http://www.economyincrisis.org/articles/show/2519
Economy In Crisis
What Brought on the Collapse
Author: Edward J. Dodson
Published On: 02/26/09
Source: www.EconomyInCrisis.Org

The measures being proposed to stabilize our financial system
and the economy reflect the sad state of discourse on substantive
economic and societal challenges. Conventional wisdoms that
conflict with reality continue to exert great power over the
decision-making of our elected officials and those who serve as
policy advisers. This circumstance is not new. Back in 1955,
economics professor Harry Gunnison Brown expressed his
frustration with many of his professional colleagues:

"Economics is concerned with the problem of 'getting a living.' It
deals, therefore, with an important phase of the 'struggle for
existence.' Unfortunately, this fact operates to prevent
unprejudiced investigation of its laws and of the effects of
various economic policies. An examination that would show the
effects of various policies from which a part of the public was
benefiting, to be injurious to the remainder, might not be an
examination which those who were profiting by the policies in
question would desire to have made. And if such an examination
were made, acceptance of its inevitable logical conclusions
would probably be vigorously opposed."

Over time, the search for solutions to the periodic tendencies of
our economic system to implode have given way to mitigation by
modest technical interventions using defined fiscal and monetary
tools.

Our very understanding of the health of our economy is obscured
by the meaningless language of mainstream economics that is
repeated regularly by journalists and news reporters. Let me
begin with one prime example: the use of Gross Domestic
Product (GDP) as a commonly-accepted measurement of
economic health and growth. I doubt that any of the media
commentators know that GDP includes (with minor exceptions)
every dollar spent by government for any purpose, whether
obtained by taxation or borrowed. GDP is calculated as follows:
consumption + gross investment + government spending +
(exports ? imports). Thus, a rising GDP is hardly an indicator
that the economy is expanding. Goods production can be falling,
unemployment rising, crime rising, environmental disasters
occurring with increasing frequency, with government spending
on the military and the servicing of debt causing GDP to be
reported as increasing.

Another fundamental problem with how economics has evolved
as a discipline is the extent to which theorists have embraced the
notion that markets for locations in our cities and towns, for
agricultural land, for natural resource laden lands, for the
broadcast spectrum and all of nature, generally, respond to
changes in price and demand in the same manner as goods we
produce from nature. Generations of political economists who
preceded economists treated nature (i.e., what they termed
"land") as the first factor of production; that is, as the source of
"wealth" but not as wealth itself. Nature was (and still is) the
passive factor of production, acted on by labor with and without
the use of capital goods.

The first lesson confirmed in the real world is that the "price
mechanism" does not work for "land." Price effectively clears
markets for labor, for capital goods and (to a great extent) for
credit. However, as we have seen during this last land market
cycle, as prices are rising speculation intensifies. Land is
acquired to be held off the market for speculative gain rather than
for development. This occurs even when locations are improved
by various types of structures. Investors ignore vacancy rates and
even negative cash flows on the gamble that rising land prices
will allow them to flip the property to someone else within a few
short years. The same mentality spills over into the residential
property markets, exacerbated by low- and no-downpayment
mortgage financing that allowed for interest-only payments or
even negative amortization.

What caused the current land market crash to spread so deeply
and broadly around the world was bank-provided credit, allowing
land speculators to pass on most of the risk to those same
financial institutions (or investors in various types of
collateralized mortgage obligations). The absence of effective
regulation and law enforcement also deepened the crash by
overloading the credit markets with poorly underwritten
subprime mortgage loans, hundreds of billions of dollars in
predatory loans made to low income, elderly and otherwise
marginal borrowers, and outright fraud (e.g., the sale of
nonexistent or extensively falsified loans by mortgage brokers).

One immediate measure that ought to be passed into law is to
prohibit any financial entity that accepts government insured
deposits from taking land as collateral. This would remove a
good deal of the accelerant from the next upsurge in land prices.
Speculators would have to commit their own funds or find other
investors willing to share the downside risk of speculation near or
at the top of the land market cycle. Consistently imprudent
bankers would be protected from their own inclination to book
high-yielding assets without an objective assessment of the risks
involved.

There is nothing governments can really do at this point to bring
us out of the economic depression. Government spending on
infrastructure will stimulate a degree of private job creation and
(combined with extended unemployment benefits and other
social welfare measures) prevent widespread homelessness and
social unrest.

The time is long past for continued reliance on fine-tuning the
economy. When we suffered through stagflation in the 1970s,
critics on the right called for business deregulation and
"supply-side" stimulation of investment based on dramatically
lower marginal rates of taxation on so-called "capital gains" and
ordinary income. These measures largely provided the
atmosphere for an economy driven by speculation rather than
goods production or the development of new technologies and
services. I believe there are four main shifts in public policy
required to start the dominoes falling in the right direction (i.e.,
in the direction of full employment without inflation):

First, make the individual income tax system truly progressive
and at the same remove its complexity. Wages and salaries are,
for most people, the largest portion of their incomes, and are
"earned" producing goods and services. This level of income
should be exempted from taxation, or taxed at very low rates. We
should begin by exempting all individual incomes up to a far
higher amount than is now the case (eliminating all other
exemptions and deductions). The national median could be a
good starting point. Above the national median, increasing rates
of taxation would be applied to higher ranges of individual
income (which, as incomes increase, are derived from what
economists describe as "rent-seeking" investment activities).

Second, establish the mechanism for gradual repayment of the
national debt by issuing fully amortizing bonds to replace
existing government bonds as they mature. The amount required
to service the debt (both interest and principal being retired)
would be incorporated as an integral expense of the government
budgeting process. The tax rates on individual incomes at the
highest ranges would be set to raise sufficient revenue to achieve
a balanced budget.

Third, we need to replace the business profits tax with a
graduated tax on gross revenue, exempting small businesses
(which create the overwhelmining number of jobs in the
economy). Some analysis is required to determine what the
exemption level should be, but the idea is to benefit those
companies most that have a stake in their communities and where
profits are circulated locally rather than routed to a distant (or
overseas) corporate headquarters where senior executives are
rewarded by compliant boards of directors for cutting the number
of employees. This measure would also end the practice of
companies being able to expense the huge compensation
packages to executives and thereby reduce taxable income.

And, finally, the federal and state governments must urge every
community across the nation to restructure the long-destructive
ways they have raised revenue for public goods and services.
What communities create by investment in infrastructure and
public amenities is land value. Thus, this community-created
value ought to be the primary source of public revenue. Every
parcel of land in a community has a potential annual rental value.
This rental value is the amount that ought to be paid to the
community in return for the services brought to a location. This
means exempting property improvements (i.e., buildings of all
types) from the property tax base. Moving to a land-only tax base
will not only stimulate new construction and rehabilitation of
existing structures, landowners will find it far more profitable to
bring the land they hold to "highest, best use" as dictated by
market forces (or sell to someone who will) than to hold onto
land for speculation. Sufficient revenue might be generated by
the taxation of location rental values to lower or eliminate taxes
on wages and commerce.

I welcome comments and questions on the above proposals.
Readers may contact me directly at ejdodson at comcast dot net

Authors Bio: Edward J. Dodson teaches economics at the Osher
Lifelong Learning Institute at Temple University in Philadelphia.
He retired in 2005 from Fannie Mae, where he worked as a
market analyst and business manager for 20 years. He is the
author of a 3-volume work, The Discovery of First Principles.
His current project is a lecture tour on the origins of the property
market and banking collapse.