Economic Policy Options:
An Alternative Set of Choices
Edward J. Dodson
[September, 2011]
I offer my perspectives not as an economist but as someone who for 35
years (20 years with Fannie Mae until 2005) worked in banking as a
credit officer, market analyst and business manager.
In my estimation, the measures being proposed to stabilize our
financial system and the economy reflect the sad state of discourse on
substantive economic and societal challenges. Conventional wisdoms
that conflict with reality continue to exert great power over the
decision-making of our elected officials and those who serve as policy
advisers. This circumstance is not new. Back in 1955, economics
professor Harry Gunnison Brown expressed his frustration with many of
his professional colleagues: .
"Economics is concerned with the problem of
'getting a living'. It deals, therefore, with an important phase of
the 'struggle for existence'. Unfortunately, this fact operates to
prevent unprejudiced investigation of its laws and of the effects of
various economic policies. An examination that would show the
effects of various policies from which a part of the public was
benefiting, to be injurious to the remainder, might not be an
examination which those who were profiting by the policies in
question would desire to have made. And if such an examination were
made, acceptance of its inevitable logical conclusions would
probably be vigorously opposed."
Over time, the search for solutions to the periodic tendencies of our
economic system to implode have given way to mitigation by modest
technical interventions using defined fiscal and monetary tools. .
Our very understanding of the health of our economy is obscured by
the language of mainstream economics that is repeated regularly by
journalists and news reporters. Let me begin with one prime example:
the use of Gross Domestic Product (GDP) as a commonly-accepted
measurement of economic health and growth. I doubt that any of the
media commentators know that GDP includes (with minor exceptions)
every dollar spent by government for any purpose, whether obtained by
taxation or borrowed. GDP is calculated as follows: consumption +
gross investment + government spending + (exports ? imports). Thus, a
rising GDP is hardly an indicator that the economy is expanding. Goods
production can be falling, unemployment rising, crime rising,
environmental disasters occurring with increasing frequency, with
government spending on the military and the servicing of debt causing
GDP to be reported as increasing. .
Another fundamental problem with how economics has evolved as a
discipline is the extent to which theorists have embraced the notion
that markets for locations in our cities and towns, for agricultural
land, for natural resource laden lands, for the broadcast spectrum and
all of nature, generally, respond to changes in price and demand in
the same manner as goods we produce from nature. Generations of
political economists who preceded economists treated nature (i.e.,
what they termed "land") as the first factor of production;
that is, as the source of "wealth" but not as wealth itself.
Nature was (and still is) the passive factor of production, acted on
by labor with and without the use of capital goods. Yet, today land
has come to be treated as just another factor input, referred to as "natural
capital" when land is the source of capital goods. .
The first lesson confirmed in the real world is that the "price
mechanism" does not work for "land". Price effectively
clears markets for labor, for capital goods and (to a great extent)
for credit. However, as we have seen during this last land market
cycle, as prices are rising speculation intensifies. Land is acquired
to be held off the market for speculative gain rather than for
development. This occurs even when locations are improved by various
types of structures. Investors ignore vacancy rates and even negative
cash flows on the gamble that rising land prices will allow them to
flip the property to someone else within a few short years. The same
mentality spills over into the residential property markets,
exacerbated by low- and no-down payment mortgage financing that
allowed for interest-only payments or even negative amortization. .
In the secondary mortgage market, the GSEs and FHA accommodated the
increase in land prices by every year increasing the maximum loan
amounts on mortgage loans. The result was as from the early 1990s on,
every mortgage loan acquired for portfolio or securitized was
collateralized by more and more land value and less and less housing
value. This was a prescription for eventual financial disaster. .
What caused the current land market crash to spread so deeply and
broadly around the world was bank-provided credit, allowing land
speculators to pass on most of the risk to those same financial
institutions (or investors in various types of collateralized mortgage
obligations). The absence of effective regulation and law enforcement
also deepened the crash by overloading the credit markets with poorly
underwritten subprime mortgage loans, hundreds of billions of dollars
in predatory loans made to low income, elderly and otherwise marginal
borrowers, and outright fraud (e.g., the sale of nonexistent or
extensively falsified loans by mortgage brokers). .
One immediate measure that ought to be passed into law is to prohibit
any financial entity that accepts government insured deposits from
making loans for the purchase or refinance of land value. This would
remove a good deal of the accelerant from the next upsurge in land
prices. Speculators would have to commit their own funds or find other
investors willing to share the downside risk of speculation near or at
the top of the land market cycle. Consistently imprudent bankers would
be protected from their own inclination to book high-yielding assets
without an objective assessment of the risks involved. .
There is nothing governments can really do at this point to bring us
out of the economic depression. Government spending on infrastructure
will stimulate a degree of private job creation and (combined with
extended unemployment benefits and other social welfare measures)
prevent widespread homelessness and social unrest. However, a large
segment of our population is experiencing the loss of household income
at a time of rising costs of living. .
The time is long past for continued reliance on fine-tuning of the
economy. When we suffered through stagflation in the 1970s, critics on
the right called for business deregulation and "supply-side"
stimulation of investment based on dramatically lower marginal rates
of taxation on so-called "capital gains" and ordinary
income. These measures largely provided the atmosphere for an economy
driven by speculation rather than goods production or the development
of new technologies and services. I believe there are four main shifts
in public policy required to start the dominoes falling in the right
direction (i.e., in the direction of full employment without
inflation): .
First, make the individual income tax system truly
progressive and at the same remove its complexity. Wages and
salaries are, for most people, the largest portion of their incomes,
and are "earned" producing goods and services. This level
of income should be exempted from taxation, or taxed at very low
rates. We should begin by exempting all individual incomes up to a
far higher amount than is now the case (eliminating all other
exemptions and deductions). The national median could be a good
starting point. Above the national median, increasing rates of
taxation would be applied to higher ranges of individual income
(which, as incomes increase, are derived from what economists
describe as "rent-seeking" investment activities). .
Second, establish the mechanism for gradual repayment of the
national debt by issuing fully amortizing bonds to replace existing
government bonds as they mature. The amount required to service the
debt (both interest and principal being retired) would be
incorporated as an integral expense of the government budgeting
process. The tax rates on individual incomes at the highest ranges
would be set to raise sufficient revenue to achieve a balanced
budget. .
Third, we need to replace the business profits tax with a graduated
tax on gross revenue, exempting small businesses (which create the
overwhelming number of jobs in the economy). Some analysis is
required to determine what the exemption level should be, but the
idea is to benefit those companies most that have a stake in their
communities and where profits are circulated locally rather than
routed to a distant (or overseas) corporate headquarters and senior
executives rewarded by compliant boards of directors for cutting the
number of employees. This measure would also end the practice of
companies being able to expense the huge compensation packages to
executives and thereby reduce taxable income.
And, finally, the federal and state governments must urge every
community across the nation to restructure the long-destructive ways
they have raised revenue for public goods and services. What
communities create by investment in infrastructure and public
amenities is land value. Thus, this community-created value ought to
be the primary source of public revenue. Every parcel of land in a
community has a potential annual rental value. This rental value is
the amount that ought to be paid to the community in return for the
services brought to a location. This means exempting property
improvements (i.e., buildings of all types) from the property tax
base. Moving to a land-only tax base will not only stimulate new
construction and rehabilitation of existing structures, landowners
will find it far more profitable to bring the land they hold to "highest,
best use" as dictated by market forces (or sell to someone who
will) than to hold onto land for speculation. Sufficient revenue
might be generated by the taxation of location rental values to
lower or eliminate taxes on wages and commerce.
I welcome comments and questions on the above proposals. Readers may
contact me directly at ejdodson@comcast.net if you care to engage in
further discussion.
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