The Law of Rent in a Collaborative Economy

Renegade Economists podcast 341

As broadcast on 3CR, Wednesday May 28.
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This our 1st translation via Dragon Dictation. Edits for readability.

Welcome to the show with your host Karl Fitzgerald. This week we are starting with an overview on some of the economic theory underpinning the show, focusing on the monopoly rights – the privileges landlords, bankers and natural monopolists enjoy over anyone earning a mere wage. How is that playing out through the eyes of the federal budget? Then we move onto some of the frontiers of change in this modern economic era with the collaborative economy, the peer-to-peer economy that seems to be booming so well overseas.

I am looking forward to actually being in California soon for a couple of conferences over there, where I’ll be investigating in more detail what’s happening with this peer-to-peer economy.

Let’s start off by taking a moment to discuss some of the core concepts here at the Renegade Economists.

The big one of course is this concept of economic rent, which is an unearned income. I often say  this is the naturally rising value of the earth and its natural monopolies.

More technically, economic rent is any payment to a factor of production in excess of its opportunity cost. That means any payment to labour or capital, or land in excess of its next best use. It’s paying them more than what they would ideally require to perform a role. This is important because people are earning money for something over and above the cost of production. That’s the key point with paying more than what we should for that product to be actually produced. If enough people are engaging in this sort of rent seeking behaviour, the comparative advantage of a nation is undermined and from there we lose out in the long run to more competitive neighbours.

Now we will get to how this is playing out in the modern world in a little bit, but I just wanted to also discuss the flipside to economic rent. If you are really going to get your head around this whole story we have to understand the Law of Rent. David Ricardo wrote in 1809 ‘the rent of land is determined by the excess of its product over that which the same application can secure from the least productive land in use’.

Wikipedia says the law of rent states:

‘the rent of a land site is equal to the economic advantage obtained by using the site in its most productive use, relative to the advantage obtained by using marginal land for the same purpose, given the same inputs of labour and capital’.

Now why this is important is because of that last half of the sentence ‘relative to the advantage obtained by using marginal land for the same purpose given the same imports of labour and capital’.

So let’s take the most marginal land (and for the sake of the story) imagine we had the NBN (high speed internet) out somewhere in the Malee here in Victoria, our desert-like lands. Say you could purchase some barely arable land that let’s say is totally unfarmable but you do have the Internet there.

You set up a business and you sell X widgets, perhaps craft, maybe you are a musician or you’re an economist and you write books out there. You sell your products online and from that neighbours see a new way of earning income is possible six hours away from Melbourne. Perhaps a couple of your colleagues say ‘well heck it’s so cheap to live up there, look how much he’s paying for land, he’s paying barely anything to live up there, I’m going to move up there as well’.

As more and more people start moving up there, there is competition for people working outside the regular economic system. If enough people start doing this and there’s profit in it, there will be added competition in the job market.

This is where it gets important.

What we’re saying here is that wages are not set by the productivity that we can produce in a workplace, they are not set by some centralised wage fixing agenda but through thousands and thousands of decisions like this that are made where people say, ‘blow working in a factory, blow working as a courier, I’m going to go and start my own business, even if it’s miles away from the city and I’m going to be able to earn some income that’s comparable if not better to what I’m earning here’.

As this goes on, manufacturers realise ‘heck we’ve got to pay higher wages to keep these people employed here’. So it is at this point where the marginal land is, where wages are truly set.

As more people move into this town in the Malee, competition for land, increases. If we were entirely rational, online salesmen would try get as close to the NBN node up there, the main distribution point where you could get the fastest Internet.

Competition around that node would increase and the land rents charged there would increase. So the economic rents there increase. This is the core issue. Should we allow this naturally rising value of the Earth to be privatised as if that Landowner created that land and created all of the services surrounding it? Or should this naturally rising value of the earth, due to competition from society, developments within society, should that be the natural source of financing government?

Of course here on the Renegade Economists, as Project Director for Prosper Australia, that’s our best case scenario. The synthesis of capitalism and socialism, there’s even a geo-anarchism version, a geo-libertarian take, where all of these various philosophies can come to some form of agreement that the least bad tax (as Milton Friedman once said) is a tax on unimproved land. This is the Earth itself.

Whilst tax is a scary kind of word, (I kind of joke that it’s white man’s word for sharing) unfortunately there’s been such a disjoint between what we pay in tax and the services that are delivered, that more and more people are protesting in effect by engaging in tax planning. This is another euphemisation for tax minimisation a.k.a. tax dodging. We will be discussing some of those issues with our guest today Jodie Hutton.

Karl Fitzgerald (KF): This week on the Renegade Economists we are joined by Jodie Hutton, co-director at DBA accountants. They specialise in family run businesses and helping them grow.

Jodie welcome to the show. I’ve invited you on to try and give us an insight into how accountants are perceiving the current federal budget.

Jodie Hutton (JH): Well we’ll wait and see. I guess my view is, there are some interesting things but they’re not law yet, but when they are, we will take action.

KF: So they must keep you very busy, reading up on the latest legislation. How many pages of tax law are there?

JH: I wouldn’t know how many pages there are, but I know my co-director would like to come back in his next life and re-write the tax law because there’s far too many pages.

KF: Do you have to read 200 pages of fine print to get on top of your trade every year?

JH: There is a lot to keep up with, a lot of reading, a lot of seminars.

KF: Well one of the big issues of course is this new deficit levy tax, which the Labour opposition is going to support, ensuring this 2% levy on those earning more than $180,000 will go through. What sort of stories are you hearing on how that will play out in the tax accounting marketplace?

JH: I haven’t heard a lot of stories, of course there are stories both ways. We hear some people saying ‘fantastic the rich should pay more tax’, other people saying that ‘it’s an unfair tax’. There are lots of measures going across a broad spectrum of taxpayers, so I’m not surprised by the levy, let’s put it that way.

KF: Yeah well it’s interesting. Australia’s $123 billion deficit (forecast over the next four years) and this deficit levy is looking to raise just $3 billion so it is not really going to do much. I’m interested to see whether taxpayers are really going to do what Joe Hockey implored them to do during his Treasury speech, ‘for everyone to contribute‘. Or will the capabilities inherent in the numerous tax planning scenarios be used?

The big one of course is whether negative gearing will be used to a greater degree as a way to write down their taxable burden?

JH: Well from my experience taxpayers will do everything within their powers to reduce the amount of tax they pay. So where there is a legitimate, legal way to reduce the amount of tax payable, taxpayers will do it.

However, I’m not sure if people who’ve really thought it through, will take on large amounts of debt to avoid what could be in the scheme of things, be not that much money. Somebody earning $300,000 per year will pay an additional $2400 per year in the 2% levy. I’m not sure that anybody that really considers it will negative gear just for the purpose of saving $2400, because they are going to be out of pocket more than that to own the property. Now the $2400 may be an attractive saving if they were considering negative gearing for other purposes or it may be a little bit of icing on the cake, but I don’t think they’re going to negatively gear just for that saving.

KF: So you’re saying negative gearing might be adopted more in the share market rather than in the property market?

JH: Property or sharemarket. I suppose you could negative gear for small amounts in the share market, but you are still going to be out of pocket. The interest that you pay on your NG is still an out of pocket expense. For every dollar that you are paying in the interest, even with the 2% levy, you are still only saving 50 cents, so you’re still out of pocket 50 cents.

KF: 3CR’s Renegade Economists this week is discussing with Jodie Hutton, director of DBA accounting, some of the tax implications of the recent federal budget.

Jodie – Self Managed Super Funds – we’ve been covering this topic on the show now for about four years and are very interested in the developments there. They (SMSF’s) seem to be growing at a rapid rate. The ATO is warning there’ll be big fines for people who were not filling out the tax paperwork correctly.

The growth of self manage super funds – is this sustainable? Will their investment strategies stand up over the long run?

JH: Well there certainly has been a growth in self managed super funds. Whether they are sustainable, time will tell. I think they will be a target for the government in terms of taxing. They certainly have been under fire from the ATO in terms of audits. We have seen a marked increase in the number of audits. Not only an increase in the number of audits but also a much more rigid stance from the ATO in the way they are conducting the audit findings.

So self manage super funds trustees beware. You really do need to make sure you’re following the rules.

KF: We jumped on this issue because of the zero capital gains exemption for those who buy property in their pension phase (over 55). Could you clarify your understanding of the basics of this capital gains tax exemption, on why the government brought this in? It seemed to be introduced in early 2010, probably via the May 2010 budget, just as housing prices were starting to fall, following the global financial crisis. This was one of a number of strategies that helped stabilise property prices, which now seems to be rocketing back up again.

SMSF property ownership is still at a relatively low level but it’s just one of a number of different policies that have gone to support the role of investment in real estate.

JH: I have heard talk about how super funds are propping up the property market.

KF: In terms of SMSF’s, do you think it difficult that we have a situation where those in the top income bracket can avoid paying 47% income taxes by using the SMSF to to wash their incomes through, in effect channelling their income through their SMSF at 47% and withdrawing the next day to pay just 15%?

JH: I don’t know how many people are actually doing this and I don’t know how much tax is being avoided because the maximum contribution people can put into superannuation is relatively low and if we’re talking about high income earners depending on their age, somebody aged over 50 putting 35,000 into super, how much tax is actually being saved there and how many people are actually doing, i’m not sure. I don’t see it being done widely at all with our client base.

KF: It is interesting the government has ceilings on Superannuation contributions. Why would they limit the amount of money you can contribute?

JH: Well I’m again assuming so that they reduce the amount of tax deductions available to employers, thereby increasing the revenue base.

KF: The Tax Expenditures in superannuation now equate to $30 bn plus a year. It is ironic that that’s the sort of budget shortfall we have. Unfortunately these loopholes were allowed to go through to the keeper. Instead, workers and students are to pay more.

JH: I can understand why people may see those headlines and be upset by it, but at the same time if we’re not encouraging contributions into superannuation, we’re going to be worse off later when there’s no money to fund retirement.

KF: Yes well it’s a Catch-22 because the public finance system is under great stress as various tax avoidance strategies are utilised. At the same time the younger generations are bleeding from the high price of land and from that, real estate, and so requiring more help from government. All that is really happening is property prices are going through the roof and we are all ending up further and further in debt. Which means being a self-supporting pensioner or even a healthy family is more difficult in the future.

JH: Yup I agree.

And there we have Jodie Hutton from Western Australia, an accountant talking to us about possible tax minimisation plays. She sees things from the other side of the fence and that’s fair enough. Apparently negative gearing on property is not going to be such a big deal because someone earning $300,000 will only be paying an extra $2400 in this deficit levy tax. Jodie says that it will not be worth going into a $400,000 – $500,000 mortgage to just wind the tax payable down to some $1200. It’s going to be interesting to see how it plays out.

Note that in the UK they increased their top income tax bracket from 40 to 50% and due to tax minimisation strategies, the government was expecting to raise I think about some £10 – 20 billion extra but they raised zero because everyone dodged their taxes. So let’s see whether just a small rise of 2% will have a more amenable result for the government. The year after that increase from 40 to 50%, the UK government cut it back to 45%. They then raised $9 billion in extra revenue.

What this is all pulling into focus with these drastic cutbacks the federal government has announced, that’s really incensed society – I thought there would be some strong are feedback on it but it’s been a lightning rod for the community to really look into the role of government inequity and the real naked support of the top tier of society, where those earning over $88,000 a year are adjudged in the top 20% of the nation and they’ll be paying something like $1.1 ($1.78) billion in extra charges but those in the lowest quintile, the bottom 20% of the population, will be paying an extra 2.9 billion – a lot of extra money. I think I may have got those figures slightly wrong but the fact is the poorest will be paying about 40% more.

This cause of concern about inequality is pertinent because around the world since the GFC, we have seen that the main Washington consensus answer has been for governments to enforce austerity, to slash and burn on health and education, to really cut back the public service and constrain expenditure. That will help the economy grow.

All that’s been good for is the upper echelons to waltz through Europe, to waltz through North America, buying up fire sale privatisations and being in a beautiful position to sit on them for the the next 5 to 50 years and keep increasing prices using their monopoly rights.

Will that occur here in Australia, with the upcoming privatisation agenda? We dare say so but what it’s really hinting at is not just the need to cut back on some areas but really to focus on how we are raising the revenue and ensuring that the way it’s raised also encourages good behaviour. This is why at the top of the show I talked about economic rents. Sorry that’s been a bit dry today but that’s what I am trying to get people to really key into is that this naturally rising value of the earth is the natural source of government revenue.That’s how government was financed for thousands of years.

It’s only been since the enclosures in the 1300s – 1400’s that the tax switch has moved away from those who owned the Earth, away from this concept, of those who own the land, paying for the governing of the land and onto workers who are forced to pay more more just to survive.

Your taxes-2

The great tragedy is that whilst workers pay the taxes that finance the infrastructure that makes land more valuable around the new train station, around the new hospital, they are the sort of windfall gains that are driving this inequality wedge through society at a rate of knots.

Unfortunately Thomas Piketty, the author of the booming book that is basically storming the world, (Michael Hudson and I discussed it a few weeks ago), has not really got his head around economic rents. He talks about a wealth tax, talks about an inheritance tax but a fairer way that may have a chance of getting both sides of politics on side, all generations on side, is that these natural advantages are paid for.

The problem is if someone does own the best land near the river with the most fertile soil, other people will be jealous of that locational advantage (reflected in the economic rents) – the high output for that land compared to someone working the same hours with the same tools on less fertile land. That jealousy often leads to wars – a la the Gaza Strip.

I did want to quickly mention what’s happening in the tech world because it’s been interesting with these privatised monopolies fighting back against this peer-to-peer revolution. Whilst there are companies getting quite a lot of buzz such as Uber, such as a Air BnB we do have to ask questions whether companies should be making millions of dollars off the back of peer-to-peer technology?

Air BnB benefits where basically as a short-term tenant you are peer reviewed by your landlord there and that review is referenced by future places you may travel to and want to stay in that property. That sort of social infrastructure is providing great advantages to Air BnB but on the downside in New York for example, basically the home of capitalist forces, what we’re seeing is that local people are being kicked out of the once bastion of affordable rental type properties because landlords are realising they can rent out their property for maybe just 8 days a month and earn more money than renting out to a local.

That’s enforcing gentrification.

It’s also leading to concerns from the American Hotel Association where the Hiltons of the world are kicking up a stink that these guys are unregistered (mum and dad Air BnB landlords) – this is bringing out the whole pile of concerns.

The Internet has done a great job in terms of lowering the barriers of entry to the marketplace so that everyday people can be involved in the beauty of demand and supply, the pricing mechanism that directs our energies to the cheapest alternatives.

From that the hotel industry is saying these guys are unregulated, these mum and dad hotel Air BnB types need some form of regulation. There’s blowback going on. This is really a battle of competitive forces but also this regulatory strength that current market powers, dominant powers in an industry have and whilst that’s part of the survival of the fittest we really have to beware that what they are trying to do is protect their economic rents.

The Hilton family probably bought their land in prime New York back in the 50s for maybe $50,000 and now it is worth $500 million for a piece of prime real estate near Central Park.That differential between $50,000 and $500 million is something that perhaps the community should have a share of.

You’ve been listening to a 3CR podcast produced in the studios of independent radio station 3CR in Melbourne, Australia.

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