How a Land-Rent Tax may enable Cuba to Open its Trade and Investment Relations Without Giving Up its Economic Independence

Michael Hudson, Ph.D.

[February 1999]

Dr. Michael Hudson is the author of Super-Imperialism: The Economic Strategy of American Empire (1972, Spanish translation 1973). His 1973 memo to the State Department reviewing the history of U.S. policies towards Russian membership in the WTO, IMF and World Bank helped open economic relations with Russia. He is presently a consultant to the Russian Academy of Sciences, Economic Division, and has made a number of trips to give support to Duma members opposing land privatization and related World Bank-sponsored "reforms."

It has long been recognized that countries may gain from trade by exporting their specialties in exchange for those of other countries. It also is commonly accepted that foreign investment may provide capital to accelerate economic growth. Yet the past half-century's trade and investment patterns have turned many countries into heavily indebted raw-materials suppliers. The final nail in their economic coffin typically has been to settle their debts by relinquishing their land, natural resources and public monopolies to foreign control.

Selling these hitherto public assets means that their revenue will be remitted abroad, putting downward pressure on the exchange rate. Meanwhile, government budgets are being squeezed as the tax laws are changed to let global investors and domestic elites use transfer pricing and debt pyramiding to avoid income taxation. Interest charges on the debts resulting from cutting taxes on wealth and income (especially for finance, real estate, tourism and privatized monopolies) force governments to cut back their social spending programs while shifting the tax burden onto labor.

Currency depreciation raises the price of dollarized imports of food, fuels and other necessities, as well as machinery prices, licensing fees, and especially debt service. (What really is devalued is the major non-dollarized cost: the wages of labor.) Workers suffer also as income and sales taxes are made regressive, topped by a vicious circle of dependency created largely by IMF and World Bank loan programs that benefit mainly foreign investors and local elites. Client countries are left to bear the cleanup costs of bailing out international lenders and speculators, who turn around and blame their victims for mismanaging a "crony capitalism" that their own loan programs and diplomacy have created.

In light of these problems there may be a silver lining in the nearly four decades of economic sanctions that Cuba has suffered. At least it finds itself in a relatively debt-free position, and remains highly self-reliant and independent. The question is, how will it cope with the pitfalls that await its opening the economy to international market relations?

For one thing, normalization of trade relations involves membership in the IMF and World Bank, whose philosophy of development is adverse to Cuban ideas of economic justice. In addition, families who left Cuba after its Revolution have made claims for compensation for property they have left, and have obtained U.S. backing for these demands.

The problem facing the Cuban people thus is how to deal with these often hostile forces without relinquishing the principles that have guided their policy since the Revolution. What is at stake is how best to preserve the nation's gains in literacy and education, public health and culture, technical innovation and investment in pharmaceuticals and other sectors.

There have been long debates of how to introduce "market socialism," using market reference points as an aid to price resources economically. Above all, the value of land and naturally desirable sites tends to be undervalued -- or rather, uncollected, for the land's value and theat of publically supplied services exists regardless of whether or not the government charges for them. Not to charge for site values such as desirable urban locations often leads to an uneconomic location of industry and housing, as Russia is now learning.

Today's discussion of pricing, taxation and fair returns to investors is taking place in the context of opening up Cuba's economy to foreign trade and investment. The immediate problem facing Cuba is how to do this in a way that does not relinquish its ideas of economic equity and justice, to say nothing of its commanding heights.

In addition to avoiding wasteful misallocation of resources and corruption, it is necessary for Cuba (and for that matter, Russia and other formerly socialist economies) to save domestic land-rent from being remitted abroad. To relinquish land (whose rent is paid in domestic currency) or to sell off public utilities (whose services also are paid for in local currency) is to invite currency depreciation and subsequent domestic inflation.

The disaster that Russia has suffered in the way it has undertaken privatization under US, IMF and World Bank direction provides an object lesson of what to avoid. A different approach is needed to enable Cuba to retain control its land, beachfront and other potentially rich tourism sites, as well as its urban land and public utilities.

These sectors represent the bulk of any economy's assets. The revenue they generate forms the natural and traditional basis for future public investment rather than being turned over to foreign or newly emerging domestic elites. How can they be protected as the basis on which to build? If they pass into foreign control, Cuba will be deprived of the bulk of its most productive present and future assets and the income they generate.

This paper proposes an alternative way for Cuba to open its economy and manoeuver within the context of international market prices. A tax on land rent (the "Henry George tax") may enable Cuba to respond to international pressures to open up its economy without relinquishing its public resources to foreigners, while retaining the principles of justice. Such a tax will free Cuban land sites and other national patrimony for optimum use in a way that reflects market incentives rather than relinquishing them at distress prices. It also will free labor and investment from the income tax and excise taxes that increase their price (although workers and other producers will pay a tax on land and other public resources).

Public collection of the land's rent -- that is, a tax on on site values and natural monopolies -- may be done in such a way as to yield the same amount that taxes on wages and profits would yield (including sales and value-added taxes). The difference is that whereas taxes on labor or manmade capital increase their costs and reduce their supply, public collection of the rental value of land does not discourage supply. The land, natural resources and monopolies exist in any event. The question is whether their revenue will be collected by the community, or privatized.

Public collection of the rent of land and other natural resources has not been widely discussed because it involves governments keeping the most lucrative sectors in the public domain rather than involving direct foreign ownership by multinationals. It does not involve loading down Cuba with debt from international banks or creating a stock-market boom for foreign speculators. It involves taking a step back to make a new beginning that can avoid entering upon the path that leads to privatization and debt-bondage.

This policy is simple to enforce. It is to tax the land and natural monopolies rather than labor or new investment. A land- rent and public-resource-rental tax, legal under international law, can protect Cuba's land and natural resources from foreign control, while also effectively nullifying the claims of Batista-era expatriots.

The rent-tax represents a form of market socialism. Fortunately, the Cuban government already is legal possessor of the land. Little or no rent exists has been pledged to the banks as backing for mortgage loans. In fact, Cuba's economy is almost uniquely free of interest and rent charges. Central to all such discussion is the premise that the public sector must retain control of the land and mineral wealth, natural monopolies and basic public utilities. Indeed, despite the past five hundred years of European colonialism, until quite recently all of Latin America retained this basic national patrimony in public hands rather than relinquishing them to private ownership by a domestic economic elite, to say nothing of foreigners.

In radically overturning these basic principles, the IMF and World Bank seemingly have created a single pathway into the international economy -- a path based on privatization and foreign debt under harsh "conditionalities." More specifically, countries are told to sell their most valuable long-term resources to global investors (mainly multinational firms raising the money from global financial institutions). These resources represent their national patrimony, whose productive powers and natural monopoly position underpin the prosperity of the entire society. The problem is that selling these resources turns over to foreigners the economy's commanding heights. In effect, economic policy itself is relinquished.

When prosperity increases, the value of good location rises. This increase in value occurs even when no new investment is made in the land. Either the landholder may sell this land at a capital gain -- keeping for himself the increased value created by the community -- or he may rent out this land at rising prices. A resource-rental tax would preserve for public use those revenues which grow simply as a result of general economic prosperity.

The object is to retain socialist economics while opening up foreign trade and investment, and the market forces they involve. All international investment agreements are subject to national tax laws. Cuba thus may to contract loans and "aid" with international organizations such as the IMF and World Bank in a way that does not relinquish any policy-making control to them or otherwise give them "advisory" power. A resource-rental tax thus would enable Cuba to avoid the web of debts to foreign financial institutions in which other Latin American and Asian countries have become enmeshed. Land rents would be saved from being privatized and sent abroad. As Cuba's population grows and becomes more prosperous, the land's rent (and the revenue of other public investments) will provide a rising stream of revenue to defray public social spending. Furthermore, this money will be kept at home, rather than remitted to foreign purchasers to put downward pressure on Cuba's foreign exchange rate.

A land-rent tax also will enable Cuba to deal with the claims from the Batista era for reimbursement of the value of properties or the direct return of properties formerly owned. A land-value tax would deftly solve this problem, for it renders the nominal ownership of property meaningless. If the entire land value is taxed, then only the actual users of property will be the bidders (save for short-term distortions). Former owners may be given title to their property, but the rental value will be collected by the government, just as it collects the rental value of all other domestic property. If the former owners would fail to make full use of their property under Cuban law, their tax levy would exceed their revenue. They presumably would either abandon the land, or make improvements to yield the government an appropriate income on it.

The important point is that absentee ownership rights will be rendered academic as the rental value is collected by the government in lieu of income and excise taxes on labor and new captial investment. As long as Cuba applies the same rules to foreigners that it applies to domestic residents, its tax system will conform to international law. Claims by Batista-era expatriates for return of their property would be subject to taxes that would make these properties economically valuable only if the former owners worked them in accordance with what fiscal authorities decide to be the most economic use.

Cuba's unique economic advantages

Cuba has made a virtue of necessity in the face of the foreign sanctions blocking its trade and deterring foreign investment. Not having sold off its public utilities to foreigners, it has no remission of earnings, and hence no chronic balance-of- payments outflow. Nor has Cuba pledged its rental income to domestic or foreign banks. The prospective income from the land's value (much of it not being collected at present), and from Cuba's natural resources and public utilities, remains available to the public sector, which may use its growing flow for purposes that benefit all Cubans.

Taxes on income and commerce can be kept low by collecting the rental value of the land and pricing public utility services to provide government revenue in lieu of income and sales taxes. The government need only collect the land's rental value and that of public utilities. This means that Cuban net wage levels may rise over time without necessarily adding to production costs, for neither labor nor capital will not be burdened with income and excise taxes.

Most important, Cuba's production costs will be free of the personal and business debt-service charges -- and taxes to carry heavy public debts -- that burden more indebted economies. Cuba is fortunate in not having a banking system already collecting the economy's rent and other monopoly revenue in the form of interest charges. Its people and their enterprises hold property tenure at very low carrying charges. Rather than having been made a direct cost to be factored into socialist market pricing, the rental value of much land and other real estate has been left uncollected. However "uneconomic" this may have been, its bright side is that rental charges and public utility fees remain free for public collection.

In fact, no less a free-enterprise advocate than Milton Friedman has pointed out the irony that only socialist economies are "pure" market economies as depicted in modern textbooks. This is because only socialist economies have no complicating financial webs of interest-bearing claims on wealth. They alone operate without a superstructure of sunk costs to be depreciated, financial shadow-debts, economic rents and other creditor or ownership charges. Such economies are in the enviable position of being able to decide just what to do with their rental revenue -- sell the right to collect it to foreigners, or keep it for public use.

Even free-enterprise advocates agree that taxing the rent of land and natural monopolies creates an optimum investment climate, by collecting "unearned income" rather than acting as a disincentive to labor and productive capital investment. The advantage of a natural-resource tax is to promote the efficient use of Cuba's resources by establishing market reference points without actually having to go so far as to privatize the land and other natural monopolies. A land-rent and public resource charge would enable Cuba to create an economic environment retaining its ideas of economic justice. Rather than seeking "market- oriented efficiency," the objective is not to rationalize the status quo, but to improve it. Cuba may use its socialist legacy as the basis for higher efficiency than can be achieved by the indebted "bubble" economies of non-socialist countries and post-socialist Russia.

The greatest problem presently confronting Cuba is how to avoid selling off land and other national patrimony at distress prices, such as have occurred in other countries. Any auction under existing conditions takes for granted the existing distribution of wealth. It enables the wealthy (in this case, mainly foreigners) to pick the most valuable rent-yielding resources, and gain possession of them so as to exclude the rest of the population from using resource rents to fund government spending for public rather than private profit-making aims.

How Cuba may preserve what it has achieved

Since its revolution, Cuba has achieved high standards of domestic literacy and public health, despite being confronted with international economic sanctions at US insistance. Unlike most "aid-recipient countries," it has not let the aid-granters strip away its national patrimony as a condition for making loans to benefit local elites. Cuba's potentially rich tourist areas on the beaches, its agricultural land and other natural resources such as its nickel mines, as well as its air waves and radio spectrum remain in the public domain to provide revenue to fund a wide range of social programs. These programs therefore need not face extinction as is occurring in third world countries "going private."

The question is, how to mobilize this national patrimony to best serve Cuba's social objectives. The economic rents generated by this patrimony have become prime objectives of predator capital forcing indebted countries to sell off their public assets to global investors. But their sale would deprive Cuba of their potential growth in revenue -- precisely that revenue which traditionally has formed the basis for public spending on social programs and economic infrastructure. Without this revenue stream, Cuba find it difficult to fund such programs in years to come.

For many countries, opening up their economies to foreign trade leads to lower wage rates as the price of making their exports competitive. But in Cuba's case, labor costs can be kept low without holding down living standards, by freeing it from high rent and interest charges, income and excise taxes. Meanwhile, public subsidy may finance education, culture, research and development.

Public collection of rental values could collect just as much as would be generated by any combination of income taxation, wealth taxation, excise taxation or value-added taxation. However, whereas all these taxes add to costs (and hence, prices), an economic-rent tax would not increase the cost at which land or other natural endowments or monopoly goods are supplied. This is because an economic-rent tax is paid out of the "free ride" which owners of natural resources and monopolies enjoy as the value of property increases to reflect the economy's general level of prosperity. Instead of such rents accruing to the fortunate users or absentee owners of high-rent resources (such as well-situated real estate), the government will collect them as the basis of its fiscal system.

The lessons of third world privatization in the 1980s and 1990s

Privatization has been a failure throughout most of the third world. What ultimately has been at issue in such "market- oriented" reform is, who will derive the income from the debtor country's most valuable natural resources: foreign investors, domestic elites, or the government?

The first effect of privatization is for indebted governments to use the proceeds to pay off what otherwise would be bad loans, including "aid debt" owed to the US agencies and large international banks that extend credit under the World Bank and IMF programs. It is as if debtor countries engaged in a voluntary bankruptcy. Creditors find themselves bailed out instead of having to take responsibility for the failure of their loans to create the productive power capable of repaying the debt with its stipulated interest charges.

The major assets demanded by international investors are land, natural resources and public monopolies able to generate export earnings. The effect of selling these hitherto public assets has been to reduce future government revenue. Instead, the income is remitted abroad, to the new owners. What complicates matters is that most rental and public service receipts are paid in domestic currency, and must be converted into foreign exchange, creating what economists call a transfer problem.

A domestic budgetary problem is also created as foreigners rather than the public sector benefit from the rental and service charges that rise exponentially with the country's economic growth. If government programs are not to be cut back, the money must be raised by raising other kinds of revenue -- and the only way to do this is by taxation. In many cases, privatization proceeds were used as a means of cutting taxes on wealth. In any case, instead of taxing the rent-yielding resources that have been privatized, governments have been advised to finance their budgets by income and sales taxes, which fall mainly on labor.

An income tax is difficult to enforce against business. As noted earlier, global investors are able to make themselves tax- exempt by using "transfer pricing," obtaining tax exemption for interest payments, taking their profits in offshore banking centers and tax havens, and making use of related "loophole" techniques. The only way to capture their rents is through a resource-tax. But such proposals are greeted by agonized denunciations by international investors and the bank consortia that stand behind them.

Now that privatization has been shown to be a blind alley, Russia is belatedly shifting its tax system to public rent collection. It is now talking of taxing Gazprom's exports, oil exports and other minerals sales. Recognizing that these are the kind of taxes that can be collected most readily, Russia's new government is adopting the principle of collecting the land and resource rents (including radio and television rights), as advocated in the early 1990s as an alternative to World Bank and IMF "reforms."

Russian privatization could have been saved from degenerating into a giveaway by enacting a full land- and resource-value tax. Collecting the rent generated by the economy's real estate, mines, oil and gas wells, radio and TV stations, electricity and phone utilities would have enabled the government to balance its budget while saving this revenue from being remitted abroad. If a hotel were sold at a give-away price, or if a factory were bought by foreign investors, torn down and converted into luxury housing so as to increase its rent yield, the government would be able to collect this rent by reappraising the property's value annually. Investors would be permitted to earn normal profits on the man-made capital they supplied, i.e., the buildings they constructed, the mining equipment they provided, and so forth. But the land or natural resource rent would be collected by the government for public use.

One way or another, some party will collect this rent. In most countries this is done by the banking system and financial investors. Absentee buyers go to their banks and take out mortgages to obtain the money to buy rent-yielding properties. These buyers then pay out their properties' rental cash-flow as interest to the bank. For the U.S. commercial real estate sector, the entire rental value typically is pledged to the bankers by holders who hope to emerge ultimately with a capital gain. The upshot has been to indebt real estate, mining and other monopolies up to the hilt.

Rather than using the proceeds of privatization sell-offs to put in place tangible capital investment, debtor countries have used these proceeds to service foreign debts that have been taken on for projects that (for the most part) have failed to help their balance of payments. For most countries, privatization has created chronic balance-of-payments outflows of earnings, interest, fees and other expenses to foreign buyers, putting chronic downward pressure on the foreign currency. And inasmuch as most non-labor costs have been dollarized throughout the world, the only "give" when a currency depreciates is to lower the international price of its labor.

A country's ultimate wealth is of course its labor, especially the skills of its educated work force. The way to protect its living standards is thus to avoid currency depreciation. By using its national patrimony as a source of public revenue, Cuba can establish social programs to elevate the status of its labor. Most notably, Cuba has established the international value of its labor capability in its pharmaceuticals and public health industry.

In addition to retaining growth in national rental and resource revenues in the public domain, the adoption of such a fiscal system would help Cuba use its resources to their greatest efficiency, while helping to get rid of the nation's anti-market image. It has been termed the "least bad tax," as its yield will enable the government to avoid taxing capital and labor, while not deterring the supply of land, mineral resources or monopoly services.

Such a tax in fact could enable Cuba to emerge as an "economic miracle" country, without a corporation tax or other business taxes, and without taxing labor (thereby providing relative low-priced labor without correspondingly low living standards!). By taxing the rental value of properties, it would solve the problem of speculators coming in to make a killing by speculating in such revenues. In sum, public collection of land and resource rents would make it unattractive for speculators who want to buy only in order to sell later at a higher price.

The moral is that a rent-tax need not increase Cuba's cost structure. Collecting the flow of rent generated by land and other natural resources does not reduce their supply, for they are produced by nature rather than by human effort. Regardless of how highly they are taxed, they already are in existence. They have no production cost, yet yield a revenue, which is determined by the degree of general prosperity. The rental value and capital gains that accrue to land and natural monopolies thus do not result from their beneficiaries' efforts, but are created by - - and belong to -- the community at large.