Old Land and New Assets

When we fail to make the critical distinction between land and capital, we get into all sorts of problems and fallacies.

Mason Gaffney: The Partiality of Indexing Capital Gains

We surely agree with Roberts et al. that domestic capital formation is a crying current need; and the means is to foster saving and investing (but properly defined, as below). We also agree there is a strong, bi-partisan case for raising investment flows of the income-creating, work-activating kind. Here, however, we meet the problem of distinguishing new capital from old assets, especially land.

Land is not formed, like capital, by saving and investment; land is not reproducible. For that very reason land tends to appreciate, and therefore has to be a major source of what are misleadingly called "capital" gains. Again for that very reason, there is no supply-side kick in untaxing gains. Most of them are land gains, and should be called that. To use land as a store of value is macro-economically unproductive at best, and on balance counterproductive and destabilizing (considering its effect on financial institutions like the S&Ls).

To handle this matter we need two semantic distinctions which often are lost in the word-fencing of debate. Walter Heller, whose policies still enjoy bi-partisan support, thought and spoke in a Keynesian framework where "investment" means "investing," an affirmative, job-making action. It is a process, not a store of value; an economic flow, not a fund. It is not the asset held: this "investment" is a noun, macro-economically static and sterile. [Land may appreciate, and one may call this "investment," but the appreciation employs no one and creates no new wealth (although it may reflect the externalities of wealth created by others).]

To signalize these differences I use the present participle "investing," rather than the ambiguous noun "investment."  [Webster's 9th New Collegiate defines investment both ways: it is an action, (the Keynesian usage); it is also an asset being held, a store of value. Such a two-faced word is a natural medium for double-talk, and has been so exploited, to the detriment of general understanding.]

Every Keynesian also knew in 1961 that investment means net, positive-sum investing. It does not include buying and selling existing assets like land: these are zero-sum transactions, macro-economically non-functional and barren. [Keynes, although careless of consistency, generally took care to distinguish old and new assets. " ... the competition of a high interest-rate on mortgages may well have had the same effect in retarding the growth of wealth from current investment in newly produced capital-assets as high interest rates on long-term debts ... " [General Theory, 1936, p. 241.] The old macro-economists generally refer to investing in newly produced assets as "income- creating expenditure," which is clear and correct, but too much of a mouthful.]

I use "investing" only in the sense of net, income-creating, job-making spending. [Note the difference between real turnover and mere ownership turnover. Ownership turnover generates no income (except for brokers and M&A personnel) and creates no capital. Real turnover also creates no capital, but does forward supplies of goods to consume, and flows of investing to produce replacement goods. Most of gross investing is reinvesting funds received or anticipated from sales of old capital (including inventories, which turn fast, and "fixed" capital which turns slowly as it depreciates and the funds are reinvested).]

As to borrowing on land, that can be worse than barren when the financial system rises and falls on a land bubble, as it has and is.

Heller and his contemporaries also knew that the incentive driving job-making investing is MRORAT, the Marginal Rate of Return after Taxes. [Economists of the 1960s, following Keynes, called it the MEC, or "Marginal Efficiency of Capital," an awkward phrase now little used. Awkward or not, and intended or not, it had great historical consequence by putting the emphasis where it belongs, on marginal rates of return, excluding rents.]

The marginal idea is pivotal. The Average ROR includes rents; the Marginal ROR is the pure return to new investment, Keynes' "inducement to invest," which is activating and functional.

These Heller ideas were invoked again by supply-siders in early Reagan times. However, policy over the course of the 80s lost the substance of that policy, keeping only the guise. Domestic leaders forgot the usage of "investment" in macro-economics.

They gradually slipped into an illusion that buying and holding and bidding up old assets like non-reproduceable lands and stocks would make jobs and produce goods. They forgot to distinguish old from new assets, and marginal from average returns on investment (average returns, recall, include rents). Both critics and supporters of "supply-side" policies now darken counsel by debating current policies in supply-side terms, when the terms no longer describe the policy at issue.

 Along with normal confusion, there is intelligence behind such error. The case for downtaxing gains depends in part on exploiting confusion, in order to pass off rent-raising as an incentive for saving and investing, and so to disguise its non-functionality and eminent taxability. The policy is called "supply side," but isn't.  

The litmus test of the sincerity of capital-formation champions is their treatment of irreproduceable land. Raising rents and land prices, and protecting the gains from taxation, is purely distributive, with no power to foster saving and investing. On the contrary, a higher share for rent and/or land purchase must mean a lower share for the investor in new capital.

Ignoring land and its distinctive attributes has the effect of treating land as though it were true, reproduceable capital, to be formed by saving and investing, to be routinely worn out and replaced in the normal course of life and business. It lets advocates of investing and capital formation abuse the legitimate case for macro incentives, exploiting the case to camouflage unearned, nonfunctional rents and increments to land value.[Brookings' major contribution to our subject is Henry Aaron (ed), 1976, Inflation and the Income Tax, with chapters by 15 eminent economists. Land is treated by none and is not in the index. [It is mentioned in passing only by one, George Lent.]]  ... read the whole article