Economic Rent

Herman E. Daly

[A letter addressed to the Russian Duma; December 18, 1998]

This short statement from the renowned environmentalist Prof. Herman Daly, Univ. of MD, seems to mark him clearly with the stigmata of Henry George. It was just published in Russian by the Duma, in a volume along with papers by Gwartney, Tideman, myself, Harrison, Roskoshnaya, Titova, Lvov, Ramsey Clark, Zvolinsky, and scads of Russians. The volume is ed. by Zvolinsky, and called *Natural Resources - the National Wealth of Russia*. [Mason Gaffney, University of California, Riverside]

To: Mr. Vyachislav Zvolinsky, and
Other Honorable Members of the Russian Duma
Committee on Natural Resources
SubCommittee on Land and Ecology

Esteemed Representatives:

I am honored to be asked to comment as a part of your deliberations on Valuation of Natural Resources and Tax Reform. Since I have no first-hand knowledge of current realities in Russia I will confine my remarks to some general principles for pricing resources in the service of community, the environment, and a just and sustainable future.

While it is true that land and natural resources exist independently of man. and therefore have no cost of production, it does not follow that no price should be charged for their use. The reason is that there is an opportunity cost involved in using a resource for one purpose rather than another, as a result of scarcity of the resource, even if no one produced it. The opportunity cost is the best forgone alternative use. If a price equal to the value of the opportunity cost is not charged to the user, the result will be inefficient allocation and waste of the resource--low priority uses will be satisfied while high priority uses are not. Efficiency requires only that the price be paid by the user of these =B3free gifts of nature=B2 --but for efficiency it does not matter to whom the price is paid. For equity it matters a great deal to whom the price is paid, but not for efficiency.

To whom, then, should the price be paid? To the owner, of course. But who is the owner? Ideally ownership of land and resources should be communal since there is no cost of production to justify individual private ownership.

Each citizen has as much right to the free gifts of nature as any other citizen. By capturing the necessary payment for public purposes one serves both efficiency and equity. We minimize the need to take away from people by taxation the fruits of their own labor and investment. We minimize the ability of a fortunate few private land and resource owners to reap a part of the fruits of the labor and enterprise of others. Land and resource rents (unearned income) are ideal sources of public revenue. In economic theory rent is defined as payment in excess of necessary supply price. Since the supply price for land is zero, any payment for land is rent--if we paid no rent the land would not disappear. If the government owns land and resources it can both measure and capture the appropriate rents by auctioning use to those who wish to use it.

But what if land and resources are already privatized?

For one thing, they might be repurchased by the government. But if that is not feasible, or if one doubts that the competence and honesty of the government is sufficient to handle the auction system, then one could leave ownership in private hands and try to capture the unearned rents for social purposes by taxation. This is the usual case. Taxes should be shifted away from value added (labor and capital) and on to that to which value is added (natural resources and land). If we tax away rent, land and natural resources will not disappear. But if we tax wages and profits too heavily then the some of the value added to natural resources and land by labor and capital will indeed disappear. The natural resource throughput begins with depletion and, after production and consumption, ends with pollution. Putting the tax at the beginning of the resource flow through the economy (throughput) is better than putting it at the end. A resource tax at the point of depletion induces greater efficiency in production, consumption, and in waste disposal.

Not only is land and resource rent the best thing to tax from the point of view of efficiency and equity in a well functioning market, such taxes are also a means for improving the functioning of the market itself by internalizing external costs and benefits. Economic theory says we should tax external costs and subsidize external benefits. Since there are significant external costs from depletion and pollution, taxing this resource flow (even above the level that captures rent) helps to internalize these external costs, in addition to capturing internal rents generated by the market. Since there are significant external benefits from increasing employment and capital accumulation, ceasing to tax (if not actually subsidizing) these socially desirable activities is a further correction of the market=B9s ability to reflect true social benefits accurately. The resource tax at the point of depletion can reflect external costs of depletion and pollution, in addition to capturing rent. Higher resource prices force production technologies to use the resources more efficiently, and also force more frugal and efficient patterns of consumption. Recycling of wastes is stimulated because the alternative of new extraction is now more expensive. Such recycling reduces pollution as well as depletion. If sufficient revenue had been raised previously by taxing labor and capital, then as we replace labor and capital taxes by resource taxes we encourage (cease to discourage) employment, capital accumulation and enterprise.

The above are very basic principles, and lest you think I am being condescending in suggesting them to you, let me assure you that these same principleshave not yet been understood by the US Congress, and that I eagerly make these very same suggestions to the government of my own country. The Primakov tax reform bill described in your letter of 16 December seems to be a good step toward applying these principles. I believe that The Netherlands and Sweden are ahead of both the US and Russia in this regard.

With all good wishes for your important deliberations,

Herman E. Daly, Professor