Pure poison on land tax

Gavin R. Putland offers the antidote for Sinclair Davidson.

There are many valid arguments which the economic establishment finds inconvenient but cannot refute, and which it therefore attacks by obfuscation and diversion. The obfuscators are entitled to the presumption (although it cannot be true of them all) that they are not instigators but co-victims, merely teaching what they have been taught. But that in no way mitigates the damage.

Consider the attack on Steve Keen, a non-establishment economist who is kicking too many goals for the establishment's liking, by Rory Robertson of Macquarie Bank. Robertson ridiculed Keen's focus on debt-to-GDP ratios by accusing Keen of “the schoolboy error of comparing debt to income (a stock to a flow — apples to oranges)”. Presumably the reader isn't meant to notice that apples and oranges are both stocks. Even if we ignore that technicality, the argument that you can't divide a stock by a flow epitomizes the remoteness of mainstream economists from the real world. A person of more practical bent, such as a plumber or a motor mechanic or even an applied mathematician, would know that the ratio of a stock to a corresponding flow has the units of time and is related to a real-world time, e.g. the time taken to fill the bathtub (while the flow replenishes the stock) or to empty the fuel tank (while the stock sustains the flow). But for the reader who is in too much of a hurry to notice these things, the combination of the jargon (“a stock to a flow”), the cliché (“apples to oranges”) and the cheap insult (“schoolboy error”) will probably be enough to hose down any interest in Keen's work. It's a form of censorship, accomplished not by gagging the speaker but by turning away the audience.

Don't get me wrong: Dr Keen's dire predictions may yet turn out to be overblown. But if they do, it won't be because he compared a stock to a flow.

The Georgists — those who would finance government from the economic rent of land and other non-replicable assets, in lieu of taxes that penalize production and strangle it with red tape — can sympathize with Dr Keen, having endured similar treatment for more than a century. As the “global financial crisis” deepens, the imperative to put down the Georgists has become acute, partly because the failure of mainstream economics has, by default, focused attention on the alternatives, and partly because an embarrassing number of Georgists predicted the crisis years ago [1,2,3,4], while central bankers remained in denial until what couldn't happen again had just happened again.

So something had to be done about Bryan Kavanagh's article “Breaking in on the rent seekers”, which appeared on the back page of the Age on March 11, saying in part:

The truth is that the public capture of publicly generated land rent never does harm to society. To the contrary, it may be dawning on politicians and analysts that the real estate bubble was the inevitable result of inadequate land-value capture. They may even consider extending and fortifying council rates and state land taxes in order to prevent damaging real estate bubbles from developing again in the future.

The rejoinder, from Prof. Sinclair Davidson of RMIT and the Institute of Public [sic] Affairs, was headed “Textbook example is not grounded in earthy reality”. The edited version in the Age did not mention Kavanagh's article, but just happened to appear two days later on the same page (and on the IPA's website). But Davidson's original text includes a link to Kavanagh's piece.

Against the Georgist premise that land is fixed in supply, Davidson writes:

While land is fixed in geographic terms, land as an economic asset is not. Land, like capital, can be allocated from one usage to another.

Note the unjustified substitution of allocation for supply. But this bait-and-switch doesn't solve Davidson's problem, because if land owners pay a sufficiently heavy holding tax on their land, they must allocate it productively in order to cover the tax, or sell it to someone who will. In either case, absentee owners cannot afford to hold land for purely speculative purposes; they need to attract paying tenants, and this need improves the bargaining power of tenants, making rents more affordable. Meanwhile the pressure to sell land makes it more affordable for prospective buyers.

If capital is taxed in the same way, one can avoid the tax by destroying the capital (or not creating it in the first place), thus reducing production. But when land is taxed in this way, one can only reallocate it, thus increasing production. Therein lies the “free lunch” whose existence Davidson denies. Therein lies the distortion in Davidson's claim that land is an input into wealth creation “just as any other factor of production.”

A uniform land-value tax does not inhibit reallocation of land. A land-value tax with exemptions does not inhibit reallocation between non-exempt uses. A stamp duty on conveyancing severely inhibits reallocation because it taxes a change of ownership rather than a continuation of ownership. But Davidson, for reasons best known to himself, complains about land tax instead of stamp duty.

Having switched from supply to allocation, Davidson then switches back by quoting John Bates Clark against the idea “that land is fixed in amount...” Giving the reader a second chance to notice the bait-and-switch is clumsy, especially as it could have been avoided by presenting the arguments in a different order, and therefore tends to support the presumption that Davidson actually believes his own bafflegab. Be that as it may, quoting Clark was obligatory because his 1899 textbook The Distribution of Wealth, more than any other, established the neo-classical doctrine that land is a form of capital, wherefore the rent of land is a form of interest — or, as Davidson's title puts it, “There is no such thing as geo-rent”. Prof. Mason Gaffney [5] describes Clark's technique as follows:

On p.2, the rent of land is merged with interest “for reasons that will appear later”. This begins a kind of “proof by infinite retreat”. The promised reasons are later put off again to Chapter XXII, which puts them off to Chapter XXIV, where they finally disappear in the fine print of one of the longest footnotes in history, pp.395–98. Along the way he repeats his idea that capital is immortal, reprinting earlier works as chapters. At one point he says rent is interest because it equals the interest rate times the price of land. Elsewhere he says unearned increments are really part of the wages of workers who are also landowners. Device after device is used; deferral after deferral of promises to treat central matters “later”. Meantime, however, rent is interest and land is capital throughout the book.

It's not science (and if you didn't get the joke, look up “proof by infinite descent”); but it's convenient for those who wish to undercut the case for a selective tax on land. To that end, Davidson quotes Clark as saying “The idea that land is fixed in amount, ..., is really based on an error which one encounters in economic discussions with wearisome frequency.” Let us put this quote back in context so that we can see what passes for logic in Clark's definitive text:

Let us see how much, in a static study, these distinctions amount to. That capital, in the aggregate, should be fixed in amount, is one of the conditions of the static state. This assumption, moreover, expresses what is true at any one moment in a dynamic state. The gross amount of capital in the world cannot be instantly changed, and the rate of interest at this moment is based on the gross amount existing at this moment. If dynamic changes were not to occur, the present amount would be the permanent one, and all capital could be treated, like land, as a fixed quantity. The idea that land is fixed in amount, and that capital can be increased at will and to any extent, is really based on an error which one encounters in economic discussions with wearisome frequency.

... At any one time, the amount of artificial capital in existence is as fixed as is the amount of land. Within any short time it is impossible to increase the general fund of artificial capital enough to make a perceptible difference in the conditions of social industry. At any one time we have to deal with a definite quantity of land, in combination with a definite amount of capital in artificial forms. Moreover, the distinction between land and other capital-goods, based on the notion that land cannot be increased and that other things can be, has obviously no validity in a static study; for the static assumption itself precludes all increase of capital.

In short, assume away the problem by supposing a static state, dismiss the inconvenient reality of a dynamic state by taking a static snapshot, pretend that what cannot be “instantly changed” might as well be set in stone, and presto! — capital is as permanent as land. Then complain because the belief that land is different from capital keeps popping up with “wearisome frequency”, and don't mention the possibility that the reason why it won't go away is that it happens to be true. Does anyone not smell a hired gun?

Davidson further informs us (in his original text) that Frank H. Knight “dismissed the idea of land as an economic asset being fixed in supply as ‘utterly fallacious’.” Here's that quote in context, in Risk, Uncertainty, and Profit (1921), Pt.II, Ch.V:

The definition given for land to make it fit the description of a fixed supply — the original and inexhaustible powers of the soil — is indeed drastic in its limitation. Later, this dogma of unconditional fixity of supply was made the basis for the single-tax propaganda. We cannot discuss this position at length, but must take space to remark quite briefly that it is utterly fallacious. It should be self-evident that when the discovery, appropriation, and development of new natural resources is an open, competitive game, there is unlikely to be any difference between the returns from resources put to this use and those put to any other.

Unfortunately this “self-evident” proposition has nothing to do with whether land is fixed in supply. But the reader who takes the time to be convinced by it, and who is sufficiently impressed by its truth (and by his/her ability to perceive its truth), will, with any luck, fail to notice that it doesn't prove what it pretends to prove. Another red herring is the reference to “original and inexhaustible powers of the soil”. Nowadays the value of land depends more on its location than on its soil quality; but this in no way contradicts fixity of supply. The pretense that the definition of land must be artificially narrowed “to make it fit the description of a fixed supply” is false and highly prejudicial. (Moreover, if we indeed define land for economic purposes as the factor limited in supply, we find that this definition is slightly wider than the everyday meaning. The Georgist literature of Knight's time already placed natural resources and “public franchises” in the same category as land.) Similarly prejudicial are the words “drastic”, “dogma” and “propaganda” in varying degrees of proximity to “single-tax”, the then-fashionable description of the Georgist proposal. It is all well calculated to bypass the reader's critical faculties at the expense of the Georgists.

Knight's “self-evident” proposition is reminiscent of another claim often adduced against Georgists, namely that the return on land is no higher than the return on other assets. This too is a red herring. The case for a selective tax on land does not depend on the premise that the return on land, relative to its cost of acquisition, is abnormally high. It depends rather on the fact that the return on an asset that can be privately produced (capital) is an incentive to produce it, while the return on an asset that cannot be privately produced (land) is not.

Knight defended and elaborated the Clarkian doctrine that capital is static. Gaffney [op. cit.] explains it this way:

Capital, unlike land, has a finite life. It depreciates and is reproduced. That is, it turns over. The reciprocal of turnover is a period of time, which the Austrians call a “period of production”. This was anathema to Clark, who wanted to erase the difference of land and capital by making capital deathless, like land, and have capital consist of a mystical essence that could “transmigrate” into land and explain its value.

Knight took up Clark's anti-Austrian attack with multiplied vigor. In this context, anti-Austrian means anti-Georgist. ...

... Knight goes so far as to commit the “fallacy of the disappearing inventory”. According to him, the existence of capital lets us treat inflow and outflow of goods through inventories as simultaneous. Likewise we may treat production and consumption as simultaneous, however long goods are stored up in inventory... The result of such thinking is to bypass the whole question of what capital is and does, and, damagingly for George, to erase a primary distinction of capital from land. Knight uses the point for this very purpose.

The lost distinction is that capital turns over; it is continuously being used up and replaced by hiring labour to produce more. The longer it takes capital to work through the pipeline, the more capital is required per worker and per unit of output, and the higher is the ratio of capital to labour. Add to that, the pipeline itself is capital. Likewise, since pipes occupy space, the more land is required. To keep the distinction of land and capital well lost, Clark and Knight were forced to dispute the Austrian capital theory, which each of them did in their oft-cited debates with, respectively, Böhm-Bawerk and Hayek. These celebrated exchanges seem quite tedious and pointless, and even mystical, until one realizes their essential role in the imperative to slam the lid on Henry George and his idea of treating land and capital separately. They were essentially battles of Anti-Georgists vs. Anti-Marxists.

Davidson, like Knight, knows how to use strong language to soften up his readers for a weak argument. Before the double bait-and-switch and the quotes from Clark and Knight, Davidson writes:

The early Greeks viewed direct tax on land as the mark of tyranny. So too do modern taxpayers.

He doesn't explain why we shouldn't regard speculatively inflated land prices, or the compliance costs of income tax, payroll tax and GST, as marks of tyranny, or why we shouldn't draw the obvious inference that modern western civilization might be headed the way of ancient Greece. But this tactic may help to explain why the geo-rent tax is attributed solely to Henry George without mentioning its earlier or later proponents. It would be a bit hard for a “free-market” think-tank like the IPA to accuse Adam Smith [6], John Stuart Mill [7], Winston Churchill [8], Milton Friedman [9] and William F. Buckley Jr. [10,11] of advocating “tyranny”. But it's easy to pin that charge on Henry George because his free-market credentials, although stronger than those of any right-wing demagogue, are less well known.

When Davidson finally gets around to presenting his core argument, it comes down to this:

[N]ature does not yield economic value easily. At any level of economic activity above hunter-gathering natural produce must be combined with capital, labour, and entrepreneurial insight before economic value can be created.

That's half the truth. The other half, which the reader is not supposed to notice, is that the party who gets the economic value is not necessarily the one who adds the “capital, labour, and entrepreneurial insight”. And when the holding tax on land is too low to offset expected capital gains, why would the owners bother applying capital, labour and entrepreneurship when they can simply acquire more land, whose value is increasing due to the capital, labour and entrepreneurship applied by other parties on surrounding land?

Davidson's conclusion that a tax on land is a tax on capital or labour does not follow from any of his earlier assertions. Neither is it true. From the micro-economic viewpoint, a tax on land does not rise or fall with the amount of labour or capital applied by the taxpayer. From the macro-economic viewpoint, the inelasticity of the supply of land implies that taxes on capital or labour, together with their deadweight costs, tend to be shifted onto land. If the same revenue were raised from taxes levied directly on land, the land owners would actually be better off because there would be no deadweight. Furthermore, if a government's revenue is apportioned to land values, that government has the ability and the incentive to invest in infrastructure that raises land values for the benefit of the owners. By opposing taxes on land values, the property lobby and its academic allies frustrate the funding of projects that would increase returns for property investors. The hired guns have shot their clients.

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P.S. (March 27): Since this article was posted, Steve Keen has released a web-friendly version of his recent critique of neo-classical economics [11a]. He does not address the conflation of land with capital, but does address the closely related static-state assumption (which he calls “the obsession with equilibrium”), saying in part:

The fallacy that dynamic processes must be modelled as if the system is in continuous equilibrium through time is probably the most important reason for the intellectual failure of neoclassical economics.

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