Review of the book
The Losses of Nations:
Deadweight Politics versus Public Rent Dividends
by Fred Harrison
[Reprinted from Land & Liberty, March
This book is an impressive sequel to Costing the Earth
(Shepheard-Walwyn, 1989), in which a team led by Ron Banks estimated
the true annual rental value of Britain=92s land and natural resources
for 1985, a fairly representative year, at 22 percent of national
income. The official figure for rent's share in Britain, as in most
other countries, is much lower than this because of the modern
economist's casual lumping together of land (including natural
resources) with buildings ("total capital investment") from
which the income is mostly regarded as "return on investment",
or interest income rather than rent.
The tragic consequence of this modern convention is that though
influential economists happily agree that the "taxation" of
rental incomes uniquely induces no "deadweight efficiency losses"
because land is in fixed supply, they dismiss the idea as a serious
replacement for other taxes when these amount to 30-50 percent of GDP
in modern economies.
One of the contributors to this volume, Professor Mason Gaffney of
the University of California, recently gave us a brilliant expose, in
The Corruption of Economics (Shepheard-Walwyn, 1994), of the
way in which the neo-classical revolution fused land with capital.
This conveniently (for the propertied classes) diverted attention from
the distinctive treatment of land, in the classical economics of
Smith, Ricardo, Mill and Henry George, as a separate factor of
production and the natural and prospectively buoyant source of public
In The Losses of Nations Banks, Gaffney and others extend
their earlier contributions in terms both of empirical and theoretical
support for the hypothesis that rent-based public finance can fairly,
efficiently and fully replace the current system of distortionary and
extortionary taxation (though, as Fred Harrison emphasises, taxes on
cigarettes and fuel may be retained on health and environmental
The first half of the book is written by Harrison and surveys the
general issues. His main concern is that the private expropriation of
rents and land values is at the heart of the boom-and-bust cycle, most
dramatically exemplified by the way in which soaring land values,
artificially inflated by speculative holdings of land in idle or
suboptimal use, brought financial crisis to Japan after 1990 and
collapse to much of the rest of Asia in 1997. The IMF, a citadel of
neo-classical economics, can only prescribe a dose of deflationary
medicine via increased taxation of all incomes and expenditures, as
the price of their massive salvage operations. These are designed to
prop up the Asian financial system, fed by western bank credits, whose
loans were collateralised by land whose value boomed and then slumped
when it had cut too deeply into the returns on productive activity.
Meanwhile, in Russia the IMF continues to urge Boris Yeltsin to
privatise land so that there too it can be used as collateral for
loans (domestic and foreign)!
Harrison coins the term "the law of economic absorption" to
describe the process whereby improvements in economic efficiency, such
as the liberalisation of world trade and capital movements, tend to be
at least partly captured by the owners of land rather than by labour
and capital. This in turn induces speculative purchases of land.
Unlike speculation in reproducible commodities, speculation in land
does not induce an increase in its overall supply to bring down its
price. It is a zero sum game. Eventually there is a price collapse as
hoarders become offloaders, and this plunges banks into crisis.
If ownership or exclusive occupancy of land were viewed as a
privilege, with rights purchased from the state as guardian of the
community interest, then it is argued that the revenues would permit
the abatement of almost all taxes on labour and capital, and eliminate
the speculative motive for holding land. By contrast, the system we do
have actually takes on the character of a negative-sum game. For the
law of economic absorption means not only that taxes on labour and
capital adversely affect the supply of labour and capital -- which
explains the "excess burden" or "deadweight losses"
of these taxes -- but also that they cut deeply into rents that owners
can charge tenants or impute to themselves. This then persuades
economists and politicians, looking only at the surface phenomena in
economic life, to dismiss land as an important source of revenue for
the modern state.
Nobel Laureate William Vickrey had deeper insight. Get taxes off the
backs of labour and capital. And price public utilities at their (low)
marginal cost -- an important efficiency criterion -- to boost demand
and exploit economies of scale. Land values will rise thanks to the
cheap services and higher disposable income, and because augmented
supplies of labour and capital increase the demand for space. Then "tax"
those enhanced land values. (Insofar as the state asks for rent
proportional to the amenity and location value of sites, the charges
are based on the benefit principle. Thus they are not taxes but fees,
like the price of theatre tickets or parking charges.)
Following Harrison's lively scene-setting come several chapters
packed with further deep insights and empirical support. First, Ron
Banks updates the earlier investigation into the underlying value of
Britain's natural resource rents, put at 22 percent for 1985. This
figure made no allowance for the depressive effect of taxation of
buildings and people. For 1996/97 Banks conservatively assumes the
figure to be 17.5 percent of GDP, but introduces a new notion: that
there is an irreducible minimum of government spending -- mainly
defence, law and order, and much of the transport system -- that is
required to maintain land values and for which citizens would always
need to pay a rent to the supreme landlord. Most other items of public
spending could, in principle, be provided privately, so their
counterpart revenues are not land rents. Banks puts the "socially
necessary" (rent counterpart) items of spending at 108 billion or
a further 16 percent of GDP. Moreover, he notes that a significant
proportion of mortgage interest, currently counted as interest on
savings (capital), is actually a return on the land element of "housing"
and other structures.
Nicolaus Tideman and Florenz Plassman tackle the "excess burden"
issue more directly. They ask how the inputs of land, labour and
capital would respond to a change to a rent-based fiscal system.
Heroically, they test a famous version of an "aggregate
production function" that relates aggregate output to the three
main inputs, which in turn are supplied in accordance with their
marginal after-tax returns. Partly building on the work of Harvard
economist Martin Feldstein who calculated the elasticity of labour
supply to a change in the marginal tax rate, Tideman and Plassman
reckon that removal of the deadweight losses of the current tax system
would increase GDP by nearly 30 percent for the USA, where taxes are
relatively low, and by over 90 percent in countries with higher taxes.
Their estimates may be conservative because they assume that the
production function is "augmented" by an exogenous rate of
technical progress of just 1% a year.
In reality technical progress is likely to be endogenous to the
opportunities thrown up by the much larger size of market that is
implied by their estimates of the elasticities of supply of land,
labour and capital to a change in incentives and relative prices.
Mason Gaffney and Richard Noyes corroborate Tideman and Plassman by
comparing those US states that rely more heavily on property taxes
with those relying more heavily on income and sales taxes. The former
are very significantly richer or fast-growing than the former. The
authors give convincing reasons why the direction of causation is
almost certainly from fiscal structure to income rather than from
income to fiscal structure. The finger of suspicion points firmly at
Proposition 13 as the origin of California's relative decline since
Another chapter by Gaffney, "The Philosophy of Public Finance",
is tough but highly rewarding. He explains rigorously how and why the
ultimate incidence of taxation falls on rent. Harrison's law of
economic absorption becomes Gaffney's ATCOR principle: All Taxes Come
Out of Rent. Building taxes, for example, reduce the amount that the
buildings=92 occupants are willing to pay in rent, or that landlords
are able to charge. If taxes on buildings were abated, a proportional
increase in the rate levied on sites would yield the same revenue
because there would be a proportional increase in the value of the
site. The revenue base would be maintained. Indeed, Gaffney shows that
this is the very minimum we could expect. In reality the base would
expand significantly because of the way the new system enhances
incentives to build and develop.
Since building taxes fall most heavily on new relative to old
buildings, "challenge values" offered for land would rise
relative to the "defence values" of existing owners and
tenants who have been holding sites off the market or in suboptimal
uses under the old regime. Urban renewal would generate more compact,
more synergistic cities. Land values at the extensive margin (catering
for horizontal sprawl) may fall, while those at the intensive margin
would rise. But building costs, relieved of taxes on capital and
labour, would fall. And so would the public costs of urban
infrastructure. There would be a gearing effect because private and
public borrowing costs would then also fall. This is equivalent in its
effect to a fall in interest rates. Building is highly sensitive to
the interest rate through its effect on expected returns on the supply
of new structures relative to the return on the old stock. The
sensitivity to tax changes would be even greater.
It is an exciting story. The message is that a rent-based fiscal
system can reconcile the libertarian ideals of limited government with
the communitarian view of man as a social animal with both rights and
obligations. (This builds on Richard Noyes's book, Now the Synthesis
.) As Fred Harrison puts it: Privatised rent is the last great
injustice inherited from previous civilisations dominated by landed
interests. By reforming public finance, rather than merely tinkering
with the existing system as New Labour is doing, we may herald an age
fit for a new millenium.