"Bust? Of Course. Use the tax code to curb land speculation, or the crashes will continue".
My colleague, Mason Gaffney has been setting up 'em up and knocking 'em down for decades with an unerring critical eye. Using a geoconomist analysis of what causes poverty, what causes the boom and bust of business cycles, and what alternatives exist to free-booting capitalism or command and control diktats...
Galloping sprawl, such as we’ve experienced in California in the last 16 years, has set us up for "The Great Crash of 2008."
Urban sprawl inflates the price demanded for nearly every square foot of land from the redwoods to Mexico. It contributes to cycles of boom followed by bust when inflated land values collapse, as now. If the process were simple, we would have mastered it long ago instead of constantly repeating it. Yet these cycles do recur in a rhythm that is almost predictable.
Booms set us up for busts. Rising land prices, building booms, bank expansion, and subdivisions of land, each carried to speculative excess, interact with each other to generate the boom psychology. Incremental increases in land values become part of the expected return that buyers pay for and lenders rely on, so high values cannot simply level off. When they stop rising, they fall.
It is algebraically possible for land rents and values to rise forever, but common sense and experience tell us that does not happen. There are several reasons why :
We press on the limits of exhaustible resources, as is so evident today.
Landowners treat unearned increments as current income, raising their consumption and lowering their real savings. This cuts the supply of loans and raises interest rates.
In boom times, lemming psychology causes the expected growth of current land rents and land values to get ahead of a realistic forecast of future events. This raises the ratio of price to rent above sustainable levels.
People and capital spread out over more land; they sprawl.
Outside money rushes in to buy or finance land, so unearned increments in land value become part of the local economic base, as though we were exporting the land itself. This stimulus soon evolves into debt service that, over time, exceeds the original inflow. Governments spend freely, on borrowed money, for street improvements and public works to boost land sales. Unearned increment becomes part of the incentive to build, as each speculative builder flips the land as he sells the house. This can result in overproduction of new buildings relative to basic demand, and in more sprawl.
At the same time, lenders’ loan turnover must slow as they turn from short-term trade credit or commercial loans to long-term loans based on land collateral. A bank that is all loaned out, no matter how sound its balance sheet, cannot make new loans much faster than its debtors pay back the old ones. When many debtors default banks lose much of their capital and surplus, for these are always a small fraction of their liabilities. They have to stop making new loans. Some or many fail. Lending slows faster than recorded interest rates rise because banks cut off sub-prime borrowers.
Building stops. We hit bottom. Governments and financial gurus blame the crash on falling land values and bend their efforts to bailing out big banks and sustaining land values, prolonging the depression. In the process most actors lose sight of the original cause – speculation in rising land values – and the stage is set to begin the next cycle.
How do we minimize the land speculation that fuels this cycle of boom and bust?
Raise more public revenue from taxes on property in general and land in particular. Prop. 13 stands in the way, but it was going to prevent foreclosures, remember? Now we see that things don’t play out that way, but the reverse. It’s time for a change.
Reform the personal income tax to bear heavier on property income and lighter on wage income.
Base land assessments on current market value, and update them annually.
Change the present income-tax treatment of capital gains to a tax on annual accrual of value.
Regulate banks away from lending on land collateral.
Local public assessors can play a major role. Private fee-appraisers typically overvalue land using sales of comparables and upward price trends. These sales, in turn, are influenced by appraisers who base their opinions on earlier comparables and upward trends. There is no cost of production to check excesses. Thus a herd mentality can take over, as it just has, divorcing prices from reality.
Overvaluation by the public assessor stops the herd. The assessor before Prop. 13 was supposed to follow a bull market, not outguess it. When private fee-appraisers overvalue land they confirm and reinforce a boom. But when the tax assessor affirms higher land values, he douses a boom with cold water: higher taxes. It was the lack of such an automatic remedy that let the farmland boom of the 1970s soar so high above reality, then the urban bubble of the late 1980s, and now of 2001-2007.
Land value collapses like today’s play a master role in economic crashes. Without new remedies, this cycle will continue, as it has worldwide roughly every 18 years over the last 800 or more.
Mason Gaffney is a professor of economics at the University of California, Riverside.