The Real Explanation for the
Tax Rebellion and the Size of Government

H. William Batt

[Reprinted from GroundSwell, January-February 2011]

The antipathy toward taxes, and by extension toward government itself, has its roots, I believe, in a distortion of economic theory that took place a century ago. Prior to that time, there was a tacit, if not explicit, understanding that the wealth and bounty that grew from common effort along with the gifts of nature should be the source of finance recaptured by society and used to pay for public services. Since surplus economic productivity is jointly produced, it was the proper source of taxation. Only government can appropriately provide these services since they are in today's language "public goods." On the other hand, wealth that was created by the people's own brains and brawn was rightfully theirs and theirs alone. Taxing people's labor, or the products thereof, was not only wrong but was tantamount to theft.

Today the resentment people feel about taxes on their hard-earned money has reached a point close to delegitimizing the income tax and government itself. Estimates of actual tax cheating are put at about 15 percent, but fully half the population believes that it would be okay to cheat if one wouldn't be caught. It has taken over a century for this all to explode. But taking the long view of tax history one could argue that this is not only understandable but also inevitable. Had economic arrangements been done as they were in earlier times there would likely be far less such resistance to taxation and perhaps even a sense of social duty to pay one's share of taxes.

In classical economics, which had its formal beginnings with Adam Smith, moral philosophers viewed production as arising from three factors: land (by which was meant any part of nature), labor, and capital goods (which were essentially tools). Labor was paid in wages, capital in interest, and the yield of or payment for land was reflected in rent. Rent from the time immemorial was understood in almost all civilizations. It was paid to the community (or to kings or lords as the case may be) in the form of labor (corvèe), as a portion of a crop, as tribute goods or in coin. Most historical accounts today put it at roughly a third of a society's total production. The French Physiocrats who inspired Smith's ideas also estimated rent at about a third. Vestiges of rent payments in feudal societies exist in the form of stories and verses that have come down to us. We all know

Bah, Bah black Sheep, Have you any Wool? Yes Sir, Yes Sir, Three Bags full.

One for my Master, One for my Dame; One for the little boy that lives down the lane.

The part for the "Master" was rent.

But the concept of rent as economists use the term, or ground rent as it is often called, has all but disappeared from common discourse today. And this rent, the volume of which is reflected by location and market vitality, was folded into capital in definitions and formulas that resulted in two-factor rather than three-factor economics. Arguably, economic theory was only catching up with the reality of land becoming a market commodity, just as it disappeared from what was earlier "the commons." This historical transformation, or "enclosure," marked with an owner's title land that had heretofore belonged to everyone; even if was in the name of a lord or king. As a commodity land had no more special standing than any other item of property, and became similar to clothing, cookware, armor or tools. Rent still flowed through land sites, but it was no longer collected to support public financial needs. Today we are seeing the further privatization of the commons as it becomes demarcated, quantified and priced. Water is being privatized in many nations, the electromagnetic spectrum is for all practical purposes privately owned although formally public property. And now even the air is being sold to utility corporations to be used as their pollution sinks, without regard to the common assumption that the air belongs to all of us. One could go on.

All the early political economists from Smith, through Thomas Malthus, David Ricardo, and John Stuart Mill, accepted that land value, reflecting the places of community enterprise, was the most appropriate tax base. Because the value of any one site's activity was explained by the total community's or region's market vitality, Smith argued that "Ground-rents and the ordinary rent of land, are... the species of revenue which can best bear to have a peculiar tax imposed on them." This is because the market value of your plot is due mostly to the value and activity of your neighbors. Mill too saw that taxing land rent not only fostered a more productive economy; he also believed that it was far more just. "Landlords," he observed, "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." He called the private retention of publicly created rent the "unearned increment." Today we refer to it as the windfall gain that is the object of land speculators the world over.

All this is recounted in a book by California Professor, Mason Gaffney, the title of which is The Corruption of Economics. It was the banks and the railroads together that persuaded the nascent economics profession at the end of the 19th century that land was an ever diminishing and even trivial factor of production in a growing industrializing society, and that a more suitable and efficient form of revenue capture was to be had by taxing income. In the post Civil War period, land speculation throughout the nation was rampant, and almost all our political leaders were engaged in it. The railroads, which held some of the priciest land around, stood to gain most by zeroing out this asset against the debt incurred by purchase of rolling stock. So their corporate taxes were thereby reduced. When taxes were not collected from the flow of land rent, property parcels had a higher capitalized market value, and required higher bank loans when bought and sold. This now brought them more profit. The last great defender of the classical economic tradition was Henry George. He argued that taxing the rent on land value alone, what he termed the "single tax," would be sufficient in and of itself to support public services. In the face of both vested interests and a growing guild of professional economists, he lost the fight. He died young, at 57, in 1897 but not before becoming as noted as Thomas Edison and Mark Twain. His book, Progress and Poverty, written in 1879 had by 1906 sold more copies than any book except the Bible.

Today's economics textbooks usually begin by mentioning the three factors of production, but seldom pay further attention to land thereafter. Moreover, they trivialize the amount of rent as an element of the nation's economy, typically counting it as about one percent of GDP. Those numbers come from our own government's accounts, which ignore several kinds of rent such as that imputed to owner-occupied homes, and that which is hidden in capital gains transactions. One should note that in Australia, where books are kept a bit differently, economic rent has been calculated at upwards of thirty percent of the economy. It seems to have grown over time and may be much higher. Why it is so difficult to measure becomes clear by the following explanation.

It also helps to understand that all revenue streams are ultimately shifted to ground rent. Put differently, whatever rent is identifiable as such is always net of taxes paid, and that all taxes in the final analysis come out of land rent. To land economists, this has been abbreviated by the acronym ATCOR: All Taxes Come Out of Rent. The claim that governments must rely on multiple tax regimes - sales, income, and property, for example - and should ideally be balanced so as to form the proverbial "three legged stool" is without foundation, and reflects a lack of understanding of how tax burdens are passed through the society - what economists call "tax incidence."

But if all taxes ultimately come out of rent, what difference does it make from which factor of production a tax is levied? The answers have been amply shown. When other factors of production are taxed, there are several downside effects, especially by what is called "deadweight loss." Taxing land rent is free from all such flaws. These are not insignificant. Harvard economist Martin Feldstein figures the deadweight loss of the income tax to be about thirty percent of the before tax income and fifty percent of after tax income if Social Security included. Taxes on the sale of goods appear to have comparable effects. Other studies show the total productivity loss of our existing tax structure to be about a tenth of total GDP. Put differently, if taxes didn't damp economic productivity, we'd all be about ten percent wealthier as a society. There are also other detrimental features of taxes imposed on labor and capital goods.

Not only do taxes on land value have no deadweight loss whatsoever, they comport moreover with all the textbook principles of sound economic theory enumerated since the time of Adam Smith. Taxes on rents from natural resources are the perfect tax. They don't influence market choices. They are easily collected and impossible to evade. They are commensurate with one's ability to pay, and they are easily visible for all to see. We could, if we only would, tax only the rental value of such resources and have sufficient revenue to support all government services, and then abolish taxes on people's labor and all the products of their labor. Substituting community created ground rent for those other noxious taxes would be far more defensible as a revenue source. Again, the community would recapture that which has been collectively created by the community.

These ideas have been around for over a century now, and even the contemporary textbooks usually give a nod to their existence. I became a convert to these ideas when I realized that we could test the validity of such claims using computers and available data. Ideas that had for so long been largely dormant are now shown as demonstrably true. There are some places where the land value tax instituted a century ago still exists, a vestige from an earlier era when argument alone could win the day without empirical evidence. Now, with empirical proofs and computer simulations, there has been a resurgence of interest in taxing land values worldwide. In the US, some twenty cities in Pennsylvania are shifting from a conventional property tax to one on land alone, maintaining revenue neutrality. Other nations are discussing it seriously. Ireland begins its land value tax January 2012. Reports are coming out monthly showing the virtues of a shift to taxing land rents. Nobel prize-winning economists are now endorsing it. Even some political leaders, always the last to voice approval of a new idea, are now giving it credence. And numerous studies elsewhere have validated and echo Adam Smith's original assertion almost 240 years ago and Henry George's more recent advocacy.

Such a shift here would not be hard to institute. Assessors are required by law to separately list the value of the land component from the total parcel market worth. We need only shift the tax burden from the total to the land alone on a revenue neutral schedule. Computer technology now allows us to accurately assess the market value of land sites separately from any buildings. Not only would such a shift relieve most homeowners of undue tax burdens - the difference would be picked up largely by high value vacant and underused parcels in urban cores, and tenants, mainly poor people, would pay nothing at all, since a land value tax cannot be passed forward. Furthermore, it has been amply shown that any tax on a fixed supply base actually fosters economic vitality: the old saw that taxes debilitate market activity has an exception in any tax on what economists call an inelastic base. In one such study, two comparable cities measured by the number of building permits per capita - one with a land value tax and one without - showed profound differences, even before the phase-in was complete. More sophisticated econometric studies have shown the same pattern. One study calculated that "on average, a one percentage point increase in the tax (buildings : land) differential will yield an increase in the total value of construction of 17.8 percent."

One should consider the possibility that a land value tax could be imposed not only at the local level but at the state level as well, ultimately in lieu of other tax regimes. There is sufficient rent available to be captured without unduly burdening taxpayers, especially since the economy would be healthier and transition measures to be discussed below would be instituted. It should noted also that New York State levied a conventional property tax throughout a good part of the 19th century; there is ample precedent.

Still, some transitional and ameliorating measures would be needed to effectuate the changes smoothly. The first step, of course, is to un-tax buildings altogether and remove the penalty it imposes on people who improve or maintain their property. The conventional property tax today is like a train with an engine on each end: the tax on buildings negating whatever positive effects the tax on land value can have. In a revenue neutral shift, most residential parcels pay less, and underused and vacant parcels in high-value urban cores pay more, providing an incentive to develop. That reverses sprawl and fosters urban revitalization, without throwing precious public dollars at the problem. Another is to have taxes paid in increments rather than in a yearly lump sum. The third part is to give households the option of deferring their tax burden until they sell. Then they pay up with interest what they rightfully owe and don't shift their burden onto others unfairly. Twenty- four states do this in some way. At the same time, policy makers should make an effort to shift the burden of taxation off the sales of goods and onto land value, with the ultimate goal of doing the same for taxes on wages.

Recognition of the significance of land's importance as a separate factor of production, along with its associated rent, is again gaining credence. The divergence from the lineage of classical economics, to what is today called neoclassical economics, may now have come to an end with the disintegration of its paradigm. George has now been vindicated. We should return to a system of taxation practiced for three thousand years.

In his time and shortly thereafter, Henry George's single tax was endorsed by Sun Yat Sen, Leo Tolstoy, George Bernard Shaw, Clarence Darrow, Theodore Roosevelt, Winston Churchill, Henry Ford, John Dewey, Albert Einstein, Louis Brandeis and Senator Paul Douglas. More recently, beside ten Nobel prize-winning economists, there are William F. Buckley, Jr., Ralph Nader, Michael Kinsley, Molly Ivins, Jack Kemp, George Gilder, and Steven Moore. The idea of taxing economic rent from land cuts totally across conventional political lines. It should be acceptable to all sides.

A clearer understanding and justification of public taxation will also relieve the anger.