Painless Taxation
H. William Batt
[Reprinted from
GroundSwell, May-June 2005]
The following was submitted by H. William Batt,
Ph.D., on April 24, 2005 to the President's Advisory Panel on
Federal Tax Reform. He gave his credentials as a former university
professor of political science, who left teaching to join the New
York State Legislative Tax Study Commission in 1982, where he worked
for a decade before retiring in 1992. Subsequently he continued to
research, write, and serve on non-profit boards reflecting reforms
he subscribes to. He referred the panelists to websites of Center
for the Study of Economics, and the Robert Schalkenbach Foundation.
Abstract
Real tax reform could do away with those taxes that are resented
by the large proportion of our population. We could replace all
taxes on wages and on interest by instead taxing economic rent. Rent
is windfall income; it is income that arises not from the efforts of
any person or corporation; it comes about as a surplus gain from
common social enterprise. There is ample moral warrant for society
to lay claim to that which it has created, as well as to that which
no individual or party has earned. Analysis increasingly makes clear
that economic rent in all its forms is far larger than official
government figures indicate; in fact it is likely sufficient to
supplant all current taxes on labor and capital (wages and interest)
which are acknowledged to have so many negative effects.
Recovering economic rent in all its manifestations by taxing its
various bases actually can foster economic performance and yield
other benefits that make it the natural source of revenue for
governments. Such a tax is essentially painless.
Introduction
Under current tax regimes, some people get hit with onerous bills
while others get windfall gains. If taxes only on windfalls were
collected, we could eliminate those burdens that fall unfairly upon
people who have rightfully earned their income and wealth, and the
total would likely remain revenue neutral. This is my thesis here,
one which should compel the attention of those who would redesign
our tax system.
It is astounding how shameful our tax system has become; one
might guess that its designers -- legislatures at all levels of
government -- deliberately conceived it just so that they might
score cheap points by taking aim at it. But perhaps this time some
chosen leader, some deliberative body, or some civic constituency
will rise to the challenge of making clear some basic starting
points rather than pandering to prejudice and low motives. Perhaps.
It leads me to write this.
Tax Principles
The starting points should be the lessons that have been learned
over the course of the past three hundred and more years about what
is a good tax. Most basic textbooks in public finance enumerate them
in very clear form, and they constitute benchmarks against which to
measure the soundness of any particular tax. They are listed as few
as three or as many as eight such principles but little disagreement
exists as to their substance, regardless of ideology or government.
Most commonly enumerated are neutrality, efficiency, equity,
administrability, simplicity, stability, sufficiency. Tax theorists
typically measure revenue structures according to any or all of
these criteria:
Tax neutrality refers to the influence (or absence of such) that
any particular design has on economic behavior. Typically taxes are
perceived as a damp on economic activity -- taxing income reduces
the incentive to work, taxing sales discourages retail transactions,
and taxing savings reduces the propensity to save. The more a tax is
perceived to be neutral the less the identifiable distortions it
imposes on the economy. The common assumption of most tax theorists
is that all taxes impose distortions; it's simply a matter of which
ones are least burdensome to economic health. A tax which imposes no
distortions is ideally best.
Tax efficiency is much like tax neutrality, and is the measure of
how much shifting of behavior it imposes, resulting in what is
called "excess burden," or "deadweight loss" on
the economy. Tax economists usually hold that the best taxes are
those that are shifted little if at all. Because the elasticities (a
technical word for the slope of supply and demand curves) of each
are very different, a tax on land values and a tax on improvement
values have very contrastive effects on economic choices. Using a
tax base that has little or zero elasticity is the best way of
assuring that taxes are not shifted. Zero elasticity is another way
of saying fixed supply.
The principle of equity is central to any discussion of tax
design. Tax design requires concern with both what is fair and the
extent to which it must sometimes be compromised to satisfy the
other principal criteria. Fairness can be evaluated according to
what is termed "horizontal equity" -- the extent to which
those in similar circumstances will pay similar tax burdens, and "vertical
equity" -- how well those in different classes bear different
burdens in the tax structure. It is this latter perspective that
leads to the use of terms like "proportional," "progressive,"
and "regressive" in referring to tax structures. A tax is
progressive with respect to income if the ratio of tax revenue to
income rises when moving up the income scale, proportional if the
ratio is constant, and regressive if the ratio declines. There is an
ancillary question of whether taxing to reach greater equity should
employ measures of income or of wealth, difficult as this is to
measure. Such questions of equity are a matter particularly central
when discussing the property tax.
Administrability refers to the ease with which a tax can be
administered and collected. Taxes which distort the economy are
inefficient but so are taxes that cost lots to administer. This is
measured not only in the direct costs of tax avoidance and
accounting expenses, but in the level of evasion and cheating, and
by the cost of government auditing and policing. When the taxpaying
public perceives that a tax is easily evaded, cumbersome, and
unfair, it loses its legitimacy and calls government itself into
question.
This is why the principle of simplicity is important: the more
complex the tax design, the more lawyers and accountants will find
loopholes, encourage the appearance of unfairness, and drive up the
cost of its administration. People know that with simple taxes other
parties are also paying their fair share, and all this enhances the
legitimacy and therefore the compliance of the tax system.
Stability refers to the ability of a tax to produce revenue in
the face of changing economic circumstances. Income and sales taxes,
for example, vary greatly according to phases in the economic cycle;
the property tax, in contrast, is highly stable regardless of the
state of the economy. This is one reason why school administrators
have typically been supportive of using the property tax base rather
than some other tax to support school services.
The certainty of a tax's collection ensures that the number and
types of tax changes be kept to a minimum. Frequent changes in tax
rates and bases interfere with business decisions and the ability to
make long-term financial plans. This concept reinforces the need for
stability because an unstable revenue system is more likely to
require continual adjustments.
In assessing the value of a tax it is also important, of course,
to understand its potential to bring in revenue for the purposes of
government, usually deemed revenue sufficiency. Income, sales and
property taxes, along with corporation taxes to a lesser extent,
have come to be regarded as the workhorses of the American revenue
structure. But, as anti-tax politicians are quick to note, the
higher these taxes are, the more they impose a drag on the economy.
This is why one should ponder whether to consider raising taxes
which have demonstrable distorting effects.
The Tax Base
The next concern should be upon what base to impose a tax -- not
about taxing whom but taxing what. There are only three
possibilities, as all revenue streams necessarily come from one of
three factors of economic production -- 1) upon resources found raw
in nature (what was classically called land), 2) upon our labor, or
3) upon things created by human hands or minds (capital). No other
source exists; every possible tax must be on one or some combination
of these parts. Each of these factors has its price: the price of
land is counted in economic rent; the price of labor is in wages,
and the price of capital (its liquid form) is in interest.
Any tax on capital has its downside effects, so that taxing
savings causes people to save less, taxing consumption causes people
to buy less, and taxing buildings causes people to build less. The
result is that economists as well as businessmen usually frown upon
taxing capital. Another alternative is to tax labor, but it is even
more widely understood that taxing labor normally discourages people
from working as much as they would in the absence of a tax. From
this comes sentiment against taxing labor, even though for want of
any alternative, people have today commonly come to accept it as a
necessity. But electing to tax labor, just as for taxing capital,
forecloses a discussion of the virtues of taxing land -- not
necessarily land as earth, but rather land as location. Yet land
rent is the most attractive tax base of all, as rent is not earned;
it is windfall income, entirely the result of being well situated in
any market of scarce natural resources and where community demand
(rather than one's own efforts) leads to an appreciation of that
land's price. To be sure many people have learned to position
themselves in situations where a land's market value is likely to
rise -- indeed these people come to think of themselves as astute
investors. But the fact is that market gain is not of their own
doing at all; it is the result of common enterprise creating a
surplus that comes to settle on land sites. An investment in land,
in any form it might take, is speculation in greater or lesser
degree.
Land in all its forms is a tax base that also conforms well to
all the classic principles of sound tax theory as enumerated above.
Land is classically taken to mean not just surfaces of the earth but
places in time, in space, in any medium whether it be solid, liquid
or gas, and even as a form of light, in the electromagnetic
spectrum, and in life forms. One needs to return to 19th century
classical economic definitions of the factors of production to
appreciate the separate significance of land as it was understood in
its manifold forms. One should ask how it is that land, so important
to 19th century classical economic theory, has been given so little
attention today in neoclassical economics. This is a story only now
recovered from the dusty archives of academic economic history. Once
understood and appreciated, it may be one of the greatest, if very
silent, political revolutions of world history.
The conventional wisdom of most contemporary tax designers,
despite lip service to the enumerated principles above, is that the
best tax regime relies upon essentially three tax bases -- property,
sales, and income -- perhaps ideally in equal weight. But it is very
questionable why, given the measurable and demonstrable virtues of
taxes upon land bases, one would resort to any other revenue stream.
When it becomes clear that taxes imposed upon other factors of
production effectively work their way through the economy to settle
ultimately upon land in any case, one sees that it simply hamstrings
the economy, distorts its natural equilibrium, and fosters
resentment and challenges to political legitimacy every step of the
way.
The Possibility of Land (Rent) Taxation
The key to understanding how taxing various forms of land conform
to sound tax theory comes with an appreciation of the importance of
economic rent. Largely discarded in 20th century economic analysis,
rent is the price for the use of land. Just as the price of labor is
paid in wages and the price of capital is paid in interest, land
rent is the unearned increment that attaches to land in the form of
a surplus when its price is not paid by its users. All taxes,
ultimately, come out of rent; however, by collecting revenue from
other sources, the rent is left to settle in ever increasing
encrustations on land sites, i.e., capitalized, ultimately raising
their market price. In so doing, these land prices are distorted so
that their optimal use is not secured.
Examples of such distortion are not difficult to identify.
Consider, first of all, the use of locations in our urban
environments, many of which are underused while prospective
entrepreneurs are driven to second-best locations because
titleholders opt to let the rent accrete and passively raise their
market price. Land speculation is rife most of all in instances
where there is a great disparity between the tax rate on these sites
and the rate of rent appreciation. When the holding costs of
ownership are nominal, there is no incentive for improving them or
selling to others who will, and urban environments suffer as a
result. Another example is rent that collects to the electromagnetic
spectrum, making it attractive for owners of electronic media,
communications networks and so on, to rely on returns to their
investments even when the resource itself is sparsely used. So also
with the time slots for take-offs and landings at airports. These
opportunities are respected as private property, even while they
gain in market value in response to the general traffic volume of
the facility. This occurs regardless whether the particular airlines
use their slots or not. London Mayor Ken Livingstone has proposed to
tax the rent from Heathrow and Gatwick both for their revenue
advantage and to assure their more optimal use. One could go on,
pointing to any number of instances where economic rent is available
to be had for the support of public services in lieu of conventional
taxes which we recognize as destructive in their effects. It is not
surprising that when pressed even conventional (neoclassical)
economists are often willing to concede that the best possible tax
of all is one placed on land rent.
Although one can infer innumerable instances where economic rent
inheres in land factors, the econometric data maintained by public
agencies has not been compiled in a way that makes it easily
identifiable. In fact the US Census of Housing ceased to keep
records on the assessed value of land in 1987, reasoning that the
quality was so poor that it was more misleading than it was helpful.
The actual account of the "rental income of persons" in
the US government National Income and Product Accounts is estimated
at less than 2%, yet this figure is widely acknowledged to be so
unrealistic an estimate that it is ludicrous by itself. What studies
have been performed to calculate economic rent suggest that the
amount for real property alone is in the neighborhood of 30 percent
of a nation's GDP. This realm of research begs for attention, but it
will not likely be more than approximate as long as government
statistics are so lacking and unreliable.
The growing availability of data, and of computer power,
increasingly offers the promise that researchers will be able to "back
into" some estimates, even if they are suggestive more than
they are conclusive. With such inviting questions, there may well
arise the prospect of better data collection, and which will allow
for even better analysis.
It should also be noted that a transition to a tax on land rent
would not be difficult. In lieu of the conventional real property
tax, it is already widely used, and many localities are presently
phasing in such a shift, downtaxing improvements and uptaxing land.
As for taxes at other levels of government, it is already conceded,
for example, that "The Public Owns the Airwaves," a
statement that is belied by the fact that the media and
communications industry treats its rights to the use of frequency
licenses as private property and whose market value is typically
reflected when such corporations are sold. One should also note as
another example the case of the Alaska Permanent Fund, which
provides a reliable citizen's dividend every year to everyone in
that state, derived from oil revenue. Development Administrator Paul
Bremer proposed such a design for the new government of Iraq in
2003, a design idea that was also endorsed by the United Nations
Association. Many other instances could be cited where already land
rent is recovered as a surplus to support public services.
A New Tax Ethic
Beyond the greater conformity to sound tax principles as noted
earlier, the taxation of economic rent that accretes as a surplus
upon land can offer two additional advantages. The first of these is
the removal of the distortions wrought upon urban land use
configurations and the negative environmental impacts which are
presently apparent. The greatest of these affects is in the form of
suburban sprawl, a phenomenon viewed with increasing alarm not only
by its degradation of life quality but in the increased expenditures
of time and resources (especially energy). Land use patterns, as
intractable as they tend to be, will have to modify simply on
account of the evolving limitations of future life. There are likely
to be changes also in the way by which air, water, and other public
goods are exploited. Treatment of these resources as "free
goods" or as captive property of private parties will end if it
is realized how generous the rental flow to public treasuries can
be.
The second benefit to be obtained by the recovery of socially
created economic rent is the restoration of a moral dimension to
taxation and to economics generally. Taxation policy today is faced
with a loss of legitimacy, and it is not sufficient to rely on
totems that have sustained its design until now. A groundswell of
resentment has occurred in all realms of tax policy -- for income
taxes, for sales taxes, and for real property taxes. All levels of
American government are suffering on account of our impoverished
fiscal design. Stalemate has reached such proportions that nothing
is being accomplished. Infrastructure is deteriorating; educational
quality is perceived to be declining, environmental ambience is
threatened, and public safety services are curtailed.
To be sure, by replacing taxes on labor and capital with taxes on
land rent, people will enjoy greater returns for their enterprise
and will be able to keep what they have earned. But people will also
cease, at least those few who have been so lucky, to be able to rely
on windfall unearned gains that they have in many cases come to
regard as their entitlements. The greatest forfeiture of such
windfall gains will be homeowners who have come to see their title
to a home as an investment, and not a place to live. But whereas
some residential locations have seen enormous increases in market
prices -- as much as 20 percent yearly on occasion -- others have
enjoyed no such fortune. People may come to understand that houses
depreciate just like cars, refrigerators and computers. They may
also see that it is only land value that increases, and realize that
any gain which their land has is due to the general vitality of
their community and region. It may help them to realize that they
are linked to and dependent upon the society as a whole, and that
their fortune is not in this dimension of their own making.
Well over a century ago, John Stuart Mill recognized that: "landlords
grow richer in their sleep without working, risking or economizing.
The increase in the value of land, arising as it does from the
efforts of an entire community, should belong to the community and
not to the individual who might hold title."
A more appropriate ethics for the 21st century is "Pay for
what you take, not for what you make." "Tax bads, not
goods," or "Tax waste, not work," is another way. At
the heart of this approach is a very profound message: the earth is
the common heritage of humanity; it belongs to everyone. That which
grows out of our own personal efforts and ingenuity is ours to keep,
and no part of it should be subject to taxation. Taxes on income,
sales, savings, structures, and things that come from the sweat of
our brow can be replaced by taxes on land rent -- which, when all
forms of it are included, is a revenue source that can fully pay
for the full services of government and is nonetheless essentially
burdenless to taxpayers. John Houseman, an actor perhaps most widely
known as Professor Kingsfield in the film and long-running
television series, The Paper Chase, later became the pitchman for
Oppenheimer Mutual Funds. In that advertisement, his tag line was "We
get our money the old-fashioned way -- we earn it." That we
should earn our money rather than live off the efforts of others
seems a simple enough moral tenet.