John Passant had an op-ed in the AFR a few days ago promoting the idea of taxing economic rent. The AFR published my response this morning.
Proposals to tax ‘economic rents’ should be viewed with the utmost suspicion – the tax system is complicated enough with easy-to-understand tax bases.
The late Milton Friedman was insistent that there could be no free lunches. Everything has a cost and every decision a consequence. In recent times the idea of a free lunch in taxation has become quite popular. This is the notion of taxing rents.
Writing in these pages John Passant has proposed that taxing rent could give raise to revenue while penalising monopoly capitalism (Economic rent ripe for tax, AFR January 12). It is not enough to simply point to the discredited Marxist idea of monopoly capitalism, the idea of economic rent being a basis for taxation itself needs to be confronted.
Economic rent is usually defined as being a return over and above some minimum return necessary to keep a factor of production working. Economists refer to this as being economic profit or super-normal return.
In classical economic theory rent was the designated as being the return to land, one of the three factors of production; the other two being capital and labour. Land, in turn, was defined as the bounty of nature. Unsurprisingly, in that framework taxing a bounty had no consequence – if you acquire something for free it shouldn’t worry you to lose it to the taxman.
But nature doesn’t surrender its bounties for free. Value is created through to application of capital, labour and entrepreneurial insight.
The classical economists didn’t understand value – they thought it was created by labour inputs or costs. They quickly ran into the problem whereby some apparently homogeneous assets – farm land in particular – were more valuable than others despite labour inputs. This differential they called ‘rent’.
Economists now have a better understanding of value. We are not surprised that fertile land is more valuable than less fertile land. We understand that the value any resource is determined by an entrepreneur’s ability to employ that resource to create a good or service that can be profitably sold on the market.
Taxing rent is a tax on entrepreneurship and innovation – something the classical economists didn’t understand well.
Modern economic theory, however, does recognise the notion of a quasi-rent – a temporary source of super-normal profit. But we know capitalism is characterised by creative destruction and temporary tax bases would be a very poor basis for funding the long-term financing needs of the modern welfare state.
Taxing rents is a theoretical proposition; yet taxation is an intensely practical matter. The government seeks secure and stable revenue while taxpayers seek clear definitions and certainty. Economic rent simply does not meet any of those practical considerations. This is the great lesson of the bruising mining tax debate. The government could not define the actual tax base, nor explain what it was doing, and had no idea how much revenue it would raise. The new mining tax is no different.
Update: Gavin R. Putland of the Land Values Research Group has a response here.
“Economic rent is usually defined as being a return over and above some minimum return necessary to keep a factor of production working. Economists refer to this as being economic profit or super-normal return.”
There always seems to be a lot of “eye of the beholder” to claims about rents.
pedro
24 Jan 11 at 6:17 pm
“Taxing rent is a tax on entrepreneurship and innovation – something the classical economists didn’t understand well.”
All taxes are taxes on entrepreneurship and innovation. This is not an argument against a rents tax.
The case for a tax on rents stands on its not leading to deadweight losses. Unless you can show that it does lead to such losses, your argument won’t succeed.
Dandy Warhol
24 Jan 11 at 9:48 pm
All that matters is the principles – equity and efficiency.
I believe low rated royalties, consumption taxes and land value taxes qualify on those regards.
The extreme position that a Georgist regime can end business cycles seems fruity.
.
24 Jan 11 at 9:54 pm
The AFR is publishing Trots as experts on matters economic now? Oh, and whenever I hear the world “equity” I reach for my revolver.
Peter Patton
24 Jan 11 at 10:00 pm
Peter, it makes it easier to administer the rough end of the pineapple to the public if they think that the bloke next to them is no better off.
Dandy Warhol
24 Jan 11 at 10:19 pm
And here’s my response to Davidson, which the AFR also published.
Gavin R. Putland
25 Jan 11 at 1:13 pm
Patton.
What is wrong with equity in a tax policy.
Remember, we’re in a democracy and so such policies need to be salable.
.
25 Jan 11 at 4:51 pm
“So the question is, which is the least bad tax? In my opinion the least bad tax is the property tax on the unimproved value of land, the Henry George argument of many, many years ago”
- Milton Friedman (1978)
“The extreme position that a Georgist regime can end business cycles seems fruity”
if you accept the proposition that a very high land tax abolishes land speculation, then you can infer given that the Panic of 1819, 1837, 1857, 1873, 1893, 1926, 1973 (REIT), 1990 and the GFC we’re all preceded by real estate speculation which caused the downturn (too much debt, insolvency, overbuilding etc), it would eliminate/mitigate the ‘endogenous’ business cycles (but not always exogenous cycles – but it may allow us to adjust to them faster).
Spadj
25 Jan 11 at 10:05 pm
“government seeks secure and stable revenue”
But, of course, as you should know very well Sinclair tax revenues do not “fund” government – the central bank electronically credits bank accounts totally independent of its tax raising power and there is no room where our taxes go to “fund” government. Governments’ only tax to 1) stablise the purchasing power of the dollar (i.e. reduce inflation) and 2) “equity”. Tax revenues are obselete.
“The United States is a national state which has a central banking system, the Federal Reserve System, and whose currency, for domestic purposes, is not convertible into any commodity. It follows that our Federal Government has final freedom from the money market in meeting its financial requirements. Accordingly, the inevitable social and economic consequences of any and all taxes have now become the prime consideration in the imposition of taxes. In general, it may be said that since all taxes have consequences of a social and economic character, the government should look to these consequences in formulating its tax policy. All federal taxes must meet the test of public policy and practical effect. The public purpose which is served should never be obscured in a tax program under the mask of raising revenue”.
http://home.hiwaay.net/~becraft/RUMLTAXES.html
Bernanke on 60 minutes:
(PELLEY) Is that tax money that the Fed is spending? (BERNANKE) It’s not tax money. The banks have – accounts with the Fed, much the same way that you have an account in a commercial bank. So, to lend to a bank, we simply use the computer to mark up the size of the account that they have with the Fed…In other words, the government taxes us, and takes away our money, to prevent inflation, and not to actually get our money in order to spend it.
Spadj
25 Jan 11 at 10:12 pm
Sinclair,
It seems the idea of a free lunch and economic rent (unearned income) is alive and well, judging by Putland’s letter and some of the comments here.
Much like asserting that Joe Blow prospector who digs up rich dirt for gold is earning rent compared to Fred Fart prospector who is digging up barren dirt for gold, both deplying the same resources and extraction costs.
But Joe Blow makes a profit and Fred Fart doesn’t, and this is supposed to be unfair? Joe earns excess income which has then to be taxed?
What’s really unfair is having to counter this specious economic thinking.
Louis Hissink
26 Jan 11 at 2:52 pm
Good point, Louis. The time spent on having to show what a stupid idea rent is is in itself a form of economic rent. Lol.
JC.
26 Jan 11 at 3:03 pm
Yeah, right. Much fairer and more efficient to make Fred Fart pay higher taxes on the wages of his day job, or on his consumption, so that Joe Blow can pay less tax on his luck.
What? – governments should collect less revenue? OK: when the total revenue grab has been reduced to your satisfaction, you still have to decide where it’s going to come from. Are you going to tax human inputs (capital and labour, including innovation and entrepreneurial insight), thereby deterring such inputs? Or are you going to tax what’s left over after those human inputs have received their market returns?
Gavin R. Putland
26 Jan 11 at 5:14 pm
Gavin, I don’t have a problem with what you’ve said above, but I did notice that you said in your reply that rent taxes weren’t taxes on innovation and entrepreneurship.
Isn’t it rather that event rents taxes are taxes on innovation and entrepreneurship, given that the taxable income stream wouldn’t exist without such innovation and revenue (the special thing being that rents taxes don’t interfere with the incentives to produce and so create no deadweight losses)?
Dandy Warhol
26 Jan 11 at 7:02 pm
If Fred Fart is indeed digging up ground in anticipation of finding something, then that’s because the price of whatever he’s digging for, and which is allowing Joe Blow to make a profit, has risen in price. So Fred’s activity is quite voluntary and driven by those high prices. This differential, “economic rent” doesn’t appear because of his activity, but actually drives his activity in the first place.
As for making Fred Fart pay more taxes, that is simply due to the greed of the state or government, and not due to the Joe Blow’s of this world. Mind you I wouldn’t call the Joe Blows of the world capitalists in any case – rather they are mercantilists who are in it for a profit from whatever source, and if they can make a profit more easily by conniving with the state, that’s what they do. Their “profits” are actually determined by the state in the first place, so when commodity prices increase, then that’s the good luck bestowed on them by the state. The urge to extract more tax from the Joe Blow’s because they are perceived to have some advantage over the Fred Fart’s is simply based on jealousy and greed and not on some specious advantage imagined by the lazy.
And who reckons mining companies are making super profits, (defined as profit in excess of the long term bond rate). Ultimately all mining profit has to be disbursed to the owners, the shareholders, and expressing dividends in terms of the current share price, the owners are lucky to make 2% on their invested capital. Companies don’t make profits, humans do, so I suppose if the accounting abstraction of a company makes a profit, then perhaps we could pay government an abstract tax using Agnelli money.
And why should I waste time and energy pondering over where government can get more revenue – government, like the rest of us, should live within its means. It’s much like us spending more than what we get in income, getting into debt, and rather than curtailing our expenditures and living within our means, instead contemplate about how to steal some money to maintain our self inflicted unsustainable lifestyle.
Economic rent seems to be an intellectual ploy used to justify pillaging the active by the lazy, more than anything else.
Louis Hissink
27 Jan 11 at 8:59 am
Who gives a crap about rent? Rent is imbued in turn of the 18th century ideas about small holdings and their relationship back to a feudal lord at that time, which went back at least 700 years.
Rent isn’t even important to the debate over if we should tax such rents, if they exist.
Georgist taxes are efficient and if rated lowly enough, equitable.
That is reason enough to examine their support and implementation.
.
27 Jan 11 at 9:18 am
Nice discussion;even the “Who gives a crap about rent”, because it certainly does signify the attitude of most Australians.
But as rent arises from location, area, shape, topography, roads, infrastructure, population, etc., why is it that such a publicly-generated value should be retained by individuals who didn’t create it? Oh, because they’re entrepreneurs!
I guess mining companies created the steel, gold, etc., in the ground that is nominally said to be ours, Louis?
And when it’s understood that some 50% of our GDP is rent, that’s a pretty good reason to give a crap about rent. But Louis is correct, Australians prefer to pay tax on their comings and goings because rent is an 18th century concept that has been revised by modern economists. Isn’t that why we’re having this GFC?
C’mon Sinclair, Louis and Co., aren’t you getting a little tired of being played for suckers?
Bryan Kavanagh
27 Jan 11 at 10:02 am
“Who gives a crap about rent?”
Plenty of rent seekers out there Dot.
Dandy Warhol
27 Jan 11 at 2:31 pm
“But Louis is correct, Australians prefer to pay tax on their comings and goings because rent is an 18th century concept that has been revised by modern economists. Isn’t that why we’re having this GFC?”
No, you do a disservice to what could be a good reform. Why are you defending a very rubbery concept? Rent, as it was first formulated, is based on some very antiquated assumptions. Implementing a LVT doesn’t require you to acknowledge or even be familiar with the concept of rent.
There is no way the GFC is connected with rent – save for maybe the credit rating agencies which acted sheltered workshops under Government mandate.
“But as rent arises from location, area, shape, topography, roads, infrastructure, population, etc., why is it that such a publicly-generated value should be retained by individuals who didn’t create it? Oh, because they’re entrepreneurs!”
The State didn’t create it either. Please explain how, as the Georgists always do, that taxing rent in this manner is “orthodox economics”. Why is taxing positive externalities “orthodox economics”?
It is most likely the indigent are going to profit from land use change – they will be the least likely to move from a depressed area before it becomes redeveloped. They will have no outlay and receive a pure windfall.
Rent confuses the man on the street. It is a lot easier to say, “if we taxed unimproved land, it would raise a lot of money at a low rate. It is efficient and fair. It is better than income tax”
Under Georgist regime, the least valuable land gets taxed as well, just at a low value amount. It’s hard to say how such land actually has “rent” other than excludability and non fungibility.
I hope we reform our tax system one day to properly costed user pays, risk adjusted fines, a Georgist tax, a consumption tax and a royalty regime. My advice to Georgists is to not ask for a too high a rate. This will destroy any appeal of the tax, especially to the cash poor and asset rich. 10% rated LVT would probably fund whole of Government. 15% plus is nation destroying. Above 6%, it begins to become unpalatable.
I’d recommend no more than 4% and replace all excise and income based taxes with it.
.
27 Jan 11 at 4:18 pm
Dandy Warhol, whether by accident or by design, makes a case for a valuation-based resource rent charge, rather than a profit-based charge. Suppose that Bill Bloggs, due exceptional “innovation and entrepreneurship”, gets a return on a natural resource that is out of proportion to the market value of the resource and to his input of capital. If the government tries to tax his economic rent with a profit-based RRT, the taxable base will indeed include the return to his “innovation and entrepreneurship” — whereas if the government merely assesses the market value of the resource, the return on his “innovation and entrepreneurship” will escape taxation.
Unfortunately valuation-based assessment is not always practical. It is practical in the case of urban land, whose value per unit area is subject to spatial continuity, but more difficult in the case of mineral deposits, whose values are not so neatly dependent on location. Hence the preference for profit-based assessment of mineral resource rents.
Does that mean the assessment of the theoretically ideal revenue base involves approximations? Yes, but that is not a valid argument for preferring other revenue bases that don’t even try to be ideal, especially when those other bases also involve approximations (e.g. the percentage of your car use that is work-related, or the percentage of a convenience store’s turnover that is GST-liable). Even if other tax bases could be assessed exactly, it would be better to be approximately right than exactly wrong.
Moreover, it is important not to reward the sort of “innovation and entrepreneurship” that is aimed at winning zero-sum games.
Meanwhile Louis Hissink continues to avoid the issue that when the government has reduced its revenue requirements to a minimum, it must still decide whether to raise that minimum revenue by taxing the fruits of hard work and thrift, or by taxing the “Joe Blows” whom Hissink describes as “mercantilists” who are not averse to “conniving with the state”. Hissink apparently regards the latter alternative as “jealousy” and “pillaging the active by the lazy”. Amazing.
However, Hissink raises the important point that super-normal profits are capitalized in share prices and therefore are not super-normal from the viewpoint of those who have bought the shares at current prices. Rather, the super-normal profits have accrued to those in whose hands the shares have increased in value. A similar issue arises with the rent of land. A related problem is that rent-yielding assets often serve as collateral for debt, in which case at least some of the rent is disguised as interest and does not accrue to the nominal owner of the asset. Obviously any honest attempt to harness economic rent for public purposes must take account of these issues.
But the resulting system would not be nearly as complicated as the present one, because if you start with a revenue base that doesn’t deter wealth-creation, you don’t have to keep cutting holes in it in the name of “incentives”, and then don’t have to keep introducing “anti-avoidance” provisions to stem the ensuing rorts.
Gavin R. Putland
27 Jan 11 at 5:48 pm