Tax Reforms Proposed to Promote Saving
Mason Gaffney
[Reprinted from GroundSwell, May-June 2005]
There is a strong movement afoot to tax just consumption rather than
all income. The good reason for this is to promote saving and
investment, and thus enhance domestic capital formation, said to be
the main force for economic growth, poorly defined but assumed to be a
good thing. A battery of well-financed pols, along with many
economists and divers publicists, are pushing it.
Leading proposals take mainly two forms. One is to create a national
sales tax, obliterating the present income tax. The second is to
exempt all saving and investing from the present income tax. This is
more sly, is easier to achieve politically, is already partly in
place, and is the more likely to occur, so my examples will come from
it.
There are several faults in the proposals. A chief one is to distract
us from the major cause of overconsumption, viz. turning land value
gains into cash. Some call it living high on the old homestead, which
is imprecise but gives you the idea. Equity withdrawal is a more
generic term. The land under and around homes is indeed a major
element of land gains, but mineral, commercial, recreational,
industrial, transportation, radio-wave, sylvan, and all kinds of lands
and waters and other natural resources are involved, including those
held by corporations, governments, and eleemosynaries.
An owner may withdraw equity by selling land for a gain; or borrowing
(tax-free) on the swollen value; or neglecting maintenance and
replacement of buildings, counting on the land gains to maintain his
or her assets while milking the old capital as a cash cow. In all
cases, the NIP A (National Income and Product Account) does not count
the land gains as income. NIPA does not count them as anything, they
are outside its purportedly aggregate social accounts, just as they
are outside the consciousness of most modern economists (except when
they invest privately). However, the gainers spend them on consumption
-- with no output corresponding to it This shows up in NIPA as
dissaving.
Some economists dig a little into causes of dissaving. They mostly
omit equity withdrawal from land value gains as a major cause,
distracting us instead with other explanations. Some favored ones are
social security (with no mention that our PICA taxes ARE a form of
saving, squandered not by us but by Congress for the benefit of richer
taxpayers); improved insurance (pooling risks, a net social gain);
easy credit for housing (but with no mention of equity withdrawal);
student-loans (with no mention that they are invested in human
capital); and consumer credit (not mentioning it is dwarfed by
mortgage credit). One may sense some class bias in the choice of
examples.
The same economists are puzzled why the following causes have not
increased saving the way they are "supposed to": the fall of
income tax rates in top brackets; the rise of the percentage of our
population in the high-saving ages, 45-65, after 1995; and the rise of
average incomes.
Economist Robert Barro got promoted from Rochester to Harvard and
became a Business Week guru for theorizing that Federal deficits would
stimulate private individuals to save more. Milton Friedman cheered.
This notion is, to put it charitably, not proving out. As for business
saving (as of undistributed corporate profits) it gets lost in the
shuffle.
Stiglitz & Walsh, whose current Macro-economics text is a cut
above most, do mention the wealth effect of high stock values, making
people feel richer and thus spend more on consuming. The authors would
seem to be getting warm, but then they dismiss the rise of home
prices: it has just meant that more individuals were saving in the
form of home equity (p.225). Thus, their only direct reference to the
rise of land values, while vague, has it backwards. Scanning other
current texts on macro, the quality is downhill from there.
A bright spot is the ongoing work of Oxford's John Muell-bauer, who
may even be having a hearing in HM Treasury in Whitehall. It is hard
to assess the impact, even from close up, and that much harder from
this distance. We do know, however, that Britain has gone over to a
VAT, and has not fully repaired Maggie Thatcher's vandalism of its
local rating system, so Britain has a long climb ahead simply to get
out of the pit it has dug itself into.
The result in the U.S., at least, is counterproductive policy advice
from economists: raise sales taxes, and lower any tax, of whatever
kind, that hits real property. This class includes property taxes, of
course, but also estate taxes, inheritance taxes, taxes on the income
from property (both land and capital), capital gains taxes, and
severance taxes. The resulting higher land values lead to more equity
withdrawal and less saving - the opposite of the alleged good reason
for taxing only consumption.
This neglect of equity withdrawal from real estate is not a simple
oversight It is the result of years of perverting economists training
and vocabularies and techniques - their groupthink, if you will - to
cloud their understanding of it and intimidate them from mentioning
the obvious. Poterba and Krugman, highly visible writers, also brought
it up in the early 1990s, but without following through, and their "words
tike silent raindrops fell, and echoed in a well of silence."
Mentioning equity withdrawal in any but a favorable tight may have
become a modern solecism, for it would discredit the measures actually
proposed.
These measures include removing land rent, values, and gains from the
base of the income tax. This is to be done by letting land buyers
write off the expenditure in the year they buy. If the buyer is in,
say, a 20% tax bracket, the Treasury thus puts up 20% of the purchase
price. After that it gets back at most 20% of the net cash land rent,
which is just a return on its own investment. If it's residential or
recreational land, with no cash flow, the Treasury gets back nothing.
In addition, mentioning how equity withdrawal pays for consumption
would discredit the fellow-traveling proposal to exempt all capital
gains (read lax gains) from the income tax. It would weaken ongoing
proposals 1 obliterate property taxes and severance taxes and taxes on
estates and inheritances.
A second major fault in the proposals to tax only consumption is
confused ambivalence toward saving. There is a strong residue of
Keynesian demand-side economics among economists, journalists and
pols, so that spending of all kinds is more often praise than
censured, even as the gurus scold us, the public, for our prodigality
and indiscipline with money. Most economics texts are uselessly
indecisive on this point. On one page they tell us that saving is
desirable to create capital to abet growth, and on another that
consumer spending is the key to growth and jobs, and saving is a
menace. Pols and the Fed chief, Alan Greenspan, may thus pick which
ever position suits their p.r. needs of the moment. As to the cause of
saving, most toss it off as an automatically increasing function of
income, and perhaps of interest yields.
A third major fault is misidentifying consumption Economists are
careless with definitions, as Henry George brought out in his day, and
the modern profession has not reformed. For example, many champions of
taxing consumption cite the authority of J. S. Mill, who did indeed
write that the income tax should exempt saving. None of them has
noted, though, that Mill defined house purchase as a consumer
expenditure, not saving, and scathed grandiose mansions on display in
conspicuous locations as wasteful Modern NIPA, in contrast, calls all
housing a capital outlay.
We know that Mill, like Smith and the Physiocrats, viewed land rent
as being peculiarly eligible for special taxation, so we may
reasonably infer that if he had been present at the creation of NIPA
he would have suggested several improvements. NIPA for example ignores
wasting slots of land-time by underuse, which should be included as
part of consumption. Investing in human capital is called consumption,
as though weddings, pregnancies, birthings commuting, nurture,
housekeeping, chauffeuring kids, and grades K-12 are all frivolity on
a par with jockeying ATVs over fragile lands, or bar-hopping. On the
second matter, the childless Mill actually had no sympathy with the
costs of parenting, a point on which his Malthusianism trumped his
humanitarianism, but we needn't follow him on everything -- just make
sure we define our terms, and make others do the same.
NIPA does NOT call depleting hydrocarbons consumption, or even a
business cost. This custom originated during W.W. II when the idea was
desperately to maximize gross output, and damn the social costs. The
custom is outrageously obsolete now, but the power of inertia is so
strong that macro-economists do not even resist efforts to redefine
terms: they simply ignore them. These are such big topics in their own
rights, and so damning of NIPA and modem macroeconomics, that we defer
fuller treatment for the next issue of Groundswell.
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