If the limitation is not in labour and not in capital, it must be in land. But there is no scarcity of land from the Atlantic to the Pacific, for there you will find unused or only half-used land. Aye, even where population is densest. Have you not land enough in San Francisco? Go to that great city of New York, where people are crowded together so closely, the great majority of them, that physical health and moral health are in many cases alike impossible. Where, in spite of the fact that the rich men of the whole country gravitate there, only four per cent of the families live in separate houses of their own, and sixty-five per cent of the families are crowded two or more to the single floor — crowded together layer on layer, in many places, like sardines in a box. Yet, why are there not more houses there? Not because there is not enough capital to build more houses, and yet not because there is not land enough on which to build more houses.

Today one half of the area of New York City is unbuilt upon — is absolutely unused. When there is such a pressure, why don't people go to these vacant lots and build there? Because though unused, the land is owned; because, speculating upon the future growth of the city, the owners of those vacant lots demand thousands of dollars before they will permit anyone to put a house upon them. What you see in New York, you may see everywhere. Come into the coalfields of Pennsylvania; there you will frequently find thousands and thousands of miners unable to work, either locked out by their employers, or striking as a last resource against their pitiful wages being cut down a little more.  Read the entire article

Rev. A. C. Auchmuty: Gems from George, a themed collection of excerpts from the writings of Henry George (with links to sources)

WITH profits this inquiry has manifestly nothing to do. We want to find what it is that determines the division of their joint produce between land, labor, and capital, and profits is not a term that refers exclusively to anyone of these three divisions. Of the three parts into which profits are divided by political economists — namely, compensation for risk, wages of superintendence, and return for the use of capital — the latter falls under the term interest, which includes all the returns for the use of capital, and excludes everything else; wages of superintendence falls under the term wages, which includes all returns for human exertion, and excludes everything else; and compensation for risk has no place whatever, as risk is eliminated when all the transactions of a community are taken together.  — Progress & Poverty — Book III, Chapter 1: The Laws of Distribution: The Inquiry Narrowed to the Laws of Distribution — The Necessary Relation of these Laws

INTEREST, as an abstract term in the distribution of wealth, differs in meaning from the word as commonly used, in this: That it includes all returns for the use of capital, and not merely those that pass from borrower to lender; and that it excludes compensation for risk, which forms so great a part of what is commonly called interest. Compensation for risk is evidently only an equalization of return between different employments of capital. — Progress & Poverty — Book III, Chapter 3: The Laws of Distribution: Of Interest and the Cause of Interest ... go to "Gems from George"

Louis Post: Outlines of Louis F. Post's Lectures, with Illustrative Notes and Charts (1894) — Appendix: FAQ

Q49. Would the single tax abolish interest?
A. I do not think so. Interest properly understood is a form of wages, and so far from abolishing it, the single tax, which would tend to increase all forms of wages, would tend to increase interest. But monopoly profits are often confounded with interest, and by force of association have given to interest a bad name; these would be minimized if not wholly abolished by the single tax. It is impossible to answer this question intelligibly to everyone who asks it, without requiring him to be specific; for it is seldom that two persons agree as to what they mean by interest. The Western farmer thinks of the high rate that he pays, partly for risk, partly from his ignorance of the modus operandi of banking, and partly because legitimate banking facilities are scarce in his Community; the Wall Street operator thinks of the premiums that he pays for currency in times of stress to tide him over from day to day; others think of "interest" on government bonds, and others of dividends of companies with valuable land rights. None of these payments are really interest, and the single tax would tend to rid society of them. But that advantage which the workmen enjoy whose implements and materials are already gathered, over those who have yet to devote time to gathering implements and materials, an advantage which is expressed in money and as interest upon capital, will not, I should think, be abolished by anything that man can do. The value of such an advantage is part of the wages of the labor that creates it. ... read the book

• The contributions of human abilities to productive efforts are called "labor," the return to labor is called "wages," and the appropriate recipients of wages are those whose labor contributes to productive activities.
• The contributions of past human products to productive efforts are called "capital," the return to capital is called "interest," and the appropriate recipients of interest are those who past saving made the creation of capital possible.
• The contributions of government-assigned opportunities to the productive process are called "land," the return to land is called "rent," and the appropriate recipient of rent is the public treasury.

• Those who contribute labor to productive processes should be allowed to keep the wages that result from their labor.
• Those whose saving makes the creation of capital possible should be allowed to keep the interest that accrues from the use of capital.
• But there is no one who has a corresponding claim to the return to land. This is the reason that fees for the use of land and other opportunities assigned by government ought to be the primary source of government revenue.

YOU MAY THINK the largest category of assets in this countrly is industrial plant and machinery. In fact the US Federal Reserve Board's annual balance sheet shows real estate to be the economy's largest asset, two-thirds of America's wealth and more than 60 percent of that in land, depending on the assessment method.

This price appreciation is actually a "land gain", that is, it's not from providing start-up capital for new enterprises, but from sitting on a rising asset already in place, the land. Its value rises because neighbourhoods are upgraded, mortgage money is ample, and rezoning is favorable from farmland on the outskirts of cities to gentrification of the core to create high-income residential developments. The potential capital gain can be huge. That's why developers are willing to pay their mortgage lenders so much of their rent income, often all of it.

Of course, investing most surplus income and wealth in land has been going on ever since antiquity, and also pledging one's land for debt ("mortgaging the homestead") that often led to its forfeiture to creditors or to forced sale under distress conditions. Today borrowing against land is a path to getting rich -- before the land bubble bursts. As economies have grown richer, most of their surplus is still being spent acquiring real property, both for prestige and because its flow of rental income grows as society's prosperity grows. That's why lenders find real estate to be the collateral of choice.

Most new entries into the Forbes or Fortune lists of the richest men consist of real estate billionaires, or individuals coming from the fuels and minerals industries or natural monopolies. Those who have not inherited family fortunes have gained their wealth by borrowing money to buy assets that have soared in value. Land may not be a factor of production, but it enables its owners to assert claims of ownership and obligation, i.e., rentier income in the forms of rent and interest. ...

Hiding the free lunch

BAUDELAIRE OBSERVED that the devil wins at the point where he convinces humanity that he does not exist. The Financial, Insurance and Real Estate (FIRE) sectors seem to have adopted a kindred philosophy that what is not quantified and reported will be invisible to the tax collector, leaving more to be pledged for mortgage credit and paid out as interest. It appears to have worked. To academic theorists as well., breathlessly focused on their own particular hypothetical world, the magnitude of land rent and land-price gains has become invisible. But not to investors. They are out to pick a property whose location value increases faster rate than the interest charges, and they want to stay away from earnings on man-made capital -- like improvements. That's earned income, not the "free lunch" they get from land value increases.

Chicago School economists insist that no free lunch exists. But when one begins to look beneath the surface of national income statistics and the national balance sheet of assets and liabilities, one can see that modern economies are all about obtaining a free lunch. However, to make this free ride go all the faster, it helps if the rest of the world does not see that anyone is getting the proverbial something for nothing - what classical economists called unearned income, most characteristically in the form of land rent. You start by using a method of appraising that undervalues the real income producer, land. Here's how it's done. ...

Site values as the economy's "credit sink"

TO CLARIFY MATTERS it may help to think of "land" in the broad sense of comprising all elements of property value that cannot be explained in terms of capital investment and its profits. This category includes the site's locational value. Site value is the essence of long-term planning by real estate developers at the local level. But an examination of the economy-wide figures shows property prices to be determined by broad macroeconomic factors, headed by the availability of mortgage credit. Real estate is the major recipient of bank credit, and price waves or cycles are determined largely by the supply of mortgage loans and their interest rates.

Stated the other way around, the costs of reproducing buildings and structures are "sunk costs". Price trends are determined not by yesterday's supply prices but by today's market demand as supplemented by mortgage credit. If anything, buildings, plant and equipment wear out and depreciate, but their obsolescence is offset (and indeed, usually more than offset) by the rise in their site value. This rise reflects the desirability of real estate as an investment vehicle, the prime recipient of the economy's savings and source of new credit.

After 1990, for instance, when commercial banks found real estate to be largely "loaned up," they reduced the rates paid to depositors, as they did not have an alternative use for these deposits. The allocation of America's savings shifted away from banks and their real estate lending to other forms of investment as depositors began to shift their savings into money-market funds invested mainly in bonds, and then into mutual funds invested largely in stocks. This shift was largely responsible for the stock market's remarkable takeoff, substantially in advance of the real estate recovery.

One would think that land prices would play a central role in modern business cycle analysis, if only because a large share of stock market value consists of corporately owned real estate. Since the late 1940s "concealed value" in the form of properties carried at outdated book values reflecting low acquisition prices was a major factor behind corporate raiding, mergers and acquisitions. Aggressive firms employed accountants to pour over the Stock Exchange's 10K reports searching for such hidden values. But macroeconomists lacked the statistics needed to follow how the business cycle affected land prices, that is, the "non-building" aspect of real estate value. This made it difficult to provide meaningful analyses of corporate net worth and the causes of its rise and fall.

How, then, can business cycle statistics be collected without land values as a prime indicator? After all, it is the inflation of real estate asset prices that provides real estate owners with the collateral to justify further borrowing from banks to acquire yet more property. And by the same token, falling land prices extinguish the collateral that backs the banking system's savings, leading to financial insolvency.

The real estate cycle is essentially a credit cycle. Traditionally, land acquisition has been the object of recycling savings and extending new credit. Site values are the economy's "credit sink" as well as its ultimate "savings sink". This is why real estate values reflect the economy's rising and declining financial surplus. Profits fall as business upswings approach their crest and the economic surplus available for saving declines. A lower volume of loanable funds means that less credit is available to real estate developers, speculators and homebuyers, curtailing their ability to bid up prices with borrowed funds. Borrowing to buy buildings is discouraged by the fact that when interest rates rise, more of the rental income must be paid to lenders.

In sum, just as real estate lending fuels land speculation, so the withdrawal of such credit leaves property markets to decline, sometimes with a crash, as occurred in Japan after 1990 when its financial bubble burst. Should this rise and fall be attributed to buildings or to land? It seems to me that inasmuch as the price rise and fall is homogeneous, applying to parking lots as well as to skyscrapers, we should attribute it to land. This achieves the logical symmetry of applying to the downturns as well as upturns in the real estate cycle. ...

Immortally aging buildings

INCOME TAX LIABILITY may be minimized in two ways.

• The most general -- and also the most economically pernicious -- is through the tax deductibility of interest. The working assumption is that interest charges are a truly inherent business expense, not simply the result of a business decision taken by investors to leverage their equity. For interest to be an inherent business expense, interest-bearing debt would have to be a factor of production, which it is not. Properties would yield their rent regardless of how they are financed. Investors choose to rely on debt rather than equity financing because the tax laws favor it, thanks to the political lobbying of institutional creditors ("the debt lobby"). Homeowners too deduct interest payments, which encourages borrowing.
• The second way to minimize tax liability, is to depreciation the building, that is, annually deduct from taxable income part of the purchase price until it's all deducted and the building is "written off" It's the most unique tax advantage enjoyed by the real estate industry. Investors are able to depreciate their buildings based on their assessed acquisition price, regardless of the actual building costs involved or the level of economy-wide land-price inflation. Investors depreciate buildings at rising prices even when prior owners already have depreciated these structures once or even many times. For real estate owned by households and partnerships (the latter being the preferred legal instrument for holding residential apartment buildings and office buildings), the Fed has estimated much higher proportions of land to buildings, but these estimates also overvalue buildings relative to land. Every time a property changes hands at a higher price, building assessments are raised proportionally - and begin to be re-depreciated for these higher valuations, regardless of how often the buildings already have been written off! There is no limit as to how often a building can be re-depreciated. What matters is simply how often the property changes nominal hands.

This fiscal privilege has created a phantom real estate economy. Buildings acquire death-defying lives, metamorphosing time and again for the purpose of enabling their owners to avoid paying income taxes. For commercial real estate investors as a whole, the repeated depreciation of buildings has made commercial real estate investment largely exempt from the income tax. Homeowners are not permitted to charge depreciation on their own residences, but only on buildings that they rent out.

SUMMARY

For hundreds of years property's value has been calculated by discounting its flow of rental income at the going rate of interest. The lower the interest rate, the higher the price a given rental stream will justify -- or as property owners express it, the more years' rent a property will bring. What is so striking about land values today is that they are rising for reasons independent of their earnings stream. The major new consideration is their prospect for future "capital" (that is, land-price) gains. In sum, the ultimate aim of real estate investors no longer is so much to seek income -- most of which is pledged to their bankers as interest payments on the property they acquire -- as much as to seek property gains. Politically opportunites abound. Merely changing zoning in New York City in the 1980s to allow using commercial loft spaces for residential purposes had the effect of multiplying asset values five or tenfold.

Whether the gains come from selling the property or from borrowing more money against it, the essential phenomenon is the rapid growth in asset values and real estate's uniquely favored tax treatment. That's why investors choose real estate instead of bonds or stocks, and much of the strategy underlying corporate takeovers has followed the strategies they developed over the past half century.

Nationwide the capital-gains dimension needs to be incorporated into the rental revenue statistics to measure real estate's total returns. This sector's nearly complete success in escaping the tax collector has placed an enormous tax burden on everyone else.    Read the whole article