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Congestion, Efficient Resource Use,
Population, and Economic Growth
of Land Value Taxation
When economists think about the contribution that land value taxation might make to economic performance, they are likely to think in terms of property tax reform. If taxes on structures are reduced or eliminated, one can expect that more structures will be built, and cities will be taller, more compact and more efficient.1 But more efficient cities are only the beginning of the contribution that land value taxation can make to improving economic performance. Land value taxation generalizes into the principle that people should pay for all of their appropriations of natural opportunities, according to the opportunity costs of those appropriations, and the resulting revenue should be shared equally. There are important applications of this principle to questions of environmental protection, relieving congestion, efficient resource use, population growth, and general economic growth. This paper discusses these more varied applications of the generalized principle of land value taxation.
The paper begins with a discussion of the justifications of land value taxation. It then applies land value taxation successively to problems of environmental protection, congestion, efficient use of renewable and nonrenewable natural resources, and population growth. Then it discusses how one might estimate the contribution of land value taxation to economic growth.
Land value taxation is sometimes justified on the ground that, unlike almost all other sources of public revenue, a tax on land value does not impose an excess burden on an economy. This argument can be found in the writings of the Physiocrats, Adam Smith, David Ricardo, and numerous modern writers. It is based on the fact that, with a properly administered tax on land value (unlike other taxes), it is not possible for a person to lower the tax that is due by being unproductive.
If people were concerned only with efficiency, this would be a fine reason to use land value taxation. But people are also concerned with issues of justice, or fairness. And so the question arises of whether taxing land values is fair. The fairness of taxing land values is generally defended on the basis of the postulate that natural opportunities are everyone's common heritage; collecting the value of exclusive use of these opportunities and using the proceeds for public purposes is a way of sharing the value of these opportunities while retaining the efficiency of private control of resources.
The idea that natural opportunities are everyone's common heritage is often defended with religious language. John Locke said:
Whether we consider natural reason, which tells us that men, being once born, have a right to their preservation, and consequently to meat and drink, and such other things as nature affords for their sustenance, or revelation, which gives us an account of those grants God made of the world to Adam, and to Noah, and his sons, 'tis very clear that God, as King David says, Psal. CXV. xvi. has given the Earth to the children of men, given it to mankind in common.2
John Locke did not advocate land value taxation. Writing in about 1690, he said that there was so much unclaimed land in America that no one could properly complain about the private appropriation of land in Europe.3 Writing nearly 200 year later, when it was becoming impossible for people to appropriate good unclaimed land in America, Henry George said:
If we are all here by the equal permission of the creator, we are all here with an equal title to the enjoyment of his bounty -- with an equal right to the use of all that nature so impartially offers. This is a right which is natural and inalienable; it is a right which vests in every human being as he enters the world, and which during his continuance in the world can be limited only by the equal rights of others. There is in nature no such thing as a fee simple in land. There is on earth no power which can rightfully make a grant of exclusive ownership in land. If all existing men were to unite to grant away their equal rights, they could not grant away the right of those who follow them.4
George preceded this argument with a psychological and linguistic one. He said that our conception of property, of a right of exclusive possession, is based on the idea that each person has a right to his or her productive powers, and therefore to what he or she produces. Since no one produced land, no one can properly claim to own it.5
This psychological and linguistic argument is not entirely convincing. It seems clear that humans, like other species, have an impulse toward the appropriation and defense of territory. Natural selection has worked in favor of those who are skilled in appropriating natural opportunities and deterring others from encroaching on them. It seems possible that, as a way of limiting violence, humans have merged an idea of ownership based on production with an idea of ownership based on the ability to appropriate territory and deter encroachment.
If this is the social and biological reality, then there is a different argument for treating natural opportunities as everyone's common heritage. Realizing that we are participants in a game of territorial appropriation and its extension into the politics of special interest legislation and other manifestation of privilege, we should also realize that substantial gains are possible from ending the game of encroachment and appropriation. We might aspire to end the waste of effort on all forms of rent-seeking and on defense against rent-seeking. But our efforts to end the game have been based primarily on enshrining the status quo: The last successful appropriator gets to keep what has been appropriated. This deference to power might be considered simply realistic. However, it has a high cost. The practice of legitimating successful past appropriations -- as when the world declines to challenge Indonesia's 1976 annexation of East Timor, or when any number of dictators become recognized as the rightful heads of nations -- induces selfish egoists to calculate that if they can grab something and hang on to it long enough for the expected furor to subside, then it will be regarded as just as legitimately theirs as North America is regarded as the legitimate property of the descendants of European settlers rather than the previously occupying natives. (And of course, in many cases those previously occupying natives had forcibly displaced earlier occupants.) A statement of the form, "No appropriation before year X will be questioned, but all aggressive appropriations after year X will be overturned," is not credible. Year X keeps getting moved, and successful aggression pays.
Much more credible is a statement of the form, "We will share equally the value of natural opportunities that might be appropriated." This is the potential of land value taxation: to provide a framework in which the value of natural opportunities will be shared equally, both as an expression of the idea that all persons have equal rights to natural opportunities, and as a formula whose potential to remove the motive for future aggression is greater than that of enshrining the status quo of any particular year. And in addition, land value taxation is one way of achieving allocative efficiency with respect to a wide variety of public issues.
Land value taxation is usually thought of as a possible source of revenue for local governments. But the ethical principle that supports it is most coherent when the principal is applied on a global basis: All persons in the world have equal rights to natural opportunities. This does not mean that all persons in the world have equal rights to all land rent. To the extent that the rent of land arises as a result of the provision of infrastructure, that rent is the natural income of the polity that provided the infrastructure, and the logical source for financing it. What all persons in the world have equal rights to is the "pre-development" rental value of land, the rental value that land would have to the potential developer of a new community if there were no community and no infrastructure. To motivate the application of land value taxation to other areas of economic life, I will assume that there is a global agreement that, because all persons have equal rights to natural opportunities, there will be transfers among nations to equalize per capita pre-development rent. The principle behind this agreement is then extended to other issues.
The first problem of environmental protection is management of the harm that is caused to nearby areas by the discharge of pollutants into air and water. In the U.S. this problem is often managed by quantitative controls. Historic polluters are allowed to continue to pollute at reduced levels, and potential new polluters are restricted even further or prevented from polluting entirely.
A system of quantitative controls can be efficient if the overall level of control is appropriate and permission to pollute is completely transferable. But these conditions are rarely met. It is particularly difficult to know the optimal level of pollution control when the costs of pollution are continuous, upward sloping and not catastrophic. And systems of quantitative controls almost always lack fairness. They grant permanent privileges to those who have a history of having caused harm. If a system of quantitative controls provided that pollution rights would be auctioned, and all the proceeds would be collected publicly, then it would be in accord with a principle that all persons have equal rights to natural opportunities. But there would still be the difficulty of determining the right number of permits to sell.
A system of managing the harm from pollution is most likely to be both efficient and fair if it is conceived in terms of taking account of effects of pollution on land values. Pollution can also affect the value of structures, but these effects are harder to quantify, because they operate somewhat differently on each structure. Furthermore, pollution can raise as well as lower the value of structures. An old structure that would be ready to be demolished in a clean environment can have continuing economic value in a polluted environment. Pollution can also have effects on the utility of individuals apart from its effects on the value of land and structures. If person A is harmed by pollution more than person B, who would move in if person A moved out, but person A does not move because of the costs of moving, then the difference between the costs of pollution to persons A and B is a pollution cost that is not reflected in the value of land and structures. Nevertheless, measuring the cost of pollution by its effects on land values is a good first approximation.
To manage pollution efficiently and fairly, one would estimate the effects on land values of various levels of pollution and derive a "supply schedule" of pollution based on the marginal cost of pollution at different levels of pollution. One would then ask polluters how much polluting they would want to do at different prices of pollution. As long as there were more than a handful of polluters, their incentives to report anything other than their true marginal valuations of pollution rights would be inconsequentially small. Thus one could aggregate the responses into an aggregate demand schedule for pollution rights and use the intersection of the supply and demand schedules to determine simultaneously the efficient quantity of pollution and the price that would achieve the efficient quantity. The payments that individuals made could be construed as payments for appropriating for themselves land rent that was everyone's common heritage.
Pollution sometimes crosses international borders, as when sulfur dioxide from coal-fired electricity generating plants in the U.S. Midwest crosses into Canada. While there are unresolved scientific issues regarding the amount of harm that such international pollution causes, the economic question of what should be done when the magnitude of damage is know is straightforward. When one country sends pollution to another, the resulting decrease in the value of land in the second country represents an increase in the proportion of natural opportunities that the first country is appropriating. The polluting nation owes corresponding compensation.
Without a theory of equal rights to natural opportunities, one could argue that international pollution could be controlled just as well by identifying the optimal quantity and limiting emissions to that level. A theory of equal rights to natural opportunities does not permit such privilege for polluters.
When the area affected by a pollutant is very large, as with the gasses that exacerbate the ozone hole, measuring damage by changes in land values becomes less attractive. Changes in land value are a suitable measure of damages when the choices that people make between land that is affected and unaffected permit the market to reflect the damages. But if all of Australia is affected by the ozone hole, then the damage that the ozone hole does to Australia would be measured by land values only if it affected migration between Australia and the rest of the world. Such effects happen slowly, and their consequences for land values are difficult if not impossible to measure.
Nevertheless, one can apply the principle that natural opportunities are everyone's common heritage. No one has a right to a disproportionate share of the opportunity to emit the gasses that increase the ozone hole. We should seek to identify the marginal cost schedule of emissions of these gasses, and charge a fee that equate the marginal cost and marginal benefit of emissions. All persons in the world should share equally in the proceeds of such fees, after nations such as Australia that bear a disproportionate burden have been compensated for their costs.
With CO2 and other greenhouse gasses, the issue is yet different. Particularly cold areas may benefit from the global warming caused by greenhouse gasses, and no area of planet is immune from the effects of global warming. Still, the principle of equal rights to natural opportunities can be applied. All people have equal rights to emit greenhouse gasses. People have different ideas about what the right level is. The appropriate way to give expression to the idea that we all have equal rights to the environment is to use a structured democratic and market process.
Consider CO2. Start by having every nation propose a quantity of permitted emissions of CO2 per capita. Weight each nation's proposal by its population, and take the weighted median of the proposals. That is an initial entitlement that represents a majority rule equilibrium, a reasonable expression of equal rights for all. Unlike the current global climate negotiations, in this entitlement no preference is given to nations of the basis of their having a history of high emissions.
Next, ask each nation how much money it would be willing to pay for reductions in global emissions below the entitlement levels, and how much money it would regard as adequate compensation for emissions above the initial entitlement level. (These question presume that nations want lower emissions. If a nation desires extra global warming, the questions would be reversed.)
To motivate nations to respond honestly to these questions, the "demand-revealing" process would be used to charge nations for their answers. That is, each nation would pay for the cost that it imposed on other nations (or receive the benefit that it provided to other nations) by having the preferences that it had instead of the average of the preferences of other nations.
The next step is to ask each nation for an offer schedule of how much it is willing to pay for the right to emit CO2 in excess of its allocation, or how much it would regard as adequate compensation for emitting less than its allocation. The (vertical) sum of the answers to the questions about the costs that nations would experience from emissions provides a "supply schedule" of emission rights. The (horizontal) sum of the answers to the question of how much nations would pay to emit more (or accept as compensation for emitting less) provides a demand schedule for emission rights. The intersection of the two schedules specifies the efficient level of emissions and the price that will induce nations to emit the efficient amount of CO2. This is the price to be paid by nations that want to emit more than their entitlements, and received by nations that want to emit less than their entitlements. In addition, all nations pay or receive something for the net cost to other nations for their having preferences that deviate from the average of the preferences of others. These payments ensure that nations are motivated to report their costs of emissions truthfully.
The logic of efficient environmental protection applies with few changes to issues of congestion. Parking meters are simple example of the application of land value taxation to solving a problem of congestion. If there is a shortage of parking places (at a zero price) then the introduction of parking meters (charging rent for the use of land) can relieve the shortage. Ideally, the price of a parking meter should vary by time of day to reflect variations in the demand for parking places. The ideal fee would equate supply and demand at each time of day, with lanes of streets devoted to parking only where the revenue generated by the parking fees exceeds the value of the additional lane in speeding traffic. Perhaps in a few years we will have parking meters with prices that vary by time of day. We certainly have the technology. In the meantime, we get by with meters that charge a single price throughout the part of the day when demand is greatest.
Charging rent for parking is only a small step from charging rent for cars that are moving on city streets. The more cars there are on the streets, the slower everyone goes. The marginal cost of having one more car on the streets is the value of the extra travel time that everyone else endures because of the one additional car. In many places, the congestion cost of traffic is less than the cost of administering a system of congestion fees. But this is not the case everywhere. William Vickrey used to say that his estimate of the cost in additional delays of having one more car in midtown Manhattan in the middle of the day was about $20,000 per hour. He would go on to say that this did not imply that people should be charged $20,000 per hour for using the streets of midtown Manhattan. He had estimated marginal cost at the present level of usage. The efficient charge -- perhaps $25 per hour -- would reduce use of the streets so greatly that the marginal congestion cost of street usage would equal the price. Efficient congestion prices for using the streets of Manhattan (or Boston or other large cities) would not merely charge for ordinary usage but would also entail special charges for anyone who double-parked or parked in some other illegal way that created congestion. If we could keep track of the movements of vehicles, then for any vehicle that stood still ahead of backed-up vehicles that wanted to move, there would be a charge for the resulting congestion cost, which would be quite high. Companies making deliveries to downtown areas might decide that it was far better to make deliveries at night than to tie up the streets in the day.
Congestion charges also apply to bottlenecks such as bridges and tunnels. Whenever such a facility has cars backed up seeking to use it, efficiency is improved by applying a toll that reduces demand to capacity. The same output is produced, revenue is generated, and the waste of queuing is avoided.
The efficiency of congestion pricing would also apply to such public facilities as airports and parks. When airlines want to have more take-offs and landings than an airport can accommodate, it is efficient and just to allocate take-off and landing slots by price. Unfortunately, Congress, at the behest of airlines, has prohibited airports from doing this, requiring them instead to allocate take-off and landing slots by non-price means.
In Central Park in New York, there are fewer baseball fields than are demanded at a zero price. There is a private company that has the right and responsibility to organize the leagues that are allowed to use the fields. This company is able to charge fees that implicitly include the scarcity value of the fields. A recognition that the parks are the common heritage of everyone in the city would lead instead to a charge for using the ball fields that equated supply and demand.
There are also applications of congestion prices at an international level. For example, there may be congestion in geosynchronous orbits for satellites. If this should occur, then the just thing to do is to charge market-clearing rents for geo-synchronous orbits and share the proceeds among all nations in proportion to their populations.
It is only a small step from charging people for street use and parks to charging them for renewable and exhaustible resources. If people who could fish as much as they wanted would deplete fish stocks excessively, then some form of control over fishing is beneficial. It is possible in theory to have efficient control through quotas, though it is difficult to set the quotas properly, and highly contentious to change them when conditions require a change. The recognition that the fish are everyone's common heritage would require that, if there are to be quotas, the quotas be auctioned, and that if not, then everyone who fishes be required to pay for fishing according to the loss in the value of fish stocks that results from fishing. If a fishing resource lies entirely within a single nation (as in a lake or river), then the recipient of the fees for fishing should be the polity that includes the resources (Though the value of the fishing resource would be included in the calculation of whether the nation was using more than its share of global natural opportunities.) When the fishing resource is in international waters, the fees should be shared equally among all nations in proportion to their populations.
Suppose that fish are caught in a river than flows from one nation into another. How should resource use be managed and accounted for in that case? The two nations should set a common price for fishing (unless fishing on one entails a greater resource cost than fishing in the other). However they divide the revenue from such charges, their ability to collect the revenue should be included in the calculation of how their appropriations of natural opportunities compare with those of other nations.
What applies to fish applies as well to water that flows from one country into another, when water is scarce. It is inefficient as well as unjust for people to use water as if it were free when it is not. When a river flows from one nation into another, there should be a common price for extractions of water from the river (unless the resource cost is greater in one country than in the other), and the revenue so collected should be included in the calculation of both nations' appropriations of natural opportunities.
The frequency spectrum is another natural opportunity whose use is analytically equivalent to that of land. When the consequences of use of a part of the frequency spectrum are confined to a single nation, then a principle of equal rights to natural opportunities implies that a right of exclusive spectrum use should be offset by a payment to the government of that nation, corresponding to the scarcity value of use. When the use that a nation wishes to make of a part of the frequency spectrum requires other nations to refrain from using it, then a recognized right of exclusive use counts as a part of that nation's appropriation of natural opportunities, and is incorporated into the calculation of what the nation owes to other nations.
With resources such as oil, which are depleted over time, new issues of efficiency and justice arise. Depletable resources ought to be regarded as part of the heritage to which everyone has equal rights, though some provision must then be made to provide incentives for discovery. Equal rights are expressed by requiring everyone who uses a depletable resource to pay for the resulting depletion. Efficiency requires that a resource that is to be depleted over time be sold in such a pattern over time as will maximize the present value of receipts. This generally means using a lot in early years, then less and less as time goes by, with the price of resources in the ground rising at the interest rate. If the receipts were spent as they were received, more would go to early generations than to later generations. A principle of equal rights to natural opportunities means that the receipts should be put into a fund, from which equal payments are made to all persons in all years. Furthermore, later generations are disadvantaged by the higher price of oil that they face. A principle of equal rights for all persons would allocate additional payments to later generations to compensate them for the higher price of oil they faced, though this could be offset by later generations having access to technology that earlier generations did not have. Thus a nation that provides the rest of the world with technology that eases the task of providing for future generations should receive a credit for this, although there will be difficulty in estimating the contribution of any innovation. (If one person had not discovered something, the chances are that eventually some else would have.)
In a world that does not recognize equal rights to natural opportunities, having children is a more private decision than when equal rights to natural opportunities are recognized. If a child comes into the world with a right only to the product of his or her labor, then there are few externalities of the decisions people make about how many children to have. Having more children might reduce the level of wages, but the consequent harm to sellers of labor services is offset by the benefit to the buyers of labor services.
On the other hand, if all persons are recognized as having equal rights to natural opportunities, then a larger number of children means less land and natural resources per person for all the people born previously. This may be offset at least partially by the greater economies of scale that are available when there are more people, but there will still be a range of population growth over which each decision by a couple to have a child reduces the real incomes of everyone else. Define such a circumstance as a scarcity of parenting opportunities.
If parenting opportunities are scarce and all nations have populations that grow at the same rate, then any issues of the cost of having children are internal to each nation. Each nation is free to divide the cost of additional children between the parents and the rest of society in whatever way expresses their sense of community. On the other hand, when nations have populations that grow at different rates and parenting opportunities are scarce, issues of justice among nations arise. The children of a rapidly growing nation will be able to say, "Our numbers are greater than those of our parents, so we deserve a greater share of the rent of land and natural resources than our parents received."
It would not be just for the rest of the world to say, "That's not our fault. Your parents had too many children. You must now get by with smaller shares of natural opportunities than the rest of us." It would not be just because the rights to natural opportunities are equal rights of persons. They are not contingent on having had parents who were not excessively prolific. Thus the issue of justice with respect to population growth arises at the time when different nations decide to have different populations growth rates.
The people of a nation that is growing more slowly than another can justly say to the people of the more rapidly growing nation, "By your decision to have so many children, you are increasing the resources that we must set aside to ensure that our children have opportunities at least as satisfying as the ones we enjoy. You owe us something for your disproportionate appropriation of the world's scarce parenting opportunities." Thus the cost (or benefit) that one nation imposes on others by its differential population growth rate would be included in the calculation of the nation's total appropriation of natural opportunities, and therefore in the equalization payment that the nation received or paid.
Recognition of the equal rights of all to natural opportunities, through land value taxation and its extension to charges for the use of other resources, is not only just and efficient, but has the capacity to make a major contribution to economic growth. This occurs through a variety of paths.
The most important path is that public collection of the value of exclusive use of natural opportunities provides revenue that makes it possible to remove taxes from the earnings of labor and capital. When people are taxed less, they earn more. Using data that emerged from changes in U.S. tax rates, Feldstein has estimated that the elasticity of earnings with respect to the fraction of income not taken at the margin by federal taxes is at least 1.0 (and more for workers in higher tax brackets).6 When the entity that removes a tax on labor is less than global, this action also attract labor to the region.
When taxes are removed from capital, the effect is even more powerful, as long as the entity removing the tax is less than global. Capital is extremely mobile in response to regional changes in net returns. It is highly counterproductive for any locality or nation to tax capital, because there will be virtually no effect on the return to capital after taxes. Capital will merely be driven from the taxed region until the return after taxes matches what can be obtained elsewhere. If the whole world removes taxes from capital, the resulting increase in the rate of return to capital will increase the rate of saving, but the adjustment will occur over some years.
Taxing land has an additional effect that increases the stock of capital. A tax on land represents a redistribution from living adults to the young and unborn, who will now be born with rights to land. Unless there is a perfectly offsetting reduction in the desire to accumulate assets to transfer to the next generation, this redistribution will induce the living, who now have fewer assets, to accumulate at a more rapid rate than they would otherwise do. That is, saving and capital accumulation will increase.
Taxing land also increases the efficiency with which land is used. This occurs through three paths.
Psychologically, explicit costs tend to be more effective in motivating efficient behavior than implicit ones.
For all of the above reasons, the substitution of tax on land for taxes on labor and capital will increase the efficiency of an economy. To estimate the magnitudes of these consequences, one needs a model of the economy. Consider the following model. There is a three-factor CES (constant elasticity of substitution) production function:
Q = (aTà + bLà + cKà)(1/à). (1)
where Q is output, T is the quantity of land, L is the quantity of labor, K is the quantity of capital, a, b and c are coefficients, and à is related to the elasticity of substitution, å, by à = 1 - 1/å. Land has a completely fixed supply. Labor is assumed to have an elasticity of supply of 0.8 (adjusting Feldstein's number for the fact that he was considering only federal income taxes. Capital is assumed to be supplied perfectly elastically. Taking the ratio of compensation of employees to Net Domestic Product in National Income and Product Accounts, I assume that labor receives two thirds of output. Somewhat arbitrarily, I assume that the remaining third is divided equally between land and capital. I estimate that the marginal tax rate on labor is 43% (28% for the federal income tax, 12% for the combination of state income taxes indirect taxes, and 3% for the Medicare tax--I treat social security as having benefits equal to its costs, and therefore not a tax.) I estimate the marginal tax rate on land and capital at 50% (28% for the federal income tax, 12% for the combination of state income taxes and indirect taxes, plus 10% for profits taxes). The elasticity of substitution is a parameter that I am very unsure of. But Feldstein has estimated that the marginal welfare cost of taxation is 1.65, and I get that result with a å of 0.68, so I assume that å = 0.68.
I have a spreadsheet that takes parameters such as the ones named and determines what would happen (in a comparative static framework) if all taxes were removed from labor and capital, and 100% of the rent of land were taxed. Here are the results:
I would like to do more work with plausible ranges of parameters. But the model at least indicates that it is not unreasonable to expect dramatic improvements in economic growth from land value taxation, without reducing total government revenue.
Land value taxation generalizes to the principle that all persons have equal rights to natural opportunities and should therefore pay for their above-average appropriations of natural opportunities. This principle has the potential to contribute to the efficiency and fairness with which a wide variety of economic problems are handled. This paper considers in particular applications to pollution, congestion, use of scarce natural resources, and population growth. The revenue raised by managing these issues efficiently, as well as by the more traditional application of land value taxation, permits the removal of taxes on labor and capital, with the potential to unleash a tremendous increase in economic growth and consequent improvement in human welfare.
1. For an estimate of the magnitude of this effect, see Plassmann and Tideman, 1997.
2. Locke, 1963, paragraph 25 (some of the author's italics and capitalizations omitted).
3. Locke, 1963, paragraph 36.
4. George, 1979, pp. 338-9.
5. George, 1979, pp. 334-38.
6. Feldstein, 1965, p. 565.
Feldstein, Martin, "The Effect of Marginal Tax Rates on Taxable Income: A Panel Study of the 1986 Tax Reform Act," Journal of Political Economy 103 (June 1995), pp. 551-72.
George, Henry, Progress and Poverty (New York: Robert Schalkenbach Foundation, 1979 ).
Locke, John, Two Treatises of Government, (Cambridge: Cambridge University Press, 1963 ).
Plassmann, Florenz and Nicolaus Tideman, "A Markov Chain Monte Carlo Estimate of the Impact of Two-Rate Taxes on Construction," working paper, Economics Department, Virginia Tech, November 1997.
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Wealth and Want
... because democracy alone hasn't yet led to a society in which all can prosper