The following is an excerpt from pages 64-75 of The Losses of Nations (1998), wherein Fred Harrison reveals that land rent makes up a far greater percentage of the national income than what is commonly asserted by economists.
How much rent is there in the economy? This question had long nagged a distinguished professor of economics at Columbia University in New York. Dr. Lowell Harriss favored the Georgist proposal to extract more revenue direct from the rent of land. He was to become the Executive Director of the American Academy of Political Science, and also a director of a New York think tank, the Robert Schalkenbach Foundation.
It was at the Foundation that Dr. Harris and his colleagues decided to finance an expedition into the darkest recesses of the nation's accounts. Who was earning what? Specifically, how much rent was tucked away from prying eyes? How was it concealed? The Foundation commissioned Dr. Michael Hudson, a Wall Street economist who had specialized in the flow of funds and international finance, to begin excavating the truth from the statistics. Hudson, as it happened, was pre-disposed to digging: he had cultivated an interest in tracing the evolution of debt and credit in the economies of ancient civilizations in the Near East (Hudson and Levine 1996). It became clear that, as the first step to establishing the scale of net income, it would be necessary to decode the concepts that shaped the nation's books. These accounts were as impenetrable as the hieroglyphics chiseled into stone and clay tablets buried in the Near East tombs that scholars have to decipher to unearth the principles that regulated the economy of classical antiquity.
The quest was on, and the results were astonishing. The remainder of this chapter draws heavily on the reports submitted by Hudson (1997) to the Schalkenbach Foundation. The challenge was to unearth the answer to the question: What part of income would flow to land and all natural resources as rent if the US were a tax-free society?
Most savings from the end of World War II through to the bursting of the global real estate bubble in 1990 were recycled by the banking system and by the insurance industry into mortgage lending. About 70% of US business loans took the form of real estate credit. This means that most of the economy's flow of interest payments are paid out of the real estate sector's rental revenue. We call it interest, but part of it -- that portion linked to land -- is actually rent.
What the statisticians -- and textbook economists -- represent as "rent" appears in Table 8.10 of the national income and product accounts (NIPA) as "rental income of persons." This is an imputed figure relating solely to homeowners. These owner-occupants are treated as running a business by buying their homes and, in effect, paying rent to themselves. Their "rental income" is supposed to reflect the hypothetical rent they would have earned if they had acted as their own landlords and paid a net rent to themselves after deducting state and local property taxes, interest and amortization on their mortgages, and even charging off depreciation (capital consumption allowances) for the wear and tear of their homes. The resulting figure -- $115.8 bn in 1996 -- was 1.85% of the national income.
A search elsewhere in the national income accounts for the term "rent" turns up nothing. Revenue earned by the mining, oil and gas industries on their natural resources, and the revenue generated by forestry, fisheries and the radio spectrum is called "profit," but that part which is attributable to the resources of nature is actually rent. The estimates contained in this chapter do not include an assessment of the rental value of these natural resources.
Nor does the full official term, "rental income of persons," include the returns to commercial real estate investment, or corporately owned real estate, or even farms. It also does not include mortgage interest, which is paid by real estate buyers out of their rental revenue, whether it takes the form of money proceeds (from renters) or "in kind" benefits (for owner-occupants). The statistic does not even include real estate taxes, despite the fact that the land portion of these taxes represents part of the pretax rental revenue.
The NIPA figure for "rent" also excludes capital consumption allowances (CCAs) that the tax laws permit owners of buildings to deduct from gross earnings. Business analysts add these depreciation allowances to profits to derive "cash flow," and use that as the basic measure of current returns to real estate. Adding the rise in real estate prices (called "capital gains") to this cash flow produces a final comprehensive measure: total returns.
Economists who wish to classify economic activity, and those who are interested in reforming public finance, must first factor these items into account when calculating the taxable capacity of the nation's land and natural resources.
We can now proceed to disentangle the official figures to arrive at an impression of the rental value of US real estate.
In 1996, estimated net rental revenue of homeowners as reported by the Commerce Department was $115.8 bn. But homeowners nearly double this figure to $225 bn in their disclosures to the Bureau of Labor Statistics (BLS). Noncorporate real estate (the category to which most commercial real estate partnerships belong) generated $145 bn in cash flow (real estate profits of $44 bn, plus $101.5 bn for capital consumption allowances). The corporate real estate sector registered a modest net book-keeping loss of $2.8 bn but kept $8.4 bn of real estate cash flow (CCAs) in the most recent year available (1994).
These revenues represent what was left after paying local and state property taxes of $202.3 bn, and the substantially larger flow of interest charges of $356.6 bn. The sum of all these various components of rental revenue amount to much more than the 2% or so claimed by some textbook writers. They add up to nearly a trillion dollars: $935 bn in 1996. According to Dr. Hudson:
"About 60% of this, or $561 bn, is plausibly assignable to land. Land-price gains add another trillion dollars or so in each of the boom years, pushing land's total returns to $1.5 trillion."
In Hudson's judgment, based on the most exhaustive analysis of the federal government's national income records, "land-rent of real estate alone represents a quarter of national income, even without taking into account the returns assignable to land and natural resources from other land-based industries."
This sum is almost equal to the US tax-take. How was a value of this magnitude made to disappear in the national accounts?
Real estate represents by far the economy's largest tangible asset. In its Balance Sheets for the U.S. Economy: 1945-1994, the Federal Reserve Board (FRB) estimated real estate's value at $13.4 trillion, about two-thirds of the economy's $20 trillion in overall assets in 1994. Of this sum, land values were very conservatively estimated at $4.4 trillion. Hudson's adjustments to the official figures, after discovering the bizarre way in which the FRB biases its values in favor of buildings, yielded a land value closer to $9 trillion.
It would seem that real estate's corporate and personal income tax payments ought to be substantial. Yet the NIPA statistics show the real estate sector's reported earnings to be so small as to give the impression that it operates virtually on a charitable basis. Most commercial real estate records net losses (for tax purposes) year after year.
Do real estate investors use "Hollywood book-keeping" of the sort found in movie studios that manage to turn out $100 million blockbusters without declaring any profit for their investors? Dr. Hudson worked out that the appropriate model was the oil industry, which showed little taxable income decade after decade as a result of the depletion allowance. The real estate, mining and oil industries, as well as finance and insurance, have long been the major beneficiaries of a similar fiscal largesse. In the case of real estate, the capital consumption allowance and the right to count interest as a pre-tax business expense are the two major factors freeing real estate investors from income taxation.
Many real estate investors do operate on the margin of solvency. They do so out of choice, however, in the pursuit of "making a killing" out of capital gains. They mortgage their properties to the hilt by using other peoples' money rather than their own. To the extent that the low net earnings of real estate in the national income statistics makes sense, then, it is by showing the degree to which real estate investors have been willing to turn over most of rental income to mortgage creditors as "interest." The strategy is to ride the wave of increasing land values and to "cash out" by selling their properties for more than they paid.
The tax laws tempt real estate holders to use as little of their own money as possible -- that is, to borrow as much as they can -- by allowing them to deduct interest charges as an operating expense. Homeowners also enjoy this privilege. The effect has been to buoy up prices, by enabling buyers to carry a larger mortgage after taking into account the tax savings.
Creditors provide an expanding pyramid or mortgage credit to bid up real estate prices, the macro-economic consequences or which are silently ignored in the textbooks.
In addition to not owing income taxes on two-sevenths of rental cash flow that is paid out as interest, landlords are allowed to set aside a tax-free portion of their gross rental earnings to reimburse themselves for the wear and tear of buildings, over and above their out-of-pocket maintenance and repair expenditures. The result is that real estate owners deduct most of their gross rental income, and hence are taxed on it. Thus is "rent" made to disappear.
The same technique operates in the FIRE (Finance, Insurance and Real Estate), which pays a uniquely small portion of income tax in comparison to the magnitude of its assets and cash flow.
Although the Internal Revenue Service (IRS) collects and reports capital gains (and losses) as part of its income statistics, no conceptual basis has been deployed to incorporate these capital gains into the NIPA format. There again, the exercise would not be particularly enlightening: the tax code permits so many exclusions and deductions that the bulk of capital gains are not declared or taxed. Thus, the major objective of real estate investors -- capital gains -- appear nowhere in the national income accounts.
Does all this matter? Dr. Hudson thinks so. He points out that, only when the earnings of each sector are known and compared to the magnitude of investment, can the fairness and symmetry of the tax system be evaluated. Such an assessment requires that each industry's cash flow and total returns be known and compared to its tax burden. When it comes to real estate, the statistics camouflage the reality.
Reflecting the symbiosis that has developed between the real estate sector and the financial and insurance sectors since World War II, most rental income now ends up neither in the hands of developers nor those of the tax authorities. Rather, it takes the form of interest paid to banks, S&Ls, insurance companies, real estate trusts (REITs) and money market funds.
Curiously, however, despite the fact that many properties were changing hands at rising prices, there was little net income to show for all this activity. At least, little income was reflected in the NIPA statistics. This statistical illusion is explained largely by the fact that with each sale at rising prices, the mortgage debt tends to grow, along with depreciation allowances. Unlike consumers who borrow money to buy cars, appliances, or for other non-business purposes, real estate owners are able to pay off their creditors out of pre-tax income.
Mortgage interest payments in the mid-1990s were running at $326 bn annually, absorbing almost half of the gross rental revenue. This mortgage interest now absorbs an annual amount equal to 7% of national income. A mortgage debt of $4.3 trillion represents some 46% of the economy's $9.3 trillion private nonfinancial debt, and a third of the total $12.8 trillion U.S. debt. Home mortgage interest also exceeds the reported rental value of owner-occupied homes and individually owned real estate. By 1991, interest payments rose to $343.2 bn, over two and a half times the total of reported net rental cash flow of persons ($42.7 bn), the $1.2 bn loss for real estate corporations, and $88.6 bn cash flow for partnerships.
In 1996 the real estate sector generated some $346 bn in interest payments. This was 75% higher than the $202 bn paid out for state and local property taxes.
Compared to interest charges and taxes, the figures reported for rental cash flow are relatively small, and net taxable income smaller yet: $24 bn rental income (and $86 bn cash flow) reported by homeowners, $130 bn earned by partnerships, and a $4 bn net loss (but $3 bn net cash flow) reported by real estate corporations.
Added to real estate's other deductions during 1989-1993, depreciation allowances exceeded gross rent by so much as to create (for the benefit of the tax authorities) a net book-keeping loss for the economy's corporate and noncorporate real estate sectors. Overdepreciation thus turns out to be a legalized scam.
Added together, the various forms of gross rental revenue of land in the real estate sector represents about 14% of National Income.
In clawing towards an estimate of the rent that must be apportioned to land, Dr. Hudson insists that we have to include the revenue that is disguised in its various forms. No matter how you slice it up, the values listed in Table 2:II are attributable to the services provided by the use and occupation of land. For analytical clarity, this revenue should be called rent.
Table 2:II
Fiscal cost of the real estate sector's fiscal privileges: $ (bn)
| Deduction |
1996 |
Tax yield (at 33% rate) |
| Mortgage interest | ||
|
-business |
97 |
32 |
|
-homeowners |
260 |
87 |
| Over-depreciation |
200 |
67 |
| Capital gains tax benefit |
300 |
100 |
| Total: |
$857 |
286 |
About $857 bn is additional rental income that would have to be declared if the loopholes were removed.
In reaching conclusions about U.S. land values, however, caution is the key word. For example, Dr. Hudson examined the Federal Reserve Board's methodology on a sector by sector basis. By 1993 the FRB estimated that the land held by all nonfinancial corporations had a negative value of $4 bn. This nonsensical number was the result of the way the FRB imputed land values: it subtracted the estimated replacement cost of buildings from overall real estate market prices. This "land residual" method leaves little room for land value, for it makes the replacement value of structures absorb most of the rising market value of corporate real estate. Replacement values are typically made to rise even when market prices are declining.
Yet real estate represents an economy's largest category of wealth. The FRB estimates that at yearend 1996, U.S. households and non-profit institutions held $11.4 trillion in tangible assets. Nearly 80% ($8.2 trillion) of gross household wealth took the form of real estate while non-profits held $0.8 trillion. Real estate also accounted for nearly half ($3.4 trillion) of the $6.9 trillion in tangible assets owned by non-financial corporate business.
In view of this dominant economic importance of real estate, it is ironic that the statistics are so pathetic. The methodology by which land values are assessed undervalues them by as much as $4 to $5 trillion -- a sum as large as the Fed's estimate of total economy-wide land value. Land appears only as a residual, not as having a site value in and of itself.
In drawing up balance sheets for the economy, the Fed's statisticians divide real estate into land and structures. The Fed's methodology meant that the Balance Sheet breakdowns of land and structures no longer represented current market prices. Subtracting buildings at their replacement cost from the property's current market value left land with only a scant (if any) residual value.
This creates danger for the innocents who want to invest their savings. Assuming that the estimated values for buildings were realistic, the inference was that corporate balance sheets were in stronger condition than many people realized. Those who thought this, however, did not understand how the Fed had derived its figures. Every overestimate of building value reflected a corresponding underestimate of land value (to the tune of $1.5 bn, in Dr. Hudson's view).
Faced with the statistical disappearance of land values, the FRB terminated the publication of land estimates. It was embarrassing to report that all the corporate land in America had a negative value in 1993 of $4 bn.
A recalculation of the Fed's figures provides estimates that appear in Table 2:III. This doubles the estimated land value, from $4.4 trillion in 1994 to nearly $9 trillion.
Table 2:III
U.S. Land Values: $ trillion
| Corporate | 2.0 |
| Non-profit sector | 0.5 |
| Residential | 4.0 |
| Non-corporate | 1.3 |
| Farmland } | |
| Corporate } | 1.0 |
| 8.8 |
SOURCE: Hudson (1997), derived from Federal Reserve Board estimates published in the National Income Accounts. The first three categories are from data for 1996; the second group is derived from 1994 data.
In Dr. Hudson's view, further research will lead to an upward revaluation of land relative to structures by $1.5 trillion for corporate real estate, another $2 trillion for owner-occupied residential real estate, $0.6 trillion for non-profit real estate, and $1 trillion more for noncorporate real estate partnerships.
Why is such research not being done to enhance the information that is vital to the competitive spirit of the entrepreneurial economy? Our survey of official statistical malpractice -- all of it lawful, sanctioned by the democratic process; much of it the outcome of horse-trading behind closed doors -- provides little comfort for Federal Reserve chairman Alan Greenspan. For the deficiencies in the data on the prime asset -- land -- cannot be deemed an accident. Attempts have been made to improve the data; notably by the late Henry Reuss when he was chairman of the House Committee on Banking, Finance and Urban Affairs. He recommended the compilation of an index on land prices (Harrison 1983: 303, n. 3). A Working Party of leading economists and statisticians in Washington was established to explore the ways in which the data could be compiled, but the project was killed when Ronald Reagan was elected president.
Meanwhile, the need to chronicle price trends mounts with every successive wave of chaos in the markets. The banking crises are now recurring with greater frequency, from the U.S. and UK property debacle in the 1980s, the collapse of many of Scandinavia's banks in the early 1990s and the excruciatingly drawn-out financial fiasco in Japan that lingered through most of the decade. Price indices for commodities -- from copper and gold to oil -- were tracked on the bourses, but the land on which we live, work and play was assiduously ignored.
The FIRE sector has a self-interest in not tracking land gains more closely. Government agencies have acquiesced in this industry bias, even though state and local fiscal authorities would benefit by creating a tax system that encouraged capital investment rather than speculation. Private consultants do track land values for their clients, but the aim is to buy stocks in corporations with undervalued land rather than to improve policy-making to everyone's benefit.
But what of the dilatoriness of economists? They display a surprising inertia towards the incompleteness of information on land. Many of them would reject such a charge; including, no doubt, Nobel prize winning economist Paul Samuelson of Massachusetts Institute of Technology. He wants economics to be judged as the "realistic science" (1967: 792), a standard against which he would agree to be judged. His stricture appeared in the 7th edition of his Economics, a textbook which The Economist of London has characterized as influencing several generations of university students.
Yet realism is what economics cannot deliver, if it will not call a spade a spade. For example, in the 12th edition of his book (1985: 114-115, co-authored with William Nordhaus), Prof. Samuelson deals with rent as requiring "only one explanation." That explanation defined rent in the national income accounts as the income of persons (which, for 1983, is shown as 2% of the Net National Product). No realistic attempt is made to enlighten students about the flow of rental income to persons who own the choicest of locations in the commercial and industrial sectors, or to decode categories like "Net interest" or "Depreciation."
Such a charge could not be leveled against Columbia's Professor of Economics. Dr. Harriss, unlike many of his peers, knew that the tax base that Henry George had in mind was not what the national income accounts classified as "rental income of persons." He had written that "much that would belong in the base consists of the fruits of parcels of land that are not subject to lease." This included, he noted,
the land owned and used by a corporation, as for factory, office space, or commercial occupancy, with the net yield appearing, presumably, as profit or in payment of interest on debt. The economic rent of much agricultural land appears as 'farm income.' Probably most of the land value in the country does not yield a rental appearing as such in the national accounts (1979: 369, n. 13. Emphasis added).
Without that realistic appraisal of what lies behind the official labels, it is not possible to achieve a working appreciation of the order-of-magnitudes in the distribution of income between land, labor and capital.
Without the hard information it is difficult to "prove" that the economy is biased by taxation in favor of the pursuit of capital gains (the ethos of the casino) rather than the production and construction economy (the ethos of the value-adding entrepreneur). The blind spots in the law-making process, nurtured by the paucity of relevant information, are
Yet the rent of land and natural resources, in all its forms (overt and disguised by the tax system and a subjective economics: see Appendix I for a comprehensive list), is sufficient to introduce the Single Tax philosophy in the United States today. All that this requires is the democratic will.
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