How is it, that whilst many young people today can afford to travel the world and have super holidays, they can’t afford to provide for themselves and their families the most basic of life’s necessities – a home of their own?
Introduction (and a short answer)
In short, our answers to the problems highlighted by these questions, are that they are due to fundamental faults in national and international government’s fiscal policies. These faults stems from a more general failure in society to fully understand the source and economic significance of land values.
This failure has lead successive governments to in effect ‘steal’ much of the ‘private property’ that their citizens create individually, whilst they fail to collect sufficient public revenue from the value which their citizens create together – as community. In turn this reduces the ‘earned income’ available to working people and productive businesses, whilst it enables others to accumulate ‘unearned income’ from the wealth that they produce and which is created by the community as a whole.
This article explains why we take this radical view, and how the situation could be remedied to the advantage of all people.
Some Key Economic Principles
Everybody that is, ever has been, or ever will be, born into the world needs space in which to live and in which to sustain the life they have been given.
This, one might say, is the first ‘birthright’ and it pre-dates and supersedes any human right that society might from time to time declare.
Society by its laws cannot, in justice, abrogate this right since, along with every person’s need for air, water and sunshine in some form, it arises from the nature of what it is to be human.
Similarly, none of these elements may be enjoyed by anyone without they have free access to some land. We might thus see that a key responsibility of all societies, and of their governments is to ensure that the laws, regulations, customs and traditions that they honour, recognises this simple fact. This is not to say that all people have a right to live and earn their living freely ‘anywhere’ within a society’s domain but that they have such a right ‘somewhere’, and that a truly ‘free’ society would ensure this.
As a society and its population develops certain places are valued more highly than other places and there will be a need for society to develop just and equitable systems for allocating places to people. There will always be some places that are the least desirable, even though they are still capable of sustaining a living in response to human exertion. In economic terms, these sites are ‘marginal’.
The key economic principle that underlies the thesis outlined in this paper is the need for, and the benefits that arise from, ensuring that land is kept free to use at the margin. We capture this idea in the phrase ‘free land at the margin’.
More Economic Fundamentals: Factors of Production
In conventional economics it is frequently taught that the primary factors of production are land, labour and capital. Sometimes the term ‘entrepreneurship’ is also cited as a fourth ‘primary factor’.
We note that the term ‘capital’ as a factor of production refers to things, like tools, machinery, factories, offices and shops etc., that are produced by people to assist them or others in further production. We reason that, whilst capital is clearly of very great importance, if it is itself a product it is misleading to regard it as a ‘primary factor’ for the purposes of economic analysis.
We reason further that since the term ‘labour’ encompasses all productive human activity, ‘entrepreneurship’ only really expresses a particular form of labour, much as any other particular skill or talent might express a human capacity to labour.
We thus conclude that the starting point for proper economic analysis is the recognition that fundamentally all wealth is the product of non-human and human elements. ‘Land’, as an economic term, refers to the non-human elements, freely provided by nature. ‘Labour’ refers to all the human forces that are brought to bear in production. There are thus only two ‘primary factors of production’ i.e. land and labour.
Arising from these two primary factors of production we may identify two primary returns from production. The return to land is termed ‘Rent’. The return to labour is normally termed wages referring directly that which workers receive directly. In this article however we shall use the term ‘earnings’ since we need to accommodate the return that is due to capital also which as has been explained above is really labour which has been stored or crystallised in the form of tools and equipment etc so as to make future labour more effective. Using this term also makes it clearer that it is the ‘earnings’ of firms rather than merely the wages of their employees that is of significance for the purposes of economic analysis.
Clarifying Economic Terms: “Wealth”
From the above we may see how, if we are to be clear in our thinking, it is important to be clear and unambiguous in our use of important economic terms. Commentators on economic matters frequently misuse, what is probably the most important of all economic terms – ‘wealth’.
Economics, as a social science, is about the creation and distribution of wealth by and for people. However there is frequently confusion and ambiguity in the use of the term ‘wealth’ particularly in connection with other key economic terms such as ‘land’, ‘labour’ and ‘capital’. If the terms are to be used to aid understanding they must each have a clear meaning such that when we use any of the terms there is no danger of confusing it with another. We have referred to land, labour, capital and wealth already but it may be useful at this point to stress the distinctions between land and labour on the one hand and capital and wealth on the other. Land and labour are defined here as primary ‘factors of production’ since they are essential to all production.
Wealth refers to products or ‘goods’ that are valued by people either because they a capable of satisfying directly or indirectly, their needs or desires or because they may be used to aid in the production of other goods or services. Where wealth is used in the latter sense, i.e. ‘to aid in the production of other goods or services’, it is termed ‘capital’. Capital is then an important ‘factor of production’, but, since it is itself a product, it is not a ‘primary factor of production’.
Whilst both ‘land’ and ‘labour’ may be highly valued, neither can, or should, be regarded as ‘wealth’ or ‘capital’ for the purposes of economic analysis. This is because neither can be the product of economic activity since they are themselves fundamental to all economic activity. We should note that for the purposes of economic analysis ‘whilst all wealth is valued, not all that is valued is wealth’.
The Cost of Housing and the General Level of Earnings
Except for the very wealthy, or those who are in receipt of a legacy or gift, most people have to provide a first home for themselves out of the income they can earn. The problem appears then to be that either house prices are too high, or that earned income is too small, or both. In this article we shall consider how both the price of housing and the level of earnings are determined. We may not be too surprised to learn that there is more to these matters than simple ‘supply and demand’ or that a key consideration is location.
Location, Location, Location!
Everybody recognises the importance of location when they choose where to go on their holidays and that it has a major influence on the price of houses. Most people also appreciate the importance of location in relation to the viability of all business enterprises and employment opportunities. In this, they realise that in some places it is easier than in other places to earn a living by farming or mining, or in some other places by manufacturing or retailing, or by banking or insurance, or even by internet trading. Every person, and every form of business, depends upon a range of support, and services provided by others, and on that which is provided, without any human intervention, by nature. Not least among these ‘gifts of nature’ and one that is essential to the wellbeing of all individuals and firms alike, is the land itself. We see then that the amount of benefit that an individual or business is able to gain from society and nature, varies depending on its’ location,.
The Cost of Housing
In considering the cost of housing, the first question that an individual or couple have to address is, should they rent or buy?
If they decide to rent a home of their own, they will find themselves dependant upon the good will and cooperation of the person, corporation or organisation that owns the house in which they live. House owners in general, as landlords, are free to choose to let, or not to let their houses out to tenants. Landlords thus have a power that tenants in general do not have – tenants must find somewhere to live. When landlords choose to let it will be because the rent charge and other conditions of the letting suits them.
They may be constrained by the availability of willing tenants or by relevant legal requirements but, if they actually own the house, they will generally be free to leave the house unoccupied if the available terms do not suit them. However if the house is held subject to a mortgage i.e. they do not completely own it, they may be under greater pressure to accept a lower rent payment rather than none. Even so if the rental income is insufficient to meet debt charges, or provide a suitable return on the equity value that they have in the house, they will be under pressure to sell it. If that equity value is to be maximised by vacant possession, the house sale will be bad news for existing tenants and for tenants in general. If, as in the past the equity value of houses continues to increase over time, there will be corresponding pressure to increase the rental charge that tenants must pay.
The individual or couple that chooses to rent a home of their own may thus anticipate a continuous increase in their lifetime cost of housing.
In evaluating the impact of this, their foremost consideration is likely to be the extent to which the income that they can earn by working, will keep pace with these rising housing costs. Recent experience in the UK as illustrated by the regular publication of the mortage/earnings ratio will not encourage them. These show how the rate of increase in house prices has continued to outstrip the individual’s earnings capability. It is easy then to appreciate the pressure that young adults may feel under as they may see their prospects of acquiring a home of their own diminish with time after they begin to approach their earning’s ceiling.
Under these circumstances it may not be surprising that most people who can afford to own a home of their own, choose to do so.
If our young person or couple decide to buy their own house it is likely to represent for them the first step on acquiring the largest item of wealth that they are ever likely to own. It is however also likely to place them in debt for a large part, if not all, of their working lives. If, over the next few years they are able to maintain their mortgage payments and their house increases in value, their debt will reduce as a proportion of their increasing equity value. If however, due to an increase in interest rates or a period of reduced earnings, or some other reason, they are unable to maintain their mortgage payments they may risk losing their home. If they are fortunate, however, they may eventually join the class of ‘property owners’. The people they purchased the house from may, or may not, have profited from their sale. However the mortgage company or bank will almost certainly have done so, as a result of the income received from the buyers due to interest charges throughout the long loan period. At even a modest rate of 4% or 5%, interest charges are likely to have exceeded the sum borrowed when repaid over 25 years. At higher rates of interest these charges can amount to several times the sum originally borrowed.
In deciding whether to buy or rent, our young householders will have estimated how much they could afford to pay each month for housing out of their earnings. If they are to rent, it will determine their acceptable rent payment. If they choose to buy it will determine their acceptable mortgage repayments. This, together with the prevailing interest rate will determine the sum that could be borrowed and hence, after allowing for any available savings or required deposit, the value of the property that could be purchased.
Few householders choose to live in a house that offers them less than they can comfortably afford and most owner occupiers will spend as much as they can to get their first home of their own. Here we may begin to see the link between the general price of houses and the general level of earnings. In the case of house and flat rents this seems to remain fairly constant at around 30% of disposable income. In the case of mortagage payments however this will vary throughout the persons working life so that at the beginning of a mortgage it is likely to represent a much higher proportion of householder’s earnings than it will later on. Ultimately, by the time most borrowers reach retirement age it is likely to be nil % of their pension income. However, we need to look closer at the effect of market prices on supply and demand to understand this better.
A common understanding of market theory is that the convergence of the supply and demand curves of any item determines that item’s market price. More accurately, it is the market price of an item that determines both how many of those items all businesses in that industry can afford to make, and how many of those items purchasers will be willing to buy.
Plotting price on a vertical scale and the quantity sold in the market on a horizontal scale the normal demand curve tends to slope diagonally downwards to the right showing how the demand for any item tends to reduce as it’s price increases. Likewise the demand for a particular sort of house will tend to diminish as it’s price increases.
The supply curve for most items is based upon the costs that producers of that item must incur in producing it. Thus, where the market price of an item is very low, only a few producers will be able to produce it at such a low cost. As the market price for the item increases, more producers will find that they are able to produce it for sale profitably and they will bring more of them to the market. The normal supply curve then tends to slope diagonally upwards to the right. The supply curve for housing however, is rather different. This is because an important part of the price of housing, the land on which the house stands, has no cost of production at all.
The supply of land for housing does not thus increase automatically with the price of land. With an increase in the price of land, however, owners of land are likely to suppose that land prices might continue to rise. It would then be folly to sell today if, by waiting until later, they could get a better price. A supply curve that is not susceptible to variations in price is described as ‘inelastic’. It does not slope diagonally upwards to intersect with a downward sloping demand curve but rather rises vertically from a relatively fixed quantity that is determined by factors other than market price.
As indicated already an important factor affecting a landowners willingness to sell or let his land is the cost, if any, of not doing so. If he is using it already there may be a live ‘opportunity cost’ to be considered, but if he is holding it out of use he may have no consideration other than its value as an asset, and whether this is likely to increase or diminish in value with time.
Building Value and Land Value
When a house is first built it is likely that it’s building costs represent a significant fraction of its purchase price. If with the passage of time land values increase at a rate faster than do building costs this fraction will diminish. Since house builders will, in general, only adopt advances in building technology if they have the effect of reducing their house building costs we may see that any increase in the purchase price of housing is likely to be due to a rise in land values or costs of raw materials rather than an increase in actual building costs. It may be shown further, that an increase in the price of raw materials may frequently be linked to a rise in the value of the land from which those raw materials have been drawn.
The price of houses (and flats) vary enormously with location. A house in one location (say in the North East of England may be purchased for a fraction of the price needed to purchase an identical house in London or the South East of England. The price difference represents the difference in value that people are willing and able to place upon living in one location compared with the other. We need to note also, how, the activities of wealthy purchasers, who may be buying retirement or second homes with the cash or equity value they have acquired from the sale or possession of other valuable property or, as in recent cases, from windfall city bonuses, in some areas, affects the price of housing. Here we may note the inflationary effect on house prices where both individuals and corporations treat both houses and their sites as items for speculation and investment.
The Parallel of Water Rationing Through Price
We see in the case of housing, where some people may price owner-occupiers out of the market, a phenomenon that is also evident with other natural necessities such as water. People in many developing world cities desperately need water for life and public health, but people also use water for trivial, amenity and luxury purposes.
Conventional free market economics would suggest that the market would ensure that if the price were right, water would be used most economically. However, experience shows that the effect of indiscriminate metered charging for clean water frequently leads to a situation where the rich are able to purchase all the clean water that is available within the city, leaving the poor with an unsafe and inadequate supply for their basic needs. If we wish to maximise the economic benefit to the community as a whole it is clear that everybody needs access to a basic water supply before anybody is able to avail themselves of this vital element for luxury purposes. The market price cannot achieve this but physical control could do so.
We often hear the problem of ‘affordable housing’ described as ‘a supply problem’ related to restrictions imposed by planning constraints on new build housing. However, new build housing represents a minute fraction of the housing market. The enormous number of unoccupied and under occupied dwellings throughout the country, together with the abundance of vacant sites with planning permission, including in those areas where demand (as indicated by high prices) is greatest, indicates that this is not the main issue.
Every existing house has planning permission and could be rebuilt or modified to suit changing housing needs if the owners of those houses really wished to do so, or they could release them to builders who would. There is a stock of housing that is substandard from both an environmental and amenity perspective in virtually every city, town and village in the UK. The scope for conversion and/or rebuild is vast and the need is pressing. The barrier to progress in this area is not fundamentally any of the planning constraints but the basic economic arrangements we have in place. It is these economic arrangements that cause many existing house owners to feel a need to hang on to more than they now need out of fear for their financial security, whilst others are encouraged to hoard by the prospect of an unearned financial gain.
The economic arrangements referred to here include not only those that relate to housing but to how people earn their living and government raises revenue to pay for public services. At its heart are fundamental questions relating to the origins of public and private property. The next step is to consider the means by which people earn their living.
Earning a Living
The main factor affecting working people’s ability to pay for housing is the economic environment in which they are obliged to earn their living. Again this varies enormously throughout the country so that in some areas the extent and forms of business opportunity and employment may be extensive and numerous whilst in other locations the scope is substantially less.
Various factors will affect the level of earned income that is available to a first time house buyer. In particular cases this will be affected by the earning capabilities of individuals arising from the supply and demand for their skills and abilities. However, the demand for individual skills and abilities is a derived demand – derived from the general level of economic activity available to firms operating throughout the economy. Like the variations in the price of a house, this varies throughout the country so that economic activity in some areas is evidently far greater than in other areas. We need then to consider the implications of this whilst considering the firm as a unit of economic activity.
The Firm as a Productive Unit
In economic terms a firm consists of a single individual or of many individuals working together in the production or delivery of goods and or services. In conventional economic analysis, the extent of a firm is taken to correspond with its definition as a ‘legal entity’. It may thus consist of many production and distribution units scattered throughout the country or indeed the globe. A major disadvantage of using this definition for the purposes of economic analysis is that it does not enable the analysis to take into account a factor of fundamental economic importance – where the production takes place i.e. the location of the production unit or firm. We shall avoid this shortcoming in our analysis by considering every firm to be located at a particular place and time. Our definition thus becomes: A firm consists of one or more individuals working as a unit in the production or delivery of goods and or services at a particular place and time. The production of a firm is thus measured by the value added by the firm’s activities at that place during a particular period.
In a modern trading economy firms produce goods and/or services for sale through a process that involves them in adding value to, and through the use of, various goods and/or services provided by others. Firms purchase or rent the goods and/service that they use from other firms through the market mechanism. However, the market does not operate in the field of goods and services that are provided by the community. You can’t do a deal with the supplier of law and order, national defence, flood alleviation, public roads, the public health or education services etc. You must pay for these indirectly, through taxation.
Hence the barber, shopkeeper, tailor, consultant, manufacturer etc. will use an appropriate array of tools and equipment, materials and wholesale goods and public services and the like in preparing their own goods or services for sale. They will also use suitable business premises that are more or less conveniently located for themselves, their customers and/or their suppliers. The firm’s production or added value can thus be identified as the value that the firm receives from the sale of the goods and services that it produces less the value that the firm has received from the use of the various goods and services that have been provided by other firms and the community in general. The challenge then is to determine the value of service that firms receive from the community in general and equate this with what they pay to the community in taxes.
We may note here that view of production described above is quite different from an accountant’s or businessperson’s view of the firm’s production or ‘profit’. Their perspective on production and profit derive from a primary concern for the interests of the owners of the firm rather than with activities and fortunes of the firm itself. The concern of the economist however should be with that from which the firm’s earnings must derive and this is what the firm actually produces as measured by the value it adds to the economy.
Business and Land Prices
Consider two identical firms, ‘A’ and ‘B’.
They both engage in the same business using the same number of individuals who have an identical range and degree of skill and expertise. They both rent similar premises and use the same tools, equipment and materials in the production of identical goods for sale. The only difference between these two firms is their location.
Firm A is very conveniently located for easy access by staff, customers and suppliers.
Firm B is not so well located. Suitable staff have a difficult, long and expensive journey. There is little ‘passing traffic’ and face-to-face meetings with clients, customers, and suppliers is difficult since they are distributed over a wide area.
Getting the best deal, both in terms of delivery and price, can be a problem. Clearly, a given value of inputs by firm A will yield a larger output value than the same input by firm ‘B’. Looked at another way, for a similar value of output from both firms, firm A will require far less input than firm B. In short, firm B’s costs of production will be higher. If we suppose that firm ‘B’ is ‘marginal’ i.e. it is only just viable, we can see that Firm ‘A’ enjoys a surplus net revenue that is due entirely to its location.
The market however has shown that it could survive if it enjoyed only a net revenue equal to that of firm ‘B’. Put yourself now in the position of firm ‘A’s landlord faced with the question of how much rent he or she should charge for the business premises that firm ‘A’ occupies. We might assume that the landlord will be obliged to charge the same for the building itself as the landlord of firm ‘B’ must charge for his identical building. However, his overall rent charge will almost certainly be more. In fact he will almost certainly charge as much as he can and the upper limit will be set by what firm ‘A’ can afford to pay.
As we have seen firm ‘A’ enjoys a surplus revenue over and above that which he needs to stay in business equal to the surplus he receives compared with firm ‘B’. He can thus afford to pay that much extra to the landlord in rent compared with that which firm ‘B’ must pay.
We now need to consider the position of firm ‘B’s landlord. He will need to cover his costs and charge appropriately for the capital, maintenance and depreciation cost of the building itself but he will also seek a rent payment for the use of the site. It is after all valuable compared with all those other sites where no viable production can take place at all or where only production of a less valued kind than that which is the business of firms ‘A’ and ‘B’.
By less valued we might mean here production that requires less labour (quality or quantity), or which is less able to take advantage of advances in technology e.g. better plant and equipment – ‘capital’. His dilemma is to know just how much firm ‘B’ could afford to pay without with going bust, as that would oblige him to seek the tenancy of a firm engaged in some ‘lower’ form of economic activity. If he asks too much the site might stand empty for a while, yielding no rental income. If he asks too little, he may feel he is wasting his asset. Again, like the house owner, his attitude will be influenced by his need for revenue.
If he has a pressing need, he may be more tempted to accept a less than maximum revenue in order to avoid the risk of no revenue. If he has no pressing need for revenue, he may prefer to play a long game and hold out for a maximum rental, comforted by the prospect of a rising asset value as property/land values continue to rise.
We should note several features here:
- All firms that rent the premises they use are obliged to operate at a level of business viability similar to that which prevails at the margin i.e. only just viable and are thus very vulnerable to even a small downturn in trade or increase in costs.
- The level of business failure and the associated risks of unemployment are higher than they need be. · The firms earnings are reduced to less than the full value that their work produces by the land rent payment that is charged at the margin
- The wages, salaries and profits that firms are able to pay out of earnings is correspondingly reduced.
- Where a firm’s viability depends upon the profits available to non-working owners of the firm, and those profits are squeezed by rent payments, the risk of failure is even higher. (Sole traders and partnerships however may be able to tolerate a drop in wages during hard times).
- Firms that do own the premises they use enjoy a surplus revenue that is really unpaid rent.
- They therefore may not know if their business is viable or not.
- They may not know if they are making best use of their land asset.
- If they are not making best use of their land asset they will be vulnerable to take over as more astute observers realise their miscalculation.
- Since even firms at the margin pay a land rent there must be other potential firms who would be viable if the land rent there were less or non existent.
- Paying land rent at the margin thus represents a ‘barrier to entry’ for new firms.
- Much land is held out of use in places that are suitable for all forms of economic activity i.e. in cities, towns, villages, and rural areas, while their owners hope for a capital gain in the longer run.
- Much land is underused i.e. used for producing forms of wealth that do not make best use of their present location. Correspondingly much wealth is not produced where it might best be produced.
- All this represents a large loss of economic potential to the nation.
Public Goods and services – their value and source
Consider now the public goods and services that we referred to earlier, what are they, how are they enjoyed, and how they are paid for? We are referring here to those goods and services that, by their nature fall under some measure of public control or regulation.
The value of these services does not relate to the cost of providing them but rather to the value that would be lost if they were not provided. Thus the value of a community’s defence from and avoidance of an external attack or breakdown of internal law and order cannot be measured by the cost of providing adequate armed forces or civil law enforcement arrangements. Similarly, the value of flood and fire defences cannot be measured by their operating or building costs. Likewise with roads, bridges, sewers, public water supplies, electricity, transport and communications infrastructure etc.
All these are subject to public control and regulation since, by their nature, they are, or are liable to become, monopolies. In addition to natural monopolies we also need to consider those goods and services that the community has chosen to supply from public funds and for which the beneficiaries do not pay directly for all or part of the costs. These would include such things as educational establishments (schools, colleges and universities), health services (hospitals, clinics and surgeries), gardens, parks, recreation grounds and sports facilities, libraries and the like.
All these are paid for completely, or in part, out of the tax revenue of national and local government. This public revenue can only come from the aggregate value of the goods and services that are produced by all of the nation’s firms. The main economic impact of all these public goods and services is on land values. The land, or site values in locations that enjoy more benefits from publicly provided goods and services will be higher than those where the benefits are less. These benefits will be enjoyed both directly by the firms themselves and indirectly through the benefits that the people who constitute the firms enjoy. The firms and people in locations, such as that of firm ‘A’ discussed earlier, will derive much greater benefit than those who work and reside in less well served locations, such as where firm ‘B’ operates.
The Effect of Taxes on Firms
The UK government’s tax revenue amounts to around 40% of the nation’s Gross Domestic Product (GDP). Ultimately it can only come from what firms in the UK produce, thus firms, in aggregate, are required to pay around 40% of the value that they produce to the community in tax. Little of this is paid directly by the firms themselves, most is paid indirectly through taxes on employment (National Insurance contributions and Income Tax) and taxes on the goods that their workers purchase. When the price of these ‘wage goods’ is increased by the imposition of VAT, customs and excise duties etc. the effect is to reduce the real earnings of the firm’s workers. This has the effect of increasing the wage costs to the firm for a given purchasing power of their employees. Under current tax arrangements, it can be shown that firms in marginal locations pay much the same tax, as a proportion of their production, as those firms who operate from better locations. We have already noted above that marginal firms have no spare capacity to absorb any increase in their costs of production (or reduction in revenue). The tax imposed on marginal firms operating from rented sites must then be drawn from the revenue that would otherwise have gone to the land-owner as a rent payment. Where the marginal firm is operated by an owner-occupier, the buffer effect of ‘unpaid rent’ will be lost, and if any additional tax burden cannot be absorbed by a reduction in earnings the firm must close down. The individuals who constituted the firm must then find another way to earn a living or become dependant upon the value created by others.
The Marginal Firm
As we have already noted with our firms A and B it is the position of the firm in the most marginal location that is most economically significant. It is the viability of this firm that sets the benchmark, that determines the general level of earnings, that will obtain for all firms and their people throughout the economy. We noted also that the earnings of this firm are, by definition, the minimum it needs to just stay in business. It does not relate directly to the value of what it produces for the economy but rather what is left after the tax-man and the land-owner (as mere landowner) have taken from that value. Clearly the earnings of the marginal firm and then of all firms would be enhanced if these deductions could be removed.
It is equally clear that it is uneconomic to require the marginal firm to bear the same tax burden as its more fortunate (but no more able) competitors. The solution must be simple – relieve taxes at the margin and collect more revenue from the better sites! But how? We have seen that if taxes were reduced at the margin the land-owner would simply increase his land-rent charge accordingly – since that’s where they came from. If however we were to link the tax to the land-rent charge itself this would limit the ability of the marginal site land-owner to exploit our marginal firms enterprise.
We could also make the tax charge higher on the better sites where there is a much larger taxable capacity. The land-rent would then be effectively split between that which goes to the land-owner and that which goes for public revenue. The question is now how much is the land-rent at the margin. We might assume as now, that it would be determined by the bargain that would be struck in the market and would amount to something between what a potential firm would be prepared to pay to occupy the site and the amount that the land-owner would be prepared to accept. The big difference however now is that if the landowner gets no takers at his asking price and the site stands unoccupied and unproductive it will cost him. If the land-rent charge was set at say 90% of the land-rent there would be a big incentive for the land-owner to ensure that the site was put to its most economic use.
With the supply of more suitable land (already approved for the given land use) becoming available the land-rent charges might be expected to fall somewhat. It should be noted however that capital land values are likely to fall dramatically, since what they actually represent is the capitalisation of an indefinite stream of future income benefits that the land-owner is able to enjoy. These will now be severely reduced and, if the land-rent value was to be collected in its entirety by the community for public revenue purposes, they would be eliminated entirely.
Collecting a Land-Rent Charge for Public Revenue
Let us now assume that for political reasons we chose to collect less than 100% of land-rent value, say 90%. Our first challenge is to discover what the land-rent value actually is. We may start with our marginal site – site B earlier. If for illustrative purposes we assume that firm B produces £100x of added value per year. As we have shown 40% of this is taken one way or another in tax. Say they also paid 10% in land-rent. From our earlier reasoning it may be seen that the true land-rent was actually £10x + £40x = £50x. This assumes that nowhere within the economy can land be available for use without payment but we have identified at the beginning of this paper the importance of ensuring ‘free land at the margin’.
We also reasoned earlier that the landowner of Firm B’s site set his rent by reference to ‘all those other sites where no viable production can take place at all or where only production of a less valued kind than that which is the business of firms ‘A’ and ‘B’.
We may see then that the maximum amount by which firm B’s site land-value exceeds that for which there is no demand for use must be £10x per year. The site may then be safely valued at this level and that this corresponds with its ‘best permitted use value’. We may see now how, if all the land in the economy was to be valued for its ‘best permitted use’, this would provide a basis for a land-rent charge that would provide a major source of public revenue. Land-owners would not be permitted to charge more in land-rent than the best permitted use valuation as agreed between the land-owner and the tenant. If all land-rent values were declared as public information this would make valuation very easy, cheap and robust. Comparisons would be easy and appeals by either landowner or tenant would be straightforward for determination by a professional surveyor.
Note now the likely effects of such a fiscal policy
- Tax at the margin would be reduced of eliminated
- Earnings at the margin would thus increase
- Earnings everywhere would thus increase
- Sites that are currently sub-marginal would, because they would bear no tax burden or land-rent become viable for new ‘start up’ businesses.
- Sites that are currently marginal thus become supra-marginal and thus yield more land-rent (and more public revenue)
- With a reduction in some and the abolition of other conventional taxes, the costs of collection and associated deadweight losses will be reduced
- The need for public revenue to alleviate poverty reduces since the general level of earnings have risen.
- The capital price of land for housing and business reduces, reducing the need for loans and thus interest payments.<
- The scope for illegal tax avoidance is reduced and so are the costs of professional financial services
- Public utility projects become more viable as the value they add is reflected in the yield from higher land-rent payments.
- Housing becomes more affordable to all who earn a living
- The opportunity to earn a living is enlarged for all
- Unearned income from land-rent is reduced encouraging those who live off it to invest in, or work on productive enterprises
Ultimately it may be shown that all production (including a house or anything produced by people) arises from the combination of two principle elements: land and human enterprise or activity.
The economic term used for productive human enterprise and activity is ‘labour’. The qualification ‘ultimately’, is used here since in building a house there is clearly an important part that is played by the employment of plant, machinery and tools – in economic terms – ‘capital’. However we may be see that just as a building, when used as an office or factory would be classified as ‘capital’ so these items of capital have their origins in land and labour. The raw materials that went into the making of a shovel or concrete mixer were drawn from land, and the labour that was applied to them in their manufacture, distribution and sale, took place somewhere on land. Capital is a sub set of wealth and like all wealth is ultimately the product of human ‘labour’ applied to a non-human, or natural resource. The economic term for this natural resource or gift of nature is ‘land’.
The first thing you might notice here is that travel and holidays take you somewhere away from your base – your home, and where you have to earn a living. Maybe however, we need first to notice that there is a need to ‘earn a living’. What does this phrase ‘to earn a living’ mean exactly, and is it true? Living for all of us involves, eating, drinking, and sleeping and being protected from the weather through clothing and a shelter of some sort. For most of us, it also means the opportunity to engage in social activities where we share the company of other people whilst we eat, drink and entertain ourselves and each other. All these activities, indeed living itself, requires that people exert themselves, in economic terms they work!
People need to grow, harvest, transport, buy and sell the food that other people transform into meals in homes and restaurants and yet another group of people may enjoy. Similarly, the clothes, houses, clubs, theatres and many of the items of entertainment and pleasure that we may think make life worth living are made, built, maintained and operated by people – people like us.
The economic term that is used to identify those goods and services that people are able to enjoy as a result of their endeavours to produce goods and services for themselves and for others is their ‘earnings’. In economic terms this is the reason why people are prepared to exert themselves – to earn a living. In short ‘there is no wealth without work’. This is not to say that an individual must work in order to enjoy the particular collection of goods and services that comes his way, but rather to point out that someone must work to produce them, before anyone can enjoy them. The individual may of course produce them him or herself but in a modern trading economy they are more likely to be received through gift or trade. We may think of these means of availing wealth as ‘economic’ in so far as they reflect the natural link that exists between the act of producing and the act of consuming, or enjoying that which has been produced.
An individual would be unlikely to exert himself in the interests of ‘earning a living’ if all his earnings were taken from him through theft, fraud or by other ‘uneconomic’ means, it would simply not be economic.
Language Problems for The Economist and The Business Person
The Same Terms but Different Meanings
In considering the activities of firms, the same term, ‘capital’, is used by both economists and business accountants. Unfortunately they do not both refer to the same thing when they use this term and this can give rise to much confusion. ‘In accounting theory, a person’s (or firm’s) capital is increased by that portion of his periodic income which he has not consumed’ (Accounting Theory and Practice – MWE Glautier and B Underdown).
To the economist, on the other hand, the term ‘capital’ relates to those assets (e.g. buildings, tools, machines equipment etc.) which are used (or consumed) in the production of goods and services. Further confusion arises with regard to the use of the term ‘capital’ in relation to financial transactions when it is used to refer to a merely financial resource – money.
The situation is further confused by the use of the same term, ‘interest’, to describe, on the one hand the ‘cost’, and on the other the ‘return’, or ‘earnings’, of these quite different entities that are called the same thing – ‘capital’.
The term ‘profit’ is another term that is used a great deal in relation to the wellbeing of a firm. Again we need to be very careful here to distinguish exactly what is meant by the term. To the business accountant ‘profit’ is a residual sum i.e. what is left to the firm from its revenue after all its costs have been met. Employees are not in fact paid out of profit but rather out the value of the product that they create as a result of their work. No work, no product, no wages, no profit! From the business persons point of view however, it is true, that if you can reduce the wage bill you can increase profits.
Looked at from an economic perspective it is clear that profits (paid to the owners of the firm as ‘owners’ only) must come from wages, interest or rent that is not paid to the providers of labour, capital, and land. In economic terms the term ‘profit’ has no clear meaning and is actually misleading for the purposes of economic analysis. Accountants, businessmen and tax collectors however, have great fun with it! Henry George said that speaking of profit as distinct from rent, wages, and interest was like speaking of people as if they were distinct from men and women. The owner of the firm as mere ‘owner’, (rather than to owners who are also managers or entrepreneurs, or the providers of capital, or land-owners), makes no contribution and is not a factor of production, his ‘profit’ is by convention only.
Reminding ourselves here of our definition of a firm for the purposes of economic analysis (i.e. that A firm consists of one or more individuals working as a unit in the production or delivery of goods and or services at a particular place and time) we will realise that business accountants description of ‘profit’ can be very misleading to an unwary economist. In economic terms a firm only consists of ‘workers’ and its assets, however it is owned! If, as in many cases the workers own the firm themselves (as sole trader, partnership or cooperative for example) the earnings of the firm may be allocated to themselves as either profit or wages as suits them best. Where it is allocated as profit it may then be distributed (to themselves as owners) or used to improve the firm’s capital. The tax rules will however have a profound bearing on how they make such allocations and distributions.