Inflation
Edward J. Dodson
[Text of a letter written to the
New York Times, October 20, 1999, in response to an editorial;
this letter was not printed]
An important question not raised in today's editorial is whether
the government or economists are including the right costs in the
measurement of inflation. Take the housing sector, for example.
Almost everywhere around the country housing prices are increasing;
in some markets, the rate of increase is double digits. Interest
rates have also increased somewhat during the last quarter or two,
putting stress on affordability for many homebuyers. As homebuyers
are forced to leverage themselves with larger mortgage loans,
monthly housing expenses absorb some of what would have remained for
other purchases. Moreover, more household income goes to pay
interest on debt than to pay down principal on loans. Less cash each
month also means more credit card and installment credit borrowing,
which also has the effect to diverting income from goods and
services to debt service and adding to the probability of higher
personal bankruptcies.
Our economy received an enormous and largely unheralded break when
mortgage interest rates fell from just under 10% down to just under
7%. Homeowners were able to refinance and either shorten the term of
their loans or reduce monthly debt service by several hundred
dollars, adding a vast pool of cash to the money supply. The benefit
of this last period of low interest rates is quickly disappearing.
What the economic models do not highlight is the enormous stress
on the economy that now underlies the rise in housing prices. This
increase is largely a function of land markets and the prevalence of
land speculation and land hoarding in markets where demand is
greatest. Only a very few communities around the country have taken
steps to mitigate this problem by restructuring their local property
taxes to relieve improvements of some tax burden while increasing
the tax rate imposed on assessed land values. And, even in these
communities the extent to which they have moved in the right
direction is far from optimal.
The economics are straightforward. Every parcel of land has a
rental value. The extent to which this rental value is captured by
the community via the property tax directly effects land prices. The
uncaptured rental value is imputed income to a parcel owner, which
is capitalized, giving land parcels a selling price. Almost
universally, unimproved parcels of land are infrequently reassessed
and taxed at low effective rates, so that most of the rental value
is there to be capitalized. Picture a supply curve for land. The
theoretical line is vertical (straight up and down). The supply
curve in most markets actually leans considerably to the left; "price"
does not clear the market for land parcels when the annual tax is
much lower than the annual rental value. The result is a
left-leaning supply curve, which means that as "price"
rises the supply actually falls as owners hold land out of the
market for speculative gains. Compare that with the supply curve for
labor, capital goods or even credit -- each of which lean to the
right, with the quantity brought to the market increasing with
increases in price. After all, there are few people and few machines
that increase in value by withholding their services from the
market. Machines depreciate and lose value; people lose skills and
become less and less marketable the longer they are not "working.
Until the government and economists take account of the land
market and the impact of tax policy on the land market as separate
and distinct from other component parts, they will continue to
misdiagnose what is happening in the economy. Perhaps more
importantly, until government finally understands that not all taxes
are alike in terms of economic consequences, we will continue to
suffer from inflationary spirals and deflationary falls.
