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Still on the mountaintop: Economically rational racism
By Gavin R. Putland
April 3, 2008

Forty years ago, as Martin Luther King Jr. spoke of the Promised Land
and prophesied "I may not get there with you," a quiet revolution in
economic theory was beginning, which would ensure that Dr. King's
hearers, except perhaps the occasional Caleb or Joshua, wouldn't get
there either. The architects of the revolution didn't plan it that
way, but that's the way it turned out.

The revolution concerned the relationship between unemployment and
inflation. A paper by Milton Friedman, published in the month before
Dr. King spoke, and another by Edmund Phelps, published a few months
later, gave reason to believe that in the long term, if unemployment
falls below a certain rate, inflation speeds up, whereas if
unemployment rises above that rate, inflation slows down. That magic
unemployment number became known as the Non-Accelerating-Inflation
Rate of Unemployment, usually abbreviated by the acronym NAIRU.

By about 1980, during the term of Federal Reserve Chairman Paul
Volcker, it was accepted that the aim of interest-rate policy was to
create enough unemployment to exert enough downward pressure on wages
to give stable (and low) inflation. That didn't mean that central
bankers always aimed at a particular unemployment rate ˜ the NAIRU ˜
because they didn't always know what the magic rate was. But it did
mean that the Fed concentrated on inflation and accepted whatever the
unemployment outcome might be. And it did mean that the Fed would
sometimes cite falling unemployment as a sign of rising inflationary
pressure, which supposedly had to be checked by raising interest
rates.

While central banks determined interest rates, governments still had a
role in setting other policies so as to minimize the NAIRU. But
eventually that role was limited to making life for the unemployed as
unpleasant as possible, in order to maximize wage restraint for any
given unemployment rate, and defining an unemployed person as narrowly
as possible, so that official statistics understated the extent of
unemployment. (Attacking workers' wages and conditions is also widely
advocated, but harder to do in a democracy. That's one reason why some
people prefer dictatorship.)

The NAIRU was more commonly called the natural rate of unemployment.
Well, of course it's "natural" to define a problem out of existence
when you have no intention of solving it. More recently, politicians
and central bankers have started referring to the natural rate as full
employment. Yes, folks: in Newspeak, "full employment" means enough
unemployment to cause enough wage restraint to give stable inflation.

So we're living in a system of enforced failure. A percentage of
people have to be unemployed, and therefore, at the boundaries of
unemployment, another percentage of people have to be underemployed or
intermittently employed or precariously employed. In other words, the
economy is being run in such a way that a certain percentage of people
have to be losers. And people know this is true, even if they don't
know why. More than half the population are too young to remember a
time of genuine full employment, and those who remember know that
unemployment has been a continuous problem since the early '70s.

If a certain percentage of the population must be losers, two
conclusions follow. First, any attempt to equalize opportunity is a
zero-sum game, in which no one can be rescued from the pool of losers
except by throwing someone else in. Second, and here's the rub: if a
certain racial or religious minority is large enough to contain all or
most of the losers, the majority stands to gain by discriminating
against that minority, because if the pool of losers contains more
members of the minority, it will contain fewer members of the
majority, so that persons born into the majority face a lower risk of
being among the losers. Such discrimination, although immoral, is
economically rational. So members of the majority will discriminate,
encourage their peers to discriminate, and vote for politicians who
make it easy to discriminate.

Not every minority is a suitable target for economically rational
discrimination. If a minority is very small, it can absorb only a
small fraction of the losers, and in so doing will not greatly reduce
the risk that a person born into the majority will be among the
losers. That's why, from the majority's point of view, a minority
needs to be at least a certain size before it's worth discriminating
against. But there are other caveats. If a certain minority consists
of recent immigrants and their descendants, they're the products of a
favorable selection process. Immigrants come with big plans, on which
they've already taken big actions. Immigrants are guaranteed to have
some "get up and go", because they actually got up and went. Their
children and grandchildren inherit some of these advantages, if not
genetically then at least by example. In America, that's part of the
Asian story and, to some extent, the Hispanic story. Employers know
this. More obviously, if a certain minority has a very strong
religious or cultural commitment to education, and especially if it
can supply the teachers from among its own ranks, its members will be
attractive to employers, and will be hired whether the majority of
workers like it or not. In America that's the Jewish story and the
Catholic story, and perhaps another part of the Asian story.

But none of these stories is the Black American story. The Black
American minority is large enough to supply as many losers as the
economy might need. The first Black Americans were immigrants, but
only because they were brought in against their will, and any "get up
and go" that they had was ruthlessly suppressed. To get ahead in their
new country, they needed a Western education to which they were denied
access, and which they couldn't supply for themselves. And what they
didn't have, they could hardly bequeath to future generations.
Therefore, as unemployment became a permanent feature of the economic
landscape, Black Americans became the perfect targets for economically
rational discrimination, which helped to keep them in the wilderness
for another 40 years.

What then is to be done?

Clearly it's no use asking the majority not to engage in economically
rational discrimination, because the majority rules, and because, in a
zero-sum game, the majority can't help another group without harming
itself.

But what if this accursed "natural rate" of unemployment were somehow
drastically reduced, without attacking wages and working conditions?
As the unemployment rate fell, all ethnic and religious groups could
share the benefit. That part of the game would not be zero-sum. And
when the unemployment rate stabilized at the new low level, there
would be so few losers, and members of the majority would face such a
low risk of being among the losers, that offloading the risk onto some
minority group would no longer be worth the trouble. The effort that
is now spent on discrimination would then pay a bigger dividend if
spent on self-improvement. Discrimination would no longer be
economically rational.

So the key to the Promised Land is to reduce the natural rate of
unemployment without creating a new class of working losers. To see
how to do that, we must revisit some basic economic principles.

For a century and a half, capitalists and socialists argued about
ownership of the means of production as if the assets that make up the
"means of production" were all of the same kind. But they're not; they
fall into two distinct categories. In one category are the assets can
be produced by private, competitive effort. For convenience I'll call
these house-like assets, although they include not only houses but
also other buildings, as well as movable plant and equipment. In the
other category are those assets that cannot be produced by human
effort, or at least cannot be produced by private, competitive effort.
For convenience I'll call them land-like assets, although they include
not only land but also other natural resources, building rights
attached to land, and monopolies and privileges of all kinds.

The returns on house-like assets include interest, which is the price
of time-preference, insurance, which is the reward for bearing
(quantifiable) risk, and economic profit, which is the reward for
bearing (unquantifiable) uncertainty. Those returns are an incentive
to produce house-like assets. Any tax on those returns, or on the
assets themselves, reduces the incentive. Conservatives repeat this
argument ad nauseam but never acknowledge that it's valid only for
house-like assets.

The net returns on land-like assets are usually called economic rent.
Some people prefer to call them usury. But whatever you call them,
they can't be an incentive to produce anything, because no private
person or corporation can produce land-like assets, while the rental
values of those assets are produced not by the owners, but by the
demand from prospective users. It follows that any fraction of the
rental value of a land-like asset can be diverted into the public
treasury without discouraging any productive activity, and therefore
without raising prices. In other words, taxes on the values of
land-like assets are not inflationary.

But instead of taxing values of land-like assets, governments ˜
including conservative governments ˜ impose punitive taxes on
everything that they pretend to encourage, such as work, employment,
consumption (which creates demand), saving (which allows investment),
and of course investment in house-like assets. Some of these taxes
directly impede production. Some of them directly increase the cost of
hiring a worker at a given standard of living. But one way or the
other, all such taxes feed inflation. Because of this additional
upward pressure on inflation, it takes more unemployment to supply the
compensating downward pressure; in other words, inflationary taxes
raise the natural rate of unemployment.

So the key to reducing the natural rate of unemployment ˜ the key to
the Promised Land ˜ is to reduce or eliminate income tax, payroll tax,
sales tax, property taxes on values of buildings, and death taxes on
house-like assets, and to replace the revenue, as far as that's
necessary, with taxes on values of land-like assets. Those taxes can
take the form of capital gains taxes, or property taxes on land values
only (not including values of buildings), or holding taxes of so many
tenths of a percent per year on values of other land-like assets.
These land-value taxes and other holding taxes can have tax-free
thresholds, so that only the portion of the value above the threshold
is taxable. For taxpayers who are asset-rich but income-poor, the
holding taxes can be deferred until the assets are sold or bequeathed,
in which case the taxes may superficially resemble estate taxes on
land-like assets only. It's even possible to set the thresholds on a
case-by-case basis so that individual taxpayers are no worse off under
the new system than under the old.

Which brings us to the question of political feasibility: Does the
Promised Land have to come at the expense of the landowners?
Paradoxically, the answer is "No," and not only because the increase
in taxes on land-like assets would be offset by reductions in other
taxes. Paradoxically, landowners as a class actually stand to gain by
shifting the present tax burden off desirable activities and onto land
values. To see why, we must revisit another old piece of economic
theory.

The overall supply of land is fixed. From the viewpoint of the
taxpayer, the supply of land legally usable for any particular purpose
is also fixed, as is the supply of land within acceptable distance of
any particular services, infrastructure, or markets. Yet access to
suitably located land is essential to life and livelihood. Therefore
land rents and land prices are bid upward until they absorb the
economy's capacity to pay. All taxes are deductions from the capacity
to pay for land. If a tax is only a deduction from that capacity, it
will take as much from landowners as it delivers to the Treasury. But
most taxes do more than that; most taxes (more precisely, all taxes
except those on values of land-like assets) target productive
transactions, causing otherwise viable transactions and enterprises to
become unviable, thus reducing the capacity to pay for land even
before the tax is taken out. This is called the deadweight effect. So
under most taxes, the returns on land-like assets fall by more than
the tax paid: the landowners are overcharged! But direct taxation of
land values avoids the overcharge because there's no deadweight: the
tax doesn't deter any productive transactions. Even if someone sells
land to avoid the tax, the incentive to use the land is not reduced,
but is merely transferred to the buyer.

The same logic applies even to landowners who are about to sell.
Anticipated liability for land-value tax reduces buyers' capacity to
pay and therefore reduces sale prices. But so does anticipated
liability for any other tax ˜ with the usual overcharge.

So, while land-value taxation takes only as much from landowners as it
delivers to the Treasury, almost every other tax takes more from
landowners than it delivers to the Treasury. Therefore, under
land-value taxation, landowners as a class would be better off.

Does that mean everybody else would be worse off? No, because the
landowners' gain would be funded by overall economic growth, not by
anyone else's loss. Furthermore, not all of the benefit of that growth
would go to landowners. (In other words, not all of the deadweight of
existing taxes is converted into an overcharge on landowners.) A
holding tax on land induces the landowner to cover the tax liability
by attracting rent-paying tenants, or avoid the tax by selling the
land. Thus it strengthens the bargaining positions of renters and
prospective buyers. A capital gains tax on land increases the
attractiveness of rental income relative to capital gains, giving more
bargaining power to renters, and discourages speculative hoarding of
land, giving more bargaining power to prospective buyers. In short,
both kinds of tax ensure that non-landowners get a slice of the
growth.

By the way, the idea that all taxes fall on landowners is indeed very
old. In 1691, one of the great philosophers of freedom wrote, in part:
"It is in vain in a country whose great fund is land to hope to lay
the publick charge of the Government on anything else; there at last
it will terminate. The merchant (do what you can) will not bear it,
the labourer cannot, and therefore the landholder must: and whether he
were best to do it by laying it directly where it will at last settle,
or by letting it come to him by the sinking of his rents,... let him
consider." That was John Locke. And in 1787, one of America's founding
fathers wrote: "Our Legislators are all Landholders; and they are not
yet persuaded that all Taxes are finally paid by the Land..." That was
Benjamin Franklin, writing to Alexander Small eleven days after the
signing of the Constitution.

So far, in explaining the advantages of moving the tax burden onto
land values, I've only considered what happens when the taxes are
collected ˜ not what happens when they're spent. A core spending
responsibility is infrastructure, including network infrastructure
such as transport, waste disposal, water, sewerage, and drainage, and
community infrastructure such a schools, libraries, and emergency
services.

The benefit of an infrastructure project (net of user charges such as
fares and tolls) is location-specific, and therefore is reflected as
an uplift in land values in the serviced locations ˜ not an uplift in
building values, because the value of a building is limited by
construction costs, but an uplift in land values, because land has
location, and therefore locational value, even if no buildings yet
stand on it.

So, if the tax system claws back x% of every uplift in land value, any
public infrastructure project with a cost/benefit ratio of x% is
self-funding, and any public infrastructure project with a lower
cost/benefit ratio is better than self-funding, yielding a revenue
surplus that can be used for other purposes. If you wish, those other
purposes can include tax cuts. That should please conservatives.
Moreover, the untaxed portion of the uplift ˜ the other (100™x)% ˜ is
a net windfall for the landowners, who therefore should
enthusiastically support the tax because it would finance projects
that would not otherwise proceed, yielding windfalls that the owners
would not otherwise get. That should please conservatives even more.

Financing infrastructure out of income tax, sales tax, property taxes
on buildings, or death taxes on house-like assets, is socialism for
landowners ˜ welfare for landowners. Financing infrastructure out of
uplifts in land values is self-help for landowners. Which is more
conservative?

I should note, for the sake of precision, that costs and benefits may
have capitalized and annualized components, while uplifts in land
values may be expressed in terms of (capitalized) sale prices or
(annualized) rents. So for the purpose of the foregoing argument, all
terms must be converted to the same basis: either capitalized or
annualized. I should also note that an annual tax on the capitalized
value of land, with or without a threshold, automatically takes less
than 100% of the benefit of an infrastructure project, leaving a net
windfall for the landowner, because your tax bill doesn't go up unless
your land value does, and your land value doesn't go up unless, in the
judgment of the market, you are better off in spite of the tax
implication. And conservatives respect the judgment of the market,
don't they?

Better infrastructure, especially better public education, has been a
touchstone of progressive politics. Unfortunately it's also been a
point of vulnerability, because it invites the question "Where's the
money going to come from?" which conservatives have answered by
accusing progressives of being taxaholics. But financing
infrastructure out of uplifts in land values does not mean raising
taxes in order to pay for infrastructure. It means redesigning the tax
system so that future expenditure on infrastructure automatically pays
for itself by expanding the tax base without any increase in tax
rates. In other words, it means financing infrastructure out of the
growth dividend ˜ not the mythical growth dividend that supposedly
comes from cutting taxes on the rich, although the tax cuts aren't
conditional on the growth or on any behavior that contributes to it,
but the real growth dividend that follows when the revenue of a
government is conditional on spending decisions that add value to
land. Mark my words: Progressives will never shake off the "taxaholic"
label until they move some of the present tax burden off productive
activities and onto land values, so that a subsequent increase in
infrastructure investment doesn't require an increase in tax rates.

Now what about those crumbling public schools left over from the
segregation era? Empirical studies have found that a satisfactory
public school adds value to land within walking distance of the
school, while a highly desirable public school adds value to land
within its entire catchment area. (The effect of a merely
"satisfactory" public school on land values within driving distance,
as opposed to walking distance, would be hard to determine empirically
because the presence of the school would be correlated with numerous
other influences.) So a public school, like any other piece of
infrastructure, raises land values in the serviced area. This implies
that so-called "free" schools aren't free at all; the admission charge
is hidden in prices and rents of land in locations serviced by the
schools, and is payable to the incumbent landowners. The argument that
property taxes shouldn't pay for schools, because schools aren't
services to property, is baloney; public schools are services to
property because they add value to property, and the property owners
get the benefit whether they send their kids to those schools or not.

So land-value taxation is good for landowners, as well as the rest of
us, because it induces investment in infrastructure that adds value to
land, and because landowners don't pay back any part of their windfall
unless and until they actually get it. Logically, landowners ought to
support this policy. But I know from experience that logic isn't their
strong suit. Some of them reject the argument not because they find
any fault with it, but because they simply refuse to engage with it ˜
they just don't want to know. Others point to infrastructure projects
that allegedly didn't raise land values. Well, if a project didn't
raise land values by at least the cost of the project, it failed the
cost-benefit test and therefore shouldn't have gone ahead. If a
funding method isn't capable of funding projects that shouldn't go
ahead, that's not an argument against the method; that's an argument
in its favor.

How then shall we overcome the non-thinkers and the land-windfall
deniers? Dr. King gave an unintentional hint when he encouraged the
Black community in Memphis to impose what amounted to
human-rights-related trade sanctions. These involved not only boycotts
of businesses that mistreated Blacks, but also what he called a
"bank-in" (keeping your money in Black financial institutions) and an
"insurance-in" (dealing with Black insurance companies). That was
then. Perhaps what we need now is a sort of "infrastructure-in".
Although Black Americans are a minority in the country as a whole,
there are many cities and counties with Black majorities, including
Detroit, New Orleans, Baltimore, Atlanta, Washington DC, and of course
Memphis. So, if we can't have land-value taxation in all American
cities and counties because it's good for all Americans, then maybe we
can have it in Black American cities and counties because it's good
for Black Americans. Of course I shouldn't have to say that. But if
the only way to get some action on infrastructure is to turn it into a
Black Pride issue, let's turn it into a Black Pride issue, because
action is needed. Then the other cities and counties can try to catch
up.

If America is sliding into recession, as seems to be the case, then
the necessity of moving to land-value taxation is amplified by, yes,
"the fierce urgency of Now." As Dr. King said at the Lincoln Memorial,
"This is no time ... to take the tranquilizing drug of gradualism."
Now is the time to cut payroll taxes that discourage hiring. Now is
the time to cut sales taxes that reduce demand. Now is the time to
exempt the values of buildings from property taxes, so that
construction is no longer discouraged. Now is the time to create
wealth and jobs by investing in infrastructure. Now is the time to
move the tax burden onto land values so that great infrastructure
projects can be financed without increasing already alarming budget
deficits. And those who hope that the present crisis can be overcome
by yet another stimulus package or taxpayer-funded bailout "will have
a rude awakening if the nation returns to business as usual," because
the tax system that gave us this recession and the one before and the
one before that, if left essentially intact, will give us the next
recession and the one after and the one after that.

The present recession, like the recessions of the early '90s, early
'80s, and mid '70s, was preceded by a crash in the land market. The
recession of 2001 may seem different because it was preceded by crash
in the share market. But shares are land-like in so far as the
underlying assets are land-like. Shares are even more land-like in the
short term because they can be bought and sold much faster than they
can be issued. Now the crucial point is this: Markets for land-like
assets are susceptible to crashes under the present tax system, but
would not be if the tax burden were moved onto values of land-like
assets.

As economic growth adds to the demand for land-like assets while
private agents can't add to the supply, prices of land-like assets
rise in the long term. When people see prices rising, they try to buy
into the market, thereby reinforcing the price rise, inducing more
people to buy in, and so on, so that prices become decoupled from
rents and are supported solely by the circular argument that prices
will continue to rise. This is a speculative bubble. But eventually
the illusion becomes unsustainable and prices stop rising, taking away
the alleged justification for current prices, and so on: the bubble
"bursts". Those who have invested heavily in the collapsed market must
reduce their expenditure. If they've invested with borrowed money,
they may be bankrupt. As one agent's expenditure is another's income,
and as one agent's debt is another's asset, a chain reaction begins.
If the initial burst is big enough, the chain reaction leads to
recession, which is made worse if the reduction in funds available for
investment causes bursts in other asset markets.

Irresponsible lending inflates the bubble further, causing a bigger
burst, hence a deeper recession. The recent practice of selling and
reselling mortgage loans, packaging them into securities and selling
them again, and so forth, makes it hard to know who is credit-worthy
and who isn't, causing a broader chain reaction, hence a deeper
recession. But these are secondary issues peculiar to the current
recession. The basic problem, common to all recessions, is that the
present tax system encourages speculative bubbles by making capital
gains more attractive than earned income. However, a sufficiently
heavy tax on values of land-like assets can prevent recessions by
preventing bubbles. If it's a capital gains tax, it directly reduces
the speculative motive that inflates bubbles. If it's a holding tax,
it provides corrective feedback: when prices rise, the tax also rises,
making the assets less attractive and opposing the price rise, whereas
when prices fall, the tax also falls, making the assets more
attractive and opposing the price fall. Thus a holding tax stabilizes
prices around the long-term trend. That's how to prevent the next
recession.

In the Promised Land of the Old Testament, there was no land
speculation and no possibility of speculative bubbles, because you
couldn't sell land in perpetuity. According to the 25th chapter of
Leviticus, every 50th year was to be a Jubilee, and you could only
sell a lease on the land up to the next Jubilee. As the time remaining
on the lease was always getting shorter, the lease was always falling
in value, so you couldn't make a capital gain on it. Nowadays, if we
somehow don't consider ourselves bound by the commandment that ”The
land shall not be sold for ever• (Leviticus 25:23), we need another
method of preventing speculation. Land-value taxation not only
discourages speculation, but also reduces inflationary pressure,
allowing a reduction in the natural rate of unemployment, so that
members of the dominant ethnic group face little risk of unemployment
and have little to gain by trying to offload that risk onto some
minority.

Alternatively, America can retain the present inflationary taxes, and
the Fed can fight the inflationary pressure by creating unemployment,
the burden of which will continue to fall disproportionately on
Blacks. Meanwhile the opportunity to make capital gains on land,
together with the lack of pressure to earn income from it, will
maintain a permanent artificial demand for land, exacerbated by
periodic speculative bubbles. The artificial demand will inflate rents
and prices of residential land, which is a necessity of life, and for
which workers will have to pay out of wages that have been depressed
by the competition for scarce jobs, eroded by income tax, and devalued
by indirect taxes. This is the Ownership Society, the caricature of
the Promised Land offered by those who call themselves conservatives.

But let's conclude on a more conciliatory note. In the present
recession, which has been triggered by a collapse in land prices,
land-value taxation would reverse the collapse ˜ not by re-inflating a
temporary speculative bubble, but by inducing investment in
infrastructure that permanently enhances the utility of the land. So
maybe it takes a recession to induce a conservative appreciation of
land-value taxation as a substitute for existing taxes. Maybe that's
one way in which "only when it is dark enough can you see the stars."

http://www.opednews.com/
articles/opedne_gavin_r__080401_still_on_the_mountai.htm
Authors Website: www.grputland.com
Authors Bio: Gavin R. Putland is the Research Officer
for Prosper Australia.

--
Stewart Goldwater
http://janusg.co.nr