As I listened to the news coverage of the financial market meltdown, I heard Sec'y Paulson refer to productive loans. It set me thinking -- not along the lines he intended, I'm sure.
A loan to buy a home is not entirely a productive loan. By this, I mean that it is to cover the purchase of two very different kinds of assets.
- One is manmade. It was produced by a builder, who coordinated a team of workers and assembled the appropriate materials. This might have occurred last month, last year, 50 years ago or 100 years ago. If others have occupied the home over the years, they, too, may have made improvements to the structure and to the rest of the property. (At the same time, the house itself has been depreciating; a May, 2006, Federal Reserve Board study pegs annual depreciation at 1.5% -- a good deal slower than the 27 years over which a commercial property gets depreciated.)
- The other is a value created by the community. None in the string of previous owners created the land value. The land value is created by the entire community. Where the economy is healthy, where jobs are available, where schools are good, where emergency services are reliable, where courts are respected, where transportation systems are available, where wages are good, land value will tend to be higher and to rise faster than where these conditions do not apply.
But a homebuyer, as we do things now, must pay the homeseller for both the house itself and the land it sits on.
The portion of his purchase money -- and his mortgage payments over the next 30 or more years -- that goes to paying the seller for land value is nonproductive. It doesn't incentivize anyone to do anything useful; it rewards the seller for value he had no part in creating! It doesn't create any jobs for anyone. The seller may have sat on many lots of increasingly valuable land for decades, forcing the community to sprawl outwards, building infrastructure to get past this pocket in the development. Or he might have simply occupied his own little lot for decades, riding the value upwards.
[Am I blaming him? No. Not at all. I'm blaming a foul system, just as Winston Churchill did 99 years ago, and calling for its identification and correction. And I'm calling attention to how it affects our younger people, in particular.]
In general, a new house tends to be on the fringe, and the value of the house itself is about 3 to 4 times the value of the land on which it sits -- which is to say that the land share of real estate value is about 20% to 25%. [This tends to be true of spec homes built after a teardown, too.] But if the local economy is healthy, and the town is a nice place to live, that will never be true again. The house itself will begin to depreciate, at 1.5% per year. The owner may make improvements -- landscaping (which may increase in value over time, as it matures, if it is well chosen and well cared for -- and which is an improvement, not part of the land value), outfitted closets, a deck, etc -- which may raise the value of the home by roughly as much as they cost (if they are of good quality and sufficiently "plain vanilla" to be appealing to others). Most other improvements do not raise the value of the overall property by as much as they cost. (One other exception: a second bathroom added to an older home with only one bathroom.)
The FRB study which found depreciation to be 1.5% per year also showed that, on average, in 2004, in the top 46 metro markets, land value represented 51% of the value of single family housing stock. In a few metros, it was as low as 25%; in others, including San Francisco, 88.5%.
Let's just look at the average. 51% of the purchase price goes to paying the seller for land value he didn't create. 49% of the purchase price represents the value of the building and other improvements, which either the seller or one in a serious of predecessors created.
Paying the seller for the 49% which represents the value of the improvements represents payment for productive activity. The other 51% is for not producing! It represents a privilege we've given over to landholders to privatize value which their community creates. Those who own choice land -- e.g., waterfront, downtown, or near transportation -- get to privatize lots and lots of money that way. The less fortunate landholders, having been created equal, get to privatize the value of inferior sites on the fringe. Tenants get to privatize none at all. (And we relaxed the borrowing standards so that more of the tenants could try to join the folks who were buying on the fringe, bidding up their cost of living, and giving the former holders of that land the wherewithal to buy better land closer to the center of things!)
So when I heard Sec'y Paulson's comment about productive loans, what went through my head was that the portion which relates to buying land -- be it for a home, or for a business -- is not productive. It is inert. It is not rewarding productive activity. It creates nothing, other than riches for the seller, who didn't lift a finger to create it, and should be no more (or less) entitled to privatize that value than the fellow who can only afford to own land on the fringe, or who can't afford to own at all and must rent from someone else.
The portion which is spent paying the seller for the depreciated value of the existing buildings on the property is compensation to him for something manmade, and for his maintenance and improvements of it. That is productive activity. Such a loan qualifies, in my mind, as a productive loan.
So what's the alternative to the non-productive portion of the loan?
Well, for a wide range of reasons, we should shift our taxes off wages and sales, and onto land value and natural resources. When we tax land value more heavily, what will the result be? The value of land will not be altered, but the selling price will go down. The tax will be capitalized into the price of the land. Quick and dirty, when we place a tax of roughly 5% to 6% on the current selling price of land (which is, in part, a function of the current property tax rate, among other factors), the selling price of land will fall to approximately zero. Returning to that average metro area, that would reduce the price of housing by half. Young people buying a house would pay half as much to the seller, and half as much to the mortgage lender -- and would pay a land value tax to their local community. And that revenue would be sufficient to meet their total tax obligation. The local community would forward a portion of that tax to the state, which would in turn forward a portion of its collections to the federal government. For the homeowner, the cost of living would go down. His taxes and his land rent would be one and the same, rather than him having to pay off the seller for value the seller didn't create AND having to pay taxes to support the services which make his community a good place to live.
No one would grow wealthy by sitting on land. And no one would be paying twice, in the form of rent on land being paid to the seller and, with interest, the mortgage lender, AND additional taxes to the community. Tenants' tax burden would be part of the monthly rent they pay their buildinglord. But it wouldn't sit in his pocket or enrich his heirs -- it would be forwarded to the community chest, the legitimate revenue source for common spending.
I've not expressed this as clearly or eloquently as I'd like, but hope you might find it useful.
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