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Wednesday, January 21, 2009:

Aye, Barack Hussein Obama. Now finish those thoughts...

By Gavin R. Putland

Our workers are no less productive than when this crisis began,” said President Obama. “Our minds are no less inventive, our goods and services no less needed than they were last week or last month or last year.

With those words, whether by accident or by design, Obama articulated the twin paradoxes of recessions: under-production in the midst of plentiful productive capacity, and under-consumption in the midst of want. What could be produced is not produced, and not because of any lack of desire to consume it. What should be consumed is not consumed, and not because of any lack of capacity to produce it. How is this possible?

The first part of the explanation is almost tautological: if production or consumption is to take place, it must take a place. It must occupy space. It must have a location or range of locations. In the terminology of economists and realtors, it must use a site. Because the supply of usable space is limited, and because some locations are preferable to others, the right to use a site has a market price. That price is the site rent.

If the full site rent is collected by government (as Henry George recommended), then no other taxes are needed, and anyone who holds title to a site must either live on it or generate income from it in order to justify the rent: nobody can afford to hold idle sites for speculative purposes. Consequently all sites are used optimally (or left unclaimed), and private economic activity is not suppressed or distorted by taxation, or by the compliance costs of the tax system, or by the desire to avoid tax, or by regulatory burdens ostensibly designed to prevent tax avoidance, or by the desire to speculate on sites, or — importantly — by the need to compete with speculators for access to sites. So the economy just works.

But if part of the site rent is not collected by government, that part (the “after-tax” rent or net rent) is convertible into a selling price. And indeed, in this fallen world, governments don't collect the full rents of all sites. If governments collected all increases in site rents after a certain date (as recommended by John Stuart Mill), they would end speculation by preventing increases in selling prices after that date; but they don't. If governments collected a substantial fraction of the rental value of each site (as recommended by Thomas Shearman and many others), the purely speculative holding of land would be uneconomic due to holding costs; but they don't. If governments taxed capital gains more heavily than current income, they would make speculative gains less attractive by comparison with the rewards from productive use of sites; but they don't — indeed, they do the opposite. So speculation on sites is unrestrained, and rational expectations periodically give way to belief in the greater fool, and banks create credit against irrationally inflated site prices, until too many people have borrowed and paid too much and can neither repay their debts by selling their sites, nor service their debts by using their sites. So they go broke, and take down their creditors, who in turn take down other creditors, and so on. Most recessions, including all major ones, follow this pattern.

(A stock-market crash may cause a minor recession, as in 2000–01. But in a major recession the bear market in stocks tends to be an effect rather than a cause; this was especially the case with the Great Depression, whose fundamental cause was a land bubble that popped in 1926.)

The damage is not limited to periodic recessions. Failure to collect site rent necessitates income taxes and consumption taxes, both of which cause the cost of labor for employers to exceed the benefit of wages for workers. In so far as the burden falls on workers, it reduces effective demand for employers' products (and let no one complain that “effective demand” is a Keynesian term; Henry George used it long before Keynes). In so far as the burden falls on employers, it deters hiring (or feeds into prices, provoking the central bank to tighten monetary policy, which deters hiring). Either way, taxes on wages and consumption are contractionary.

To prevent recessions and maintain full employment, the tax system must be redesigned to unburden productive activities and deter speculation on sites. Whether Obama knows it or not, the neglect of that task is the prime example of what he called “protecting narrow interests and putting off unpleasant decisions” — but only if the unpleasantness consists in the danger and difficulty of trying to enlighten the self-interest of powerful people, and only if their interests are defined so narrowly as to exclude every cost or benefit that is not immediate.

Yes, I mean that heavier taxes on sites can be good for site owners.

One reason is that all taxes, directly or indirectly, are site-value taxes. Because sites are limited in supply but essential to economic participation, the rents and prices of sites are bid upward until they absorb capacity to pay. All taxes, together with their distortionary costs, are deductions from that capacity, and therefore are deductions from the rents and prices that current site owners can command. Applying the taxes directly to site values (as distinct from any activities conducted on the sites) would eliminate the distortionary costs and therefore, for the same total revenue, reduce the burden on site owners.

Another is that if a government's revenue depends on site values or increases in site values, that government has an incentive to do things that increase site values for the benefit of the owners. Such things include investing in infrastructure. Provided that the government's clawback is less than the increase in the site value (as can be easily guaranteed), this arrangement enriches site owners by financing infrastructure projects that would not otherwise proceed.

Site owners are well aware that they gain from public investment in infrastructure (especially transport and communications). Unfortunately they want the infrastructure to be funded not by clawing back part of the benefit, but by taxing the people at large, including those who don't own sites in the serviced areas — or don't own sites at all. Such exploitative taxes have only so much capacity to finance projects, because the non-beneficiaries of the projects have only so much capacity to be exploited. That is one reason why “a nation cannot prosper long when it favors only the prosperous.

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