Tax Reforms Proposed to Promote Saving
Mason Gaffney
[
GroundSwell, May-June 2005]
There is a strong movement afoot to tax just consumption rather
than all income. The good reason for this is to promote saving and
investment, and thus enhance domestic capital formation, said to be
the main force for economic growth, poorly defined but assumed to be
a good thing. A battery of well-financed pols, along with many
economists and divers publicists, are pushing it. Leading proposals
take mainly two forms. One is to create a national sales tax,
obliterating the present income tax. The second is to exempt all
saving and investing from the present income tax. This is more sly,
is easier to achieve politically, is already partly in place, and is
the more likely to occur, so my examples will come from it.
There are several faults in the proposals. A chief one is to
distract us from the major cause of overconsumption, viz. turning
land value gains into cash. Some call it living high on the old
homestead, which is imprecise but gives you the idea. Equity
withdrawal is a more generic term. The land under and around homes
is indeed a major element of land gains, but mineral, commercial,
recreational, industrial, transportation, radio-wave, sylvan, and
all kinds of lands and waters and other natural resources are
involved, including those held by corporations, governments, and
eleemosynaries.
An owner may withdraw equity by selling land for a gain; or
borrowing (tax-free) on the swollen value; or neglecting maintenance
and replacement of buildings, counting on the land gains to maintain
his or her assets while milking the old capital as a cash cow. In
all cases, the NIPA (National Income and Product Account) does not
count the land gains as income. NIPA does not count them as
anything, they are outside its purportedly aggregate social
accounts, just as they are outside the consciousness of most modern
economists (except when they invest privately). However, the gainers
spend them on consumption -- with no output corresponding to it.
This shows up in NIPA as dissaving.
Some economists dig a little into causes of dissaving. They
mostly omit equity withdrawal from land value gains as a major
cause, distracting us instead with other explanations. Some favored
ones are social security (with no mention that our FICA taxes ARE a
form of saving, squandered not by us but by Congress for the benefit
of richer taxpayers); improved insurance (pooling risks, a net
social gain); easy credit for housing (but with no mention of equity
withdrawal); student-loans (with no mention that they are invested
in human capital); and consumer credit (not mentioning it is dwarfed
by mortgage credit). One may sense some class bias in the choice of
examples.
The same economists are puzzled why the following causes have not
increased saving the way they are "supposed to": the fall
of income tax rates in top brackets; the rise of the percentage of
our population in the high-saving ages, 45-65, after 1995; and the
rise of average incomes.
Economist Robert Barro got promoted from Rochester to Harvard and
became a Business Week guru for theorizing that Federal deficits
would stimulate private individuals to save more. Milton Friedman
cheered. This notion is, to put it charitably, not proving out. As
for business saving (as of undistributed corporate profits) it gets
lost in the shuffle.
Stiglitz & Walsh, whose current Macro-economics text is a cut
above most, do mention the wealth effect of high stock values,
making people feel richer and thus spend more on consuming. The
authors would seem to be getting warm, but then they dismiss the
rise of home prices: it has just meant that more individuals were
saving in the form of home equity (p.225). Thus, their only direct
reference to the rise of land values, while vague, has it backwards.
Scanning other current texts on macro, the quality is downhill from
there.
A bright spot is the ongoing work of Oxford's John Muellbauer,
who may even be having a hearing in HM Treasury in Whitehall. It is
hard to assess the impact, even from close up, and that much harder
from this distance. We do know, however, that Britain has gone over
to a VAT, and has not fully repaired Maggie Thatcher's vandalism of
its local rating system, so Britain has a long climb ahead simply to
get out of the pit it has dug itself into.
The result in the U.S., at least, is counterproductive policy
advice from economists: raise sales taxes, and lower any tax, of
whatever kind, that hits real property. This class includes property
taxes, of course, but also estate taxes, inheritance taxes, taxes on
the income from property (both land and capital), capital gains
taxes, and severance taxes. The resulting higher land values lead to
more equity withdrawal and less saving -- the opposite of the
alleged good reason for taxing only consumption.
This neglect of equity withdrawal from real estate is not a
simple oversight. It is the result of years of perverting economists
training and vocabularies and techniques - their groupthink, if you
will -- to cloud their understanding of it and intimidate them from
mentioning the obvious. Poterba and Krugman, highly visible writers,
also brought it up in the early 1990s, but without following
through, and their "words like silent raindrops fell, and
echoed in a well of silence." Mentioning equity withdrawal in
any but a favorable light may have become a modern solecism, for it
would discredit the measures actually proposed.
These measures include removing land rent, values, and gains from
the base of the income tax. This is to be done by letting land
buyers write off the expenditure in the year they buy. If the buyer
is in, say, a 20% tax bracket, the Treasury thus puts up 20% of the
purchase price. After that it gets back at most 20% of the net cash
land rent, which is just a return on its own investment. If it's
residential or recreational land, with no cash flow, the Treasury
gets back nothing. In addition, mentioning how equity withdrawal
pays for consumption would discredit the fellow-traveling proposal
to exempt all capital gains (read land gains) from the income tax.
It would weaken ongoing proposals to obliterate property taxes and
severance taxes and taxes on estates and inheritances.
A second major fault in the proposals to tax only consumption is
confused ambivalence toward saving. There is a strong residue of
Keynesian demand-side economics among economists, journalists and
pols, so that spending of all kinds is more often praised than
censured, even as the gurus scold us, the public, for our
prodigality and indiscipline with money. Most economics texts are
uselessly indecisive on this point. On one page they tell us that
saving is desirable to create capital to abet growth, and on another
that consumer spending is the key to growth and jobs, and saving is
a menace. Pols and the Fed chief, Alan Greenspan, may thus pick
whichever position suits their p.r. needs of the moment. As to the
causes of saving, most toss it off as an automatically increasing
function of income, and perhaps of interest yields.
A third major fault is misidentifying consumption. Economists are
careless with definitions, as Henry George brought out in his day,
and the modern profession has not reformed. For example, many
champions of taxing consumption cite the authority of J.S. Mill, who
did indeed write that the income tax should exempt saving. None of
them has noted, though, that Mill defined house purchase as a
consumer expenditure, not saving, and scathed grandiose mansions on
display in conspicuous locations as wasteful. Modern NIPA, in
contrast, calls all housing a capital outlay.
We know that Mill, like Smith and the Physiocrats, viewed land
rent as being peculiarly eligible for special taxation, so we may
reasonably infer that if he had been present at the creation of NIPA
he would have suggested several improvements. NIPA for example
ignores wasting slots of land-time by underuse, which should be
included as part of consumption. Investing in human capital is
called consumption, as though weddings, pregnancies, birthings,
commuting, nurture, housekeeping, chauffeuring kids, and grades K-12
are all frivolity on a par with jockeying ATV's over fragile lands,
or bar-hopping. On the second matter, the childless Mill actually
had no sympathy with the costs of parenting, a point on which his
Malthusianism trumped his humanitarianism, but we needn't follow him
on everything -- just make sure we define our terms, and make others
do the same.
NIPA does NOT call depleting hydrocarbons consumption, or even a
business cost. This custom originated during W.W. II when the idea
was desperately to maximize gross output, and damn the social costs.
The custom is outrageously obsolete now, but the power of inertia is
so strong that macro-economists do not even resist efforts to
redefine terms: they simply ignore them. These are such big topics
in their own rights, and so damning of NIPA and modern
macroeconomics, that we defer fuller treatment for the next issue of
Groundswell.