Topic 2.

4:
Rent, Inequality and Tax

Course: Institutional Economics

Presented by: Nishat Farzana (685)
Rent, Inequality and Tax
Outline of the Discussion
Ricardo: Principles of Political Economy and Taxation
The Concept of Economic Rent
Classical and Neo-classical views on rent and tax
Inequality and Tax by Michael Hudson
Piketty: Tax on Inherited Wealth
Rents, Efficiency and Growth by Mushtaq H. Khan
Rents and rent-seeking society by Krueger
Fiscal Monitors: taxing times by IMF
The Concept of Economic Rent

The concept of economic rent originated with David

Ricardo in the early 1800s
For Ricardo, economic rent was the extra profit earned
on the most productive land as prices rose to bring less
productive land into cultivation
The modern meaning of the term by either its textbook
or more general definition above is much broader, and
some believe that understanding rents is the key to
understanding inequality
Defining Economic Rent
There are two definitions of economic rents a textbook
definition, and a definition that prevails in more
common usage
The textbook definition is straightforward. It is any
payment over and above the minimum payment
needed to bring a factor of production -- labor, capital
or land -- into productive use
Suppose it would take $10 per hour to induce someone
to work. If the wage were any lower, the person would
prefer not to work at all. If he or she is paid $15 per
hour, then the difference between what they are
actually paid and what it takes to induce them to work
($15 - $10 = $5) is economic rent
On The Principles of Political
Economy and Taxation, Ricardo
(1817)
The produce of the earth all that is derived from its
surface by the united application of labour, machinery,
and capital, is divided among three classes of the
community; namely, the proprietor of the land, the
owner of the stock or capital necessary for its cultivation,
and the laborers by whose industry it is cultivated
But in different stages of society, the proportions of the
whole produce of the earth which will be allotted to each
of these classes, under the names of rent, profit, and
wages, will be essentially different;
To determine the laws which regulate this distribution is
the principal problem in Political Economy.
Chapter 2. On Rent.

Rent is that proportion of the produce of the earth,

which is paid to the landlord for the use of the original
and indestructible powers of the soil.
Rent increases most rapidly, as the disposable land
decreases in its productive powers
Chapter 8. On Taxes.

Taxes are a portion of the produce of the land and

labour of a country, placed at the disposal of the
government; and are always ultimately paid, either
from the capital, or from the revenue of the country
There are no taxes which have a tendency to lessen the
power to accumulate. All taxes must fall on capital or
revenue
Chapter 9. Taxes on Raw Produce

Any tax which may be imposed on the cultivator,

whether in the shape of land tax or tax on the raw
produce when obtained, will increase the cost of
production, and therefore raise the price of the raw
produce
A tax on raw produce would not be paid by the
landlord; it would not be paid by the farmer; but it
would be paid, in increased price, by the consumer
Chapter 10. Taxes on Rent.

A tax on rent would affect rent only; it would fall wholly on

landlords, and could not be shifted to any class of consumers
The landlord could not raise his rent, because he could not
alter the difference between the produce of the least
productive land and land of every quality
A tax on rent would discourage cultivation, because it would
be a tax on the profits of the landlord
Also, landlords would soon find a way to discriminate between
which is paid for the use of land and which is paid for use of
infrastructure and improvements made by landlords stock
He would either cease to make improvements or pass the
burden onto the tenants
A land tax would not differ from a tax on rent
 Ricardos concern
For Ricardo the chief concern was the long- term evolution of
land prices and land rents
He was influenced by the Malthusian model but pushed the
argument farther.
He was above all interested in the following logical paradox.

Once both population and output begin to grow steadily, land

tends to become increasingly scarce relative to other goods.
The law of supply and demand then implies that the price of
land will rise continuously, as will the rents paid to landlords.
The landlords will therefore claim a growing share of national
income, as the share available to the rest of the population
decreases, thus upsetting the social equilibrium. For Ricardo,
the only logically and politically acceptable answer was to
impose a steadily increasing tax on land rents.
Malthus on Rent

population tended to increase faster than the food

supply, resulting in an ever increasing demand for
agricultural products.
Given the fact that, lands differ in fertility, the
difference in productivity of the best land over the
poorer constitutes as rent goes to landowners.
Production of glut thus recommended luxurious
consumption for landowners.
Neoclassical Paretian rent
Vilfredo Paretoextends the concept of rent to include
factors other than natural resource rents (Ronald &
Vincent 1999).His understanding of economic rent is
synonymous with the more appropriately named term
economic profit.
Definitions:
The excess earnings over the amount necessary to
keep the factor in its current occupation (Ross, 1990)
The difference between what a factor of production is
paid and how much it would need to be paid to remain
in its current use
A return over and above opportunity costs, or the
normal return necessary to keep a resource in its
current use (John & Jean 2003)
Chamberlinian Rents
Chamberlinian rent is a particular entry barrier accrued
from monopoly rents and monopolistic competition.
Monopoly rents are economic rents whenever earned
in the competitive forces framework.
The barriers include technical know-how, reputation,
brand awareness and ability of managers to work
together.
 Schumpeterian Rent
R= Y(p-c)-YFm (Von Thunens equation) where R=land
rent;
Y=yield per unit of land;
c=production expenses per unit of commodity;
p=market price per unit of commodity; F=freight rate
(per agricultural unit, per mile); m=distance to market.
The fact that uncertainty plays a fundamental role in
producing the possibility for entrepreneurial rents.
The entrepreneurial innovation to produce rents must be
socially efficient.
Entrepreneurship is generally justified by the existence of
impediment isolating mechanisms (Rummelt, 1987)
Classical and Neoclassical on Rent and Tax

Hudson pointed out one big difference between the Classical

economists and the neoclassicals in their analysis of taxation
as applied to economic rent
He draws attention to a historical correspondence that would
probably surprise many, between high top tax rates and
strong economic growth, and observes that the top rates
were high in the period prior to WWII.
Importantly, the focus of taxation in Classical Political
Economy, which Hudson argues influenced US government
policy in the late 1800s and much of the first half of the
1900s, was on confiscating economic rents.
These rents include income that derives from ownership of
assets that appreciate in value merely because of the growth
in national income and/or improved public infrastructure, and
not due to any participation in the production process (they
arise especially in the real estate and financial sectors)
Inequality and Tax
Hudson goes on to stress that the taxation imposed in
the late 1800s and first half of the 1900s was highly
progressive.
Initially only the top 1 percent of income earners were
required to submit tax returns.
The purpose of this was to keep taxes on wages and
profit low to promote price competitiveness against
lower wage countries.
This can be contrasted with neo-liberal policies of today
which seem to be designed almost with the opposite
intent: to tax wage and profit income (and also
consumption) but provide loopholes or tax breaks for
the recipients of economic rents
Free market: Free from what?

Hudson distinguishes between what the classical

economists meant by the term free market and what
that term has come to mean in the neo-liberal period.
For the classical economists, free market meant a
market unencumbered by rent-based claims on income
that would draw economic activity away from income
production and toward speculation. The aim of the
classical economists was to incentivize production.
This is a very different notion than the neo-liberal one of
labor-market deregulation (meaning regulation in
favor of employers over employees), which is really just
code for union smashing and an attack on real wages,
or the neo-liberal deregulation of financial markets,
which is a euphemism for enabling financial parasitism
The result of neo-liberal policy

Hudson discusses how, over time, much of the progressivity in

the tax system was removed, paving the way for the
construction of the inequitable and anti-productive monster of
today
Keynesian demand-management policies were also largely
eschewed throughout the neo-liberal era on the basis of an
opportunistic misinterpretation of the stagflation of the 1970s.
All this took place alongside deregulation of the financial sector
and an aggressive dismantling of worker employment
protections
The result of this neo-liberal policy mix was an increasing
financialization and rentification of the economy, widening
income inequality, and an adherence to fiscal austerity that
directly corresponded to an unsustainable build up in the only US
debt that matters private debt and culminated in the Global
Financial Crisis and Great Recession
 Marxian Concept Of Capital Accumulation

Capital accumulation has a double origin, namely in trade

and inexpropriation, both of a legal or illegal kind. A stock of
capital can be increased through a process of exchange and
through directly taking resource from someone else, without
compensation.David Harveycalls thisaccumulation by
dispossession.
Capital Accumulation & Rent-Seeking
Inefficient institutional arrangement such as poor property
right works as parameter assumption of the model - it is
the exogenous variable that eventually drives all results
(Tullock effect)
two economic decisions: one static and the other
dynamic. The static is the factor allocation problem, and
the dynamic is the consumption-investment allocation
problem .
usual effect of a distortion, and will be called the Harberger
effect (cost of the monopoly is the deadweight loss it
generates, and found out that this loss is small).
Competition in productive sectors does indeed improve
welfare. But competition in unproductive sectors generates
more unproductive output than a sole rent seeker would.
For the long-run, when sector is capital intensive, a
worsening in the institutional set would lead to a reduction
in capital and output.
How does this relate to inequality?

But there is another more common usage of the term

"rent" that explains the rise in inequality another way.
This refers to any return over and above what would
occur if a market were perfectly competitive
One example is monopoly power that occurs naturally or
that is due to government action, such as requiring
occupational licenses that restrict entry into a profession
and increases profit above the competitive level
More generally, the idea is that "rent-seeking behavior"
by those with political power -- such as the wealthy -- will
tilt the rules in their favor and allow them to capture a
larger share of the economic pie. The ability to keep taxes
relatively low for those at the top is one example of this.
Inequality and Trickle Down Effect
Taxing the Economic Rent

Reformers from Adam Smith to John Stuart Mill to

Thorstein Veblen hoped to streamline industry and
increase economic competitiveness by doing away with
the special privileges inherited from feudalism; namely,
economic rents earned from longstanding land,
monopoly, and banking rights.
Income from these entitlements added to the cost of
doing business but neither produced anything tangible
nor spurred technological innovation.
Classical economists contended that the tax burden
needed to be shifted off of industry and labor and onto
that which was taken from nature or granted by
government decreewhat Mill called the unearned
increment that landlords extract in their sleep.
Tax the Rentiers

As reform-minded economists have long argued, we must tax the

rentiers. Taxing their privilege would yield as much as the present
income and sales taxes combined, without eating into the earned
income of wages and profits.
For example, roughly half of the estimated $1.4 trillion rental value of
all residential and commercial real estate comes from the land on
which buildings sit.
The idea is to tax not the buildings but this land value sites that are
provided by nature and that increase in value incidentally when a rail
line or a Starbucks is built nearby.
By taxing only the land, we would no longer be penalizing new
construction and would discourage speculative hoarding. Indeed, in
both 2006 and 2007 the market price of land went up by $2.5 trillion.
This increase in balance-sheet valuation was not earned, since
landlords did not have to make an investment to create it; moreover,
taxing these sites could help cover the costs of new development and
would not reduce the supply of land.
Tax the Rentiers

According to Hudson, the transition from a feudal

economy to a modern one remains incomplete in US
and elsewhere
Hereditary estates and monopolies still retain huge
privileges; taxes on property and rents remain at
historic lows
Taxing these unproductive incomes would help to
unburden labor and enterprise, and these changes
would go a long way toward fixing what ails our
economic system
Question ???

The central question: Can the capture of "economic

rents" by those at the top of the income distribution
explain the rising inequality that fuels patrimonial
capitalism?
Piketty: Tax on inherited wealth

Economist Thomas Piketty's book, "Capital in the Twenty-First

Century," highlights the dangers of an economy dominated
by inherited wealth -- an economy in which birth is more
important than effort and ability
He provides evidence that the U.S. is headed in this direction
-- toward what he calls "patrimonial capitalism" -- and Piketty
recommends taking measures such as imposing high wealth
and inheritance taxes to offset the accumulation of wealth
that appears inherent to capitalist systems
One of his explanations forrising inequalityin the U.S. and
elsewhere around the world is what economists call "rent-
seeking behavior." That refers to the ability of the wealthy
and powerful to influence the political process, keep top tax
rates low and increase their income at the expense of
everyone else
Rents, Efficiency and Growth
(Mushtaq H. Khan)
For the economist, rents refer to excess incomes
which, in simplistic models, should not exist in efficient
markets. More precisely, a person gets a rent if he or
she earns an income higher than the minimum that
person would have accepted, the minimum being
usually defined as the income in his or her next-best
opportunity.
A glance at the real world tells us that rents as excess
incomes are widespread in all types of economies.
Rents may take the form of higher rates of return in
monopolies, the extra income from politically organized
transfers such as subsidies, or the extra income which
comes from owning scarce resources, whether natural
resources or specialized knowledge.
Types of economic rents

Monopoly Rent
Natural resource rent
Rents based on transfer
Schumpeterian rent for innovation
Rents for learning
Rents for monitoring
Types of rent and structure of rights
Growth and efficiency implication of
different rents
Good rents and bad rents

We see that some forms of rent can signal inefficiency

or lost growth opportunities while others may signal the
reverse.
Indeed, some rents may be essential for growing and
efficient economies, particularly in the context of
development.
However, good rents are often only effective under
well-defined conditions and can become bad rents if
these conditions change.
The existence of rents may also result in a further set of
potentially wasteful activities which seek to create,
maintain or redistribute these rents. These are called
rent-seeking activities
Rents and rent seeking
(Anne O. Krueger)
In many market-oriented economies, government
restrictions upon economic activity are pervasive facts
of life.
These restrictions give rise to rents of a variety of
forms, and people often compete for the rents.
Sometimes, such competition is perfectly legal.
In other instances, rent seeking takes other forms, such
as bribery, corruption, smuggling, and black markets.
There Are Many Forms of Rent-Seeking

Fair trade laws result in firms of less-than-optimal

size.
Minimum wage legislation generates equilibrium
levels of unemployment above the optimum with
associated deadweight losses.
Ceilings on interest rates and consequent credit
rationing lead to competition for loans and
deposits and/or high-cost banking operations.
Regulating taxi fares affects the average waiting
time for a taxi and the percent of time taxis are
idle.
Capital gains tax treatment results in overbuilding
of apartments and uneconomic oil exploration.
Fiscal Monitor: Taxing Times (Oct.
2013)
This issue of the Fiscal Monitor explores whether and
how tax reform can help strengthen public finances
Scope seems to exist in many advanced economies to
raise more revenue from the top of the income
distribution if so desired.
And there is a strong case in most countries, advanced
or developing, for raising substantially more from
property taxes
taxes on wealth also offer significant revenue potential
at relatively low efficiency costs
What Should be vs. What has been

Following insights from the above discussion, I propose

some combination of the following policy responses:
tighter regulations of speculative activities
a more steeply progressive tax system targeted at the
confiscation of economic rents instead of taxing wage and
profit income along with consumption.
incentivization of production and consumption
rule of Law
accountability
Thank You