Right now land prices need to be stabilised, but wages and inflation need to accelerate so our debts don’t drag the economy into recession. Ideally land prices would stay constant, and wages would grow faster so the price of land in real terms (after inflation) falls. This is easier said than done…
After the Federal election, our hopes for reform to the Capital Gains Tax discount and Negative Gearing will not be fulfilled in this term of parliament. Some are suggesting that this is for the best, as housing (read: land) continues to dive, and the economic soothsayers are warning of recession. While we all want lower land prices relative to real wages, we don’t want fewer jobs and less business. That’s what a recession can bring.
Will reforming tax on land and housing really blow up the economy? It is worth taking a step back to assess what is really going on and what can be done about it.
The canary in the coal mine
At Prosper, we look to falling land prices as a leading indicator of economic recession. Notably, recession usually occurs within 2 years of peak prices. For this cycle, the market’s upward trajectory peaked in September 2017.
The Reserve Bank of Australia has re-examined the tea leaves, and divined that its estimation of the NAIRU (non-accelerating inflation rate of unemployment) is now too high. The NAIRU attempts (albeit poorly, if at all) to capture the fullness of “full employment”; how low unemployment can go before inflation takes off. Inflation has been persistently lower than expected, resembling the situation in the US and elsewhere.
That means the economy has more spare capacity than previously thought, the upshot of which is that the RBA is not doing enough to reduce unemployment. The RBA is mandated to fix the problem, but interest rates can’t go much lower. Rate cuts below 1% are also ineffective.
QE (Quantitative Easing) has been proposed, however recent international experience with quantitative easing is uninspiring. Providing cheaper debt to already heavily indebted workers and reluctant businesses has little impact. This is because the economic problems have little to do with the cost of borrowing for investment. Instead, QE inflates asset prices (e.g. shares, bonds and potentially property) to the benefit of the wealthy who already owned them.
Slow deflation or catastrophic bust?
The decline in property prices was triggered when prudential regulators actually started doing their job by enforcing proper lending standards on banks. The Royal Commision combined with more risk averse banks, resulted in a credit crunch. This has affected potential buyers, and also developers. The downturn has raised the spectre of knock on effects to construction and retail related businesses that cater to new housing investment.
During the election campaign, the government stoked fears that the ALP’s tax reforms would amplify the property market downturn into a recession-causing bust. However, it’s hard to see how winding back negative gearing and the capital gains tax discount could have done much more harm. The proposed changes were all grandfathered, and had no impact on existing investors. Potential investors may have been deterred from buying, but those impacts are stronger when prices are rising. Prices are falling. Had the ALPs policies come to pass, they would have softened the next boom, and prevented spiralling housing unaffordability.
The ALP also proposed to direct millions of dollars into social housing development and build-to-rent. Aside from providing targeted relief for those marginalised by soaring housing costs, this strategy made the government and superfunds a sort of “buyer of last resort” to bailout the market. Proposed large income tax cuts would have also fed back into higher property prices via the trickle up effect.
The current nominal decline in land prices (~10%) has been manageable, but much further would cause big problems. As Keynes (and other economists) have noted, capitalism has an easier time with prices going forwards rather than backwards. Debt becomes debilitating when prices fall but what’s owed does not – no one buys for capital loss. People stop spending, jobs stop opening, and the economy grinds to a halt.
Stabilising land prices. What can be done?
The RBA has been calling on the government to spend more on infrastructure and effectively engage in stimulus deficit spending. The GFC shows us this works in practice, although if rushed can be poorly executed. There is a problem though… Governments are already spending big on infrastructure. So big in fact, that Victoria is short on concrete. There is no spare resource capacity left in the construction sector to build more infrastructure on the east coast at the moment, let alone more housing. So in some ways it has been beneficial that developers have been stunted in building more housing.
The Government needs to throw money at something that doesn’t involve more concrete.
Income tax cuts (by raising tax brackets and wind back bracket creep), are one obvious option that will help significantly, especially considering the retail sector is already in recession. Tax cuts were taken to the election by both major parties, however they are not large enough, and alone are not enough to achieve the RBA’s desire to get an extra 100,000 jobs overnight.
The government needs to spend more on things we have a lot to spare… Maybe re-hiring those CSRIO scientists and public servants it’s sacked over the years? Although that assumes they’re still around, and would be a more long term commitment. Health, education and expansion of social services pose a similar issue. Spending more on these things would be beneficial, but limited in scope given stimulus is needed now. Now is the time for Australia to look at a Green New Deal and directly employ people to fix the planet. This could be a good fit for the re-elected Coalition Government, given their preferences for Direct Action.
Its not debt that “drags the economy down” into recession, but the lack of opportunity to find work and to a degree to find suitable accommodation too. When there is speculation of the land value and some of the development sites of land being are being withheld from use, there is less of it available at a reasonable rent or price. Then entrepreneurs will cease to begin new projects and cut down on existing ones. This is what reduces the opportunities for unemployed workers to find jobs. The debt itself is not the direct cause of the recession, although it can cause the effects of it to worsen when mortgages turn sour and banks find themselves having to release more money that they might otherwise hold in reserve.
Hello. I disagree with this article. House prices have nearly tripled in Sydney and doubled in Melbourne in a span of 5 years and yet this is not so much of a concern? Today, house and land values are going down and this article states the need to stabilize land prices? Totally disagree. W should focus on the root of all of Australia’s economic woes.
Our problem is we have gone from a production based economy to an importing one. One sided trade deals in favour for other countries are the norm. The focus on the accumulation of debt rather than on savings. In other words, we spend more than we earn. None of this is mentioned or analysed. This irresponsibility didn’t happen by accident. Consecutive governments deliberately encouraged all this corruption.
The blame is on the all governments irrespective of the political spectrum and especially the voters for encouraging this irresponsibility by voting for them. I say let the whole house of cards fall alongside house and land values.
Hi David,
I should probably clarify that when I talked about debt, it was not as the cause of the recession but rather a factor that makes falling nominal prices an issue in capitalist economies. There are similar issues with falling nominal wages and nominal consumer prices (even if real wages are increasing) aka deflation. Falling (land) prices trigger a credit squeeze. The credit squeeze itself causes the recession when consumer spending, private investment and aggregate spending (absent Government intervention) falls. In Australia credit for financing new dwelling construction has dried up, which means new development has ceased. Falling land prices shouldn’t affect the productive sector, but it does because of the relationship to credit that indirectly fuels demand for productive sector output.
Hi Theo,
The purpose of this article is not to dismiss the problems of the huge rises in land prices, nor ignore the other (important) factors you have mentioned. It is analyse how falling nominal land prices cause economic (primarily recession) problems in capitalism. Land prices need to fall in real terms, but doing so doesn’t require the actual $ value to go down. If your pay increases by 10x and land prices do not change, then the price of land has fallen in real terms relative to your wage – land has become cheaper. The point is we need to engineer inflation in everything else (especially wages) while keeping land prices constant.
The primary assumption in the piece is we care about avoiding recession and impoverishing millions of people, since we want Australia to “Prosper”. If we create a recession sure we’ll lower land prices, but if people can’t buy land because they’re unemployed it kind of defeats the point.
There are not many instances where land prices have fallen without causing recession. Only Japan has managed to get out of a recession and keep prices falling. However Japan’s circumstances are a bit different. Firstly their population is ageing and shrinking, which reverse the demand pressures for housing. Secondly Japan’s economy is more heavily reliant on value-added exports and (now via QE + stimulus) government spending, it does not (at least these days) have a dominant industry built around the real estate sector that relies on constant development. This is something Australia needs to move away from, however shock therapy without any transition plan in place would do a lot of harm. Whereas keeping land prices stable in nominal terms allow those shifts without the same levels of disruption.
The Most Socially Just Tax
Our present complicated system for taxation is unfair and has many faults. The biggest problem is to arrange it on a socially just basis. Many companies employ their workers in various ways and pay them diversely. Since these companies are registered in different countries for a number of categories, the determination the general criterion for a just tax system becomes impossible, particularly if it is to be based on a fair measure of human work-activity. So why try to do this when there is a better means available, which is really a true and socially just method?
Adam Smith’s (“Wealth of Nations”, REF. 1) says that land is one of the 3 factors of production (the other 2 being labour and durable capital goods). The usefulness of a particular site of land is expressed by its purchase price and in the amounts that tenants willingly pay as rent, for its access rights. Land is often considered as being a form of capital, since it is traded similarly to other durable capital goods items. However it is not actually man-made, so rightly it does not fall within this category. Indeed, the land was originally a gift of nature (if not of God), for which all the people in the region should have equal rights for sharing in its opportunities for residence, accessibility and use.
However over many years, as communities became established and grew, the land has been traded as if it was an item of durable goods and today it is often treated as a form of capital investment. It is apparent that for a particular site, its current site-value greatly depends on location and is related to the community density in its region, as well as the size and natural resources that it can provide. Such bounty, often manifest in the exploitation of rivers, minerals, animals or plants of specific beauty and use are available only after infrastructural developments have made possible access to the particular place. Consequently, much of the land value is created by man within his society, by his need and ability to reach it and take from it materials, plants and live creatures, as well as the opportunities it provides for working space near to people. These advantages should logically and ethically be fairly returned to the community, for its general use within the government, as explained by Martin Adams (in “LAND” REF 2.).
However, due to our existing laws, the land is owned and formally registered and its value is traded, even though it can’t be moved to another place, like other kinds of capital goods. This right of ownership gives the landlord two big advantages over the rest of the community. He/she can determine how it may be used, or if it is to be held out of use for speculative reasons, until the city grows and the site becomes more valuable. Secondly the land owner enjoys the rent from a tenant or its equivalent if he uses the land himself. Speculation in land values and its rental earnings are encouraged by the law, in treating a site of land as personal or private property—as if it were an item of capital goods, although it is not, see Prof. Mason Gaffney and Fred Harrison: “The Corruption of Economics”, REF. 3.
Regarding taxation and local community spending, the municipal taxes we pay are partly used for improving the infrastructure. This means that the land becomes more useful and valuable without the landlord doing anything—he/she will always benefit from our present tax regime from which the land value grows. This also applies when the status of unused municipal land is upgraded and it becomes fit for community development. When this news is leaked, after landlords and banks corruptly pay for this valuable information, speculation in land values is rife.
There are many advantages if the land values were taxed instead of the many different kinds of production-based activities such as earnings, purchases, capital gains, home and foreign company investments, etc., (with all their regulations, complications and loop-holes). The only people due to lose from this are those who exploit the growing values of the land over the past years, when “mere” land ownership confers a financial benefit, without the owner doing a scrap of work.
Consequently, for a truly socially just kind of taxation to apply there can only be one method–Land-Value Taxation.
Consider how land becomes valuable. Pioneers and new settlers in a region begin to specialize and this slowly improves their efficiency in producing specific goods. The land central to the new colony is the most valuable, due to its easy availability and least transport needed. After an initial start, this distribution in land values is created by the community. It is not due only to the natural land resources. As the city expands, speculators in land values will deliberately hold potentially useful sites out of use, until planning and development have permitted their more intensive use and for their values to grow. Meanwhile there is fierce competition for access to the most suitable sites for housing, agriculture, manufacturing industries, transport byways, etc. The limited availability of the most useful land means that the high rents paid by tenants make their residence more costly and the provision of goods and services more expensive.
Entrepreneurs find it difficult or impossible to compete with the big organizations who have already taken full advantage of their more central sites. The greater cost of access, or the greater expense in transportation from less costly outlaying regions, discourages these later arrivals. It also creates unemployment, causing wages to be lowered by the land monopolists, who control the big producing organizations, and whose land was previously obtained when it was relatively cheap. Consequently this basic structure of our current macroeconomics system, works to limit opportunity and to create poverty, see above reference.
The most basic cause of our continuing poverty is the lack of properly paid work and the reason for this is the lack of opportunity of access to the land on which the work must be done. The useful land is monopolized by a landlord who either holds it out of use (for speculation in its rising value), or charges the tenant heavily for its right of access. In the case when the landlord is also the producer, he/she has a monopolistic control of the land and of the produce too, and can charge more for this access right than what an entrepreneur, who seeks greater opportunity, normally would be able to afford.
A wise and sensible government would recognize that this problem of poverty derives from lack of the opportunities to work and earn. It can be solved by the use of a tax system which encourages the proper use of land and which stops penalizing everything and everybody else. Such a tax system was proposed about 140 years ago by Henry George, a (North) American economist, but somehow most macro-economists seem never to have heard of him, in common with a whole lot of other experts. (I would guess that they even don’t want to know, which is even worse!) In “Progress and Poverty”, REF. 4, Henry George proposed a single tax on land values without other kinds of tax on earnings, sales of produce, services, capital-gains etc. This regime of land value tax (LVT) has 17 features which benefit almost everyone in the economy, except for landlords, tax collectors and banks, who/which do nothing productive and find that land dominance and its capitalistic exploitation have their own (unjust) rewards.
17 Aspects of LVT Affecting Government, Land Owners, Communities and Ethics
Four Advantages for Government:
1. LVT, adds to the national income as do other taxation systems, but it should replace them. The author has shown in REF.5, that taxation of any kind is beneficial to the country as a whole due to its national income providing for more work too, but that when the tax applies to land the topology and spread of its effects are about 3 times as beneficial as when the same amounts of income are taken directly from labour.
2. The cost of collecting the LVT is less than for all of the production-related taxes–tax avoidance becomes impossible, because the sites are visible to all and who owns each site is public knowledge. The army of tax collectors who are opposing a similar set of lawyers, are no longer busy with tax loop-holes in the law, so the number of people more productively employed will grow and the penalty on the country of having complicated taxation is less.
3. Consumers pay less for their purchases due to lower production costs (see below). They can buy more goods and enjoy a raised standard of living. This creates greater satisfaction with the management of national affairs and more prosperity.
4. The national economy stabilizes—it no longer experiences the 18 year business boom/bust cycle, due to periodic speculation in land values (see below). The withholding of unused land is eliminated see item 7, so there is less need for the complications of frequent land sales, with developers searching and buyers hunting for unused sites.
Six Aspects Affecting Land Owners:
5. LVT is progressive—this tax depends on the site area as well as its position. The owners of the most potentially productive sites pay the most tax per unit of area. Urban sites provide the most usefulness and their owners will pay at greater rates, whilst big rural sites have less value and can be farmed appropriately, to meet their ability to provide useful produce. Small-holder farming closer to population centers becomes more practical, due to local markets and reduced distribution costs.
6. The land owner pays his LVT regardless of how his site is used. A large proportion of the present ground-rent from the tenants (who do use the land properly), becomes transformed into the LVT, with the result that the land has less sales-value but retains a significant “rental” value.
7. LVT stops speculation in land prices, because the withholding of land from its proper use is not worthwhile.
8. The introduction of LVT initially reduces the sales price of sites, even though their rental value can grow over a longer term. As more sites become available, the competition for them is less fierce and entrepreneurs have more of a chance to get started.
9. With LVT, land owners are unable to pass the tax on to their tenants as rent hikes, due to the reduced competition for access to the additional sites that come into use.
10. Speculators in land values will want to foreclose on their mortgages and withdraw their money for reinvestment. Therefore LVT should be introduced gradually, to allow these speculators sufficient time to transfer their money to company-based shares etc., and simultaneously to meet the increased demand for produce (see below, items 12 and 13).
Three Aspects Regarding Communities:
11. With LVT, there is an incentive to use land for production, transport or residence, rather than it being vacant and held unused.
12. With LVT, greater working opportunities exist due to cheaper land and a greater number of available sites. Consumer goods become cheaper too, because entrepreneurs have less difficulty in starting-up their businesses, and because they pay less ground-rent–consequently demand grows, whilst unemployment and poverty decrease.
13. Investment money is withdrawn from land and placed in durable capital goods. This means more advances in technology and cheaper goods too because the effectiveness of labor has been raised.
Four Aspects About Ethics:
14. The collection of taxes from productive effort and commerce is socially unjust. LVT replaces this national extortion by gathering the surplus rental income, which comes without any exertion from the land owner or by the banks–LVT is a natural system of national income-gathering.
15. Previous bribery and corruption for gaining privileged information about land, cease. Before, this was due to the leaking of news of municipal plans for housing and industrial development, causing shock-waves in local land prices (and municipal workers’ and lawyers’ bank accounts!)
16. The improved use of the more central land of cities reduces the environmental damage due to unused sites being dumping-grounds, and the smaller amount of fossil-fuel use (with its air-pollution), when traveling between home and workplace.
17. Because the LVT eliminates the advantage that landlords currently hold over our society, LVT provides a greater equality of opportunity to earn a living.
Entrepreneurs can operate in a natural way– to provide more jobs because their production costs are reduced. Then untaxed earnings will correspond more closely to the value that the labor puts into the product or service. Consequently, after LVT has been properly and fully introduced as a single tax, it will eliminate poverty and improve business ethics.
References:
1. Adam Smith, 1776: “The Wealth of Nations”, UK
2. Martin Adams, 2015: “LAND– A New Paradigm for a Thriving World”, North Atlantic Books, California, USA
3. Mason Gaffney and Fred Harrison, 2005: “The Corruption of Economics”, Shepheard-Walwyn, London, UK
4. Henry George: “Progress and Poverty” 1897, reprinted 1978 by the Schalkenbach Foundation, New York, USA
5. David Harold Chester, 2015: “Consequential Macroeconomics—Rationalizing About How Our Social System Works”, Lambert Academic Publishing, Saarbüchen, Germany