Mason Gaffney
February 2009
“Phantom faces at the window.
Phantom shadows on the floor.
Empty chairs at empty tables
Where my friends will meet no more” – from Alain Boublil, Les Mis
Many stores have closed in the last year; they stand empty behind signs reading “Available”, “For lease”, or “First month free”. So have many industries, their gates locked, their girders rusting. The capital in them is wasted, poured down a rat-hole. Multi-million dollar freighters are mothballed, with no cargos to carry; others sail with unfilled capacity. Vast warehouses stand half-empty. Fleets of trucks wait for loads that never come. Redundant McMansions stand waiting for buyers, some advertising “Bank-owned”. Freight trains haul too many “empties going back”.
It’s not just the capital that’s wasting. There is land under and around those empty buildings, often more valuable than the buildings themselves. It might better be vacant, for then at least the owner would not feel committed to speculate in the old building as well as the land. It’s more than the land literally under the building, too. Even residences have yards, garages, and driveways; some have palatial grounds. Retail and wholesale and industrial buildings have vast parking areas and aprons attached for employees, customers, and deliveries. When city planners count up vacant lots, if they do, they usually see just lots without buildings, of which there are many, but nowadays there are as many or more invisible vacant lots under and attached to empty buildings.
We worry about attacks from Al Quaeda, and invasions of immigrants from Central America, but these empty spaces and vacant lands might just as well be ceded to the Taliban, or drowned like the lost continent of Atlantis, for all the good they are doing us. Osama bin Laden’s attacks are pinpricks compared with the damage we do ourselves by mismanaging our economy: we are doing his work for him.
Trivializers tell us that abandoned lands in declining cities are worthless, noting that the median house in Detroit now sells for only $35,000 or so. However, that is to misunderstand three important matters. One is that Detroit not long ago was our fourth biggest city, home of the assembly line, core of the “arsenal of democracy” and the locus of our biggest industry. Its location has not worsened, but improved with the St. Lawrence Seaway opened and global warming lengthening its ice-free season.
The second is that Michigan’s leaders can renew Detroit and their whole state any time by shucking their terrible counterproductive “modern” tax system and returning to the system that sparked Michigan’s spectacular growth, as documented in this writer’s previous Insights column, “What’s the Matter with Michigan?”. The third is that urban renewal in a free market proceeds from the fringe of a slum in towards the center. Richard Hurd taught us back in 1903 that land values are marked by continuity in space, because developers seek to anchor new neighborhoods to the best of the old. The heart of a slum may be hopeless, if you try to start renewal there, but the edges are always renewable, and revival proceeds inwards from there.
But hold on, what’s the use of new buildings when so many old ones are empty? To be sure, new ones may replace old depreciated and obsolete buildings, there is always some of that, but many of these unsold buildings today are brand new themselves. Supply has outpaced demand, leaving us with a great housing crash. There were some 2.3 million foreclosure filings in 2008. It’s not saying much that it’s the greatest crash of this millennium so far, but going back to the one before it’s worse than 1990, worse than 1975, worse than 1958 … it is rightly being compared to 1929, for like 1929 it has brought the banking system down with it, and the rest of the world as well.
This brings into sharp focus a weakness in local-oriented Georgism, which emphasizes the benefits of modifying local property taxation to untax or downtax buildings. Not long ago the local Building Industry Association approached me to help them lobby to lower various fees in lieu of taxes imposed on builders. I could have used the money, and easily repeated the litany of Georgist arguments against taxing buildings, when it occurred to me we have too many buildings already.
I do not fault and I seek no quarrel with the many Georgists who give such splendid service in the cause of downtaxing buildings to uptax land values. But please consider this. It made more sense when Henry George wrote because the property tax was the major tax levied by both state and local governments, and federal taxes were small by comparison. Also, taxable property included “personal” (movable) property as well as real estate, while most states today have exempted all or part of personal property from the base. Reforming the property tax was reforming a major part of the whole tax system, in George’s day.
Today we have sales taxes, business taxes, personal and corporate income taxes, payroll taxes for social security and medicare, employer responsibility for workmen’s comp and, in many cases, pensions. We have an income tax system, federal and state, that has turned owner-occupied housing into the greatest tax shelter while simple basic labor bears the brunt of what housing does not pay. On top of that we have subsidy programs for housing, while no one subsidizes the overtaxed worker for working. Income from commercial buildings is mostly untaxed, too, as Hudson and Feder’s work for the Levy Institute has shown. This is done through a combination of accelerated depreciation, avoidance of the capital gains tax, and sequential depreciation of the same building. It’s not buildings per se that are overtaxed. It is USING the buildings that is overtaxed. That is why we have more buildings than are being used.
It also helps explain why we have such high unemployment. Construction makes jobs, yes, but not nearly as many jobs as using the buildings once constructed. Using buildings, in turn, depends on entrepreneurs’ raising funds to hire workers. Turgot perceived in 1767 (Réflexions) that investing is the independent force that “animates all the work of society”.
Adam Smith, who learned his economics from Turgot and the Physiocrats, put it this way:
“A capital employed in the home trade will sometimes make 12 operations, or be sent out and returned 12 times, before a capital employed in the foreign trade … has made one.”
Wealth of Nations, Republished, 1937, pp. 338, 341, 349.
Adam Smith is here referring to capital as cargo, a form of stock in trade. For generating employment, fixed capital frozen in buildings or turnpikes was so sterile as not to be worth Smith’s mentioning: the payback is too slow. Time has not changed that much. One modern desk worker occupies about 200 s.f. of floor space. The cost of constructing that is roughly $100 per s.f., or $20,000 per desk worker. Some 20%-30% of on-site construction cost is labor, say $5,000 per desk worker. If the mean desk worker earns $30,000 a year, and the floor space lasts 60 years, the labor input in using the space comes to $1,800,000, or 360 times the construction labor. It is using floor space, not building it, that makes most jobs and produces most goods and services.
The greater importance of building is that it gives labor better access to the location, which might otherwise go unused. In the absence of working capital, however, as today, even access to land via floorspace is not enough by itself. There must be “front money” too. There are two sources of front money: net new saving, and recovery of capital from sales of previously invested capital. The second item includes bank loans made from repayment of earlier loans. Most businesses, especially small ones, depend on lines of credit to finance day-to-day operations.
Consider retailing. Sales p.s.f. in modern department stores might be $300 p.s.f. per year – much more in downtown New York, less in smaller markets. Over 40 years, thus, sales total $12,000 p.s.f., or 120 times construction cost. The flow of capital through the store – the throughput – accounts for so many times more jobs and products than the capital in the store building that a macro-economist can nearly ignore building construction as a job source.
John Stuart Mill applied this insight to taxation, noting how a general sales tax would slow down investing.
“… if there were a tax on all commodities, exactly proportioned to their value,… there would … be a disturbance of values, some falling, others rising, owing to … the different durability of the capital employed in different occupations.
… The gross produce of industry consists of two parts; one portion serving to replace the capital consumed, while the other portion is profit. Now equal capitals in two branches of production must have equal expectations of profit; but if a greater portion of the one than of the other is fixed capital, or if that fixed capital is more durable, there will be a less consumption of capital in the year, and less will be required to replace it, so that the profit, if absolutely the same, will form a greater proportion of the annual returns.
… To derive from a capital of 1000 £ a profit of 100 £., the one producer may have to sell produce to the value of 1100 £., the other only to the value of 500 £. If on these two branches of industry a tax be imposed of five per cent ad valorem, the last will be charged only with 25 £., the first with 55 £.; leaving to the one 75 £. profit, to the other only 45 £.
… To equalize, therefore, their expectation of profit, the one commodity must rise in price, or the other must fall, or both: commodities made chiefly by immediate labour must rise in value, as compared with those which are chiefly made by machinery.” – Principles, 1848, “Of taxes on commodities”.
Where Mill says “machinery” he clearly means durable capital of all kinds, including buildings, trees, breeding herds, freighters, oil wells, highways, airports … you can name a thousand examples. And where his numerical example contrasting two “branches of industry” is understated and abstract, let us contrast buildings with the “commodities made chiefly by immediate labor” inside the buildings. A building may last for, say, 50 years, and return the principal of the capital in it in, on the average, about 2/3 of that time (a little in the first year, a lot in the last years, according to the sinking fund depreciation formula of standard financial mathematics).
The “immediate labor” of workers inside the building adds value to materials to be sold in, say, a month, returning capital that the entrepreneur can reinvest immediately, for a turnover of 12 times a year. “Turnover” is the single word that epitomizes Mill’s labored prose, and “loan turnover” expresses its effect on bankers. Taxes on commodities tax capital each time it turns over. They “disturb The Force” (as Darth Vader might say) and push capital out of producing commodities “made by immediate labor”, hence more into commodities and services rendered over long periods by durable capital: capital of slow turnover.
Following Mill the baneful influence of J.B. Clark engulfed the profession like a miasma. In his tortured efforts to conflate land and capital, Clark deleted the turnover of capital from the professional consciousness, calling the product “neo-classical economics”. His main objective was to avoid singling out land for taxation, but a byproduct was to remove capital turnover from micro-economics.
Other economists struggled for a while to fit Böhm-Bawerk’s ideas into their neo-classical models from which time had been largely banished, only to reject or isolate such ideas when they could not fit them into their static, Clarkian models. From 1870-1920, “much of the economics was … an economic theory of a capitalistic production. Considerations of capital theory proper … simply disappear from the picture” (Robbins, 1934). It was Auguste Comte who wrote that all science consists of relations either of coexistence or sequence. Clark confined neo-classical economics into a box that shut out relations of sequence. Not until Keynes did they return, and then in distorted form.
Keynes picked up on Turgot’s insight, but in a twisted sort of way that loses much of its force. In Keynes, “investment” is the motor of the system, but it means net new investment only. He takes reinvestment and turnover for granted, as results of “consumption”, regardless of what is consumed – it could even be the services of land, for all he seems to care. He puts everything in monetary terms, with little attention to the corresponding flows of goods and services, as though their composition has no effect on the outcome. Thus for him construction is just as good as tailoring or cooking or delivering mail or waiting on table for making jobs, and maybe even better because construction soaks up the capital invested for long periods, and Keynes saw capital as being formed in excess of need – quite the opposite of today’s problem when businesses are starving for want of working capital.
In the previous Great Depression, as today, America was loaded with empty buildings and excess capacity. Empty subdivided lots went begging; owners abandoned many of them for back taxes. The Georgist message, locked into a paradigm from earlier times, seemed irrelevant and was shunted aside, where it has mostly remained.
What we need today is to attack taxes on Mill’s “commodities made with immediate labor”, and taxes on labor itself. We need to stress how taxes that “shoot anything that moves” keep things from moving. We need to show how removing such taxes will raise the value of empty buildings and lands, so we can replace such taxes with property taxes. We need to show that the present system, by seeking to spare property values, actually depresses them by more than would direct taxes on property, because of the “Excess Burden” of indirect taxes.
As we make this great shift we can also, of course, focus the property tax more on land, but as we do so let us give higher priority to untaxing work and turnover and cash flow and sales than to untaxing buildings. We already have empty buildings to burn.