Land Taxation & the Renewal of Growth in the Irish Economy

Oct 15, 2012 Comments Off on Land Taxation & the Renewal of Growth in the Irish Economy by

A Briefing on Rent-as-Public-Revenue requested by

Mr Joe Costello T.D.
Minister of State for Trade and Development
Department of Foreign Affairs & Trade
Republic of Ireland

Fred Harrison
Land Research Trust
London

Land Taxation & the Renewal of Growth in the Irish Economy

At our meeting on September 24, 2012, arranged by Mr Konrad Dechant, I explained that Ireland’s economy would gain significantly by shifting the public’s finances away from taxes on wages and onto the rents of land and natural resources. I pointed out that such a fiscal restructuring would alter the terms of trade in Ireland’s favour. By cutting the costs of hiring people, the price of exported goods would be lowered without reducing people’s take-home pay. This would increase exports, and increase the attraction of investment in Ireland from both domestic and foreign sources, rendering the Republic an attractive place for corporations to locate their production facilities.

Killing the Celtic Tiger

Understanding why the Irish economy really collapsed is the pre-condition for recalibrating public policies in ways that would enable Ireland to recover from the worst depression since the 1930s. We may illustrate the internal dynamics of the market economy by briefly reviewing the impact, over the past two decades, of the inflow of capital into Ireland.

Take, as one example, the inflow of EU structural funds (over €60bn?). This money did improve the nation’s infrastructure. But it also had an unintended consequence of the kind that exposed the weakness in the structure of the economy. The investments automatically raised the price of land. We know from the empirical evidence documented in the literature that the net gains from such infrastructural investments are captured by land owners. They capitalise the net gains into the price of this one asset. In Ireland (as in Portugal, Spain, southern Italy and Greece), that effect triggered property speculation, which in turn led to the over-extension of bank loans which, in turn, undermined the financial sector. The causal sequence – the chain of events, the flow of funds – is vital to understand. It is currently ignored by most analysts. And that is why (if present policies are retained) the regulation of banks will not prevent the next cyclical land-led property boom/bust and social implosion.

The only way to prevent the next boom/bust is to re-arrange financial incentives. The only market-based policy capable of achieving this is a significant land tax. If such a revenue-raiser had been in place over the 1990s-2007, Ireland’s enterprises would have enjoyed growth without the prospect of the Celtic Tiger being neutered in 2008. The inflow of the capital that the nation needed would have been re-cycled back into productive investment, yielding yet more job-creating capital formation. Instead, the incentive structure was biased to encourage rational people to indulge in the one activity that yielded the highest capital gains for minimal entrepreneurial effort: land speculation.

The Best Kept Economic Secret

The trade-related strengths of the land tax are not discussed in the academic economic literature. I have reviewed the university textbooks, and I find that there is no coherent discussion on fiscal policy of the kind that examines the dynamic influences of the tax shift. This void in the fiscal knowledge base is a serious constraint on policy-making. Law-makers who rely on consultants who have been schooled in orthodox economics are not provided with a full briefing on all the policy options that favour optimal development.

The most thorough recent study of tax policy was undertaken in Britain by the authoritative Institute for Fiscal Policy. A panel of distinguished economists was chaired by Nobel laureate Sir James Mirrlees.2 (A copy of their two reports may be downloaded from http://www.ifs.org.uk/mirrleesReview ) A taste of the significance of the tax shift is given on page 2 of Chapter 16 of the Mirrlees report. Here, we read that their intention was to “contrast the strong case for taxing land values with the strong case against taxing business property”. The report states:

“To understand how to tax land and property, it is important to keep these issues and themes distinct. To be clear:
• Land, whether used for business or residential property, can be taxed at an arbitrarily high rate on economic efficiency grounds.
• Business property is an input into the production process and, on efficiency grounds, should not be taxed.
• Owner-occupied housing combines the features of an investment and a consumption good, and we should consider its taxation from both these points of view.
• Rental housing is an investment good from the point of view of the owner and a consumption good from the view of the renter. Overall, there is a presumption in favour of taxing it at a similar level to owner-occupied housing” (Mirrlees et al., 2011: 368).

The report, Review of the Tax System, concluded that

The taxation of property in the UK is currently something of a mess. As we have seen when considering the practicalities involved in implementing an ideal system, up to a point this is understandable. But it remains both desirable and feasible to clear up much of the mess. Our conclusions can be summarized thus: There is a strong case for introducing a land value tax. The priority should be to use it to replace the economically damaging business rates system (Mirrlees, 2010: 36. Emphasis added).

Mirrlees and his associates employ non-scholastic language to leave readers in no doubt about their views on the state of the British tax regime (which was largely inherited by the Republic of Ireland). While Mirrlees advocated a charge on land, notice the limits to their ambitions. They state in their concluding paragraph on page 39:

This is a radical set of proposals, and the changes would need to be phased in carefully. But this is also an area where the current practice is a long way from an economically rational and efficient system. Stamp duty and business rates defy the most basic of economic principles by taxing transactions and produced inputs respectively. Income tax and capital gains tax create a significant bias against the rental market in favour of owner-occupation. Meanwhile, council tax is indefensibly regressive and, thanks to spineless government refusal to undertake a revaluation, we find ourselves in the absurd position that tax bills are still based on relative property prices in 1991. Over time, this arrangement will come to be seen as more and more untenable. At some point, some government will have to grasp the challenge of making the case for intelligent reform.

Why confine the direct charge to raising a tiny fraction of the budgetary requirements of the state? In the same chapter in which they affirm the correctness of the theory of charges on land rents, they stress the received wisdom of taxing people’s consumption. Their advocacy of consumption taxes did not make sense in terms of the needs of the UK economy, which was locked in the trough of the severest downturn since the Depression of the 1930s. To escape from the depths of recession, it was vital that debt-laden consumers should spend more in the shops. So why add to the price of goods with taxes?

Will the Real Tiger show its Stripes?

In view of the neglect, in the technical literature, of the rent/revenue policy, we have to turn to empirical evidence. The most revealing data would stem from a comparative analysis of Ireland with a comparable economy which did directly draw very heavily on rents. Taiwan is such a case. It was the first of the Asian Tigers to emerge after World War II, and it did so precisely because of the decision that was taken to switch to land rents as a primary source of public revenue.3 But with a population of 23m and GDP at around $650bn, sceptics would persuade themselves that this Tiger could not be reasonably compared to Ireland.

So we suggest that Ireland’s Department of Foreign Affairs and Trade undertake a study of the performance of the Hong Kong economy to infer the benefits from rent-as-public-revenue.

A quick survey of British colonial history would provide the poignant context for this comparative analysis. The appropriate starting point would be the 1840s. In that decade, Ireland endured the terrible consequences of Westminster’s financial policies. These policies put the capital G in the Great Famine. Historians have recorded how food was exported while people died from hunger, and the rents of the British landlords were exported to the UK. But on the other side of the world, at the farthest most point of the British Empire, something remarkable was about to happen. In 1843, Britain acquired a barren rock on the Chinese coast. This became Hong Kong. On January 4, Lord Aberdeen, the Foreign Secretary, dispatched his instructions to the new colony, declaring:

“The principle source from which revenue is to be looked for is the land…Her Majesty’s Government conceived that they would be fully justified in securing to the Crown all the benefits to be expected from the increased value which such a state of things would confer upon the Land. Her Majesty’s Government would therefore caution you against the permanent alienation of any portion of the land, and they would prefer that Parties should hold the land under Leases from the Crown, the terms of which might be sufficiently long to warrant the holders in building upon their allotments.”4

This decision was not inspired by fiscal enlightenment. The British government was continuing with its mission to alienate the rents of the kingdom in favour of landowners; transferring the fiscal burden onto the labouring population. But Britain could not legally employ this fiscal strategy in Hong Kong, because it had acquired the rock on a lease. So the UK had no choice but to instruct the colonial government to collect the rents from sub-leases. It was not legally possible to remain faithful to the Westminster model of transferring the beneficial interest in land to private landowners. What were the demographic and macro-economic consequences?

Compare Hong Kong with Ireland. The empire’s outpost flourished. Capital flowed in, public infrastructure was funded by the Crown out of the rents, and Hong Kong became a successful experiment in optimum fiscal policy. The population grew, and grew. And grew. Tellingly, during the communist era people risked their lives to climb the bamboo curtain to escape mainland China so that they may live and work in Hong Kong. The constant expansion of population placed strains on public services, but the colonial government was able to fund the demands on the social infrastructure out of the rise in land rents. Those rents automatically increased with the rise in the prosperity of the people who settled in the colony. In other words, the rents of land and natural resources are a buoyant source of public revenue.

What of the history of Ireland during the 19th and first half of the 20th century? The trends were the reverse of those that turned Hong Kong into the world’s No. 1 dynamic market economy. (This rating is by the Washington-based Heritage Foundation, which compiles an annual index with the Wall Street Journal.5)

Table 1

Who had the Tiger in its Fiscal Tank?

 

 

Ireland

Hong Kong

Population

4.2m

6.9m

GDP (PPP) [2008]

$160bn

$242bn

Corporate Tax Rate

12.5%

17.5%

Top Income Tax Rate

42%

16% (Gross Income)

Note: In Hong Kong, individuals are taxed either progressively, between 2% and 17%, on incomes adjusted for deductions and allowances, or at the flat rate of 16% on gross income, depending on which liability is lower.

Table 1 provides some illustrative data for 2008, the last year of growth in the business cycle that ended in 2010. From this we see that tiny Hong Kong, with no natural resources, performed a remarkable feat compared to the land-and-resource-rich Republic of Ireland. Hong Kong is literally a barren rock. Mountains had to be demolished to make space for the merchants of the 19th century and to install the world-class infrastructure for the 21st century. And yet, she could support a population of nearly 7m people, compared with Ireland’s 4m people. Today (to cite one example of infrastructural excellence), Hong Kong’s metro system is the envy of the world. It was funded out of the rents from sites surrounding the metro stations. Hong Kong demonstrates that public infrastructure pays for itself: it is not a capital cost which, elsewhere, burdens the working population.6 Because Hong Kong draws a large part of its revenue by auctioning leases and from various land-related charges, it can rely less on income taxes.

The overall outcome is as theory would predict.

Ireland’s lower corporate tax rate is a two-edged sword: it attracted foreign capital, but the net gains were either (i) capitalised into disruptively higher land values, which helped to fuel the property boom/bust, or (ii) were repatriated.
Hong Kong’s much lower income tax heightened incentives to work, save and invest. Hong Kong is recognised as the most competitive economy in the world. We only need to compare the skyline of Hong Kong with Dublin to appreciate that something remarkably different was, and is, driving the Asian Tiger’s economic engine.

But the most poignant contrast is provided by the data on migration.

People migrated into the island of Hong Kong: it was and remains a magnet of opportunity for people who want to improve their lives.
Ireland is an island from which the young have been forced to flee ever since the 1840s. They took with them the skills and enterprise that ought to be ploughed into Ireland’s future.

Ireland’s tragic outflowing tide of souls did reverse momentarily at the turn into the 21st century. But we now know that this was a cruel illusion. The exodus has resumed. Last year, over 70,000 people left Ireland, which is back to levels last seen in the Great Famine.7

Strategic Policy-Making

It would be an historic mistake for the Irish government to now adopt a trivial property tax of the kind employed by countries like the UK (which taxes an arbitrary value placed on both buildings and land). Rather than making a rushed decision under current crisis conditions, the Irish government would be well advised to begin from scratch, to examine the virtues of the rent-based revenue-raiser from all angles – social, demographic and legal, as well as economic. This would require the commissioning of expert research.8 Above all, the people of Ireland are entitled to an informed public debate. Following such a debate, people would be in a position to express their preferences on the question of whether they want fiscal policy to be shifted in the direction that serves both the needs of the individual as well as the common good.

A New Beginning for Ireland

The current socio-economic crisis could be turned from a tragedy into a blessing.

Under current policies, in the judgement of the present author, there will be no authentic recovery of the Irish economy and society. The reasons are spelt out in The Traumatised Society.
The crisis is Europe-wide, manifesting itself in the depletion of both culture and economic infrastructure, but the shared pain offers no comfort to the parents who once again endure the sight of their children fleeing the land of their birth. Long-range forecasts provided by agencies like the OECD are based on wishful thinking (but note the new sombre mood in the IMF’s World Economic Outlook, published on October 8, 2012).9
The one policy that is capable of firing the economic engines is the tax shift that progressively transfers the funding of public services onto the rents of land. This policy rests on the natural justice principle of people paying for the benefits received.

A controlled phasing in of the new fiscal paradigm (which would need to be revenue neutral, to begin with), would have an electrifying effect.

The markets would immediately compute and price in the huge advantages that would accrue to those who invested in Ireland. Interest rates, for example, would decline when the markets realised that the Irish economy was to benefit from long-term stable growth.
The human effect? The reversal of the exodus of the talented young of Ireland. The fabric of the nation would be enriched by the one fiscal system that was pro-growth of the community-balancing, culture-enriching, environment-friendly kind.

The prognosis: a unique phase of cultural renewal. The foundations would be laid for a new post-land speculation society, the characteristics of which would be for the people of Ireland to define and create.

October 8, 2012

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