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Free Lunches aren't free ... whose expense?
Michael Hudson: The Lies of the Land: How and why land gets undervalued
Turning land-value gains into capital gains
YOU MAY THINK the largest category of assets in this countrly is industrial plant and machinery. In fact the US Federal Reserve Board's annual balance sheet shows real estate to be the economy's largest asset, two-thirds of America's wealth and more than 60 percent of that in land, depending on the assessment method.
Most capital gains are land-value gains. The big players do not want their profits in rent, which is taxed as ordinary income, but in capital gains, taxed at a lower rate. To benefit as much as possible from today's real estate bubble of fast rising land values they pledge a property's rent income to pay interest on the debt for as much property as they can buy with as little of their own money as possible. After paying off the mortgage lender they sell the property and get to keep the "capital gain".
This price appreciation is actually a "land gain", that is, it's not from providing start-up capital for new enterprises, but from sitting on a rising asset already in place, the land. Its value rises because neighbourhoods are upgraded, mortgage money is ample, and rezoning is favorable from farmland on the outskirts of cities to gentrification of the core to create high-income residential developments. The potential capital gain can be huge. That's why developers are willing to pay their mortgage lenders so much of their rent income, often all of it.
Of course, investing most surplus income and wealth in land has been going on ever since antiquity, and also pledging one's land for debt ("mortgaging the homestead") that often led to its forfeiture to creditors or to forced sale under distress conditions. Today borrowing against land is a path to getting rich -- before the land bubble bursts. As economies have grown richer, most of their surplus is still being spent acquiring real property, both for prestige and because its flow of rental income grows as society's prosperity grows. That's why lenders find real estate to be the collateral of choice.
Most new entries into the Forbes or Fortune lists of the richest men consist of real estate billionaires, or individuals coming from the fuels and minerals industries or natural monopolies. Those who have not inherited family fortunes have gained their wealth by borrowing money to buy assets that have soared in value. Land may not be a factor of production, but it enables its owners to assert claims of ownership and obligation, i.e., rentier income in the forms of rent and interest. ...
Hiding the free lunch
BAUDELAIRE OBSERVED that the devil wins at the point where he convinces humanity that he does not exist. The Financial, Insurance and Real Estate (FIRE) sectors seem to have adopted a kindred philosophy that what is not quantified and reported will be invisible to the tax collector, leaving more to be pledged for mortgage credit and paid out as interest. It appears to have worked. To academic theorists as well., breathlessly focused on their own particular hypothetical world, the magnitude of land rent and land-price gains has become invisible. But not to investors. They are out to pick a property whose location value increases faster rate than the interest charges, and they want to stay away from earnings on man-made capital -- like improvements. That's earned income, not the "free lunch" they get from land value increases.
Chicago School economists insist that no free lunch exists. But when one begins to look beneath the surface of national income statistics and the national balance sheet of assets and liabilities, one can see that modern economies are all about obtaining a free lunch. However, to make this free ride go all the faster, it helps if the rest of the world does not see that anyone is getting the proverbial something for nothing - what classical economists called unearned income, most characteristically in the form of land rent. You start by using a method of appraising that undervalues the real income producer, land. Here's how it's done.
PROPERTY IS APPRAISED in two ways. Both start by estimating its market value. The land-residual approach subtracts the value of buildings from this overall value, designating the remainder as the value of land. ... The building-residual approach starts by valuing the land, and treats the difference as representing the building's value. ...
Everyone recognized the absurdity of calculations depicting all the corporate land in America as having a negative value in 1993. Suppose somebody same to you and said: "I'll give you $4 billion, but there's a catch. Along with the $4 billion in cash, you will have to accept ownership of all the land owned by every non-financial corporation in the United States." Most people no doubt would see that they were being given assets much more valuable than $4 billion, and would jump at the offer. The Fed's statistic would be dismissed as a comic exercise showing how economists tend to lapse into otherworldly speculation. But in this case the motive is all too worldly. Looking beneath the surface, one finds the not-so-invisible hand of self-interest by the real estate industry and its financial backers.
To give the Fed economists their due, they evidently came to the conclusion that their statistics were fatally flawed. The September 1997 balance sheet estimates made a start along new lines by including a calculation reflecting the original (historical) cost of buildings. This gave land a positive value. But nationwide totals were no longer compiled. No longer was there a line labeled "land," nor does the Fed publish a residual number for market value less the historical cost (or even the replacement cost) of buildings. Instead of making better land estimates, the Fed has dropped what had become a political and statistical hot potato. 1994 is the last year for which it has estimated economy-wide land and building values.
This leaves in limbo the macro-economists and business analysts whose business is to explain the finance, insurance and real estate (FIRE) sector's dominant role in the economy. According to the land-residual appraisal technique, high-rise buildings seem to have the lowest land values. Real estate interests argue that this is realistic, because at least in New York City the higher a building is, the more of a subsidy its developers need, given the economics of space involved for elevators, surrounding air space and so forth. The land itself is assigned a negative value as a statistically balancing residual reflecting the difference between the building's high construction costs and its lower market value. ...
In view of real estate's dominant role in the economy, it is ironic that no attempt has been made to provide better statistics. My research has shown that the Fed's methodology undervalues land by as much as $4.5 trillion. As matters stood in 1994, for instance, the Fed estimated the U.S. economy to hold some $20 trillion in real assets (excluding human capital, for which no official statistics are published). The land's value was calculated to be $4.4 trillion, and building values $9 trillion. My estimates based on historical values suggests that land rather than buildings represents two thirds of the nation's overall real estate value -- $9 trillion, leaving building values at just half this amount. ...
The commercial loft building in which I lived rose in price from $40,000 in 1986 to $120,000 in 1980 and $4,000,000 in 2000. This sharp increase cannot be explainable by rising building costs. The building itself steadily deteriorated. All that increased was its site value. Today, of course, that property a block from the World Trade Center has fallen back in price, just as many new buyers had renovated their structures. The site's value changed without any significant reference to construction costs. One must infer that it is the site that determines the property's value.
In a thriving real estate market appraisers typically use a rule of thumb in allocating resale prices as between land and buildings to reflect their pre-existing proportions. Buildings typically are assumed to account for between 40 percent and 60 percent of the property's value. As a result, building values are estimated to grow along with a property's overall sales value. This appraisal practice is made to appear plausible as the pace of asset-price inflation tends to go hand in hand with rising construction costs, and hence in the theoretical replacement cost of buildings.
As noted, the anomaly occurs when real estate prices fall. Real estate prices are volatile, while construction costs rarely dip more than slightly, if at all. When real estate prices turn down, they often plunge below the reproduction cost of buildings. Hence, the residual ("land") rises and falls much more sharply than do building replacement costs (which are estimated as rising at a fairly steady pace) and overall property values. ...
Real estate industry's priorities
REAL ESTATE LOBBIES recognize that what is not seen is less likely to be taxed. What is not quantified for public policy-makers to see clearly may avoid taxes, leaving property owners with a larger after-tax return. They prefer land-residual's capital gains statistics at the national level, even as individual investors seek site-value gains at the local level.
This explains the seeming irony that investors in an industry dealing primarily with the development of land sites have campaigned to minimize the statistical treatment of land. Relegating land to merely secondary status enables the real estate industry to depict its "capital" gains as resulting from cost inflation and hence the reproduction costs of buildings -- whose value is allowed to be depreciated and re-depreciated at rising values over time. The free lunch of land-price gains is unseen as attention is diverted from the real estate bubble and land-price inflation to building costs. These fiscal considerations help to explain why it has been so hard to get Washington to produce national land value statistics. ...
Whether the gains come from selling the property or from borrowing more money against it, the essential phenomenon is the rapid growth in asset values and real estate's uniquely favored tax treatment. That's why investors choose real estate instead of bonds or stocks, and much of the strategy underlying corporate takeovers has followed the strategies they developed over the past half century.
Nationwide the capital-gains dimension needs to be incorporated into the rental revenue statistics to measure real estate's total returns. This sector's nearly complete success in escaping the tax collector has placed an enormous tax burden on everyone else. Read the whole article
Charles B. Fillebrown: A Catechism of Natural Taxation, from Principles of Natural Taxation (1917)
Charles T. Root — Not a Single Tax! (1925)
Mason Gaffney: Land Rent in a Tax-free Society (Outline of remarks by Mason Gaffney, for use at Moscow Congress, 5/21/96)
3. Rent will become huger yet when you abate taxes presently levied on production and exchange, because these now depress the rent of land. That is, in a tax-free market economy, the benefit of abating present taxes will lodge mainly in land rents. The taxable surplus simply shifts from one form to another.
This is more than a simple shift of a fixed amount. When you substitute land revenues for existing taxes, the surplus actually grows, as if by synergy. You gain more revenue base than you lose, because existing taxes now suppress much latent production. Payroll taxes directly drive workers from taxable jobs to untaxed gains from crime. Abating those taxes will unleash suppressed economic giants, along with all the new surplus values their latent production will generate. "Monetarists" warn you that "there are no free lunches." In fact, however, good policy creates lots of "free lunches." It makes the whole greater than the sum of its parts. Imagine the benefits, alone, of turning people from destructive careers in crime to useful jobs producing goods. Read the whole article
Mason Gaffney: The Power of Neo-classical Economics (Introduction to The Corruption of Economics, London: Shepheard-Walwyn, 1994)
Neo-classical economics makes an ideal of "choice." That sounds good, and liberating, and positive. In practice, however, it has become a new dismal science, a science of choice where most of the choices are bad. "TANSTAAFL" (There Ain't No Such Thing As A Free Lunch) is the slogan and shibboleth. Whatever you want, you must give up something good. As an overtone there is even a hint that what one person gains he must take from another. The theory of gains from trade has it otherwise, but that is a heritage from the older classical economists.
Henry George, in contrast, had a genius for reconciling-by-synthesizing. Reconciling is far better than merely compromising. He had a way of taking two problems and composing them into one solution, as we lay out in detail infra. He took two polar philosophies, collectivism and individualism, and synthesized a plan to combine the better features, and discard the worse features, of each. He was a problem-solver, who did not suffer incapacitating dilemmas and standoffs. ... read the whole essay
Mason Gaffney: Sounding the Revenue Potential of Land: Fifteen Lost Elements
Raising taxable rents by untaxing capital and labor, production and exchange: the concept of ATCOR (All Taxes Come Out of Rents) The meaning and relevance of ATCOR is that when we lower other taxes, the revenue base is not lost, but shifted to land rents and values, which can then yield more taxes. This is most obvious with taxes on buildings. When we exempt buildings, and raise tax rates on the land under them, we are still taxing the same real estate; we are just taxing it in a different way. This “different way” actually raises the revenue capacity of real estate by a large factor, by relieving it of the excess burden of taxing production and capital. This is that “free lunch” that Chicago economists wrongly preach “There ain’t no such thing as.”Jeff Smith: What the Left Must Do: Share the Surplus
Historical experience with exempting buildings has shown that builders offer more for land, and sellers demand more, when the new buildings are to be untaxed. The effect on revenue is the same as taxing prospective new buildings before they are even built, even though the new buildings are not to be taxed at all.
Net result: the revenue capacity of land, when it is substituted for other tax bases, is comparable to current revenues. Owing to efficiency effects, and renewal effects, it may well be higher. Read the whole article
What would you do if you could work two days and take five off? Write? Play soccer? Tend to the community garden? Time off is an option made increasingly viable by our relentlessly rising rate of productivity. French Marxist and media critic Jean Baudrillard, while still advancing the interests of labor, implores the Left to move on from seeing humans as workers to seeing workers as human beings, with more needs than merely the material. Enabling people to live their lives more fully is an issue made to order for rescuing the Left from the doldrums that descended when “history ended”.Dan Sullivan: Are you a Real Libertarian, or a ROYAL Libertarian?
What would single mothers do with enough income to stay home? What would minorities do with the wherewithal to begin their own businesses? What would communities do if they did not leak resources up to an upper class and out to a distant lender or tax collector? What would the elite do without our commonwealth? The means to these ends is an extra income apart from labor or capital (savings), that is, a “social salary” from society’s surplus, a “Citizens Dividend” from all the rents, natural and governmental, that people pay for land and to the privileged, redirected to everyone equally. Merely demanding a fair sharing of the bounty from nature and modern society would raise people’s self-esteem, a key component for political involvement. Actually receiving an income supplement would transform our lives and restructure society.
To deliver a bigger pie, the Right touts efficiency and growth; to better distribute the pie, the Left urges equity and jobs. Yet jobs are less for distributing, more for producing – if that. As automation and globalisation expand the pie, they contract the workforce. Even when, or especially when, people take time off to go to war, output increases, proving we’re well over over-capacity. Juliet Schor in her Overworked American notes this rise in productivity does not bless us with leisure but curses us with unemployment.
However, even when employment is high, jobs still do a lousy job of distribution. They capture less than a fair return to labor while swallowing up our free time. Full employment with a liveable wage may mean jobs with justice for some, but not for those unable to work, and it reduces humans to workers, not players or creators.
Demanding jobs rather than a fair share of society’s surplus implies that there is no commonwealth or that expropriating it by a few is OK. Neither is true. Rents are real, and they are ours. There is a free lunch (just ask the privileged), as those downing it do get money for nothing. And since society, not lone owners, generates these values, that flow of funds belongs to everyone.
RENT – THE STUFF OF FORTUNES – ROCKS AND RULES
The value of a parcel of land is initially based on the natural endowments of the location (“location, location, location”), created not by an owner but by whatever created all of us. Next, land value rises with the presence of society, and grows with the population of society. It’s highest where society is densest, in the city centers, typically 2000 times more valuable than sites in the boondocks. Land values as economic values disappear whenever society quits respecting one’s claim, as in a war zone; there, real estate offices nimbly shut down. And while land titles may be the holy grail of wannabe homeowners, they’re also the ticket to pocket unearned rent by absentee landlords, such as Donald Trump.
Making land public does not guarantee that the public end up with the rent. The public’s steward, the state, often lets public resources at “fire-sale” prices, unduly enriching Chevron, Arco, Kerr-McGee, Weyerhauser, etc. The state gifts enormously valuable licenses for TV, radio, and cell phones to GE, Disney, Time Warner, and Clear Channel. The metaphor, “field of knowledge”, lets us see patents and copyrights as flags; by excluding innovative outsiders, they not only skew techno-progress (thus addicting civilization to oil) but also enrich those few who can afford to corral them: GM, DuPont, and Microsoft. Similarly, a utility franchise lets AT&T pay investors, and Enron insiders, handsomely. ... Read the whole article
We call ourselves the "party of principle," and we base property rights on the principle that everyone is entitled to the fruits of his labor. Land, however, is not the fruit of anyone's labor, and our system of land tenure is based not on labor, but on decrees of privilege issued from the state, called titles. In fact, the term "real estate" is Middle English (originally French) for "royal state." The "title" to land is the essence of the title of nobility, and the root of noble privilege.
When the state granted land titles to a fraction of the population, it gave that fraction devices with which to levy, and pocket, tolls on the fruits of the labor of others. Those without land privileges must either buy or rent those privileges from the people who received the grants or from their assignees. Thus the state titles enable large landowners to collect a transfer payment, or "free lunch" from the actual land users.
According to royal libertarians, land becomes private property when one mixes one's labor with it. And mixing what is yours with what is not yours in order to own the whole thing is considered great sport. But the notion is filled with problems. How much labor does it take to claim land, and how much land can one claim for that labor? And for how long can one make that claim?
According to classical liberals, land belonged to the user for as long as the land was being used, and no longer. But according to royal libertarians, land belongs to the first user, forever. So, do the oceans belong to the heirs of the first person to take a fish out or put a boat in? Does someone who plows the same field each year own only one field, while someone who plows a different field each year owns dozens of fields? Should the builder of the first transcontinental railroad own the continent? Shouldn't we at least have to pay a toll to cross the tracks? Are there no common rights to the earth at all? To royal libertarians there are not, but classical liberals recognized that unlimited ownership of land never flowed from use, but from the state:
A right of property in movable things is admitted before the establishment of government. A separate property in lands not till after that establishment.... He who plants a field keeps possession of it till he has gathered the produce, after which one has as good a right as another to occupy it. Government must be established and laws provided, before lands can be separately appropriated and their owner protected in his possession. Till then the property is in the body of the nation. --Thomas Jefferson ... Read the whole piece
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Wealth and Want
... because democracy alone hasn't yet led to a society in which all can prosper