The rise of the freeloaders

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The rise of the freeloaders

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In areas like Greenwich in London, the construction of public infrastructure has led to an increase in the value of private land (photo: Jim Linwood)

We’d all like something for nothing. In the BBC comedy series Private Schulz, the Nazis plot to undermine the British economy by flooding the country with counterfeit currency. The hero parachutes into Britain carrying £2m of fake five-pound notes, and the fun begins.

How nice it would be to own a printing press that could produce fabulous amounts of money. Common sense tells us this would be immoral and wrong—a counterfeiter creates no real wealth himself and freeloads on the economic activity of others. It also tells us that society would stamp down hard on any form of economic freeloading. But common sense is mistaken.

The ability of individuals to make something for nothing is so pervasive that it even has a special name: “economic rent.” It was identified by the great eighteenth-century economist Adam Smith as one of the three main types of income. In The Wealth of Nations, Smith divided income into wages, profits and “rent.” He refers to “rent” in a way that confuses the modern reader, so I’ll use the term “economic freeloading.”

Freeloading, once it is recognised, provokes instinctive revulsion. Recent studies indicate human morality evolved partly as a response to the damage done by “free riders.” In primitive societies, anyone hitching a free ride was lethal to the social group, since hunter-gatherer existence required everyone to pull their weight. Humans had to develop a finely tuned sense of fairness and root out free riders, or their social group would become extinct. Most people (except Private Schulz) feel guilty when they hitch a free ride on others, and therefore avoid doing so.

One group engages in economic freeloading on a gigantic scale: landowners. This group, consisting of commercial property owners and private homeowners, sucks billions of pounds out of society each year. The average homeowner would be shocked and indignant at being described as a freeloader. A house is somewhere to live. Freeloading suggests some sort of sneaky behaviour, but those buying a home are overwhelmingly law-abiding and responsible, supporting themselves and their dependents without calling on assistance from the state. But the tax system makes them freeloaders, whether they know it or not.

In a speech supporting the Liberal government’s “people’s budget” of 1909, Winston Churchill explained why this counts as freeloading:

“Roads are made, streets are made, railway services are improved, electric light turns night into day, electric trams glide swiftly to and fro, water is brought from reservoirs a hundred miles off in the mountains—and all the while the landlord sits still… To not one of these improvements does the land monopolist as a land monopolist contribute, and yet by every one of them the value of his land is sensibly enhanced.”

There is nothing a property owner can do to change the value of his plot of land. The value per square foot depends on its location. Is it near a station? A good school? All of these factors are determined by the actions of society, not the individual efforts of the owner. Any increase in the value per square foot of his plot is a pure free ride, towards which he has done nothing to contribute.

The scale of this free ride is huge. The total value of the private housing stock in the UK has risen from about £1.3tn in 1992 to about £4.2tn today. This increase is largely due to inflation and growth in land value; the stock did not substantially increase during this period. If the increase had been due to inflation alone, this would have taken the value to £2.3tn. The additional £2tn reflects the increase in the value of the land that the houses are built on. So landowners, including homeowners, have gained almost £2tn over 20 years from a rise in land values.

A specific example of landowners getting a free ride at public expense was the construction of the Jubilee line extension in London in the 1990s. This cost £3.5bn and led to an increase of £13bn in the value of nearby land. The cost of building the line was almost exclusively borne by the general taxpayer, but the £13bn benefit was pocketed by local landowners, most of whom had contributed no more to the building of the Jubilee line than any other British taxpayer.

Some of the profit made by these property owners may have been recycled back to the economy through increased economic activity. But people do not willingly spend money on a project when they see no personal benefit. When society separates reward from contribution, the contribution dries up. Money for public infrastructure projects comes from the general taxpayer; the beneficiaries are always a lucky group of property owners in particular locations. There is therefore little enthusiasm for sustained infrastructure expenditure from UK taxpayers (or for that matter from private sources). The dilapidated state of UK infrastructure is a direct result.

Private Schulz performs his counterfeiting in secret, but owning a property is a public act sanctioned by the state. Failing to tax easily identifiable free riders on windfall gains provided by society seems crazy, but history provides an explanation. In 1909, the British aristocracy blocked the attempts to tax land in the “people’s budget,” and they have sabotaged attempts to tax land ever since, along with companies owning city centre business property (which is increasingly foreign-owned). The richest British-born individual is the Duke of Westminster, whose family owns the central London Grosvenor estate. In dynamic economies, the greatest wealth is held by entrepreneurs and innovators such as Microsoft’s Bill Gates. In the British economy, a propertied ruling class sustains its wealth by playing the economic role of a currency forger. This has caused a century of social stagnation and economic decline.

The government must find the courage to tax the gains of economic freeloaders and to liberate the productive part of the economy. The solution is a land value tax, an annual tax based on the value of the plot of land. This would be very difficult to avoid paying, and would ensure those who benefit from public expenditure shoulder their share of the costs. At present, the only serious tax on residential property is council tax, which takes a lower proportion of the property value as the property gets more expensive, thus punishing owners of low-cost homes and rewarding owners of more valuable properties. Furthermore, it reaches a maximum level once the house is sufficiently expensive, so a £30m house can attract the same council tax as a family home.

A land value tax would make some infrastructure projects self-financing. There have been examples of large public improvement projects financed in this way since the 19th century. When the city of New York decided to create Central Park, it purchased several city blocks at market prices and demolished them. The increased property taxes resulting from increased land values in the vicinity of the park more than paid for the up-front costs.

Recent calls by the Business Secretary Vince Cable to introduce a mansion tax are welcome, and are the only serious attempt by any major party to tax property progressively. However, a mansion tax fails to target freeloading since, like council tax, it is based on the buildings as well as the land. Cable is fully aware of this, but shies away from the political battle that would be needed to promote a fully fledged land value tax.

And Private Schulz’s fate? Like the best fictional scoundrels, his schemes get him nowhere. If only real life were like that.

  1. December 5, 2012

    barani

    fantastic article. So illuminating; perhaps my knowledge of the economic history is dim.

  2. December 5, 2012

    Dan Sullivan

    As much as I agree with the idea that *large* landowners are freeloaders, ordinary home owners, for the most part, pay far more in other taxes, and in inflated mortgage payments, than they capture in land values. At least that is the case here in Pennsylvania, US, where we rely enough on real estate taxes (and sometimes on land value taxes) to keep speculators from getting too far out of hand.

    More to the point, another kind of freeloader, and one very similar to the Private Schulz example, is the banking system, which lends money into circulation and collects interest off of money it created out of thin air.

    New money should only be issued by government, should be either spent into circulation or distributed on a per capita basis. Banks should only lend the money they actually hold, and should not be able to create monetized credit. To do so is a form of legalized counterfeiting.

    • December 6, 2012

      David Cooper

      Pennsylvania USA is one of the few areas where LVT is actually used, albeit only as a local tax. I believe it has been successfully applied some cities, for example Harrisburg, and has gone some way to rectifying city centre blight.

      At no point do I suggest that capturing real estate uplift is the only form of freeloading that the rich and powerful employ. I do suggest it is the largest, even taking into account the enormous amounts of money we have given to bankers.

    • December 19, 2012

      Peter Whipp

      I would say that the only reason by which property prices can increase across the board is by the application of credit to buy it. The real cost of rising property prices is surely the additional debt that households must assume in order to buy their home. A whole generation that strived to own their own home now grapple with this debt and that is the greatest cause of the current financial crisis.
      It is probably too late to tax gains now because banks are no longer advancing the credit that creates them but if governments retook the monopoly right to create money from banks, they could control the supply of credit so that property prices increased only in line with the level of wages and, therefore, with the ability to repay mortgage debt.
      I am an accountant and, from that perspective, I have written a book called “The Trouble with Money”.

      • December 19, 2012

        William Davison Chair of ALTER

        I think you need to consider how banks lend money, as Prof Steve Keen describes, they make the loan then look for the reserves, often going to interbank market. In a fractional reserve banking system, the money is debt, so as the banks lend more the money supply growths, if the no one is willing or can’t take on more debt the money supply will shrink. Its not the banks that suddenly print more money, some one has to borrow the money to increase the supply to drive up asset prices. Often it is property (really land) speculation that drives the lending. Land owners can restrict the supply and drive up property prices, start the speculation. Land speculation can allocate capital away from productive industries, you see that in the stock market performance after 2000 compared to the property boom along with derivative investments link to property. In 2007 there was not much evidence to suggest equity prices were significantly of over valued, the price earning ratio’s were not high by historic values, this was no 1929.

        When Britain was on the Gold standard it did not stop property booms. The problem with using interest rates or credit controls when land speculation starts is it slows the whole economy not just the land speculation. Even if you replace or reduce Fractional reserve banking it would not stop land speculation, the pressure on who ever controlled the money supply to increase credit in the economy would be difficult to resist. As money supply in the economy is debt and the demand for mortgages is based on the belief that house prices will rise or fall, it has major impact on credit growth. Rigid control of the money supply is more difficult than many think and can lead to very volatile interest rates. It would be unwise to ignore the effect of demand on credit growth.

        • December 20, 2012

          Peter Whipp

          I must disagree. When banks lend money they credit the recipient (vendor of property) and debit the borrower (the purchaser). An individual bank only requires reserves if it lends more than the other banks. Reserves used to be gold and this restricted lending because the supply of gold was restricted. Reserves are now merely credit balances with the central bank and are solely required to settle interbank accounts. The requirement to hold reserves was abandoned in the UK in 1981. We no longer have fractional reserve banking but zero reserve banking; there is no longer any limit to the amount that the whole banking system can lend but there is a limit to the amount that individual banks may lend.

          I do refer you to my book, “The Trouble with Money” and will be delighted to send you a copy.

           
    • December 26, 2012

      John

      Dan, It may be true that home-owners do pay a lot of tax which may cancel out mortgage payments and land value rises. But once the mortgage is paid off, or the payments drop off as time moves on, that is not the case. There are millions of grey people who are quite well of and sitting on an asset, the land, which the value they never created.

      If I buy a “new” car with a loan, few houses bought are “new” in the UK, the value of the car depreciates in value over time, unlike a house, which increases, well the land increases in value not the building (the capital).

      It is true the creation of money should only be by the government owned central bank. In the UK five private banks can create money – the Tory gvmt in 1971 allowed this to happen. Since the Tories (them again) abolished Schedule A tax in 1964 – a tax on land assets set in the early 1800s as income tax was introduced, and the allowing of private banks to create money, land prices and boom and busts have become the norm.

      A bank gets a mortgage deal. They do not have the money in their koffers for the loan. They get the business, press a computer key, the money is created and a debt is created. Money is created out of thin air. There have been many people who have been turned down for their first loans because they have no track record of repayment of debt. In ye olden dayes, not long ago, a loan was given on a guarantor, not a computer database debt record.

  3. December 6, 2012

    Nigel Quinton

    An excellent article, glad to see Churchill’s 1909 speech getting an airing, For those interested in reading more from Churchill from that period, there is available on the Free Books App for iPad a wonderful collection entitled Liberalism and the Social Problem which contains speeches and articles from the period 1906-09.

  4. December 6, 2012

    Alan Craw

    First rate piece. I particularly like Dan Sullivan’s comment. US property taxes are a good way of discouraging speculation, and yesterday’s bank lending bubble was predicated on tomorrow’s inflation. It did indeed create money out of nothing, and so was unsustainable.

    • December 6, 2012

      Dan Sullivan

      I don’t know if capturing land rent is biggest or creating money out of nothing is biggest, but it doesn’t matter, because the two are in partnership through mortgage banking. American progressives derailed each other by arguing this question when they should have been partnering against the combination.

      In any case, property tax costs the home *buyer* nothing, because what it saves him in mortgage costs more than offsets the cost of the tax. I documented this by comparing housing prices and property tax rates for all 243 US cities with populations over 100,000. This was 2005, the peak year for US real estate.

      http://savingcommunities.org/issues/taxes/property/affordabilitycharts.html

  5. December 6, 2012

    Dave Wetzel

    An excellent article. Annual Land Value Tax is certainly required not only to reduce taxes on production but also to bring empty buildings and idle urban brownfield sites into use thus reducing the need for urban sprawl and the resultant Co2 created by duplicated infrastructure and unnecessary commuting.
    Re Mansion Tax: most homes worth over £2m enjoy a higher percentage of land value than building value so Mansion Tax would be collecting a high percentage of land value.

  6. December 11, 2012

    Jeremy Buxton

    Only a decadent, envious society could comtemplate a tax on family homes. The only fair taxation is on incomes ore expenditure. This wicked proposal will punish those who are asset rich and income poor, taxing them out of their homes.

    • December 11, 2012

      David Cooper

      Dear Mr Buxton,
      I think you will find it hard to argue that Winston Churchill, when advocating Land Value Tax, was decadent (although he did like his whiskey) and I cannot think anyone the great man would envy! Wealthy freeloaders always scream “politics of envy” when their gravy train is threatened.

      The residual modicum of sense in your comment is that the measure would punish the asset rich and income poor who have made financial decisions in good faith based an a flawed tax system. Any change in a tax (or benefits) system has this danger, and the introduction of Land Value Tax would need to be phased in with measures taken to deal with difficult cases (the “poor widow in family mansion”).

      I wonder if you would worry about an income poor widow who was renting a mansion when the landlord upped the rent. Actually, I have a hunch you wouldn’t.

      • December 26, 2012

        John

        David Copper wrote:
        “Any change in a tax (or benefits) system has this danger, and the introduction of Land Value Tax would need to be phased in with measures taken to deal with difficult cases (the “poor widow in family mansion”).”

        In the current system a poor widow who is asset rich but cash poor, would need to sell up if she cannot meet the maintenance of the mansion or pay the Council Tax. Why should a comprehensive LVT system support her otherwise? She can sell up, pocket the sale money, and move to a lower LVT district – which like having an internal tax haven. She can move to remote Wales or Scotland and pay next to nothing in LVT.

        This also means properties in prime locations are used to better effect. Those not in mansions can have the LVT deferred until sale of property or death and be forced to move.

        • December 28, 2012

          David Cooper

          Dear John,

          There is a difference.

          The state has never offered to pay the maintenance costs of the “income poor rich widow”.

          It has however implicitly given the widow an idea that she hang onto the full value of property value uplift. If this widow has arranged to finance her retirement on this assumption (for example is relying on the income from renting a room, but has not factored in LVT liability), she has some reason to complain. One should be able to make long term financial decisions on the basis that the rule don’t change in an unpredictable way.

          Thus the “poor rich widow” is a real problem. Nor is the solution all that difficult; simply allow her to transfer the freehold to the state in return for an annuity sufficient to cover future LVT liability. Since the state receives an asset in return for the annuity, there is no effect on the balance sheet. In practice, this sets an upper limit on the rate that LVT should be levied.

           
    • December 26, 2012

      John

      Mr Buxton, the misnomer, Land Value Tax is “reclaiming” value created by the community. It eliminates Income tax, Council Tax (a tax on the home), VAT and other stealth taxes.

      It is best you understand what Land Value Tax achieves.

  7. December 11, 2012

    Alan Craw

    Only a decadent envious society could grab all its unearned income to itself. When I was a councillor, I had complaints from people whose houses were increasing in sale price by £1,000 a month about £100 a month council tax. What cheek! £900 a month profit for them. Council tenants paying the same tax had no such unearned income to compensate.

  8. December 19, 2012

    Rayhan Rafiq Omar

    If you want to increase tax, you must also reduce tax. Modern society is crying out for a modern tax system that takes into account a burdened middle class who currently have no hope of creating wealth of being securely employed.

    Increase confidence in the economy by taxing at an ultra low rate, flat tax.

    My proposal is 3% across both income and non-depreciating assets.

    I would very much appreciate thoughts on this: http://bit.ly/ZjPTIN

    Rayhan

  9. December 28, 2012

    Peter Whipp

    The average home should cost about four times the average salary because it takes a little more than three man years to build the average home and also because an average earner can afford to repay four times his salary over 20 years. If the rate of pay increases, then the value of one’ s home should increase in line with this and that, surely, is reasonable and should not be subject to tax.

    In recent years banks lent a lot of money that they never had and this caused the price of that average home to become nearly eight times the average salary. To tax this gain before it is realised is surely wrong because the debtor is already struggling to repay the debt. To tax any realised gain during one’s lifetime will make it impossible to move home. The answer, surely, is to control banks’ lending so that the price of homes only increase in line with the rate of pay. Central banks’ Monetary Policy has been deplorable.

    • January 3, 2013

      John

      Peter, it appears you are mixing the capital (the building) and the LAND. It is true that a house should be worth about 3 times the average salary, a it take approx 3 man years to build. That three years is to build the bricks on the land, the house, the capital. But the land will always be worth something, so that is factored in with the capital.

      Land Value Tax does NOT tax the capital, the building.

      Banks lent a lot of money that they never had because they used LAND as collateral. The values lift in land is created by community economic activity, so to them it was a sure-fire winner. They could always take back the house on the land and sell if a sub-prime lender defaulted. Few would use some industrial machinery as collateral, as that depreciates in value.

      The stripping of financial controls was a factor in the crash, however when drilling deeper it was that they could use value lift of LAND as security. A value lift was created by us, the community. Speculators were also pouring borrowed money into as it was tax free and always rose in value. Land Valuation Tax puts a brake on LAND speculation and free-loading.

      Peter wrote:
      The answer, surely, is to control banks’ lending so that the price of homes only increase in line with the rate of pay.

      The answer is Land Valuation Tax based on 100% rental value reclaim – it is self regulating.

      “Solving the land question means the solving of all social questions… Possession of land by people who do not use it is immoral – just like the possession of slaves.”
      - Leo Tolstoy

  10. December 29, 2012

    John

    Hi David, I never stated the state has offered to pay the maintenance costs of the “income poor rich widow”. ;)

    I agree the state has implicitly given the widow an idea that she can hang onto the full value of land value uplift. This is the case. Most people believe she should hang onto it. Many will point to the value uplift of say a painting or a classic car and that should the state take that as well. Land is very different to a capital item. Look in any neoclassical economics text book and you not see a proper definition of land. It will not tell you the fact that land is not consumable, that it can be used continuously for various uses without wearing out, land is the surface of the planet & the physical space above and below and that when usable land is kept idle it represents a permanent loss of production and welfare.

    “One should be able to make long term financial decisions on the basis that the rule don’t change in an unpredictable way.”

    There may be the odd case of those in negative equity, however these will be few and far between. Provision must be made for these. But they disappear quite soon after LVT introduction and then not a problem.

    Thus the “poor rich widow” is a real problem.

    It is problem in that the LVT supporters have no stock answer to put down the “old Widow Bogey” instantly. What is the prime point of the “Old Widow Bogey”? That an old widow on a small pension will pay full tax, while now she only pays Council Tax and that may be fully or party paid by Housing Benefit. There are a number of ways to approach this. Taking the property into state ownership is a vote loser. Although in principle it is fine, but it will be perceived as the state grabbing private property. Forget it! Something like the state securing a “loan” on the land, to pay the LVT would be more acceptable.

    Deferring LVT, all or part of LVT is probably the best solution. Or well thought out exemptions. But, the sound point that an Old Widow should be in a house worth £0.5 to 1 million, of which the value lift she did not create, should pay little in tax of any sort and her relatives take the value of say £1 million when she dies is immoral and just downright wrong.

    When LVT is explained to the uninstantiated, they immediately think of the “old widow bogey” without any prompting. A stock convincing answer is needed they they can understand and dismiss the concern.

    • December 29, 2012

      David Cooper

      Dear John,
      It would be nice if there were some easy “stock convincing answer” to the poor rich widow question. There is not, for the simple reason that the state has created certain expectations that LVT is bound to disappoint.

      True, there is no moral reason that the state should go to great lengths protect owner occupiers of homes (and their heirs) from the impact of land taxes, while showing no such concern about tenants forced to move when rents increase or benefits are cut. But this expectation has been created, and we must live with the consequences.

      The problem with your suggestion of deferring LVT until the owner moves or dies is that it will immediately pilloried as a death tax. So it really doesn’t help.

      ALTER has produced a paper on introducing so called “LoTax”, but I’m afraid we have no “stock” answer to the poor rich widow question. My personal opinion (which is at variance with the LoTax paper) is that the state should offer an annuity in return for the property freehold, which covers LVT liability.

      • December 29, 2012

        John

        David,

        “My personal opinion (which is at variance with the LoTax paper) is that the state should offer an annuity in return for the property freehold, which covers LVT liability.

        I like it.

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Author

David Cooper is secretary of Liberal Democrat Alter (Action on Land ­Taxation and Economic Reform), a Liberal Democrat campaign group 




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