Unlocking the Riches of Oz
Bryan Kavanagh
[A case study published in 2007 of the social and
economic costs of real estate bubbles 1972 to 2006]
SLAVERY/AFFORDABILITY
Exactly two hundred years after the abolition of the trans-Atlantic
slave trade, is it possible that our taxation and landholding systems
are evolving into a more subtle form of slavery?
The unfortunate English sociopath Edward Gibbon Wakefield, who
abducted then married two young heiresses, dreamed up a theory of
colonisation whilst in Newgate Prison for the second of these offences
from 1827 to 1830. Wakefield espoused that new settlements required
neither slaves nor convicts for cheap labour; a compliant workforce
may be had simply by selling land at 'sufficient price' that only the
wealthy would be able to afford it. Wakefield had stumbled upon the
high-land price, high-taxing formula that Pliny the Elder said had
been the ruin of Ancient Rome: ["The great landed estates
destroyed Italy"]
Latifundia perdidere Italiam. It is this selfsame socially
damaging regime into which at the outset of the 21st century world
economies have morphed.
Unlocking the Riches of Oz uses Australian data as a proxy for
the economies of the world to confirm this thesis.
SYNOPSIS
This report collates Australia's real estate sales since 1972 to
create 'The Barometer of the Economy'. As the barometer demonstrates a
delayed inverse relationship between property bubbles and the economy,
we investigate the extent of Australia's publicly-generated natural
resource rent in order to assess the scope for 'Unlocking the Riches
of Oz' currently suppressed by the deadweight costs of taxation.
Re-calculating GDP on the assumption of the notional public capture of
one half of Australia's resource rent since 1972, we show the benefits
that would flow to all Australians, the environment, housing
affordability and industrial relations by reducing taxes in favour of
greater reliance on resource rents to be substantial.
INTRODUCING THE TAX SYSTEM
Revenues sourced from other than the capture of annual land and
natural resource values all offend against at least one of the four
classical canons of taxation, namely, that revenues should (1) bear
lightly upon production, (2) be cheap and easy to collect, (3) be
certain, and not able to be passed on and, (4) bear equally, giving
advantage to none (
Progress and Poverty, chapter 33).Therefore, the almost
complete lack of interest in establishing a community claim to the
land values generated by public infrastructure and the existence of
community as the primary source of public revenue is curious. It is
perhaps best understood in terms of a media bias thought to favour its
real estate advertisers, even though they too can be shown to benefit
from land-based revenues. Amazingly, the forces of both left and right
have fallen under the spell of this blinkered mind-set, and the idea
of extending land value capture has rated little discussion.
Poll-driven governments are therefore unlikely to be burdened by
matters of principle in considering from whence they will draw their
revenues. Considerations of the canons of taxation will go out the
window in favour of cynicism such as 'The art of taxation consists
of so plucking the goose as to obtain the largest amount of feathers
with the least amount of hissing' (Jean Baptiste Colbert,
1619-1683), or the modern equivalent, the metaphorical 'three legged
stool', ie. that a mix of taxes on incomes, sales and property
provides the most 'stable' tax base. Politics being deemed to be the
art of the possible, it appears that policy makers and politicians
have decided to appease noisy landed interests by up-taxing productive
activities and down-taxing resource rents, the canons of taxation and
the axiom that 'taxes destroy' notwithstanding.
Given the lack of intellectual rigour concerning the equitable
sourcing of revenue, it isn't surprising that tax systems have run
amok and developed into a Mad Hatter's Tea Party. A welter of tax
legislation is directed towards fining labour and capital for working,
and rewarding property holders and speculators for inflating socially
damaging property bubbles. Those who follow the imperatives of the tax
system by turning to rent-seeking tend to do very well for themselves,
while all others tend to do poorly. Taxes on productive transactions
impede the supply of goods and services and therefore raise prices,
feeding inflation and increasing the unemployment rate 'required' to
lower wages sufficiently to stabilise inflation. This unemployment
rate is accepted as 'natural', and even defined as 'full employment'.
All these effects widen the gap between a minority of haves and the
vast majority of have-nots, despite transfer payments nominally
targeted to narrow the poverty gap. Paradoxically, those most
disadvantaged by the tax system cling to the forlorn hope that it may
be tinkered with in order to redistribute wealth more justly. It
cannot - unless the three legged stool's extremely shortened
'property' leg is replaced. This conclusion will be tested by analysis
of Australia's real estate sales, some 70% of which, including vacant
land sales, is now represented by land price. Importantly, this
compares with the far lesser figure of 25% in 1970.
To date, all discussion about declining housing affordability has
ignored that in a rational market land price is simply the private
capitalisation of publicly generated annual land values, as explained
below in italics. When the land market develops into a bubble, the
rational price is inflated by a temporarily self-fulfilling
expectation of capital gain.
How does land price arise?
If residential returns in a particular
locality are showing 4.0% after deduction of $1000 in municipal
rates, and if vacant lots are selling for $200,000, the
indicated annual value of sites is $8000 per lot net of rates
[i.e. 4.0% of$200,000].
However, if half this imputed annual yield were captured for
public revenue, the price of the sites would immediately fall
from $200,000 to $100,000, as the $4000 annual value remaining
uncaptured by government would be privately capitalised at 4.0%.
That is, people would be prepared to pay a capital sum of
$100,000 for a site on which they did not to have to pay the
annual value of $4000 to government.
On the other hand, if the existing council rates of $1000 were
abolished on the sites, their price would increase from $200,000
to $225,000 (i.e. $9000 annual value capitalised at 4.0%).
So, whether people realise it or not, land price is actually
the private capitalisation of imputed site rent remaining on a
site, developed or undeveloped, after deduction of government
charges.
Hence, as taxes in other areas of the economy act to increase
prices, policymakers should consider greater land value capture
as the most effective way to reduce land prices and improve
housing (read land) affordability, because there would remain
less annual site value to be capitalised into land price.
[This analysis deals with the effect on land prices due to
annual charges on land. It does not allow for effects on land
prices due to changes in spending power caused by other kinds of
taxes or tax reductions. Neither does it allow for bubbles.
These matters are addressed elsewhere in the text.]
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Land price is now the greater part of residential property values in
Australia, so it may be that greater public capture of annual land
values has much to commend it on at least four fronts: (1) reducing
land prices, or at least dampening speculative price increases by
imposing a holding cost on speculators, (2) providing scope to
redress a Mad Hatter's tax regime which penalises work and employment,
(3) establishing a citizens claim to Australias natural resource
values and, (4) assisting to foster a natural job-shift, away from
further intensive urban agglomeration, towards cheaper and more
decentralised locations.
A vast government workforce currently administers well-intentioned
transfer payments which are categorised and distinguished
unnecessarily and at great cost to the nation. It would be far cheaper
were all Australians to claim their equal birthright to the annual
surplus, national resource rents, in the form of a yearly citizen's
dividend. Whilst a guaranteed annual income has remained a pipe dream,
it need not, and there could be no sounder foundation than community
generated resource rents.
In order to make land more affordable, Alan Moran, head of the
Institute for Public Affairs (IPA) Deregulation Unit has recently
promoted greater release of broadacre lands for residential
subdivision. However, this is an indirect and ineffective way of
reducing land prices. In The Tragedy of Planning: Losing the Great
Australian Dream (IPA, 2006), Moran makes a case against the
reulatory morass into which Australia's town planning has descended,
showing it to be akin to California's. He fails, however, to mention
the substantially higher than average crime rates in those US cities
he approvingly cites as having a more relaxed attitude to zoning more
land for residential development on the urban periphery. Ironically,
the higher crime rates in those cities may have contributed to their
lower land prices, therefore, greater housing affordability, because
increased rates of crime will usually prove to be the corollary of
inadequate social infrastructure on the urban fringe. Perhaps those
people living within Australia's urban sprawl, a term to which Moran
objects, are not doing as they wish, as he suggests, but are following
the dictates of job opportunities as they must. Under a tax code
delivering enormously disproportionate benefits to Australia's capital
cities, the cities are where jobs are most likely be found. The
largest capital gains are also to be found in the best parts of our
major cities, and whilst investors refer to this as location,
location, location, economists know it as Ricardo's Law -- that is,
those locations where supra-marginal rents are greatest.
It is quite natural that many young people will be attracted to the
vibrancy of the big city, but how many might have eventually returned
home had the benefits of location, location, location been
recognised by geo-spatially based revenue systems which acknowledge
relative locational values? We witness instead the private plunder of
vast slabs of community resource rents, whether by Russian oligarchs
or Nigerian oil crooks abroad, or to a lesser extent by Macquarie
Bankand leveraged buyouts of our natural resources at home. The cost
to everybody but the proponents of these insidious rent-seeking
techniques is an increasingly pernicious tax system, higher and higher
land prices and declining levels of social welfare.
In a recent book Ricardo's Law: House Prices and the Great Tax
Clawback Scam, British economist and journalist Fred Harrison
takes his readers on a journey from the centre of London northwards
along the ancient Roman road to Lincoln and onwards to Hadrian's wall.
Harrison documents that wealth, property values, and the very length
of life itself, all decrease as the trip proceeds north through
Englands six statistical divisions along the way. He notes London's
parasitical dependence on these far-flung locations for its surplus
tax funding, and that London redistributes only part of this
ill-gotten gain back to the benefit of these lesser locations. In all
likelihood, a study of the tax privileges dispensed to Australia's
mainland capitals would disclose great similarity to Harrison's
analysis.
SCOPE FOR REPLACING TAXES WITH RESOURCE RENT/LAND VALUE CAPTURE
In 2000, The Land Values Research Group (LVRG) commissioned Dr Terry
Dwyer, then visiting Fellow, National Centre for Development Studies,
Asia Pacific School of Economics and Management, Australian National
University, to quantify Australia's natural resource rents. The result
was a tabular time series analysis from 1911 to 1999 published as
The Taxable Capacity of Australian Land and Resources in
Australian Tax Forum, Volume 18, Number 1, 2003. Dr Dwyer found that
smoothed land incomes in the financial year 1998/99 had reached 134.1%
of Australia's total corporate and personal income tax. The LVRG has
extended Dr Dwyers analysis since 1999, using his technique of
establishing the value of land and other natural resources and then
adding their current and accrued yields. Annual resource values proved
to be 22.41% of GDP in 1999, but by 2005 they had grown to 32% of GDP,
under the influence of what from 1996 to 2004 has been the greatest
real estate bubble in Australia's history. This percentage of GDP was
sufficient to have replaced taxation at all three levels of government
in Australia.
It may be argued that economic rationalism has amounted to little
more than thirty years of government acquiescence to the private
plunder of Australia's natural resources, and that the environment has
suffered mightily as a consequence. As resource rents may be seen to
represent community, the whittling away of the sense of community that
has accompanied this quite irrational period of our economic history
cannot be considered coincidental.
Whereas the national accounts simply roll Australia's earned incomes
and unearned natural resource rents together as income, using Dwyer's
study we have disaggregated rent and taxes from GDP to arrive at the
net earned incomes of labour and capital in classical economic terms.
These non-speculative incomes are shown at Figure 1, together with the
relatively small percentage of resource rent which is currently
collected for public revenue.
FIGURE 1
Economic rationalism is characterised in the chart by an upsurge in
rent and rent-seeking from 1980, following the abolition of death
duties, and the Whitlam government assuming responsibility for funding
a large part of local government. The more extensively privatised
capture of land rent and the concomitant increase in taxation from
this time is readily observable.
IMPLICATIONS FOR INDUSTRIAL RELATIONS
Other than providing some idea of the scope for reducing land prices
and rectifying a Mad Hatter's Tea Party of taxes, the most striking
feature of the chart is its import for industrial relations reform.
Under existing taxation arrangements, labour and capital fight over
the 40% of GDP remaining from earned incomes after 28% of GDP has been
taken from them by taxation and after 27% of the 32% of GDP comprising
publicly generated resource rents has been creamed off by private
interests - many of whose names will be found listed each year in
Business Review Weekly's
Australias Richest 200.
Winning a greater share of land and resource rents is currently
proving to be a soft target for speculative capital. Therefore, both
labour and capital appear to have a common interest, not only in
winning back some of the 28% of GDP taken from their earned incomes in
taxes, but also in seeking greater public capture of Australia's
annual land values. Further analysis discloses that net earned incomes
have declined by 40% as a percentage of GDP since 1972, taxes have
grown by 27%, and annual land values/resource rents or unearned
incomes have grown by 160%. Whilst the earned incomes of many
Australians may indeed have been supplemented by land values, it may
also be seen that this rapidly appreciating natural resource fund has
much to recommend it as the natural revenue base - and from which an
equal dividend may be delivered to all Australian citizens.
ASSESSING THE INFLUENCE OF THE PROPERTY MARKET ON THE AUSTRALIAN
ECONOMY
Other than recording building commencements and borrowings for the
purchase of real estate, the Australian Bureau of Statistics (ABS),
the Reserve Bank of Australia (RBA) and federal Treasury have shown
little interest in quantifying the overall Australian real estate
market. The LVRG has therefore set out to fill this void by gathering
real estate sales at current prices from Australias six States and
two Territories, each of which by the mid-1980s collected, analysed
and published the details of its own real estate sales.
FIGURE 2
FIGURE 3
Figures 2 & 3 show that real estate sales turnover declined in
the early 1990s after the bursting of the 1988/89 bubble. Although it
may not appear to be the case, real estate sales actually proceeded
quite sluggishly until 1996 - with the exception of Queensland. Figure
2 shows Queensland's sales prices surpassing those of Victoria between
1991 and 1995, and closely approaching the New South Wales juggernaut
in 1993. Whilst Queensland did experience a strong real estate boom
from that time, this was not the case elsewhere in Australia where the
upward inflection in the sales graph includes major commercial and
industrial sales by banks as mortgagee-in-possession. Properties of
lesser defaulters from the late 1980s bubble had already been meted
out onto extremely depressed markets, but these larger commercial and
industrial properties had been held back whilst business bankers
wrestled with their greater complexity.
In 2005, the volume of real estate activity in most states had either
turned down or levelled out; but in Western Australia it continued to
climb, underpinned by prosperity emanating from its extraordinary
minerals boom. In Tasmania, the highest number of migrants in a decade
in the 2004 financial year was part of the sharp increase evident in
its real estate market between 2002 and 2004 in Figure 3. This
included immigrants who sold down into the Tasmanian market to realise
capital gains and release funds on their higher valued mainland
properties.
THE AUSTRALIAN REAL ESTATE MARKET
We collated the values of states' and territories' property sales
into a national total in order to remove local influences and to
permit comparison with other national aggregates. This is shown here
in nominal and real terms. (Figures 5 & 6)
FIGURE 5
FIGURE 6
The total number of sales (Figure 7) confirms the price of real
estate to be numbers-driven, sales in the troughs numbering from only
380,000 to 500,000, whereas numbers at the peaks range from 500,000 to
767,000.
FIGURE 7
But what drives the numbers? It is difficult to resist the conclusion
that, apart from normal user demand, two pathologies are hard at work.
One is the Mad Hatter's tax regime encouraging residential landlordism
by granting deductions for interest on the land price on an equal
footing with productive business investment, whilst the other is the
herd mentality that arises, either when prices in the real estate
market start to boom or when, more rarely, they begin to fall.
On the latter occasions, residential landlords will be heard
demanding that land taxes be slashed, or seeking other government
support to rectify their declining capital gains. Otherwise, we will
stop providing rental housing. God forbid the creation of a genuine
real estate market by deterring the private capture of
publicly-created asset values! Such fiscal discouragement would pose
the pointed question to those holding real estate assets: Am I really
using this property, or simply seeking capital gain - thereby pricing
future generations of Australians out of home ownership? In what
market essential to human existence other than real estate may
anything achieve the incredibly generous capitals gains shown below
(Figure 4 - from Land Monopoly and Income Polarisation in Australia
1950 to 2000), simply by holding it off the market until the blackmail
price is met for it?
FIGURE 4
THE BAROMETER OF THE ECONOMY
Australia's total real estate sale prices, extrapolated back to 1972,
was then divided by gross domestic product (GDP) at current prices in
order to provide an aggregate adjusted for population growth and
national movements in consumer prices. The graph of the quotient at
Figure 8 paints such an extraordinary picture that we have nominated
it
The Barometer of the Economy. Not only does it provide at a
glance Australia's socio-economic record over the last thirty years,
but it may be employed to forecast periods of economic growth or
decline. Upward inflections in the barometer signify that real estate
sales prices are outperforming economic growth, so these may be seen
as property booms. A downward deflection, on the other hand, shows the
economy to be doing better than the real estate market, and this
clearly does not represent a property boom.
As a response to the recessionary fallout from the bursting of a
worldwide property bubble in the early 1970s, it became fashionable to
reduce the incidence of property-based revenues. The 1970s real estate
bubble has virtually been written out of history and blame for the
resulting recession laid instead at the foot of the simultaneous OPEC
oil crisis. However amongst other remaining public records, the
gigantic real estate bubble is well documented in a ten page special
report in TIME magazine of 1 October 1973, entitled The New
American Land Rush.
FIGURE 8
As with all recessions, the 1974/75 recession, heralded in Australia
by the collapse of Cambridge Credit and Dick Baker's Mainline
Corporation, affected everyone badly, but the property investment
lobby was successful in capturing the ear of western governments by
claiming that not only had its property values fallen, but that
property taxes had created the recession. Nothing could have been
further from the truth, but the media reported the property tax revolt
sympathetically. California's Proposition 13, which put a ceiling on
the property tax in 1978, represented the full flowering of this
putsch in the USA. [Pan the property lobby's propaganda cameras to
Whistler's mother being evicted onto the sidewalk in her rocking
chair!]
In Australia, although local government had once funded itself, Prime
Minister Gough Whitlam saw fit to support municipalities from federal
taxation in order to slow the naturally increasing growth in municipal
rates. Shortly afterwards, Premier Joh Bjelke-Petersen removed probate
duty from the statute books of Queensland. Governments of the other
states and territories followed suit, and the federal government then
proceeded to scrap estate duty. By 1980, growth in local government
rates had been constrained and the field of Australian death duties
entirely vacated. The coast was now clear for the 1981 residential
real estate bubble.
The Australian residential market grew from 64% to 80% as a
proportion of the total property market between 1984 and 2004, whilst
the commercial/industrial and rural categories both contracted to 10%
(from 16% and 20%, respectively, in 1984). Whereas Australia's
population grew by a factor of 1.36 between 1984 and 2004 (from 15
million to 20.4 million) and GDP increased in real terms by a factor
of 1.86, real land values increased a remarkable 3.2 times.
The barometer's bubble line has been pitched empirically at 19%,
simply because the boom appears to transform into a socially
devastating bubble from this point. For example, whereas no recession
ensued in the decline of 1985/86 after the real estate market had
peaked at a ratio of 18%, recession has followed on each occasion the
relationship has exceeded 19% - even at 19.24% in 1981. So, while
neo-classical economists seem unable to identify a bubble until it
bursts, the LVRG offers the following definition: an Australian
real estate bubble is any occasion when, in one financial year, total
real estate sale prices exceed 19% of GDP.
The 1994 peak is an apparent exception in that real estate turnover
exceeded the bubble line but no national recession followed. The
explanation in this case is that both the bubble and the ensuing
recession were confined to Queensland. Elsewhere in Australia, the
peak in turnover in 1994 did not coincide with any peak in prices, but
was caused by banks divesting themselves of their remaining portfolios
of distressed commercial and industrial properties overhanging from
the bursting of the property bubble in late 1989. The delay worked to
the advantage of the banks as land prices gradually began to recover.
Price escalation gained a momentum from 1996 which did not falter
until the bubble peaked in 2004.
Whereas the earlier 1987 to 1989 bubble had been driven mainly by the
commercial and industrial property markets in which the names Bond,
Skase and Elliott loomed large, and terms such as the white shoe
brigade were featured, the recent eight-year land price phenomenon has
notably been residentially inspired. So, whether as owners or tenants,
everyone has been directly involved in this particular bubble.
The Barometer of the Economy indicates that, after the whole
Australian real estate market escalates from boom into bubble
conditions, a national economic recession may be expected to ensue
within 24 months of the real estate sales to GDP relationship cutting
back below the 19% bubble line again. Swinging voters, that is, those
people not permanently committed to either one of the two major
parties, will usually throw the government of the day out at the next
election, influenced mainly by their hip-pocket nerve. An exception
occurred when the John Hewson-led federal Liberal opposition managed
to lose the unlosable election of 1993. That Hewson could not convince
people on national TV how his proposed goods and services tax would
affect the prices of a normal cake and a birthday cake differently
played no trivial part in the Keating Labor government being returned
to office.
A pattern emerges. Commercial/industrial bubbles alternate with
residential bubbles, and major barometer peaks are found to be 15 to
16 years apart. There will usually be a lesser mid-term event that may
or may not be a national bubble.
The volume of debt contained within the height and breadth of the
recent residential bubble offers a strong degree of confidence to
suggest that Australia will experience a severe economic recession
within two years of the graph retreating back below the 19% bubble
line. Scapegoats will undoubtedly be sought for the crash, for what is
fundamentally a systemic problem. It is the natural, if constantly
overlooked, outcome of a Mad Hatters tax regime which suppresses
employment and business activity as it works to inflate unsustainable
real estate bubbles.
In the mid-90s, Queensland went solo to inflate its own property
bubble, much the same as Western Australia has recently, and this
coincided with property bubbles in the South-East Asian tiger
economies. Deep recessions in Queensland and across South-East Asia in
1997 related entirely to the bursting of their real estate bubbles and
the unsustainable levels of debt contained therein. Although the
Howard government erroneously claimed responsibility for having
averted national recession in 1997, it will be unlikely to accept its
real part in the tanking of land prices by some 40% between 2005 and
2010. The subsequent mismatch between record levels of household debt
and declining asset values during the period does not bode well for
Australia's social and economic health.
Sceptics may claim that the relationship between the Australian real
estate market and the economy is not causal, because the economy
drives the real estate market, not vice-versa; but this is not borne
out by the facts. Figure 9 demonstrates that changes in the direction
of the property market precede matching changes in the direction of
the economy. So, we may conclude that economies march very much to the
beat of pathological tax systems acting to drive property markets into
bubble fantasyland at relatively regular intervals.
FIGURE 9
Australian economic historians reported that "Early fluctuations
in the Australian economy were mainly connected with changing land
prices. Two major boom periods occurred in 1826-28 and 1837-39."
(The Australian Economy in Perspective).The great Chicago land
economist Homer Hoyt had also documented the phenomenon of US property
market peaks preceding each economic recession a little further back,
to 1818 Under tax systems designed to minimise land value capture, it
is difficult to imagine outcomes other than increasingly larger
property bubbles and greater busts.
That real estate currently drives the economy into boom and bust
gives the lie to the often quoted investment cycle diagram shown,
which purports the property market to be a lagging indicator.
FIGURE 10
LAND VALUES
The relationship between Australia's total rateable land values (not
to be confused on this occasion with real estate sales) and GDP
indicates the manner in which Australia's various tax regimes have
shaped our land values since 1911; this is shown at Figure 11. Over
the period, the relationship has averaged one-to one. Whereas the
chart hit a notable peak of 1.5 in 1932 during the depression, it now
stands at a heady 2.5. The option of down-taxing labour and its
products and capturing a greater part of community-created land and
resource values offers government the only effective means of turning
the portended recession around quickly when the market does correct.
Otherwise, the period of social and financial distress promises to be
protracted.
FIGURE 11
The best opportunity to institute a staged program to raise the level
of public land value capture is, of course, in the event of such a
recession, when land values will have already declined. It is on these
occasions that government needs to react in the interest of the
general community rather than that of residential landlords only, who
will inevitably seek public compensation once again for their own
peculiar burdens.
ROLE OF THE RESERVE BANK OF AUSTRALIA
The RBA was appointed to maintain economic prosperity by managing
full employment and stability of the Australian currency. The spirit
of this brief is violated when full employment is quietly redefined as
the natural rate of unemployment. More obviously, the RBA fails its
brief every time a real estate bubble is permitted to develop, because
bubbles lead to recessions. The RBA can therefore scarcely seek to
skirt the issue by claiming that real estate bubbles are beyond its
jurisdiction. Nor may the Bank intend to cripple employment and
productive activity when it raises interest rates in order to deter
speculative borrowings at inflationary outbreaks; but, as interest
rate policy notoriously fails to distinguish between speculative and
productive behaviours, the crippling of employment and productive
activity inevitably results.
As taxation growth is partly responsible for price inflation, the RBA
is well placed to advise a superior attack on inflation, based on the
down-taxing of labor and its products and greater capture of
Australias annual land values. This would complement interest rate
policy and be the most direct way of deterring the property market
from escalating into bubble territory. At the same time, it would make
real estate eminently more affordable for future generations of
Australians, who would no longer need to compete with speculators. A
side effect would be to render Australian exports much more
cost-competitive in international markets.
QUANTIFYING THE COST OF PROPERTY BUBBLES TO GDP
Question: How much GDP did Australia lose in 2005-6 as a
consequence of the bursting of the last three property bubbles and the
ensuing interruptions to economic growth?
The question would be pointless if there were no way to eliminate
property crashes. Nor could it be answered without a reasonable
estimate of economic growth based upon the absence of such crashes.
Lets look at these issues.
Boom-bust cycles are more correctly described as bubble-burst cycles.
One can eliminate the burst if one can eliminate the bubble, and one
can eliminate the bubble if one can obviate its cause. Prices become
decoupled from earnings in a bubble and are supported only by the
assumption that someone else, the greater fool, will pay an even
higher price at a later stage. When that assumption loses credibility,
that is, when the market runs out of greater fools, there is no
support for today's prices and the bubble bursts. Bubbles cannot occur
in the market for buildings, because buyers understand that the price
of a building is limited by its production cost, and this tends to
decline with wear and tear; there is no expectation of capital gains,
nor of finding a greater fool. But bubbles can and do occur in the
market for land, because land, being a gift of nature, does not have a
production cost. A property bubble is a land bubble.
But if a more substantial part, say at least half, of the rental
value of land were taken as public revenue, any land owner who failed
to generate income from the land would make recurrent cash losses, and
would therefore feel pressured to use the land more productively -- or
to sell it to someone who will. Thus it would become unattractive to
hold land for capital gains alone. Buyers would shift their emphasis
from capital gains to earnings, and much of the speculative motive
that inflates land bubbles would be removed. If the amount to be
captured by government were calculated on the basis of the capitalised
value of a site, then rising prices would cause holding costs to rise,
which would repel buyers and reduce prices, while falling prices would
cause holding costs to fall, tending to attract buyers and raise
prices. Thus, land price growth would stabilise around the long-term
trend: competition among buyers, whose spending power is influenced by
economic growth, would cause land prices to grow, but grow no faster
than the maximum sustainable rate.
It is quite realistic therefore to believe that property bubbles, and
the recession following their bursting, may be eliminated. If
Australia had done since 1972 as we here advocate, what would be the
typical rate of economic growth, and what would be the effect on
present day GDP? That part of the question is more difficult, but a
range of arguments may be put.
The public capture of half the rental value of land would release
both land and money for more productive projects by discouraging the
holding of land for speculative purposes. It would also permit
reduction of taxes that feed into prices, and thereby reduce
inflationary tendencies, allowing more accommodating monetary policy,
reducing the internal rate of return needed for a viable investment,
and therefore increasing the available range of investments. The need
to find productive uses for land, or else sell it, would increase the
supply of commercial and residential accommodation, strengthening the
bargaining position of renters and buyers relative to lessors and
sellers - thereby making accommodation more affordable.
The foregoing is obviously extremely conducive to sustainable
economic growth. It is reasonable, if not conservative, to suppose
that the typical rate of growth achieved through such a deliberate
pro-growth policy would be at least comparable with the maximum rate
of growth achieved by accident at certain points of the bubble-burst
cycle under current anti-growth policies.
It should be noted that elimination of bubbles also implies
elimination of cycles, and therefore of the retrogression in growth
that occurs during each too-politely named business cycle. Therefore,
if we start with Australian GDP for the financial year ending 1972,
expressed in 2006 prices, and assume that the highest real
year-on-year GDP growth figure achieved since then had applied in
every year, GDP for the 2006 financial year would have been a
staggering $1.98 trillion, that is, more than $1 trillion higher than
it actually reached - as shown in this spreadsheet.
FIGURE - SUPPRESSED GDP
It might be alleged that this approach is optimistic in that it fails
to allow for possible long-term variations in growth potential, and
that it would therefore be better to raise the hypothetical growth
rate for each cycle to the highest actual growth rate recorded within
that cycle, i.e. not the highest for the whole period under study.
Accepting this reasoning, if the cycles are taken as beginning in the
recession years, namely the financial years ended 1975, 1983 and 1991,
and the highest year-on-year growth figure for each cycle (or part
thereof) is applied to every year of the cycle, GDP in the financial
year ended 2006 would nevertheless still have been $700 billion
greater, as also shown in the spreadsheet.
Even on the more conservative calculation, the GDP lost due to
current tax policy amounts to $35,000 per year for every man, woman
and child in the country, a figure that should give pause to all
Australian policymakers and politicians. Property owners might also
consider how the additional spending power brought about by tax cuts
would affect the rental and resale value of their properties. In the
scenario painted by these figures, one cannot escape the conclusion
that property owners would also gain in absolute terms, regardless of
the improved bargaining power of tenants and buyers. It would seem
that Charles Bazlinton's The Free Lunch, for all, may indeed
be a possibility.
There is opportunity for economic modellers to improve this analysis.
Precisely how much existing investment is speculative? What would be
the quantitative effect on economic growth if the speculation were
redirected into productive investment by public capture of at least
one half of the publicly generated rental value of land? If existing
taxes were reduced by a matching amount, what would be the effect on
economic growth? In other words, can deadweight be redefined in terms
of growth rates in addition to effects on static GDP? When these
effects are quantified, is it possible that our more optimistic
estimate of additional GDP as shown at Figure 12 will be proven to be
conservative? It would also stand to reason that GDP growth would be
even greater were more than 50% of rent captured to the public purse
and the deadweight costs of taxation reduced accordingly. In any case,
taking account of locational values and other components of the 32%
of the economy constituted by natural resource rents might introduce
greater reality into economic modelling.
FIGURE 12
The adverse effects of present tax policy are not limited to GDP.
People working longer and harder in downsized workplaces, and
household debt levels having risen to accommodate the phenomenon of
earned incomes now being less as a percentage of GDP than that which
was received in 1972, characterise what are bruited to be prosperous
times. Government advisors, seeming to confuse technological progress
with economic progress and social welfare, succeed in painting a scene
of prosperity because escalating asset values mask the true economic
situation. The wealth effect engendered by high land prices will prove
to be ephemeral, however, when lending institutions are found to have
provided credit against the security of a bubble.
Nor are the adverse effects of taxation limited to the economy. Real
estate bubbles create a greater human footprint than is necessary on
the natural environment, as families requiring residential land must
leapfrog over other land held idle by speculators. This leads to
sprawling cities and long commuting distances. Meanwhile, as the RBA
fights inflation by creating unemployment through artificially high
interest rates, workers tend to become less discriminating about their
job specifications. What logger of old growth forests, being a family
man, will act upon a twinge of conscience to leave his tractor to go
to the barricades against wood-chipping? He has a job to do and he
will do it well. Upton Sinclair put it succinctly: "It is
difficult to get a man to understand something when his salary depends
upon his not understanding it." Nick Naylor, the extremely
successful lobbyist for the tobacco industry in the movie Thank
You For Smoking, also cuts right to the heart of the matter when
he says that he is directed by his mortgage to do what he does so well
for a living. We might all be better off if we were to rent our
properties, Naylor suggests.
When people had cheap access to land and a new federal land tax,
Australia experienced the highest standard of living in the world.
This study hints that she might easily attain the position she
occupied early in the twentieth century again were she to exercise the
same initiative to remedy what appears to be a terminally ill tax
regime.
It is more likely, however, that both sides of politics will continue
to pay their ritualistic deference to powerful landed interests for
some time yet. Paradoxically, this report suggests that retaining the
status quo will not only adversely affect the poor, the middle class,
a sustainable environment, education, infrastructure and health, but
also Australias bunyip aristocracy itself.
The Mad Hatter's Tea Party meanwhile remains Australia's reality.
In a terribly sophisticated society, some truths go missing
*****
John Locke (1632-1704) Philosopher of Freedom
It is in vain in a country whose great fund
is land to hope to lay the public charge on anything else; there
at last it will terminate. The merchant (do what you can) will
not bear it, the laborer cannot, and therefore the landholder
must: and whether he were best to do it by laying it directly
where it will at last settle, or by letting it come to him by
the sinking of his rents, which when they are fallen, everyone
knows they are not easily raised again, let him consider.
- Some Considerations of the Lowering of Interest
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© The Land Values Research Group, May 2007 All rights reserved.
Parts of this study may be reproduced if due acknowledgement is
given.
The Land Values Research Group gratefully acknowledges a grant
from the Henry George Foundation of Australia for publication of this
report, and the assistance of Gavin Putland and Karl Fitzgerald in
offering the author helpful suggestions. The use of Peter Nicholson's
insightful cartoons does not imply that he supports the views of The
Land Values Research Group.
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