The term “unearned income” became famous with economists David Ricardo and Henry James, who used it to denote the appreciated value of property which was not from development of itself, but of the surroundings. The idea was that this was done without any significant contribution by the owner, yet he or she reaped the lion’s share of this appreciation. A very famous speech by Winston Churchill in 1909 is often quoted to define the problem, if there is assumed to be one, with a landowner making possibly huge profits on land without having exerted any effort whatsoever to receive them. Instead, Churchill spoke about the profit arising because of the labor and expense of the general community surrounding the property, near and far, who improved the potential utility of the land without any development of it having been done. Churchill favored that the unearned profits from the sale of such land be taxed by the state and used for the good of the community, whose efforts produced it.
The general principle of taxing unearned income more than earned income has received support from many quarters, and seems to be an acceptable principle upon which to base a taxation system. However, there has been no end of controversy and change in what is considered unearned income. This blog has as a goal, a better way of defining it, and a better way of taxing or otherwise regulating it.
It is a natural way of human existence to avoid tax, and tax avoidance mechanisms are as ubiquitous as tax plans and almost as prevalent as tax payers. Even more prevalent are the paid experts who promote the income and wealth of their sponsors as earned, or whatever label receives less opprobrium. The same experts are at the ready to explain or rather excuse any tax avoidance scheme in terms relating to personal choice or corporate advantage or professional practices or some other rationale for its use, other than stating it to be exactly what it is. In contrast, there are a few individuals who simply label tax avoidance schemes for what they are, and state they are proud to have located and made use of them. All this obfuscation makes it somewhat difficult to exactly define what is ‘unearned income’, if there is anything like this, and what should be done to tax or regulate it. To deal with this murky situation, some basic principles need to be enunciated.
The first point to be made is that unearned income does not exactly exist. All income is partially earned and partially unearned, and the difficulty is in deciding how much of it is one and how much is the other. The land value appreciation gain that Churchill spoke about is one of the easiest and simplest ones to describe as it is almost binary. In Churchill’s picture, the value gain is unearned if the landlord does not develop the property, but the development, if it appreciates, produces earned value. Things aren’t binary in economics, but quantitative. The landlord invests his money in a piece of property, and could have instead put the money into a CD or some other investment. The lack of interest paid for undeveloped land represents a loss, as compared to the interest from other investments. Annual tax, even if small, represents another cost of holding the property. Thus, taxing the gain of a piece of undeveloped property at 100% would eliminate all potential interest in such investments. However, a tax at 100% of the amount over some multiple of the average gain of investments, plus tax costs, would be a better approximation to the return of unearned income back to the community which created it. What multiple to use is debatable, but it should not be large, perhaps somewhere between one and a half and four.
Churchill also used the same speech to promote the annual tax on a piece of property, as distinct from tax on the appreciation recognized in a sale, as dependent on the potential value of the property, as opposed to its original value. Sometimes and in some places, the exact opposite is done; zoning is a tool for maintaining artificially low appraised values, and limits on tax appraisal changes annually is another. The taxation on an annual basis, as opposed to the tax on the sale profit, is simply a moving in time of the amount of the taxation, if the mathematics of tax rates is done correctly.
The label ‘monopolist’ was used in Churchill’s speech, and this again is because of the nearly binary nature of land. There is little land created on the planet’s surface, and only by reclaiming wetlands, dredging dirt for use in artificial islands, or using polders to force back the sea. One can claim that a particular piece of land is held as a monopoly, if it is in a particular location that cannot be bypassed, but otherwise, land is somewhat fungible. The owners of all the land in some particular location might be said to have a collective monopoly, but so could all the owners of a particular stock or anything else. Supply and demand slides into monopoly as the owners form a cartel to dissuade individuals from selling before some process increases the price substantially.
A real monopoly would exist if some individual or band of individuals obtain rights to all of some land, just as they would if they had obtained all the rights to some resource, like oil, or some invention that was patented or some drug which was likewise limited. These monopolies have not been similarly singled out for extra taxation, as Churchill did with land, but they could be with similar justification. The basic point of the singling out needs to be clearly stated. Churchill felt that there was little justice in allowing unearned income to be lightly or inconsequentially taxed, but he felt that justice was done better with a mere 20% tax on land profits. Others have written that societies need to harness the labor, capital, land, and resources they have available to them so that these four quantities could be put to the best use in increasing the living standards of the population, or at least some of them. The Churchill 20% tax would not do that.
In designing a new socio-economic system, or even trying to see if there are any better ones possible, it is necessary to be specific about the goals of the society. Should this goal of increasing the living standards of some subset of the population be one which shapes all the tax and regulation policy of the governance mechanisms? This one, as are most others, has some appeal to it, but like all goals, it is arbitrary as well as being poorly defined. Should a socio-economic system be defined by setting down a few goals and then building up the details of the system to accomplish them? Soviet communism had a simple slogan, something about changing the distribution of the products of society to be based on needs rather than productivity, past and present. Other systems have had slogans as well. The alternative is to be more Churchillian, and stick with what we have but modify it a small amount in the direction we think would improve it.
These are just two of the many ways to conduct planning for a society or for a project or anything else. One is to set a destination, which might be listed as a set of goals, and then try to get there. The other is to keep doing exactly what is currently being done, and just make small corrections. Both work well in many instances. The first one is more appealing if the general opinion of the existing socio-economic system is negative, and then a new plan or a new set of goals might be chosen to break away from it. The second one, obviously, has appeal in the inverse situation, where the general opinion is that things are not so bad, and can be corrected. The second one also arises in the instance where it is recognized that no one at all can figure out how to design a new socio-economic system from scratch, and that any system should have some experience with it before it is adopted. Since one cannot experiment with a whole society, it means that there is no way to make a new socio-economic system that is acceptable to the population. Theoretical justifications as to how a system would work are not likely to be correct, as there is no body of experience and no general theory of sociology and economics which would assist a team of designers in figuring out the details of the new system.
Are these latter opinions justified? Is it indeed impossible to come up with a whole new system, and the best that can be done are minor course corrections, perhaps a large amount of them in an never-ending stream. How exactly would we know if minor course corrections will take us in a desired direction or steer away from it or lead us into unknown territories, if there is no competency in sociology and economics? The lack of experience and the lack of theory seem to be an inhibition to small changes, as well as to large ones. So, let’s just keep trying.
Uneducated Economics 