Taxable Rent, More than Enough: after Professor Gaffney

H. William Batt, Ph.D.

[Draft prepared in November, 2011. NOT FOR ATTRIBUTION]

Abstract - Taxable Rent

Despite frequent arguments about the merits of taxing economic rent rather than the wages of labor and capital goods, the assertions largely fall on deaf ears. The reason is that neoclassical economic theory doesn't regard rent as a significant element in a modern economy. Conventional treatments view rent either as the yield of agricultural land alone or else as trivialized and swamped by the productivity of the other factors of production. Moreover, in most contemporary analysis, land has been conflated into capital in two-factor theory, in contrast to formulas of classical economics that prevailed until the 20th century. Many estimates suggest, however, that rent as a proportion of social wealth is typically about one third, but ranges from twenty to over forty percent.

This paper collects what evidence is available in contemporary economic literature as well as that in historical and cross-cultural analysis to show that rent continues to be a significant element even in today's economies. Far from being less than in historical periods when agricultural economies dominated societies, rent may well be an even larger component of a society's gross domestic product. The paper looks at the literature where rent was a recognized phenomenon, and distinguishes between that understood by David Ricardo and that of Heinrich von Thünen. It goes on to discuss what today is recognized as the Henry George Theorem - that the rent generated in a typical municipality is sufficient if taxed to support all its necessary services. It further lists resources of nature where the yields of rent are recognized in theory, even though they are not now being measured.

One difficulty in calculating socially-produced resource rents stems part from the fact that taxes on other factors of production - labor and capital goods - all ultimately come out of rents, and the deadweight losses that are imposed by these other taxes also come out of rents. This has been explored and identified with the acronyms ABCOR and EBCOR. The upshot of available inquiry is that rent is fully adequate to finance public services were it to supplant other taxes. The question is of significant moment, and calls for further analysis of national income and product accounts in order to provide more definitive answers.

Short Abstract

Several contemporary economists have urged a return to the tradition of classical theory wherein the basis of taxation is the rent from natural resources. From all its sources it is likely about a third of a society's gross product, easily enough to supplant conventional taxes on wages and capital goods.

Key words: rent, economic rent, ground rent, land rent, Ricardian rent, von Thünen rent, resource rent, land, Henry George Theorem, ATCOR, EBCOR, classical economics.

Taxable Rent, More than Enough: After Professor Gaffney

Does Rent Exist?

In December of 2010 Professor Joseph Stiglitz wrote the following:

One of the general principles of taxation is that one should tax factors that are inelastic in supply, since there are no adverse supply side effects. Land does not disappear when it is taxed. Henry George, a great progressive of the late nineteenth century, argued, partly on this basis, for a land tax. It is ironic that rather than following this dictum, the United States has been doing just the opposite through its preferential treatment of capital gains.

But it is not just land that faces a low elasticity of supply. It is the case for other depletable natural resources. Subsidies might encourage the early discovery of some resource, but it does not increase the supply of the resource; that is largely a matter of nature. That is why it also makes sense, from an efficiency point of view, to tax natural resource rents at as close to 100% as possible.[1]

That this recent Nobel laureate should express his approval of taxing resource rents is noteworthy, for such full-throated endorsements today have been rare. But he is far from being the first. Although in more muted contexts, a good many prominent contemporary economists, even those most closely identified with the neoclassical tradition, have made similar avowals. More recently still, in testimony before the US Senate Finance Committee, Professor James K. Galbraith, posed this question:

Should we tax capital, labor ? or rent? Is it a good idea to shift the tax burden from high-income to low-income Americans, in the guise of shifting the tax burden from capital to labor, in order to promote "saving and investment"? In particular, will this create new jobs? History says not: we have been shifting this burden for decades with no appreciable effect on savings, investment or jobs.

And there is also no shortage of capital in our economy. As the economist Mason Gaffney wrote in a paper delivered to the National Tax Association in 1978: "The key to making jobs is changing the use and form of capital we already have. Tax preferences for property income, in their present and proposed forms, bias investors against using capital to make jobs, doing more harm than good."[3]

Economists from Smith to Ricardo to Mill understood that fixed investments, however useful, do not generate many permanent jobs. What creates jobs is the revolving capital that supports payrolls. A tax policy aimed at supporting employment would shift the tax burden away from labor, and off of short-term capital, and place it instead on long-term capital accumulations. If this reduces the investment in fixed capital that is desired for other reasons ? in particular, investment with broad public benefits ? then that sort of investment should be done by public authority, funded by an infrastructure bank.

Thus as a general rule fixed assets -- notably land -- should be taxed more heavily than income. The tax on property is a good tax, provided it is designed to fall as heavily as possible on economic rents. This basic argument, going back to Ricardo, remains sensible, for it aims to not-interfere where there is, in fact, no public purpose to interfere with private decision-taking. Payroll taxes and profits taxes do interfere directly with current business decisions. Taxes effectively aimed at economic rent, including land rent and mineral rents, and at "absentee landlords" as Veblen called them, do not.[4] If these assertions are any surprise, they are due to the fact that for decades neoclassical economists and contemporary experts on tax policy have dismissed the idea of taxing resource rents as not sufficiently worth attention. Why bother, they have argued, when rent constitutes at most only two percent of the gross domestic product. Contemporary textbooks for introductory economics are unanimous in their conclusion that resource rents are inconsequential.[5] Moreover, of seven texts in the field of Public Finance only two of them mention rent at all. And they do so only in the context of rent-seeking or imputed rent (of owner occupied housing).[6]

In recent book subtitled "A Brief Economic History of the World," University of California Davis Professor Gregory Clark writes,

In the modern world, land per person which had completely dominated income determination before 1800, no longer matters in economic growth. This is because land rents have fallen to only a few percent of total output in modern high-income economies. … Farmland rents, which were 23 percent of national income in 1760, fell to 0.2 percent by 2000. In part this decrease was offset by arise in the site rental value of urban land. But by 2000 urban land rents represented only 4 percent of national income, even in crowded England with its very high housing costs.[7]

A widely read book by Todd Buchholz comes to a similar conclusion.[8] After giving a nod to 19th century economist Henry George, the most notable proponent of taxing land rent, he continues,

George fans can proudly point to property taxes as a source of state and local finance. But they cannot point as confidently as they could sixty years ago. George overestimated the future importance of rents and rental income. Governments at every level have grown tremendously in the last century. Even if governments could take all rents without rebellion or severe recession, rents would not come close to covering expenses. In 1929, property rents accounted for about 6 percent of national income. The percentage has steadily dropped to well under one percent today. Where property taxes once provided 65 percent of state and local budgets, they now supply about 17 percent.

Finally, Paul Krugman was asked about the potential of taxing economic rent in 2009 by an American journalist who has written for The Atlantic Monthly, Slate, and the Los Angeles Times. He recounts the exchange as follows:

[He] came to Berlin in 2008, right when the subprime crisis had started to rumble, and I asked his opinion of Henry George. He squinted and tried to remember the name of the book. "Uh - Progress and Poverty I think is the [main text]?"

"That's right."

"Well, look. Believe it or not, urban economics models actually do suggest that Georgist taxation would be the right approach at least to finance city growth. But I would just say: I don't think you can raise nearly enough money to run a modern welfare state by taxing land. It's just not a big enough thing."[9]

There are those, however, that have argued that economic rent is at least a third of an economy, and perhaps far more. Terry Dwyer claims that economic rent on real estate land alone is about 30 percent of the Australian GDP, ignoring other resource rents that exist. "The 'bottom line' reinforces the overall conclusion …that land-based tax revenues are indeed sufficient to allow total abolition of company and personal income tax. Further, to the extent that some taxes, such as rates, land tax, resource rent taxes and even part of income tax on land rents are already capitalized in lower market values for privately held land, the figures would tend to understate the capacity of land income to replace existing taxes."[10] Mason Gaffney, after showing the numerous ways in which rent is consistently under-represented, argues that rent in a modern economy is an ample basis of public finance, a claim reflected in his title, "The Hidden Taxable Capacity of Land: Enough and to Spare,"[11] The article enumerates in detail some sixteen ways in which economic rent is undercounted in conventional treatments.

The point at issue then is whether rent has really ceased to be a significant element of a nation's economy or whether it is simply not being counted. Michael Hudson argues the latter. In an important paper he wrote about fifteen years ago, titled "How Rent Gets Buried in the National Income Accounts," [12] he explains how land rent is calculated in the US National Income and Product Accounts so as to be grossly misleading. Since the data is compiled from income tax filings, it is derived from commercial real estate transactions, and these favor that industry's purposes. Since the NIPA accounts have no other sources for their data, the inability to recognize rent except by this source leads to its trivialization. The data takes no account of imputed rent of owner-occupied homes, the rent yield from commercial real estate properties, or indeed the yield from other (non-realty) natural resource elements of the economy. For the real estate industry itself, depreciation rates are so generously calculated that land values actually show a net loss! The upshot is that the only numbers are for real property rental income, i.e., that listed for payments by tenants who rent properties - i.e., offices and households.

Ricardian Rent

If land rent is a factor associated only with agricultural production, as contemporary neoclassical economics texts or as Clark and Buchholz both argue, their arguments can be linked largely to the declining importance of farming as a proportion of modern economies. This is the dimension of rent that David Ricardo identified and best explained in the early half of the 19th century.[13] Ricardo's definition of rent is "that portion of the produce of the earth which is paid to the landlord for the use of the original and indestructible powers of the soil." Ricardo's land use model implies that the intensity of production rises with the demand for land, as higher levels of economic rent justify the expenditure of more labor. But with the application of technologies, both of machinery and of fertilizers, much of the pressure on land has been relieved and forestalled. It then stands to reason that, even given the wide expanses of farmland in the US and elsewhere, its significance, as a proportion of total economic productivity might be less. As important as agriculture is to the welfare of a society, the place it holds as a component of GDP (gross domestic product) is far smaller than two centuries ago. This perception reflects the inadequacy of our statistical measures, however, more than the diminution in importance of the agricultural economy. Even if the raw food supply is a small a part of GDP, one cannot dismiss its pivotal position in society. A certain eminent statesman/economist once also trivialized petroleum as inconsequential using the same argument.[14]

Since the concept of economic rent, also known as Ricardian rent, land rent, and ground rent, has essentially disappeared from our contemporary vocabulary, it is helpful to look to a time when rent was a recognizable reality in people's daily lives. From the Middle Ages of European feudalism, we have many words in contemporary English and French that build on this root word. To rend is to remove from a location, to split or tear apart, often violently; rendition is the forfeiture, cession, or handing over of something; and to render is to give, interpret or make available. Rentiers are people who depend and live on the rent of others. Rent seeking is the "competition for privilege. The form of government affects the extent of rent seeking that takes place… in general, whenever personal benefits depend on decisions made by other people, life can become a quest for personal favors, and people spend time and effort in rent-seeking activity."[15] A still more pointed definition is "the use of resources to get a rent by reducing the welfare of others."[16] The importance of rent, economically speaking, is its presence in market value of any resource of nature regardless whether it flows through nature or is collected and paid by its titleholder. Left fixed in capitalized form in whichever resource base has commodity value, it becomes a loss of liquid capital for other use and a distortion of economic productivity.

The challenge of understanding the economics of the feudal age would seem to be far less difficult using the framework of classical economics than for neoclassical economics. Classical economics is based on a tripartite factor division - land, labor and capital. The prices of labor and capital are wages and interest respectively, and any resulting surplus appears as rent yield from the land. This is something understood from the time of John Locke until the beginning of the 20th century. With the institutionalization of economics as a formal discipline, land and the associated rent was conflated into capital, eventuating in the subsequent creation of two-factor theory. This was easy to do given land's increasingly permuted and commodified status. This conceptual transformation has been explored in detail by a number of historians of economics, most cogently by Mason Gaffney, in his 1995 book, The Corruption of Economics.[17] Not only was rent as a tool of analysis essentially eliminated from definitions and formulas, but the moral basis on which the discourse of political economy rested was lost as well.

One would need to be exceedingly familiar with the economies of various medieval societies in order to extrapolate the component of land rent in their GDPs, and with sufficient confidence to estimate the proportion of community income it represented. The historical chronicles are replete with stories, noting in detail the amount paid, whether in agricultural yields, in money, or in labor service. But historians seem less interested in or able to make estimates of rent as a total share of an economy, or even for any given domain (demesne). There is a further danger of applying a single term to an array of socio-economic arrangements that only in the collective sense are called feudalism. The term rent is context dependent. This is made clear by Keith Tribe:[18]

If we examine manorial accounts of the thirteenth or fourteenth centuries, the existence of 'rent' and its association with a named subject and a piece of land is quite clear; but this rent can undergo some peculiar transformations, and the amount of rent paid has little or nothing to do with the price of saleable agricultural produce, or even with the extent of land occupied. This 'feudal rent' is in fact not a rent of land, but is an expression of the subordination of feudal labour. As a consequence of this, it is really quite accidental that feudal and capitalist rents can appear to be variants of a particular category. In order to understand the nature of this feudal rent, it is necessary to devote some space to an outline of what can be roughly termed a 'feudal economy.'

The greatest difficulties exist in understanding and putting a value on various rental payments when they can take many forms. Rents were paid in the form of labor (corvèe), as a portion of a crop or other yields, as tribute goods, or in coin. Payment of rent to lords was as integral a part of the circular flow of their economic systems as the flow of taxes is today. Quantifying the value of such payments for socio-historical analysis today remains inherently subjective especially when, for example, the labor contributed to repair and maintain fields and hedges or roads and canals served not just a lord's domain but also the general welfare of the community.[19] Even if these obligations were perceived as duties solely to lords, they were essentially communal. There were also payments of a share of crop yield or tribute gifts. How would one price the gift of one's daughter to a lord to serve as a minor wife or concubine?

A second challenge arises out of the fact that the strength of patriarchal rule ebbed and flowed over time. When political rule was casual, rents were often unpaid; when the nobility was strong rents were collected.[20] Practices, as a result, did not always follow formal arrangements and rules, nor were they consistent. In fact the chronicles and other records that have come down to us show that payments were often in arrears, and were often adjusted to reflect the state of economic circumstances. In efforts to cope with such changes, Immanuel Wallerstein, for example, points to the case of another economic historian writing about the 16th century.

[One] may assume that at the beginning of the Price Revolution wage payments represented three-fifths of production costs… I guess that in 1500 the rent of land may have been one-fifth of national income in England and France and that, with the tendency for rising agricultural prices to raise rents and the infrequent removals of rent contracts to lower them offsetting each other, rents rose as fast as prices during the Price Revolution.[22]

There are an ample number of archived chronicles where records of rent payments survive but inferences about its gross level as a proportion of the gross domestic product are difficult. Even if the economic systems of the age are identified as being of a single sort, in a span of roughly seven centuries on a continent of many societies and nations, generalizations are problematic. One can generalize about lands "owned" by lords, usually under sufferance of their kings, but then it gets more complicated. Britnell[23] distinguishes three arrangements between 1000 and 1500: manorial leases, feudal tenures, and peasant tenures.

Manorial leases were contractual in character and were the usual means by which landlords managed their estates. Whole manors, both the income and services from peasant tenures and the demesne land under direct seigniorial control, were leased, often for one or more lives at a fixed rent. Unlike feudal tenures, receipts from seigniorial leases were geared directly to providing the household services of the king, bishops, abbots, barons and other greater landlords. Feudal tenures were those created originally as contracts to provide for a lord's personal service, usually of a military kind. They were of many different sizes. At the top end, from the Conqueror's reign onwards, whole baronies were held from the crown for the services of a stipulated number of knights, though the lands of the barony had to maintain the baron himself as well as his knights. At the lower end of the scale were individual knights' fiefs (the land given to knights to support them). Such fiefs were often taken out of the demesne land of a baron or a wealthy church burdened with military service. A few of the larger ones became new manors in their own right, though this was unusual in the eleventh century. Peasant tenures were those held by the various categories of villager who owned rents and services at a manor house; they're mostly family holdings of fifty acres or less and the terms of tenure were all customary in some degree. Most manors had some tenants of this kind.

References here deal largely with English history due to the especially rich scholarly examination of its feudal period,[24] but similar practices can be identified in continental Europe as well. In the final analysis, we can only depend upon the best guesses from economic historians of the period as to the amount of rent comprised in feudal societies. Robert Allen, who has written three books on the period, argues that the enclosure movement radically increased the productivity of English society. He concludes, "If rent accounted for one third of revenues, then enclosure boosted rent by 64 percent." He continues to work from the premise that rent accounted for a third of the revenues with the onset of the enclosure movement.[25] The French Physiocrats estimated rent at about a third, as did Adam Smith who was deeply influenced by their work.[26] Vestiges of rent payments in feudal societies also exist in the form of stories and verses that have come down to us. We all know

Bah, Bah Black Sheep, Have you any Wool? Yes Sir, Yes Sir, Three Bags full. One for my Master, One for my Dame; One for the little boy that lives down the lane.[27]

The part for the "Master" was rent. That "one third" estimate is repeated often. Yet Christopher Dyer, who is just as steeped in the history of the English Middle Ages and who consulted with colleagues upon meeting the question, puts the proportion at only about twelve percent.[28]

It appears that as the feudal system evolved, less of the rent was paid in a proportion of crop yield or in labor, and more in the form of hard money. But the terms were always negotiated according to the leverage that each party could bring to bear, sometimes favoring the peasants and sometimes the landlords. The full amount of Ricardian economic rent was never paid to the lord - indeed that is a sum only discernable by theory or extrapolation. Calculating amounts based on all the inputs and outputs exceed the capacities of accounting both then and even now.[29] In efforts to bridge the various meanings of rent as it was applied, some scholars have elected to include more than Ricardo's meaning of "original and indestructible powers of the soil" alone. They add in the use of any capital that the lord frequently supplied to tenants. Hence, rent was defined as "the share of the produce taken by the landlord for the use of the soil and for the equipment of the farm, which we call rent," a meaning borrowed from earlier scholarship.

Tribe discusses rent and feudal society as described in a number of scholarly treatises.[30] But he is insistent in pointing out that rent is not a category that can be applied a priori to other civilizations and other times. Nonetheless, there is good reason to maintain that counterparts of feudal societies elsewhere in the world with many of the same attributes offer equivalents that can be identified as rent.[31] This is made quite clear, for example by Max Weber. Gerhard Lenski notes that the Chinese gentry was able at times to collect as much as 40-50 percent of the land yield as rent and has no reservations about using the term.[32] This writer's work in Thailand suggests that land rent for the roughly three centuries of the Ayutthaya and Bangkok Chakri dynasties until the 20th century was from 20 to 40 percent.[33] This raises the question whether the three factors of production as employed in classical economic theory tend typically to equilibrate in a way that they always maintain a constant proportion in relationship to one another.[34]

Von Thünen Rent

By far the largest single element of land rent today, however, is an outgrowth of spatial location. For this understanding we owe most to a German economic geographer named Johann Heinrich von Thünen.[35] Von Thünen was also a gentleman farmer, and was interested foremost in the theory of marginal productivity of land as regarded its relative location for growing crops. He understood that the cost of a crop yield had to take into account the price of getting it to market. The most expensive and perishable commodities it made sense to grow nearest the city centers. The less expensive and less perishable crops could be allocated to agricultural land in more remote areas. With this in mind he developed formulas including several variable factors that would decide the optimal location to grow various crops. The complete formula is

L = Y(P - C) - YDF, where

  • L = Locational rent
  • Y = Yield
  • P = Market Price of the Crop
  • C = Production Cost of the Crop
  • D = Distance from the Market
  • F = Transport Cost

Figures 1-4 could not be reproduced here.
Contact the author for a version that includes the image files