labor L and capital goods K. This contradiction is not questioned by graduate students in economics, who are too busy learning the calculus of “math econ” to bother asking if the whole system makes sense.

Therefore the inequality meme is now blended with the labor-capital meme, ignoring the real source of economic inequality, unequal land tenure. Politicians exploit the all-too-real economic inequality with a superficial, simplistic, and dangerous remedy: tax the rich and transfer the funds to the poor. Of course governments are doing that already, and that has not reduced inequality, but the welfare-statists insist that government should do more of it.

Conservative opponents of greater redistribution point out, correctly, that higher taxes and takings from the rich will stifle entrepreneurship and savings, reducing the economic growth. But other than eliminating some of the tax deductions and generating more growth by reducing the top tax rates, the conservatives have no effective remedy. Their call to flatten the tax rates play into the political agenda of the redistributionists who call for higher, not lower, tax rates on the rich.

The danger in the inequality meme is the confiscation of the wealth not just of the rich but also of the middle class. A family that spent all its income and now has no wealth would be given welfare aid, while the family with the same income but frugally saved its income for retirement or to provide for their children would have their wealth taken away, not just by ordinary and predictable taxation, but by a sudden taking, as happened in Cyprus in 2013. Government chiefs facing a debt crisis can kill two birds with one stone: confiscate savings and use some of it to pay off debt and the rest to transfer to the poor. Such confiscation has been suggested by the International Monetary Fund, which lends funds to countries bogged down in debt. In its publication Fiscal Monitor Report, the IMF stated (pdf):

The sharp deterioration of the public finances in many countries has revived interest in a “capital levy”— a one-off tax on private wealth—as an exceptional measure to restore debt sustainability. The appeal is that such a tax, if it is implemented before avoidance is possible and there is a belief that it will never be repeated, does not distort behavior (and may be seen by some as fair).” There we have the proposition that such confiscation of wealth can be “fair” (49).

This IMF capital-levy proposition was presented in Forbes with the title, “The International Monetary Fund Lays The Groundwork For Global Wealth Confiscation.” The Wikipedia article on “capital levy” shows that this meme is getting some traction, such as by Germany’s Bundesbank. The concept of a capital levy, confiscation of savings and investment, comes from the meme of economic inequality that looks only at the superficial existence of unequal wealth and not to the source.

It has been well pointed out by British journalist and economist Fred Harrison in his Youtube video “Ricardo’s Law: the Great Tax Clawback Scam” that while the rich pay much in taxes, many of them get the tax back, as a clawback, from government’s public goods, which generate higher rent and land value.

The effective and equitable remedy for economic inequality is not redistribution but the proper initial distribution of income. Wages and capital yields should be kept by the workers and investors, while land rent should be equally distributed either as cash or in public services. Public revenue from land rent would equalize income while promoting growth and raising wages. We need to bring land back into economic discourse, but that requires penetrating the appeal of superficial thinking. That’s what Henry George tried to do, and the Georgist meme had reached up to the heads of state in China, Great Britain, and Russia (after the first revolution with Kerensky), but World War I blasted the impending tax reforms to bits.

The candidates who now rant against inequality, the corporations, and the billionaires, even if they don’t win the election, will influence policy and generate calls for more redistribution and, perhaps in the next financial crisis, a capital levy. While alarmists often exploit impending doom for their own gains, sometimes they are right.

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This article is also in progress.org under the title “Tyrants Exploit Income Inequality”

[Ed. note: I added tags, categories, and links, and patched up some grammar – BC]

The 100th Anniversary of the Defeat of Economic Land

Fred Foldvary Economics, History , , , , , , , , ,

The year 2014 is the 100th anniversary of an economics article that was the final nail in the coffin of classical economics, as it marked the victory of the neoclassical economics war against land. This was a victory so great that economists today do not even realize that there had been such an academic war.

Alvin Saunders Johnson (1874-1971) was an American economist at several universities, including Columbia, the University of Chicago, and Cornell. He was a co-founder of the New School at New York City. In 1902 he wrote “Rent in Modern Economic Theory: An Essay in Distribution.” Johnson, along with other economists who were turning the classical theories of the 1800s into the neoclassical doctrines of the 1900s, generalized “rent,” from the yield of land, into any surplus above opportunity cost, i.e. above the cost needed to put a resource to its most productive use. For example, a movie star paid $1 million to act in a movie, whose next best opportunity is being a salesman earning $100,000, has an economic rent of $900,000.

In 1914, Johnson published “The Case against the Single Tax” in The Atlantic Monthly. As has been well explained by Prof. Mason Gaffney in The Corruption of Economics, Johnson played a major role in suppressing, by falsification, the land-tax ideas of Henry George. Land is now visible everywhere except in academic economics. For example, the generation of land value by public goods is not even mentioned in the general textbooks.

Johnson correctly stated that a tax on the entire rent of land would bring the purchase price down to zero, but he expressed it as: “the value kernel of landed property will have been seized by the state.” In policy analysis, we need to examine inflammatory vocabulary. The moral case for land-value taxation rests in the proposition that the benefits of nature belong to all humanity equally, that the creation of local land values by population and commerce belongs in equal shares to the members of those communities, and that the rentals generated by public works may be used to pay the providers, whether this be private-sector or government providers. None of this is confiscation or seizing by the state.

In Georgist ethics, the people own the rent, not the chiefs of state. A government may justly act as the agent of the people to protect their property, such as the atmosphere, from damage, and a government may, as the agent of the people, collect the rent to distribute it among them, or to use to pay for public goods. The premise that the rent belongs to the people implies that the rent is not being seized from the landowners as though these title holders are the morally legitimate owners, but rather that the state is facilitating the collection of the rent to the proper owners, the people. Hence the terminology used by Johnson taints his analysis and begs the question of the proper ownership of land rent.

Johnson continues his attack by calling the single tax on land value “propaganda for the universal confiscation of land.” Henry George had unfortunately stated in Progress and Poverty that “It is not necessary to confiscate land; it is only necessary to confiscate rent.” The Latin origin of “confiscate” is “confiscare,” from “fiscus” meaning the government’s treasury. Fiscal policy is about governmental revenue and spending. Thus in linguistic origin, to confiscate means simply to tax, to transfer assets to the public treasury. But in modern popular usage, to “confiscate” means to take by force, with the implication that the state is seizing property that was legitimately owned. And despite George’s statement that it is only the rent, not the land itself, that is being “confiscated,” Johnson attacks the single tax as confiscating the land.

Moreover, by dismissing the theory behind the single tax as “propaganda,” Johnson denigrated the logic and evidence for land-value taxation in an anti-scholarly manner, and thus he himself indulged in propaganda.

Johnson’s mixing up the ownership of land and of its rent is also shown by his statement that if all the value of land is taxed, the revenue would cover the costs of government, “provided, of course, that the public can manage the lands as efficiently as they are now managed by their private owners.” This despite the statement of George that “I do not propose either to purchase or to confiscate private property in land.” Land-value taxation would not disturb private titles; it would not alter private control and possession. The government would not “manage the lands.”

Johnson states that much of the financial wealth of the middle class is in land value, and that the full taxation of land value would take more value from them than they would regain in the removal of other taxes. Of course in 1914, the 16th Amendment had just been enacted in 1913, and the middle class did not yet suffer from the income tax.

Nevertheless, Johnson’s statement is illogical. Suppose the total land rent is $1 trillion, and the cost of government is half of that; then the rent does not disappear, but is distributed back to the people in cash. So the effect of land value taxation would be to equalize the ownership of the rent, and a person who owned an average amount of rent would get half back in cash, and half back, ideally, in valued public goods. If government is squandering some of the rent, then the remedy is to give it all back to the people. Then the average land owner is in a neutral position.

Johnson falsely declared that “The Single Tax is, then, essentially a device for the spoilation of the middle class.” One could justly say that Johnson’s malicious attack was a device for the spoilation of the remedy for poverty, depressions, and land conflicts. What has spoiled the middle class is high taxes on their wages and on the goods they buy. Johnson’s falsifications were the spoilation of a policy that could have promoted sustainable prosperity and prevented needless economic inequality. Johnson’s propaganda succeeded in helping squash land-value taxation, but to the ruin of economies worldwide.

With the neoclassical victory against land, most economists today suffer from cognitive dissonance. Even if economists reject an egalitarian view of natural resources, they know that the supply of land is inelastic, so public revenue from land rent avoids the excess burden that other taxes have. But they do not extend this knowledge to the rest of theory and to policy. Mason Gaffney calls this the “corruption of economics.” I call it “academic brain freeze.” At any rate, it is worth marking the 100th anniversary of Johnson’s attack.

Blaming Finance, Ignoring Real Causes

Fred Foldvary Economics , , , , , , , , , ,

The fall 2014 Cato Journal has an article, ‘The Financial Crisis: Why the Conventional Wisdom Has It All Wrong,” [pdf] by Richard Kovacevich, Chairman Emeritus of Wells Fargo. The author is correct in saying that the conventional wisdom is wrong in blaming the slow recovery on the “uniqueness of a financially led economic recession.” The US economy recovered from the severe 1980 recession within two years, while now the economy is creeping like a turtle.

The economic cause of recovery and growth is simple. Economic investment – the production of capital goods – drives the business cycle. Recessions are caused by a sharp fall in investment. Then, as the prices of raw materials fall, and as land rent drops, a depression reduces these costs of production, therefore increasing profits, so investment recovers. Government can boost the recovery by further reducing the costs of production, by decreasing the taxes and regulations it imposed previously. This is the “supply side” policy of increasing investment and production by reducing the costs of regulations and taxes.

But this time around, the federal government did the opposite. Costly regulations have magnified, with an anti-supply-side effect. Every year, there are thousands more regulations that hamper enterprise, and finally, regulations plus taxes have achieved the tipping point of making it too costly for enterprise to invest and hire labor.

After the Crash of 2008, the federal government had two basic policy options: it could help the economy recover with market-enhancing supply-side policies, or else the government could enact the welfare-state agenda of greatly increased governmental medical services. The government chose the latter option, which imposed even greater costs on enterprise and labor.

When the recession hit the economy in 2008, one of the responses was TARP, the Troubled Asset Relief Program. As the article states, one of the problems with TARP was that it did not focus on the troubled banks, but imposed the policy on all banks. The banks that were not troubled had to obtain the funds and then pay interest on them. TARP imposed the impression that all banks were in trouble, which destroyed confidence, and then Congress responded to the turmoil by imposing 25,000 pages of Dodd-Frank regulations.

None of the financial regulations, going back to the Great Depression, confront the causes of the boom and bust. The fundamental cause is massive subsidies to land values. The Cato article focused on the financial industry, but the more fundamental issue is government policy regarding real estate. The problems of the financial industry originate in their financing of real estate.

The history of the Americas has been that of grabbing land and enslaving labor. In the American colonies, the British government promoted European settlement to control land and to profit from trade. After the defeat of the French in 1763, the United Kingdom changed policy to avoid conflict with the people of Quebec and with the Indians, by restricting western speculation and migration. That annoyed the landed interests enough to declare independence, and to establish a constitution that would better extend and protect land speculation. Huge grants of land were given to railroads, veterans, colleges, and speculators.

After the public domain was disposed of, the government continued the subsidy of the large landed interests with implicit policies that are invisible to the public and to most economists. The provision of public works, welfare to the poor and elderly, and artificially cheap credit, all generate greater land rent and land value. This amounts to a vast redistribution of wealth from workers, tenants, and enterprise owners, to landowners, especially the concentrated owners of commercial and farm land.

With a fixed supply of land, much of the gains from an economic expansion is captured by higher land rent and land value, which then attracts speculation that carries real estate prices to unsustainable heights. When land values crash, they bring down with them the financial system that provided the loans. None of the financial regulations touch this basic cause, and land-value seeking is so deeply ingrained in American culture that people favor it even at the price of high taxes, high unemployment, and the destruction of liberty.

Ask a typical American, “Would you favor a tax reform that eliminates taxes on your wages, on interest from your financial assets, and on buildings, replaced by a tax only on land values?” The answer is, “No! I would rather suffer unemployment, insecurity, crime, poverty, and loss of liberty, than have my precious land taxed!”

“OK, then, would you favor the complete replacement of government’s public goods with private, contractual, provision that eliminates the subsidy to land values?” “No! We need government to provide these things!”

Then you ask, “So why do you want the word ‘liberty’ put on our coins?” The answer is, “I want liberty so long as it is not put into practice!”

And that is why government deals with the superficial financial appearances, and not the implicit reality that causes the booms and busts.

How the Rentenbank Stopped Inflation

Fred Foldvary Economics, History , , , , , , , , , ,

After World War I, Germany had to pay reparations to the United Kingdom and France. Having sold off its gold, the German government had no specie with which to back its currency, the mark. Therefore Germany issued fiat money, not backed by anything. It was called the Papiermark, the paper mark.

With its economy in ruins, the German government printed more and more currency with which to pay its bills, and the German expansion of money became the world’s most famous example of hyperinflation.

The inflation induced alternative currencies in Germany. In 1922, the Roggenrentebank was established, issuing notes backed by rye grain. In 1923 several local governments issued small-denomination loan notes denominated in commodities such as rye, coal, and gold. The commodity front served as a price index relative to marks for the notes.

The inflation came to a halt with the replacement of the Papiermark with a new currency, the Rentenmark on October 15, 1923*. One Rentenmark could be exchanged for a trillion Papiermarks.

The Rentenmark was fronted by bonds indexed to amounts of gold. Since the US dollar was backed by gold then, the Rentenmark was thus also pegged to the US dollar at 4.2 RM to $1. To “back” a currency means to exchange it for a commodity at a fixed rate. It was not enough to merely index the units of the Rentenmark to gold. To become stabilized, the new currency needed to be fronted by a commodity that was actually used. That commodity was real estate.

The Deutschen Rentenbank, the central bank of Germany, established reserves that included industrial bonds as well as mortagages on Germany’s real estate. A currency is fronted when the issuer has collateral that it can deliver in exchange for indexed units of the money. Real estate rentals payable in Rentenmarks were fronts for the new German currency. “Rente,” derived from French, means income in German, such as a pension.

After having stabilized the money, the Rentenmark was replaced by the legal-tender Reichsmark in 1924 one-to-one, although Rentenmark notes continued to serve as money until 1948.

Previous attempts to front a currency with land value failed, because such frontage is insufficient. In France during the early 1700s, John Law’s bank issued money on the collateral of land in Louisiana, but that hypothetical land value did not constrain the over issue of the banks’ notes. Then during the French Revolution, the government issued “assignats” on the collateral of confiscated church land, but that too did not prevent the inflation of the money.

Land rent cannot “back” a currency, since there are no uniform units of land that can be exchanged for units of money. But land rent can be a “front” for money when taxes are payable in that currency, which helps give that money its value. But that alone does not prevent an excessive expansion of the money. To stabilize the currency, it also needs to be backed by or indexed to some commodity. And gold has been a common and suitable backing for paper and bank-account currency.

The German experience also shows that the gold backing does not require large amounts of gold. It is sufficient for stabilization that there is some credible limit to the expansion of the money. The Germans were lucky in 1923 in having monetary chiefs such as Hans Luther of the Finance Ministry, and Hjalmar Schacht, Commissioner for National Currency, who maintained the gold index by limiting the expansion of the new currency.

But as the experience of France, shows, it is risky to depend on the integrity of monetary chiefs. Permanent monetary stability requires a structure of money and banking that is self-correcting. That structure is best provided by free-market banking, in which the real money (outside money) is some commodity beyond the control of the banks, and the banks issue “inside money” or money substitutes backed by the real money. Competition and convertibility prevent inflation.

Any kind of tax can serve to help endow money with value, but a land-value tax offers the greatest frontage for currency, because in effect, LVT acts as a mortgage on land value, and the government can take over land when the tax is not paid. Unlike with taxes on income, nobody goes to prison for not paying a real estate tax, because the rent serves as a reliable collateral. Land rent can serve as collateral not just for real estate loans, but also for taxation, and for currencies. All countries can have “renten money” when they covert from market-hampering taxes on production to market-enhancing taxes on the economic surplus that is land rent.

* This was corrected from an earlier typo listing the year as 2013 instead of 1923.

How to Achieve Peace in Gaza

Fred Foldvary Current Events , , , , , , , , , , ,

Israel’s bombing of Gaza has not stopped its rocket attacks, so it is counterproductive. Instead, Israel should help the people of Gaza establish a communitarian democracy.

The government of Israel would announce on radio, television, web sites, and leaflets, that it will be sending in troops, not to fight against the people of Gaza, but to empower their communities.

The Israeli government would also apologize for its misguided policies of the past, and for the suffering and humiliation it caused for the Gaza Palestinians. Of course the Israelis have suffered also, but if one demands a counter apology, one is not really repenting and regretting.

The Israeli administration would designate neighborhood boundaries for communities of about 1000 residents and also enterprise owners. Residents would volunteer to serve on the community council. The Israeli troops would defend the community from any extremist opponents of the new democracy. The communities would set up their own protective elements, and the Israeli troops would withdraw.

Israel should have democratized Gaza in 1967 rather then let the area fester. Then in 2005, Israel removed its settlements without negotiating with the Palestinian rulers. Now Israel should do what occupiers world-wide have failed to do, lay down an infrastructure of democracy.

The community councils of Gaza would elect representatives to regional associations, and the regions would elect representatives to a Gaza parliament. The Palestinians of the West Bank should also elect their own parliament. Then the two parliaments would elect a Palestinian federation of two provinces, Gaza and the West Bank (perhaps renamed East Palestine). It would be best to leave local matters to the two provinces.

Israel should then stop imposing tax policy on the Palestinians and let them set up their own public finances. But advisers should encourage the Palestinian councils to collect the land rent and use that for public revenue rather than tax their wages and goods.

Unfortunately the Palestinian governors have focused their resources on fighting Israel rather than economic development. But after the communities in Gaza have become empowered, Gaza will no longer be occupied territory. Israel would remove the barriers around Gaza gradually, since there will still be extremists who seek destruction. But Israel should facilitate the greatest possible mobility for the Palestinians under the constraint of protection, rather than treat the Palestinians with the arrogance that has been practiced in the past. “No more humiliation” should be the stated slogan.

A similar policy should be pursued in the West Bank. The Palestinian authority chiefs will resist transferring power to the people and their local councils, but a democratic Gaza (or West Palestine) will cause the East Palestinians to demand genuine democracy. A bottom-up governance in the West Bank would then result in a federation of West and East Palestine that would then negotiate a lasting peace with Israel.

There have been some peace gatherings among Israelis and Palestinians to humanize their relations and to see that individuals are people much like themselves. But such personal interactions are no substitute for confronting the essential issue of who shall own the land.

The solution that is both just and politically feasible is to recognize the pre-1967 boundaries and then convert the Israeli settlements as leaseholds that pay rent to the Palestinian government.

Ideally all landowners in Israel and Palestine should pay the market rent of their land possessions. Land rent would serve as the best public revenue for a Confederation of Israel and Palestine. Palestine would be a state within the Confederation and would itself also be a federation of West and East Palestine.

The other contentious issue has been the return of displaced Palestinians to their pre-1948 lands. A peace treaty should allow a limited return of Palestinians to Israel, with some compensation for lands that have become homes for others. So long as justice is sought, the maximalists will usually be in the minority.

If justice is not established, time will be an enemy of both the Israelis and the Palestinians, as extremists and nuclear perils are on the rise. The choice is either justice now or destruction later.
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Note: this article is also at http://www.progress.org/views/editorials/democracy-and-justice-for-gaza/

The Theory of the Non-Working Class

Fred Foldvary Economics , , , , , , , ,

In the USA, people of age 16 and above are considered of working age. Of those of that age range, those who are working, seeking work, or hired but not yet working, are designated to be in the labor force. The labor force participation rate is the number of people in the labor force divided by the number of those of working age.

From 1950 to 2000, the labor force participation rate in the USA rose from 59 percent to 67 percent. Much of that increase came from the doubling of the participation rate of women, from 30 percent in 1950 to 60 percent in 2000. But total labor participation has declined since 2000 to 63 percent.

While the portion of women in the US labor force rose, the portion of men has been declining. The prime working years are considered to be from age 25 to 54, and one sixth of the men of that age range are not working. In 1950, only four percent of men of that range were not employed.

Many of those not working are not seeking work, and are therefore not counted in the labor force. They are also not counted as unemployed, because by definition, the unemployed are those actively seeking work plus those who have been hired but not yet started to work for wages. Two thirds of working age men are not seeking work, although some who sought work but stopped because they were discouraged, would take a job if offered.

About 40 percent of the men seeking work have been unemployed for six months or more. The chronically unemployed are less likely to become employed, so the long-term unemployment feeds on itself.

The real wage of lower-skilled workers has been falling since 1970. For workers who did not finish high school, the real wage (adjusted for inflation) has fallen 25 percent. That fall in wages is offset somewhat by the availability of new products such as cell phones and by the fall in the relative prices of electronics and other goods, but the cost of housing, medical care, taxes, and college tuition have risen to offset some of that productivity gain.

There are several reasons why male labor participation has fallen. First, more men are attending college. Second, due to the expansion of the war on drugs, the portion of men in prison has risen. Third, as more women work for wages, some male partners choose home production, doing house work and child care at home, which is real labor but not counted in the output data. Fourth, more people are obtaining government’s disability income. Very few on disability go back to work. Fifth, many in the first of the baby-boom generation, born during 1946-1950, are retiring.

The downward trend of labor participation will continue. The Congressional Budget Office estimates that the participation rate will fall to 61% by 2024. CBO calculates that the Affordable Care Act reduce the labor force by more than 2 million jobs. Workers will be able to quit their jobs without losing medical coverage, and the expansion of Medicaid will induce many more adults to obtain medical care without having a job.

One of the problems with a lower labor participation rate is that it reduces the ratio of workers to non-workers. Social Security and Medicare are supported by transferring income from workers to non-workers. A smaller labor participation rate will use up the trust funds and create a deficit for these programs sooner. Also, fewer workers results in lower economic growth, which implies that more of those in poverty will stay that way.

Much of the labor participation decline is not voluntary, but caused by tax and subsidy policies. Without taxes on wages and enterprise profits, both wages and employment would be higher. If the funds now going into Social Security instead went into tax-free private retirement accounts, those who retire would rely on their own past savings rather than transfers from those working. Without the income-tax distortion caused by tax-free medical insurance and taxed money wages, workers would be able to choose the insurance plan that fits them best rather than having to accept the limited plans offered by employers and the government.

The best alternative to taxing wages is to tax land rent or land value. But even without such a fundamental shift in policy, the labor force participation rate can be made more voluntary with employee and self-employment incentives for those long out of work, such as tax offsets and exemptions from restrictions (e.g. licensing, union rules, and city zoning) that prevents working at home, and exemptions from litigation risks. Immigration reform – legalizing those already in the country and allowing more of those with labor skills into the country, would also substantially increase the labor population.

The basic problem with labor world-wide are restrictions on hiring and firing labor, and the heavy costs imposed by taxes, regulations, and mandates on employers. If an employer, including a self-employer, could simply hire a worker without having to deal with forms and regulations, and with no taxes on the employer and the employee, we would have full employment at wages that would provide a decent standard of living. The labor problems we have are iatrogenic, a disease caused by the doctor, in this case, the economic malady caused by government policy. The government people look to for solving economic problems has caused them in the first place.

Gold as Implicit Money

Fred Foldvary Economics , , , , ,

Economics encompasses two realities, the explicit and the implicit. The explicit is visible, obvious, recorded, and quoted. Explicit expenses are paid to others and recorded by accountants. The explicit is also called “nominal,” since that is what is named. For example, nominal interest is what a bank says it is paying, and the money it pays to depositors.

But there is also an implicit realm that is also real. Indeed, the implicit is more real than the explicit. What is explicit is often merely the superficial appearance. But things are often not what they appear to be. The reality beneath is implicit, not visible, not quoted, and not recorded, yet it is the true reality. Economists often use the adjective “economic” to designate the real thing in contrast to the explicit number or the accounting data.

An enterprise has explicit and implicit expenses. The explicit expenses are recorded by bookkeepers and accountants. The implicit expenses are non-recorded opportunity costs, such as what the owner of a business would have earned elsewhere, or what the assets of the firm would yield if sold and converted to bonds. The real cost of oil is not what the buyer pays but also includes the implicit costs of pollution damage not paid for by the customer.

Real interest is the nominal interest minus the inflation rate. Economic profit is accounting profit minus implicit expenses. Real GDP is nominal GDP (in current dollars) adjusted for inflation. Economists deflate prices and include implicit costs to get at the implicit reality. Continue reading →

Around the Web

Brandon Christensen Current Events, Economics, Links , , , , , , , , , , , , , , ,

Co-editor Fred Foldvary is participating in a symposium over at Bleeding Heart Libertarians.  Check him out.

Michael Mungowitz bags on Greece and the Euro Zone.

Zach Gochenour has a complimentary follow-up piece on Dr. Foldvary’s essay: Progress or Poverty: The Economics of Land and Discovery.

All Hail Azawad.  A blogger obsessed with maps from the New York Times writes about the new state’s prospects .  I have written about Azawad here, here, here, and here (oh God I hope I don’t sound like Walter Block!).

Jacques Delacroix provides even more insights into the French elections and its implications for the Euro Zone.

The collapse of the Euro Zone is kind of a big deal.  Personally, I hope the collapse only destroys the currency of the zone, and not the ability of its members to trade and work freely anywhere throughout the zone.  I also want a pony and never-ending supply of really good weed.

The European policymakers and technocrats should not have been so brash as to believe that they could unify Europe politically.  Not only is that bad for democracy, but it has also given the underlying principle behind the EU – free trade – a very bad name.  Repeat after me: large polities that are economically united and politically divided are good for everybody, but large polities that are economically and politically united are bad for everybody.

It’s even worse when you throw in concepts like Old World identities such as ethnicity into the mix and try to get everybody to play nice through the democratic process.

Chicago, Vienna and San Francisco

Brandon Christensen Economics, Links , , , , , , ,

Co-editor Fred Foldvary has a great essay up on three schools of economic thought that deserves to be read by all.  An excerpt:

The Vienna school emphasizes the dynamics of the economy, while the Chicago method is to apply self-interest and economizing in an equilibrium analysis.  The San Francisco school uses both equilibrium and dynamics.  The dynamic approach of change over time is used to show the advance of rent and lowering of wages as the margin of production moves to less productive land and as land speculation moves the margin out even further.  Equilibrium shows that since market rent is based on the fixed supply of land and the demand to rent space, the tax on land not affecting the rent.

The San Francisco school agrees with the Vienna school that the spontaneous order of the free market best allocates goods to human desires.  But the San Francisco school points out that if the ground rent is not tapped for public revenue, when taxes on other things finance civic works, then there is in effect a subsidy to land owners, which distorts the market.

The San Francisco school has a theory of the business cycle based on land values, which rise during a boom, when speculation carries land prices so high that investment gets choked off, resulting in a recession.  But San Francisco has lacked a consensus on the role of central banking and money.

Check out the rest here.

I tend to pay attention whenever Dr. Foldvary writes, because he is the guy who wrote a book in 2007 accurately predicting the economic collapse of 2008.  You can access the book for free here.