Land Value Taxation will solve many of the 21st century's most serious social, economic and environmental problems, and promote justice, fairness and sustainability. We CAN have a world in which all can prosper.
Progress and Poverty, by Henry George Here are links to online editions of George's landmark book, Progress & Poverty, including audio and a number of abridgments -- the shortest is 30 words! I commend this book to your attention, if you are concerned about economic justice, poverty, sprawl, energy use, pollution, wages, housing affordability. Its observations will change how you approach all these problems. A mind-opening experience!
Henry George: Progress and Poverty: An inquiry into the cause of industrial depressions and of increase of want with increase of wealth ... The Remedy This is perhaps the most important book ever written on the subjects of poverty, political economy, how we might live together in a society dedicated to the ideals Americans claim to believe are self-evident. It will provide you new lenses through which to view many of our most serious problems and how we might go about solving them: poverty, sprawl, long commutes, despoilation of the environment, housing affordability, wealth concentration, income concentration, concentration of power, low wages, etc. Read it online, or in hardcopy.
Bob Drake's abridgement of Henry George's original: Progress and Poverty: Why There Are Recessions and Poverty Amid Plenty -- And What To Do About It! This is a very readable thought-by-thought updating of Henry George's longer book, written in the language of a newsweekly. A fine way to get to know Henry George's ideas. Available online at progressandpoverty.org and http://www.henrygeorge.org/pcontents.htm
Where Else Might You Look?
Wealth and Want The URL comes from the subtitle to Progress & Poverty -- and the goal is widely shared prosperity in the 21st century. How do we get there from here? A roadmap and a reference source.
Reforming the Property Tax for the Common Good I'm a tax reform activist who seeks to promote fairness and reduce poverty. Let's start with the enabling legislation and state requirements for the property tax. There are opportunities for great good!
To me at least it would be enough to condemn modern society as hardly an advance on slavery or serfdom, if the permanent condition of industry were to be that which we behold, that 90% of the producers of wealth have no home that they can call their own beyond the end of the week; have no bit of soil or so much as a room that belongs to them; . . . are housed for the most part in places that no man thinks fit for a horse. . . . This is the normal state of the average workman in town or country.
— FREDERIC HARRISON, Remedies for Social Distress,
Report of the Industrial Remuneration Conference, 1885, pp. 428-462.
20. What is the best way to insure that affordable housing -- for people of all ages and stages, all income levels -- is available, both for ownership and for rental, both near the center of activities and, if needed after the desire for housing near the center of activities is satisfied, on the fringes?
B. Community Land Trusts
C. Affordable Housing Regulations that require that for every 10 new condos built, 1 must be affordable to people earning less than the local median household income
D. Rent control
G. Habitat for Humanity
H. Relaxed mortgage lending rules and more private mortgage insurance
I. Land value taxation, to encourage the redevelopment of underused sites near the center of things
In the files I've been digging through, from the late 50s to the early 80s, I found an early draft of a fine paper by Mason Gaffney about California's Proposition 13, for presentation at an August, 1978 conference. I dug around and found a published copy of that paper, and think it worth sharing here. Original title, "Tax Limitation: Proposition 13 and Its Alternatives"
First, a few of my favorite paragraphs, which I hope will whet your appetite for the whole paper. I won't attempt to provide the context (you can pick that up when you continue to the paper, below).
"There is a deferment option for the elderly, bearing only 7% interest (which is about the annual rate of inflation). In California, as also in Oregon and British Columbia, hardly anyone takes advantage of this deferment option. This fact, it seems to me, rather calls the bluff of those who so freely allege that the woods are full of widows with insoluble cash-flow problems, widows who are losing their houses to the sheriff and whose heirs presumptive, will not help keep the property, which they will eventually inherit."
We hear a lot these days about cutting the fat out of the public sector; but there is fat in the private sector too. I interpret "fat" to mean paying someone for doing nothing, or for doing nothing useful. Most economists agree that payments to people. for holding title to land is nonfunctional income, since the land was created by nature, secured by the nation's armed forces, improved by public spending, and enhanced by the progress of society. "Economic rent" is the economist's term, but in Jarvis-talk we may call it the fat of the land or "land-fat." It has also been called unearned increment, unjust enrichment, and other unflattering names. Howard Jarvis has said that the policeman or fireman who risks his life protecting the property of others has his "nose in the public trough." But it has seemed to generations of economists that the owner whose land rises in value because public spending builds an 8-lane freeway from, let us say, Anaheim to Riverside, and carries water from the Feather River to San Diego, is the first to have his nose in the trough. Nineteenth-century English economists who worked this out were more decorous. They said things like "landlords grow rich in their sleep" (John Stuart Mill), or the value of land is a "public value" (Alfred Marshall) because the public, not the owner, gives it value.
Some 43% of the value of taxable real estate in California is land value. When we lower the property tax we are untaxing not only buildings, but also land-fat.
The ownership of property is highly concentrated, much more so than the receipt of income. Economists in recent years are increasingly saying that the property tax is, after all, progressive because the base is so concentrated, and because so little of it can be shifted. But this message has not yet reached many traditional political action groups who continue to repeat the old refrains. Two remedies are in order.
One is to collect and publish data on the concentration of ownership of real estate. The facts are simply overwhelming and need only to be disseminated.
The second remedy is to note how strikingly little of the Proposition 13 dividend is being passed on to renters. This corroborates the belief of economists that the property tax rests mainly on the property owner where it originally falls, and not on the renter.
A high percentage of real property is owned from out of state and even out of the country. The percentage is much higher than we may think. It is not just Japanese banks and the Arabs in Beverly Hills. It is corporate-held property which comprises almost half the real estate tax base. If we assume that California's share of the stockholders equals California's share of the national population, then 90% of this property is absentee-owned; the percentage may be higher because many of these, after all, are multinational corporations with multinational ownership.
No one seems to have seized on the fact that half the taxable property in California is owned by people not voting in the state. Senator Russell Long has suggested the following principle of taxation: "Don't tax you, don't tax me, tax that man behind the tree." Property tax advocates have done well in the past and should do well again in the future when they make their slogan: "Don't tax you, don't tax me, tax that unregistered absentee. Don't tax your voters, they'll retaliate; tax those stiffs from out of state." Chauvinism and localism can be ugly and counterproductive, as we know; but here is one instance where they may be harnessed to help create a more healthy society. The purpose of democracy is to represent the electorate, not the absentee who stands between the resident and the resources of his homeland.
California's legislative analyst, William Hamm, estimates that over 50% of the value of taxable property in California is absentee-owned. This is such a bold, bare, and enormous fact it is hard to believe that Californians will long resist the urge to levy taxes on all this foreign wealth. They may be put off by the argument that they need to attract outside capital, but that carries no weight when considering the large percentage of this property which is land value.
Property income is generally more beneficial to the receiver than is the same income from wages or salaries, because the property owner does not have to work for it.
Property, particularly land, has been bought and sold for years on the understanding that it was encumbered with peculiar social obligations. These are, in effect, part of our social contract. They compensate those who have been left out. Black activists have laid great stress in recent years on the importance of getting a few people into medical and other professional schools. Does it not make more sense that the landless black people should have, through the property tax, the benefit of some equity in the nation's land from which their ancestors were excluded while others were cornering the supply?
A popular theme these last few years is that property owners should pay only for services to property, narrowly construed. Who, then, is to pay for welfare — the cripples? Who is to pay for schooling — the children? Who should sacrifice for the blacks — Allan Bakke? Who should finance our national defense — unpaid conscripts? The concept that one privileged group of takers can exempt itself from the giving obligations of life denies that we are a society at all.
Here is, perhaps, my favorite:
We can ask that a single standard be applied to owners troubled by higher taxes and to tenants troubled by higher rents. When widow A is in tax trouble, it is time to turn to hearts and flowers, forebode darkly, curse oppressive government, and demand tax relief. When widow B has trouble with escalating rents, that touches a different button. You have to be realistic about welfare bums who play on your sympathy so they can tie up valuable property. You have to pay the bank, after all. A man will grit his teeth and do what he must: garnishee her welfare check. If that is too little, give notice. Finally, you can call the sheriff and go to the beach until it's over. That's what we pay taxes for. Welfare is their problem.
Anyway, widow B is not being forced out of her own house, like widow A and so many like her. Jarvis said that taxes are forcing three million Californians from their homes this year. But in truth, while evictions of tenants are frequent, sheriff's sales of homes are rare. Those who do sell ("because of taxes," they say, as well as all their other circumstances) usually cash out handsomely, which is, after all, why their taxes had gone up.
Then there is the fruit tree anomaly. Under Proposition 13, a tree can only be assessed at its value when planted, with a 2% annual increment. The value of a seed thrown in the ground or even a sapling planted from nursery stock is so small compared with the mature tree that this is virtual exemption. This anomaly rather graphically illustrates how Proposition 13 automatically favors any appreciating property over depreciating property. The greatest gain here goes, of course, to appreciating land.
Finally, build no surpluses. Surpluses attract raiders and raiders are often organized landowners. "Property never sleeps," said the jurist Sir William Blackstone. "One eye is always open." Even though the surplus was built up by taxing income, Howard Jarvis made it seem the most righteous thing in the world that it should be distributed to property owners. He was geared up for this because his landlord patrons kept him constantly in the field.
Economists of many generations even before Adam Smith and continuing to the present — have preached on the advantages of land as a tax base. Let me enumerate a few of those.
A tax on land value is the only tax known to man which is both progressive and favorable to incentives. One can wax lyrical only about a tax that combines these two properties, because the conflict between progressivity and incentives has baffled tax practitioners for centuries, and still baffles them today.
A land tax is progressive because the ownership of the base is highly concentrated, much more so than income and even more so than the ownership of machines and improvements.
Also, the tax on land values cannot be shifted to the consumer. The tax stimulates effort and investment because it is a fixed charge based merely on the passage of time.
It does not rise when people work harder or invest money in improvements. Think about this. It is remarkable. With the land tax, there is no conflict but only harmony between progressivity in taxation and incentives to work and invest. In one stroke it solves one of the central divisive conflicts of all time.
The land tax does that because it cuts only the fat, not the muscle. It takes from the taxpayer only "economic rent," only the income he gets for doing nothing. If people could grasp this one overriding idea, then the whole sterile, counterproductive, endless impasse between conservatives who favor incentives and liberals who favor welfare would be resolved in a trice, and we could get on to higher things.
The final paragraphs speak directly to us in 2012. 34 years have passed since this was written.
Summing up, Walter Rybeck, an administrative assistant for Congressman Henry Reuss of Wisconsin, and head of the League for Urban Land Conservation, has sagely suggested that we distinguish two functions of business: wealth-creating and resource-holding. A good tax system will not make people pay for creating wealth but simply for holding resources. Most taxes wait on a "taxable event" — they shoot anything that moves, while sparing those who just sit still on their resources.
If we really want to revive the work ethic and put the United States back on its feet, we had better take steps to change the effect of taxes on incentives. Legislatures have got in the habit of acting as though persons with energy and talent, and with character for self-denial, should be punished, as if guilty of some crime against humanity. We cannot study the tax laws without inferring that Congress regards giving and receiving employment to be some kind of social evil, like liquor and tobacco, to be taxed and discouraged by all means not inconsistent with the rights of property. Little wonder the natives are getting restless. If we tax people for holding resources rather than creating wealth and serving each others' needs, we will be taking a giant step toward a good and healthy society.
If your appetite is whetted by these excerpts, you can read the entire article below:
Found in the files ... the phrase at the beginning of the 3rd paragraph caught my attention, and then the rest seemed worth sharing:
Thank you for letting me see Mr. ___'s thoughtful and thought-provoking paper on tax incidence.
I could go through this paper in detail, praising where I think it warranted and criticizing in other spots. However, it seems more constructive to offer, tentatively, a different set of parameters, which, for me at least, clarify the matter of incidence as no current author is doing. At least it will suggest a different viewpoint from which to analyze incidence.
In the first place, land values are the great catch-all of externalities, both positive ones and negative ones. To an extent, that is what Lowell [Harriss]'s conferences on "Subsidies and Other Government Spending: Effects, with Special Reference to Land Values" and the subsequent book "Government Spending & Land Values: Public Money and Private Gain" were all about.
In the second place, as his paper points out, taxes on land values are not shifted and taxes on improvements are shifted, and for the reasons he states: land is of fixed supply and improvements are not. This, ceteris paribus, is why they are built into price and paid for by the consumer in the one case and are reflected in a lower price in the other.
But there is a factor not cited in the paper, nor in the limited amount of the literature with which I am familiar: that is the current state of the economy -- whether we are in a boom or a bust. When the demand for office or residential space is lively, the lessor waits only for the expiration of the current lease (and only if he must!) to raise the tenant's rent; when the rental market is in the doldrums, he grins and bears it, or is foreclosed, or tears his building down, to escape taxes.
I think the idea of "backward shifting" is specious; I believe it is a conconction of dear old Harry Gunnison Brown's. It has certainly set thinking on incidence back generations, having muddied the waters of a simple phenomenon to the point where no one seems to know anything certain at this time.
Lastly, may I suggest that Mr. ___ dip into Homer Hoyt's "100 Years of Land Value in Chicago," Chapter 7, especially pp. 373-403, where Hoyt lists the order in which various phenomena occur from trough to trough. He counts twenty of them; the enclosed chart, based on Hoyt, expands the list to thirty, in the interest of elucidation. In this he will see how land values tend to lag on the upside somewhat at the beginning, then get out of hand completely, and finally again especially lagging on the downside. In this he may discover primary forces affecting the natural tendencies of incidence.
--at least, this is what I think I see in all this. Thanks again for the opportunity of studying this interesting paper.
--from a letter from Weld Carter to Arthur Becker
(professor of economics, University of Wisconsin-Milwaukee and
Mason Gaffney discusses them in his "The Great Crash of 2008" (see the LVTfan blogpost here).
and finally, Which Georgist first called LVT the "least bad" tax? contains a reference to Hoyt; this book was his PhD thesis at the University of Chicago, which Milton Friedman was likely aware of when he said, both in the 1970s and shortly before he died in 2006, that land value taxation was the "least bad" tax. (Incidently, that blogpost title does not refer to Friedman; it refers to Lowell Harriss, mentioned in Carter's letter.)
Finally, you might take a look at Carter's discussion of Hoyt in his Clarion Call.
Some people think that land rents are not a significant percentage of GNP, or, when they hear "land reform," think only about agriculture, probably in the context of Third World latifundia.
If you believe that land rents don't matter in a modern economy, I have a wonderful get-rich-quick scheme for you! And I won't charge you a cent for my brilliant idea, so listen up!
I was looking at the real estate ads in the Washington Post (October 2, 2010, p. F1), and I observed that for just $271,000, you can buy a four bedroom, three bath contemporary chalet in Basye/Bryce Resort, Virginia, with screened porch and hot tub. It looks pretty nice, it has trees in the yard, and it was built in 2005. I'm not sure just where Bryce Resort is, so it must not be too close to DC, or I'd know more.
Other houses are more expensive. There's a three bedroom townhome (what used to be called a row house) in Alexandria, less than a mile from the Huntingdon Metro, for $579,000, more than twice as much, $308,000 more. Alexandria is on the Potomac, across from Washington DC.
What else can you buy? There's a three bedroom townhouse in Alexandria, for $642,800. There's also a white house, described as a 1920's classic, with the number of bedrooms unspecified, but a yard and landscaping of its own, for $1,250,000, nearly a million dollars more than the chalet in Bryce Resort. It looks attractive, but it's not a huge mansion. When I was a child, say in 1975, I think you could have bought a house like that in my home town for under $50,000, $60,000 at most.
So how do you get rich quickly? You buy houses in Bryce Resort, of course, and sell them in Alexandria at a $300,000 markup! Even after the costs of cutting up houses and moving them on flatbed trucks, you should come out way ahead. Buying and selling one house a year should give you a middleclass income, and if you work faster than that, you'll soon be set to retire rich.
Can anyone consider the obvious flaw in this scheme, and not realize that land prices matter? Land prices in Alexandria must be at least $300,000 for the land under a decent townhouse, more for the land portion of a home with a nice yard. Annual land rents must be about $10,000 or more for modest lots, several times that for bigger ones. This is not a trivial percentage of homeowners' incomes, or of GNP.
As a 19th century Georgist put it, instead of paying rent to a landlord and tax to the state, why not pay rent to the state and no taxes?
Every week when I scan the NYT's "What You Get" column, which showcases three homes currently on the market in various parts of the country, I wonder why the column doesn't provide the answers to the important questions?
How far is each home from a vital job market?
What share of the children in the local school district graduate from high school? attend 4-year colleges? graduate from college?
What sort of public goods and services and cultural amenities does the community offer?
Must those who live there have a car for every working adult?
I think Nicholas Rosen nailed it when he quoted a 19th century Georgist: instead of paying rent to a landlord and tax to the state, why not pay rent to the state and no taxes?
I'd read this a few years ago, but on a recent re-reading, some other things jumped out at me. (The emphasis is mine.) It references a number of the themes of this blog (at left). See also a related essay, The Incredible Shrinking Dollar.
Henry George foreboded that landowners might take a growing wedge of the national “pie”, or product. Labor’s wedge might grow absolutely, as the whole pie grows, but still fall as a fraction. It might even shrivel.
In our times, George’s grimmer scenario is coming true. Since about 1975, labor’s wedge of the pie is shrinking as an absolute. “Real” wage rates have been falling since about 1975. “Family wage” used to mean a breadwinner’s wage high enough to support a family; now it means the combined wages of two adults. Many of these are “DINKS” (Double Income, No Kids) because that is all they can afford without cutting their customary material and educational standards.
What is this “real” wage rate? It is a ratio: the nominal money wage rate on top, divided by an index to the Cost of Living (COL) on the bottom. The higher the COL, the lower the real wage. Landowners cut into labor’s share from both the top and the bottom, because the COL includes many products of land (like building materials and energy) and land itself (like homesites). Shelter costs are by far the largest part of household budgets.
The standard index to the COL is the Consumer Price Index (CPI), calculated and published regularly by the Bureau of Labor Statistics (BLS). This index is, we will see, a political football.
Henry George said little about inflation because it was not a threat in his day. That was a time of “hard money” and the gold standard. Prices were stable or falling; DEflation was the great bugbear. Today, though, to check on George’s forecast, we have to distinguish between nominal money wages, and real wages.
An old Kingston Trio classic offered the following folk wisdom about survival in The Everglades: “If the skeeters don’t gyitcha then the gators will.” If the skeeters of life are nicks taken from money wages, the big gator now is the price of buying and owning a home.
Why deny inflation? Those in power have several reasons to understate rises in the cost of living (COL), measured by the CPI.
1. To mask the fall of real wage rates. This is supposed to placate working voters. It is supposed to support orators declaiming that our standard of living is ever rising, and we should all feel good. Actually, real wage rates have fallen steadily since peaking in about 1975. That is using the official Consumer Price Index (CPI) to measure rises in the COL. If the CPI understates rises in the COL, real wage rates have fallen even faster than the data show.
As a by-product, this denial of inflation supports those who like to dismiss George as a false prophet of doom.
2. To mask the fall of real interest rates, making savers and lenders feel better, and more willing to lend to governments. In this age of massive and growing federal debts, the U.S. Treasury depends on willing lenders more and more, to stay solvent.
3. To cut the real value of social security payments. This point is straightforward. These payments are also indexed to the CPI. If the CPI understates the COL, real social security benefits fall every year. Congress gets to spend the savings on wastes like Alaska’s “bridge to nowhere”, redundant imperialistic ventures, tax cuts for major campaign contributors, and no-bid contracts for the well-connected.
4. To cut rises in labor union and other wage contracts that are indexed to the CPI. The Federal minimum wage, like most state minima, is also indexed to the CPI.
5. To give the Federal Reserve Bank credit for having “tamed inflation”, when in fact inflation of land prices is running wild.
6. A lesser point today, but important before Congress leveled out the rise of tax rates with income, is to slow the rise of income tax brackets. That is because these brackets are indexed to the CPI. That is, when the CPI rises by, say, 5%, the income level at which you pass into a higher tax bracket also rises by 5%. Congress, briefly in a reasonable mood, enacted this sensible provision when enough people became aware that they were victims of “bracket creep”. Bracket creep is when inflation boosts your money income into a higher tax bracket, although your real income has not risen.
However, if the true COL rises by 10%, while the CPI rises by only 5%, this provision no longer protects us against bracket creep. It just gives a talking point to those who claim to protect us. Sneaky! That is why you, dear reader, may have had a hard time following the bean under one of the three shells. Politicians, of course, are good at withdrawing promises. The sneakier the method, the easier it is for them to cover their tracks
That is the “Why” of veiling inflation. Now let us look at the “How”. There have been two major steps in recent decades.
First was removing the costs of buying and owning homes from the CPI. The Bureau of Labor Statistics (BLS), the agency that calculates the CPI, did this from 1983 onwards. They didn’t remove it altogether, that would have been too transparent. Instead they substituted the “rental equivalent” of housing. This is supposed to be what your house would rent for, or what you would pay to rent a similar house. It is a hypothetical and casual figure - sloppy and unverifiable, that is - based simply on questionnaires to a sample of homeowners. It takes no account of the fact that some people will, and therefore everyone must pay a premium to own, because of expected higher future rents and resale values.
The “rationale” (cover story) for doing this is that a home is both an investment and a residence, and only the residence cost belongs in the cost of living. In fact, the annual economic cost of owning a home is the market value times the interest rate (plus the property tax rate, homeowners’ insurance, depreciation, etc.). When prices are rising we may deduct annual gain from the cost, but when prices are falling we then must add the annual loss to the cost of ownership, and now that losses are becoming current, there is no thought of adjusting the CPI for that. If the BLS were constructing a true measure of the COL they would be on top of this point; but they do not balance their act. They seize on reasons to lower the CPI, not to raise it.
Thus the land boom of 1983-89 was mostly blanked out of the official published CPI of those years. The CPI rose gently as though the land boom never happened. Again, in 2004 housing prices rose by 13%, while these “rental equivalents” rose only by 2%.
The CPI also takes no account of the price of extra land around some houses. It takes inadequate account of recreational lands, which now have displaced farming and forestry over whole counties and regions. And can we believe that the price of access to recreational lands has advanced as slowly as other prices? In 1946 a summer family membership in the Dorset Field Club, Vermont, cost $100, giving access to the links, tennis courts, and clubhouse privileges for three months. Today there is no access for non-members. A membership costs about $30,000, by private negotiation, and annual dues were $3,000 in 2003. Meantime, in the big leagues, Donald Trump is asking $300,000 or so for a membership in Ocean Trails C.C.; and even Rupert Murdoch is complaining about the green fees at Pebble Beach, $450 for one round. I am grateful that I got my fill of golf when I was young and dad could afford it.
The second major step was the Boskin Commission Report of 1995 (Newt Gingrich was dominating Congress), and its acceptance and implementation. Michael Boskin of the Hoover Institution was called upon to legitimize allegations that the CPI overstated inflation. He and his Commission obliged, and supplied the rationale for several rounds of trimming down the CPI even more.
The Boskin Commission’s advanced methodology included a lot of old-fashioned cherry-picking. They accumulated evidence supporting the foregone conclusion, and omitted contrary evidence. Most tellingly, they were silent about the biggest factor by which the CPI understates inflation: that is the use of “rental equivalence” in place of home prices. Now, shelter costs are about 40% of consumer budgets, and hence of the true COL. To accept an extreme understatement of shelter costs, while distracting us with lesser factors and arcane methodology, shows bias.
Most professional economists, sad to say, treat Boskin’s report as holy writ. They come on like preachers, salesmen, or just cheer-leaders, not like scientists exercising independent judgment. I have recently surveyed 20 current texts in Macroeconomics. They all list the same four “biases”, in the same order, that they allege make the CPI overstate inflation. These are:
a. Substitution bias. When the price of something rises, you use less of it, so it should be weighted less in the index.
b. Quality improvement bias. Products of the same name keep getting better, so they say.
c. New product bias. The CPI lags in showing how new gadgets raise our welfare. Microchip products, of course, are the example of choice.
d. “Discount bias”. The CPI scriveners assume that products sold in discount stores are of lower quality, when they really are just as good, according to Boskin et al.
As to point “a”, above, when the price of food rises elderly pensioners turn to cat food, so now the cost of fresh fruits and veggies counts for less in their cost of living, and they have shown a preference for cat food, whose weight in the CPI should rise, and they are as well off as ever. Hmmm – something fishy there.
Let’s take point “b”, above, quality improvement bias. The texts give some examples, but not a single counter-example. Here are a few of the latter.
2x4 dimensional lumber is no longer 2x4, but 15-20% smaller in cross-section, and of lower grade stock
salmon is no longer wild, but farm raised in unsanitary conditions, and dyed pink (ugh)
“wooden” furniture is now mostly particle-board
“wooden” doors are now mostly hollow
new houses have remote locations, far from desired destinations
ice cream is now filled out with seaweed products
the steel in autos is eked out with fiberglass, plastic, and other ersatz that crumbles in minor collisions
airline travel is no longer a delight but a series of insults and abuses
gasoline used to come with free services: pumping the gas, checking tire pressure and supplying free air, checking oil and water, cleaning glass, free maps, rest rooms (often clean), mechanic on duty, friendly attitudes and travel directions. They served you before you paid. Stations were easy to find, to enter and exit. Competing firms wanted your business: now most of them have merged.
cold fresh milk was delivered to your door
clerks in grocery and other stores brought your orders to the counter; now, many clerks, if you can find one, can hardly direct you to the right aisle
suits came with two pairs of pants and a vest, and they fitted the cuffs free. Waists came in half-sizes
socks came in a full range of sizes
shoes came in a full range of widths; the clerk patiently fitted the fussiest of customers
the post office delivered mail and parcels to your door or RFD, often twice a day
public telephones were everywhere, not just in airport lobbies. Information was free; live operators actually conversed with you, and often gave you street addresses
public transit service was frequent, and served many routes now abandoned
live people, living in America, used to answer commercial telephones, with no telephone tree to climb, and tell you what you actually wanted to know
autos used to buy “freedom of the road”; now they buy long commutes at low speeds and rage-inducing delays. One must now travel farther and buck more traffic to reach the same number of destinations. Boskin et al. dwell on higher performance of cars, and the bells and whistles, but rule out taking note of the cost-push of urban sprawl.
classes keep getting larger, with less access to teachers and top professors, and more use of mind-numbing “scantron” testing.
before world war II, an Ivy-league college student lodged in a roomy dorm with maid service and dined in a student union with table service, and a nutritionist planning healthy meals. All that, plus tuition and incidentals, cost under $1,000 a year. Now, to maintain your children’s place and status in the rat race, you’d put out $40,000 a year for a claustrophobic dorm and junk food. On top of that, a B.A. no longer has the former value and cachet. Now you need time in graduate and professional schools to achieve the same status. Many students emerge with huge student loan balances to pay off over life, with compound interest.
warranties on major appliances cost extra, aren’t promptly honored, and expire too soon. Repair services and fix-it shops used to abound to maintain smaller appliances. Now, most of them are throwaway.
replacement parts for autos are hard to find, exploitively overpriced, and are often ersatz or recycled aftermarket parts
musical instruments are mass-produced and tinny instead of hand-crafted and signed
piano keys were ivory; now plastic
many new “wonder drugs”, if you can afford them, have bad side-effects, while old aspirin still gets the highest marks
a rising array of taxes and other payroll deductions stand between one’s nominal income and consumer goods it might buy. Income and social security taxes are not counted as part of the CPI.
Medical doctors once made house calls, in the dim mists of history. Since then, access has become progressively more difficult, until today ... well you know, you’ve been there. In many small towns there is no doctor at all.
In 1998 the BLS dropped auto finance charges from the CPI. I do not find the cost of other consumer credit in the CPI (although I stand subject to correction). Certainly the largest cost of consumer credit, mortgage interest, has been removed by use of the “rental equivalent” substitute, with never a squawk from Boskin.
In 1995 the BLS eliminated an “upward drift” in the “rental equivalent” index, with no explanation. It is probably relevant that Congressman Newt Gingrich was in the saddle.
One could go on, but the point is that Boskin et al. seem not to have considered counterexamples to their foregone conclusions. If they did this where we can observe them, what else did they do under cover of black box models? The BLS, succumbing to the political pressure, keeps modifying the CPI to show less inflation, even while our daily experiences and shrinking savings tell us there is more. A 1999 study of the changes in the 20 years between 1978 and 1998 showed the cumulative effect of many changes had been to lower the CPI substantially (Monthly Labor Review, 6-99, p.29).
George warned that landowners might take most of the fruits of progress, leaving labor barely enough to survive. Critics then and now have urged us, instead, to don rose-colored glasses. The rosiest of these is the CPI as manipulated to screen out bad news, especially news about soaring land prices. Let us be aware of who is manipulating the news, why, and how.
 Your old geometry teacher called this a “sector”.
A note to Tea Party activists: This is not the movie you think it is. You probably imagine that you’re starring in “The Birth of a Nation,” but you’re actually just extras in a remake of “Citizen Kane.”
True, there have been some changes in the plot. In the original, Kane tried to buy high political office for himself. In the new version, he just puts politicians on his payroll.
I mean that literally. As Politico recently pointed out, every major contender for the 2012 Republican presidential nomination who isn’t currently holding office and isn’t named Mitt Romney is now a paid contributor to Fox News. Now, media moguls have often promoted the careers and campaigns of politicians they believe will serve their interests. But directly cutting checks to political favorites takes it to a whole new level of blatancy.
Arguably, this shouldn’t be surprising. Modern American conservatism is, in large part, a movement shaped by billionaires and their bank accounts, and assured paychecks for the ideologically loyal are an important part of the system.
Scientists willing to deny the existence of man-made climate change,
economists willing to declare that tax cuts for the rich are essential to growth,
strategic thinkers willing to provide rationales for wars of choice,
lawyers willing to provide defenses of torture,
all can count on support from a network of organizations that may seem independent on the surface but are largely financed by a handful of ultrawealthy families.
And these organizations have long provided havens for conservative political figures not currently in office. Thus when Senator Rick Santorum was defeated in 2006, he got a new job as head of the America’s Enemies program at the Ethics and Public Policy Center, a think tank that has received funding from the usual sources: the Koch brothers, the Coors family, and so on.
Now Mr. Santorum is one of those paid Fox contributors contemplating a presidential run. What’s the difference?
David Cay Johnston spoke to some of this in his writings about the effort to re-brand the estate tax, which affects a tiny fraction of households, as the "death tax," funded by those who would be beneficiaries. (Remember all that talk about saving the family farm? Think about that family-owned factory farm in Iowa which produces all those eggs. That's the sort of entity we'd be protecting.)
Condemning the post-industrial economy to protracted periods of economic failure, this thought-provoking book documents how the integrity of economics as a discipline was deliberately compromised in the United States towards the end of the 19th century. Several chairs of economics were funded at leading universities to rebrand economics to justify unearned income. The tools for this strategy became neo-classical economics, and, unlike classical economists like Adam Smith who described wealth as the product of three factors — land, labor, and capital — the new theorists reduced these to two: labor and capital, thus treating land as capital. This concealed the benefits enjoyed by those in receipt of the rent from land. The effect, the authors reveal, was to deprive professional economists of the ability to diagnose problems, forecast important trends, and prescribe solutions.
The cover material reads,
Henry George championed social justice and economic efficiency so successfully he had to be stopped. He was. Here's how: 'With the development of democracy . . . Mind control became the urgent need: neo-classical economics was the tool.' Economics was uprooted from reality and we are all paying the price today."
What comes to mind is that the vast majority of those who learned our/their economics from economists and instructors who only know neo-classical economists become highly useful idiots.
I hope you -- and Dr. Krugman -- will take a look at both.
What is it the plutocrats are protecting? The concentration of wealth in this country. If you don't have the statistics top of mind, here's a quick version, from the Federal Reserve Board's 2007 Survey of Consumer Finances, which under-reports the concentration of wealth because it expressly omits the Fortune 400 families, who represent about 1% of aggregate net worth.
1. EQUITY (stock in publicly held companies and equity mutual funds, whether held individually, in trusts, in retirement accounts): 2. BUS (the value of privately held businesses) 3. EQUITY and BUS combined
Distribution of Wealth: Stocks, Privately Held Business, and all other, by percentile of NETWORTH
Doing some housecleaning, I came across the May, 2006, issue of Harper's Magazine, whose cover story was entitled "The Road to Serfdom: An Illustrated Guide to the Coming Real Estate Collapse." On the promotional half-cover, the headline said "THE HOUSE TRAP: How the MORTGAGE BUBBLE Will Bankrupt Americans -- in 20 East Steps."
I looked online, and found a copy of the article in PDF format here, which permits me to throw away my hardcopy.
Never before have so many Americans gone so deeply into debt so willingly. Housing prices have swollen to the point that we’ve taken to calling a mortgage — by far the largest debt most of us will ever incur — an “investment.” Sure, the thinking goes, $100,000 borrowed today will cost more than $200,000 to pay back over the next thirty years, but land, which they are not making any more of, will appreciate even faster. In the odd logic of the real estate bubble, debt has come to equal wealth.
And not only wealth but freedom — an even stranger paradox. After all, debt throughout most of history has been little more than a slight variation on slavery. Debtors were medieval peons or Indians bonded to Spanish plantations or the sharecropping children of slaves in the postbellum South. Few Americans today would volunteer for such an arrangement, and therefore would-be lords and barons have been forced to develop more sophisticated enticements.
The solution they found is brilliant, and although it is complex, it can be reduced to a single word — rent. Not the rent that apartment dwellers pay the landlord but economic rent, which is the profit one earns simply by owning something. Economic rent can take the form of licensing fees for the radio spectrum, interest on a savings account, dividends from a stock, or the capital gain from selling a home or vacant lot. The distinguishing characteristic of economic rent is that earning it requires no effort whatsoever. Indeed, the regular rent tenants pay landlords becomes economic rent only after subtracting whatever amount the landlord actually spent to keep the place standing.
Most members of the rentier class are very rich. One might like to join that class. And so our paradox (seemingly) is resolved. With the real estate boom, the great mass of Americans can take on colossal debt today and realize colossal capital gains — and the concomitant rentier life of leisure — tomorrow.
If you have the wherewithal to fill out a mortgage application, then you need never work again. What could be more inviting — or, for that matter, more egalitarian?
That’s the pitch, anyway. The reality is that, although home ownership may be a wise choice for many people, this particular real estate bubble has been carefully engineered to lure home buyers into circumstances detrimental to their own best interests. The bait is easy money. The trap is a modern equivalent to peonage, a lifetime spent working to pay off debt on an asset of rapidly dwindling value.
Most everyone involved in the real estate bubble thus far has made at least a few dollars. But that is about to change. The bubble will burst, and when it does, the people who thought they would be living the easy life of a landlord will soon find that what they really signed up for was the hard servitude of debt serfdom.
From there, Hudson proceeds to list the 20 steps, each illustrated with a graphic. I encourage you to look up the original; the graphics are generally quite helpful to making the point -- but the text is valuable here.
But where does that dynastic plutocracy begin? There is an astronomical gap between Mr. Buffett’s fortune, which Forbes estimated at $47 billion, and two retirees in Marin County, California, whose life’s work might have allowed them to leave their heirs $3.5 million in assets, mostly in the value of a house.
Oh, I was so pleased to read someone expressing it so clearly. Tell me about that house in Marin County. Let's see. Let's say our retirees bought it in, say, 1980, for, say $200,000. They probably put down 10% or 20% in those days (borrowing standards were a little different then). Let's say that they had a mortgage for, say $160,000, at 8%. They finished paying it off last year. The monthly mortgage payment was $1,174. Over the course of 30 years, they paid off $160,000 of principle, and paid the lender about $266,000 in interest. To rise from the $200,000 purchase price to today's value of $2 million, the average annual appreciation was about 8.3%. Obviously, some years it was more, some less. But 8.3% is an average.
What the paragraph quoted doesn't explain is how our hard-working retirees caused their property to appreciate by 8.3% per year over 30 years.
The reality is that houses depreciate. What rises in value is the land, and it rises for reasons which have nothing to do with the individual landholders, or even all the landholders in aggregate. Land appreciates as a result of the presence and growth of population and a healthy economy; as a result of the public provision of goods and services which people value and which make a community or state a better place to live. Advances in technology can also contribute to increases in land value -- consider elevators in cities, air conditioning in the American south, fiberglass boats in waterfront communities.
Our retirees experienced an 8.0% average annual growth in the value of their residence. Paying off their mortgage raised their equity by the $160,000 they originally borrowed. Appreciation, provided by their community and their nation, provided $1,800,000 -- over 10 times as much! Their hard work paid the mortgage, but their community contributed FAR more.
But, you might argue, they did pay property taxes all those years. Yes. Under Proposition 13, their property tax is based on 1% of the assessed value of the property, and the assessed value of the property can only rise by 2% per year, no matter how much the market value has risen. Voters can approve additional payments in the form of parcel taxes, which might bring taxes up to perhaps 1.25% of the assessed value of the property.
At 1.25%, over those 30 years, our hardworking Marin retirees have paid in $109,514 in property taxes. The rest of their "hard-earned" appreciation comes from
the scarcity of housing close to California's cities, compared to the number of people who would like to live close in;
spending supported by taxes on sales and wages -- which come not only from their own pockets but from the pockets of the 50% of California residents who are renters because they can't afford to buy;
federal dollars spent on California infrastructure
effects created by changes in mortgage interest rates and mortgage lending policies, including loan-to-value ratios, underwriting standards related to income ratios, etc.
Does it seem churlish to collect back a portion of the value we-the-people have created once per generation? We'd be much wiser to collect it year-in and year-out, in the form of a tax on the value of the land itself, and let our workers keep their wages and not pay taxes on their purchases or homes.
Does it seem churlish that the Marin retirees' children should not be entitled to keep all that value we-the-people created just as if the retirees had created it themselves? After all, other people's children, including those of tenants, don't get to keep that value, but they've contributed to creating it.
A 15% capital gains tax on the $1,800,000 somehow seems an insufficient share for the commons. Even a 50% estate tax seems a bit insufficient, too.
This is trickle-up economics at work, and saying that some of it trickles to people we might consider middle class doesn't change the fact that some grow wealthy in their sleep, while others simply grow poor despite working hard for decades. The two situations are not unrelated. (And a $3.5 million estate doesn't fall into most definitions of middle class in America.)
The term "millionaire" used to always be a reference to net worth. Recently, we've started to see it used to refer to people with annual incomes of $1 million or more -- usually in articles suggesting that a significant and growing percentage of us fall into that category and isn't America wonderful?
In 2007, according to the Federal Reserve Data, only 9% of U.S. households had at least $1 million in net worth. That
9% made the majority of charitable contributions, owned the majority of
equity in unincorporated and closely held businesses, and had a
disproportionately large share of investable assets as compared with
the remaining 91% of the population. These “wealthy households” made
53% of all household charitable contributions ($117 billion). They also
owned 93% ($13.7 trillion) of business equity owned by all households
in unincorporated and closely held businesses, and they had 41% ($10.3
trillion) of investable assets owned by all households, i.e. liquid
assets, stocks, bonds, and mutual funds. Typically, wealthy households
do not have million dollar incomes. In 2006, the average wealthy
household income before tax amounted to $354 thousand, while the median
amounted to $159 thousand. Only 6% of millionaire households made as
much as $1 million in 2007. The pattern is similar for unearned income.
The average household unearned income of millionaire households was
$145 thousand in 2006 and the median was $18 thousand. Only 6% of
wealthy households had unearned income of as much as $500 thousand.
Nevertheless, wealthy households received 86% of total unearned income received by all households in 2006.
Among wealthy households, both household income and household assets
are importantly related to charitable giving, but assets, especially
investable assets, are much more important than income. Statistically,
the relationship between the value of assets and the amount of
charitable giving is roughly 7 times stronger than the relationship
between the level of income and the amount of charitable contributions.
Put simply, millionaire households make charitable contributions more
because they are wealthy than because they earn a high income.
Most (more than 90%) millionaires acquired their wealth in their own
lifetimes through business, investment, or service as corporate
executives rather than through inheritance. The majority became wealthy
through growing their own business or investing in businesses of
others. They tend to be entrepreneurial and agents of economic
expansion. In earlier paragraphs we saw that as a group they own 93% of
the equity in unincorporated and closely held businesses owned by all
households in the U.S. Even in retirement millionaires participate in
business opportunities. They contribute to local economic development
as a source of funds, as a potential investor, and as an agent for
creating new businesses and expanding established ones.
This seems to be a paean to trickle-down economics, and even those of us who don't believe in trickle-down economics can be tempted to accept that, since our wealthiest fellow citizens have such a large fraction of the total net worth, trickle-down must be the only relevant model for understanding wealth.
I question the realities behind the statement that "Most (more than 90%) millionaires acquired their wealth in their own
lifetimes through business, investment, or service as corporate
executives rather than through inheritance."
Many of them, I suspect, were given college educations by their parents or grandparents; a private college education today costs about $200,000. Not an insubstantial figure. Graduate school runs about the same amount, particularly in the private universities or for out-of-state students at public universities.
Many of them, I suspect, were given the 20% down payment on a home either by the government or by their parents or other relatives. It might have been 20% of $80,000 or $125,000, which might sound trivial in relation to their 2007 $1,000,000 corpus -- but it made a big difference which the paragraph above fails to acknowledge. (Paying off the other 80% made a relatively small contribution to their "home equity.") The appreciation of the land under that home may be a major contributor to their net worth.
We may call that "investment" but it is really the legalized privatization of that which one's community and one's local, state and federal governments' spending has created. Self made men? Hmph! And the startup funds for their businesses may have come from borrowing on that land equity. -- and of course that interest is deductible on one's federal and, likely, state income taxes. A nice subsidy, huh? And the most profitable businesses tend to be those who own the building and land on which the business is conducted -- and the sites of others' businesses too! Those folks may work hard -- almost as hard as their employees -- but they also get the benefit of the local economic activity as it drives the selling and rental value of their landholdings upward. Bu we permit them to call themselves self-made. Aren't we generous? Or would it be more accurate to say that we're wearing blinders?
We should set the playing field level between landlord businesses and tenant businesses. (Land value taxation would do this.) Landlords do not create land! To permit structures which compensate them as if they do is dumb.
A bit later, the study continues,
According to the Survey of Consumer Finances, sponsored by the Board of Governors of the Federal Reserve, on a national basis households
with net worth of at least $1 million, headed by a person age 60 or
older, comprise 4% of all households but donated approximately 25% of
all household charitable contributions in 2007 (the most recent year for which data is available).
The first paragraph of their 3-paragraph conclusion reads:
During the December 13, 2009 edition of “Meet the Press” former Chairman of the Federal Reserve, Alan Greenspan, touted the importance of rising stock prices to economic recovery. In a broader context Greenspan’s words highlight the importance of wealth to economic growth. During decades of research at the Center on Wealth and Philanthropy we have consistently found that wealthy households contribute disproportionately more to charitable causes both from their household assets and from their foundations, trusts, and donor advised funds.
Perhaps we would have less need for charity if we had a less concentrated distribution of wealth in America. Perhaps, if we funded our local, state and federal spending via taxes on the value of the commons that individuals and corporations and other domestic and foreign entities claim as their own -- instead of taxing sales and wages and buildings -- we'd create more opportunity for more people to earn adequate incomes.
Until we do that, though, shouldn't we be collecting back this land appreciation once per generation, through taxes on the largest estates?
I stumbled across a bit of data on wealth concentration which I thought worth sharing. Previously I've reported data from the 2007 Survey of Consumer Finances, which was published just about a year ago. The data on Net Worth as reported shows top 1%, next 4%, next 5%, next 40% and bottom 50%:
Ed Wolff, of NYU, is quoted here as reporting this distribution of Net Worth for 2007:
Top 1%: 34.6%
Next 19%: 50.5%
Bottom 80%: 15.0%
Since the source is a working paper not yet published online, I don't know the underlying data source, but I'm guessing that Wolff might be working with the SCF 2007 data and following up on the statement in Arthur Kennickell's Ponds & Streams, the Federal Reserve Board paper which published the 2007 SCF, that the wealth holdings of the Forbes 400 are omitted from the SCF data, and that Wolff is adding that data both to the top 1% and the aggregate to come up with these data. (If I'm wrong, I'd welcome correction!) If I'm correct, his 50.5% for the "next 19%" indicates that the distribution of Net Worth is roughly as follows:
Top 1%: 34.6%
Next 4%: 26.4% Top 5%: 61.0%
Next 5%: 10.8% Top 10%: 71.8%
Next 10%: 13.3% Top 20%: 85.1%
Next 30%: 12.4% Top 50%: 97.5%
Bottom 50%: 2.5%
Those figures include housing wealth.
The same table which reported that Net Worth data also reports Wolff's findings for Financial Wealth, which he defines as Net Worth minus the [gross] value of one's home:
Top 1%: 42.7%
Next 19%: 50.3%
Bottom 80%: 7.0%
The same article reports some useful measurements of stock ownership -- that is, ownership of shares in publicly held companies, whether directly, through retirement accounts or mutual funds.
Top 1% own 38.3% of the stocks
Next 19% own 52.8% of the stocks
Bottom 80% own 8.9% of the stocks
48.1% of us owned no stocks in 2007
51.9% of us owned some amount of stocks in 2007
17.5% of us owned stocks worth less than $10,000 in total
31.6% of us owned stocks worth more than $10,000
What do you conclude from this data?
Do you conclude that the bottom 80% of us are simply shiftless folks who must not be working very hard, or stupid folks who don't work very well, or invest what little we save very well, or do you think there might be something else going on? What is it that the bottom 80% of us lack?
Does it seem to you that if only we shift some more of our wealth
to the top 1%, benefits will somehow begin to trickle down to the rest of us, perhaps in the form of job creation by wealthy benefactors?
Does it seem to you that increasing homeownership is (or was ever) the solution to these problems, or do you think we might need to dig deeper to find the root of the problem?
We have permitted a wealth-concentrating machine to be created, sustained and, within the adulthood of the boomer generation, strengthened.
Few understand this machine, but I submit that the first step to understanding it is to read a 130 year old bestseller.
Progress & Poverty begins with the questions "why, despite awesome technological progress which has the potential to wipe out poverty, do we still have poverty?" and "why is wealth so concentrated?" It examines the standard answers to those questions (you'll recognize them all) and finds them wanting. It then sets out to find a more satisfactory answer, and to examine its implications. It proposes a remedy -- the remedy -- and explores what that remedy means for the individual and a society with America's ideals.
I came across an interesting table in a November, 2007, Federal Reserve Board Study entitled "First-Time Home Buyers and Residential Investment Volatility" by Jonas Fisher and Martin Gervais, and another version from "Why Has Homeownership Fallen Among the Young?" (FRB, March, 2009), by the same authors.
While median income (in real dollars) has fallen, the ratio of median house price to median income has nearly doubled, down payments at the median are down by over 1/3, and, perhaps most important, the proportion of after-tax income going to mortgage payments has nearly doubled, to 40%. Consider also that in 1976, most mortgages were fixed rate instruments, while by 2005, a very high percentage were adjustable rate mortgages, whose interest rate could rise by 2% at the end of the first year, raising that proportion higher in the second year.
And then, of course, in addition to paying 40% of after-tax income to the mortgage lender, our young people must also pay taxes: payroll taxes, wage taxes, sales taxes, taxes on their house and the land on which it sits. Those who have read this blog for a while will know that placing the largest share of our tax burden onto land value would have many desirable effects, including reducing the selling price of land to a nominal amount. Instead of borrowing from a mortgage lender a large sum to pay the seller for land value the seller didn't create, we'd pay land rent to our community, which would keep some of it for local purposes, and pass some up to the state and the federal government -- revenue which would replace some or all of the state sales and income taxes, and the federal income taxes.
And that 40% is mostly interest, not principle payment. Depending on the interest rate, in the first year of a mortgage, one pays 70% (at 4%), 78% (at 5%), 83% (at 6%), 88% (at 7%) 91% (at 8%) of one's mortgage payment as interest, and only 30% to 9% to pay down principle. The fact that, for some, mortgage interest isn't taxed, should be little consolation. (Why "for some"? Because for many families, the standard deduction is a better deal than itemizing deductions. Most homebuyers don't realize that, and assume they'll benefit as homeowners.)
Yet another FRB study, from May, 2006, showed that in the top 46 metro areas, on average, land value represented 51% of the value of single-family residential property. In San Francisco metro, the figure was about 88%; in NYC and Boston metros, it was well over 70%. Oklahoma City was the lowest, in the 20's range.
Homesellers reap gains they didn't sow. Mortgage lenders get to pocket large shares of young people's wages. There has to be a better way. Longtime readers will know what it is: shift our taxes onto land value, and off productive activity.
Table 2: Characteristics of First Time House Buyers
Median Real Income
Median Price/Median Income
Mean Monthly Payment/After-Tax Income
Notes: The table entries are from various issues of The Guarantor,
1978-1998, the 2005 National Association of Realtors Profile of Home
Buyers and Sellers, and 2005 American Housing Survey. The Real median
income is based on the CPI. Mean Monthly Payment/After-Tax Income
before 2005 is from The The Guarantor. In 2005 we made an assumption
about the average tax rate, .25, to calculate this variable.
From "Why Has Homeownership Fallen Among the Young?"
Table 3: Characteristics of First-Time House Buyers
Median Price/Median Income
Mean Monthly Payment/After-Tax Income
Source: Various issues of The Guarantor, 1978-1999.
A May, 2009, paper by Michael LaCour-Little, Eric Rosenblatt and
Vincent Yao entitled "Follow the Money: A Close Look at Recent Southern
California Foreclosures" provides some interesting data about
single-family residential real estate in one part of the US.
Briefly, the paper looks at loans in five southern California counties
which went into foreclosure in November in 2006, 2007 and 2008.
It traces the collateral and loans from purchase to foreclosure, and
provides some useful findings. Here's their abstract:
Abstract The conventional wisdom is that households unfortunate enough to
have purchased at the top of the market during the recent housing
bubble are those most at risk of default due to recent price declines,
upward re-sets of adjustable rate mortgage instruments, the economic
downturn, and other factors. Here we use public record data to study
three cohorts of Southern California borrowers facing foreclosure in
2006, 2007, and 2008. We estimate property values as of the date of the
scheduled foreclosure sale with the automated valuation model of a
major financial institution and then track sales prices for those
properties that actually sold, either at auction or later as REO. We
find that borrowers did not, in general, buy at the top of the market
and virtually all had taken large amounts of equity out of the property
through refinancing and/or junior lien borrowing. Given sales prices of collateral
thus far, aggregate losses to lenders will reach almost $1.0 billion
dollars compared to almost $2.0 billion dollars of equity previously
extracted by property owners.
They do for mortgage foreclosures what Elizabeth Warren (et al)'s, study did for understanding the role which uninsured medical expenses play in personal bankruptcy filings. California may be a more extreme case, for reasons which relate to the perverse incentives involved in the 1978 Proposition 13 property tax limitations. But my interest is not the same as what the authors were driving after.
I took their data and created a small spreadsheet to look at the data from a different point of view.
Their sample is composed of 4,258 properties which went into foreclosure in Novembers of 2006, 2007 and 2008. On average, the properties in each of the three cohorts had been purchased in 2002, and for an average price of $356,200. By November 2006, the properties which went into foreclosure that month had an average value of $519,000 (as calculated by a commercial proprietary Automatic Valuation Model). I made the assumption that the properties which were foreclosed on in November 2007 and November 2008 had the same AVM valuations in November 2006.
My calculations proceed as follows: I compare the average 2002 purchase price of $356,200 (a weighted average of the three cohorts) with the 2006 AVM valuation of $519,000, which provides a 4-year appreciation of $162,800 per property. Assuming that each homeowner's annual property taxes started at 1.25% of their 2002 purchase price, and rose by the Prop 13 maximum of 2% per year, they each paid, on average, $19,578 in property taxes over 4 years.
Houses don't appreciate. They depreciate at about 1.5% per year. They're never worth more than what it would take to reproduce them. Taking 65% as an estimate of the share of the value of single family homes in southern California which can be attributed to land (1998 was 64.9% and 2004 was 78.7% in Los Angeles, according to Davis & Palumbo, May, 2006), 65% of the 2002 purchase price of $356,200 is $231,535. Let's assume that the house doesn't depreciate at all, to account for owner-made improvements. Land value, then, rose from $231,535 on average in 2002 to $394,300 by 2006.
So what produced that rise in land prices?
Some of it has to be attributed to the increase in population during that period of time -- due to fertility, improved public health, immigration from other countries and other states. New relationships and broken relationships both contribute to the demand for housing. Since the quantity of land is fixed, land prices tend to rise with population.
Some of it has to be attributed to relaxed lending standards, which permitted more people to borrow more money
Some of it has to be attributed to changes in interest rates, which permitted more borrowing for the same monthly payment.
Some of it has to be attributed to Proposition 13, which limited property taxes to 1.0% (in practice, roughly 1.25%) of the original purchase price, with an annual increase capped at 2%. The annual rental value of land is generally 5% of the purchase value, so the 3.75% to 4% difference gets capitalized into the selling price of the land.
But let's think, too, of why people were willing to pay more to live in these five counties. It was due to the schools, to jobs, to the roads, the sewers, the water system, the police and other emergency services, buses and trains, airports, the courts, jails and prisons, the universities, the hospitals and libraries, and public health and a myriad of other publicly provided goods. The homeowners as homeowners paid only about $20,000 in taxes, and received, if the AVM is correct and they sold in 2006, $162,800 in appreciation on their land.
The study shows that those who were in the 2006 foreclosure cohort had total average housing-related debt by November, 2006, of $469,000, up from the original loans of about $334,400. So they'd taken out an average of $134,600 by borrowing against their home equity.
Did the services which contributed to raising that land value by over $160,000 over 4 years really only cost $20,000 per property? No. Sales taxes, and wage taxes and other taxes also financed those services. And they were paid not just by landholders -- the roughly half of southern California residents who own their own homes -- but also by the other half, who rent their homes from others.
So homeowners reaped a huge windfall, and those who were not homeowners ended up financing it. And as we attempted to increase the homeownership rate by a few percent by relaxed lending standards, they got to pay another time.
Most people think there is no viable alternative. They're so used to the current structure -- and in California, Proposition 13 is sometimes referred to as the "Third Rail" of California politics" (touch it, and you die!) that few stop to consider that our taxes are at the root of our most serious problems.
So what's the alternative? Sanity would be for all those public goods whose effect is to support and increase property values to be financed by a tax on land value. Justice -- ditto. Efficiency -- ditto.
California is floundering because it can't fund its spending. And yet these 4,258 households stood to collect from buyers, if they sold in 2006 after buying in 2002, an aggregate windfall of $693 million: I've aggregated the data for these November foreclosures and here's the story.
Aggregate purchase price, approx 2002:
Aggregate down payment:
Aggregate value in 2006:
Aggregate appreciation 2002 to 2006:
Aggregate 4-year appreciation as percent of down payment
Aggregate real estate taxes paid
(@1.25% of purchase price, rising by 2% annually)
Aggregate appreciation as percent of property taxes paid
Folks who think they and people like them stand to reap a gain of $700 million on an investment of $264 million in 4 years, while paying just $78 million in property taxes may not consider it to be in their best interests to shift taxes off wages, off buildings, off sales.
Had Proposition 13 not been in place, and property owners paid just 1.25% of their properties' market value each year, aggregate property tax would have been $97,500,000, or about 25% more (assuming straight-line increase from 2002 purchase to 2006 average value of $519,000). Still a tiny fraction of the appreciation.
The study's sample was only the November foreclosures. To approximate the figures for all the foreclosed properties in the five counties in those 3 years, one might multiply by 12. And recall that foreclosures are still a tiny fraction of all single-family residential properties in these five counties, and that these are relatively newly purchased properties. Think of how much could be collected in the form of a tax on land value if everyone, no matter what year they bought their property, paid at the same millage rate on their true market value, instead of some paying on values based in the 1970s.
We-the-people created that appreciation. Should homeowners and other landholders get to keep it as if they created it? Does the answer to that question hinge on whether the homeownership rate is 30%, or 50%, or 65%, or 75% in that particular place, or in our country as a whole? Or is the homeownership statistic irrelevant to the justice or logic of this privatization? (Remember that residential real estate is frequently NOT the biggest piece of this: the urban real estate owned by corporations, REITs, foreign investors including airlines and sovereign funds, pension funds, philanthropies, 150-year trusts, private equity funds and other private entities, appreciates far faster. (Remember Leona Helmsley's description: we don't pay taxes; the little people pay taxes.)
On the other hand, when one takes into account the fact that the run-up in prices this situation has led to a situation in which all these people have been foreclosed on, a large and rising proportion of mortgages are "under water" and observers are saying that the "bust" portion of this boom-bust cycle is going to leave something like 50% of mortgage holders "under water" by 2011, perhaps one might reach the conclusion that even if one is not convinced of the justice of revising our system, one might choose it strictly on the basis of avoiding boom-bust cycles being wise.
What is home equity, and how does it relate to the American Dream?
Sometimes we hear about "building home equity" as if it were some sort of muscular activity. There are two ways to "build home equity." The first, the old-fashioned way, is by paying down the mortgage. This happens fairly slowly. On a 30 year mortgage, and making no extra payments, here is the payoff schedule for several mortgage rates:
Cumulative Mortgage Payoff Schedule for 30-year Mortgage
Mortgage Interest Rate
The other -- and much faster -- part of home equity, of course, is the appreciation we have come to expect. What few people realize is that houses do not appreciate; they are never worth more than what it costs to build them, less depreciation, to account for deterioration, obsolescence of systems, etc. A Federal Reserve Board Study (May, 2006) pegged annual depreciation of single family home stock at 1.5%.
So when housing was rising in value by 5% or 10% per year, what was rising was the price of the land under the houses, not the houses themselves.
What causes land to rise in value? Not individual activity. Not the landholder himself. There is no muscular activity on the part of the landholder here! (Yes, the owner who does a gut renovation adds to his property's total value, though not always as much as the project costs. Most studies suggest that adding a second bathroom to a home which has only one actually adds more to the value of the property than the project itself costs; some say that adding a deck also pays back more than the project costs. Few other projects pay back fully, so while home equity may rise, it is through individual investment, and the owner's net assets do not increase as a result.)
Land rises in value for reasons which have little or nothing to do with the landholder himself:
Local taxpayers invest in goods and services which people value: good schools; well-paved streets; well-equipped fire trucks and ambulances; police trained in CPR and equipped with defibulators; parks; courts, jails; sewers and city water replacing septic and wells; libraries; community colleges; letc.
State and federal taxpayers invest in goods and services which people value: electricity; good transportation systems; infrastructure; "pork"; broadband; public colleges and universities; etc.
Private sector investments: good hospitals; cultural amenities; an active and vibrant local economy; a healthy downtown; private universities; charities; etc.
Technological advancements: elevators (urban land); air conditioning (southern states); earth moving equipment -- advances from WWII equipment (making difficult sites easier to develop); fiberglass boats (waterfront properties); maglev trains; etc.
Population increases: natural fertility increases; assisted fertility; fewer wars or auto or industrial accidents; better outcomes after such events; reduced infant mortality; better health resulting in longer lifespans; people having larger families because of religious beliefs or greater prosperity; local amenities which attract population to the school district or metro area; immigration from other countries; lower cost of living drawing more people;
So if all those things were happening, why did we just experience a crash in land values?
Well, what we experienced was a crash in land prices. Land prices got well ahead of land values in many places. This is known as land speculation. People were "investing" in land, buying homes for outlandish prices, thinking that prices would continue to rise forever. Mortgage lending standard went from 20% down to 10% down to 5% down to 1% down to 105% financing. Private Mortgage Insurance became the norm for first-time buyers. Debt to income ratios rose from 28% to the high 30's, or weren't even discussed. Mortage rates dropped, particularly for Adjustable Rate Mortgages. Interest-only mortgages became available, and negative amortization mortgages were a possibility.
How could we be so stupid?
Did someone yell "FIRE?" (as in the FIRE sector of the economy: Finance, Insurance, Real Estate) The FIRE sector was making money from this. Home builders. Land sellers -- including farmers, land speculators, mom-and-pop subdividers, and many others. Builders. Real estate brokers. Mortgage brokers. Mortgage insurance sellers. Title insurance sellers. Homeowners' insurance sellers.
We considered this private enterprise and pronounced it good.
Go back to the five items listed above, and tell me why a smallish -- or even a largish -- portion of the private sector ought to reap all the benefits for all those things, in proportion to the size and quality of their landholders.
But only the Georgists were aware of what was really happening. What was happening was that we attempted to increase the homeownership rate from the low 60's to the high 60s, under the guise or illusion that by doing so we'd be extending the "American Dream" to an additional 10% of our fellow residents of this country. But of course the homes they could afford were not in the places where land was appreciating, and their attempts to "catch the brass ring" which would, they hoped, make them part of the "rising tide." (Okay, too many metaphors ... but haven't we heard all of them in this context?)
What did the Georgists know? That land value which our system permits landholders to privatize ought to be socialized. Small landholders ... most of the residential owners, that is ... get to privatize some small land value ... a bone to shut them up, while the big landholders -- individuals, family trusts, corporations, REITS, philanthropies, universities, churches and other tax exempts, individual foreign investors, pension funds, private equity funds, foreign sovereign funds, etc. -- get to privatize the BIG land value in our cities. Even in our small cities and medium-sized towns, the businesses which are their own landlords are, on average, far more profitable than those which are tenants, and landlords take a significant share of their tenants' production -- a non-agricultural version of sharecropping, which we honor as if the landlord was actually a producer of some sort.
John Stuart Mill, one of the classical economists, told it this way: Landlords grow rich in their sleep.
So back to the initial question: what is home equity, and how does it relate to the American Dream? Home equity is a sop, thrown to keep the puppies quiet and calm, while the big dogs enjoy the contents of the manger.
We'd be far better off if the vast majority of us -- and our elected officials -- understood and talked openly about what Henry George was telling us, in his landmark book on political economy entitled Progress and Poverty -- subtitled: An inquiry
into the cause of industrial depressions and of increase of want with
Remedy: that we permit the privatization of the economic value of our natural and other rightly-common resources, including urban land value, at our extreme peril.
We turn the American Dream into our common nightmare. Increasing home equity holdings is not the answer to our problems; it is, at bottom, a symptom or sidelight of the problem itself!
We can fix this through a simple and just tax reform.