Mason Gaffney on the U.S. Economy

The first part of an interview with Mason Gaffney, who was interviewed by Kevin Press for SunLife Financial’s Today’s Economy blog. Gaffney is promoting his new book After the Crash: Designing a Depression-Free Economy.

November 30, 2009

After the Crash: Designing a Depression-Free Economy, Selected Works of Mason GaffneyAt a time when most everyone has an opinion about the state of the U.S. economy and the quality of decision-making in Washington, D.C., the voice of esteemed economics professor and former TIME magazine journalist Mason Gaffney is an important one. Currently teaching at the University of California, Gaffney has been publishing vital contributions to economics since his PhD dissertation in 1956. Western Canadians will remember him as the founder of the British Columbia Institute for Economic Policy Analysis.

I spoke with professor Gaffney last week about what went wrong with the American economy, and what he thinks president Barak Obama should be doing about it. (Hint: the president hasn’t got it right.) Today’s post sets out Gaffney’s description of what’s wrong with traditional government stimulus programs and U.S. tax policy. Part 2 will feature Gaffney on the trouble with macroeconomics. He also makes a startling prediction about U.S. unemployment.

You write that the state of the U.S. economy is a result of a misallocation of capital. What do you mean?

The emphasis here is on the allocation between durable capital, or capital that turns over slowly and working capital. Capital goes into highways, dams and battleships easily, but it doesn’t come back out easily. That’s where we are today. Any corner bakery or hamburger stand makes more jobs per dollar of capital than the massive public works that we depend on traditionally to fight unemployment. We depend on it, and it doesn’t work. Yet we go on depending on it. It’s been that way for hundreds of years. One of the worst examples, which sent many of our ancestors over to this country, was the English attempt to solve the potato famine problem in Ireland by putting Irishmen to work building roads. The people were starving to death, quite literally. They needed breakfast for tomorrow morning, and they were being put to work building roads for the next century. That, in an extreme case, is the kind of policy mistake that has been repeated time after time. What they needed was working capital for the private sector.

How do you provide capital for the private sector?

The private sector generates capital itself. Step one is not to take it away from it. Step two, in our own case, would be to pay down the public debt, because when you pay down the public debt, you put capital in the hands of the bond holders. If you don’t give them the alternative of putting their money back into public debt, they invest it in the private sector. There’s also a great deal of saving going on in the private sector at all times. It gets aborted by a phenomenon that I’ll refer to generically as land speculation. That is what’s been happening in the last eight years or so. The value of residences, or at least the land under them, has skyrocketed. The owners have borrowed on that through lines of credit and other means for consumption, with no production corresponding to it. The increase in land value appears to the owner of land as an income, but nothing is produced. So when you consume that, you’re eating the seed corn, so to speak. You’re consuming capital and not replacing it. I’ve been living on the old homestead myself for several years and now I’m sorry. Along with millions of other people who ran up debts based on their expectation of rising residential values which have turned negative. It happens wherever there is real estate.

What’s the answer?

Change tax policy, which would dehydrate the unearned increments of land value and keep them from getting started in the first place. If you focus your taxes on the value of land instead of on payrolls, let’s say, that nips a land boom in the bud. As the boom gets started, the irrational exuberance would cause the tax levy to rise. That throws cold water on the irrational exuberance as it gets started. It keeps it from going to the extremes that we have just been through…[Currently,] the tendency is to stick with the old values for several years. Tax valuations lag behind market valuations as the latter are rising. That lets the bull get off to a flying start. In California for example, the assessors are forbidden by law from following the market up. They’re allowed to raise values by 2% a year at the most, while market values are going up, or were, by 10% a year. It wasn’t long before the tax burden became negligible compared to the value of the land. In my own case, my own value went up so high and so fast, that my taxes were less than .2% of the market value at the peak of the boom. They didn’t amount to anything; they were less than my fire insurance for heaven’s sake. This situation let the boom in California and other extreme areas get completely out of hand, and we’re now experiencing those results…They should be revising tax policy in a drastic way, to exact less tax money from honest labour and productive labour and more money from unearned increments – capital gains.

By increasing taxes on capital gains, you tamp down market speculation.

That’s correct. Once the capital gain has occurred, you have this enhanced value which is an excellent tax base.

Read the original interview.

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