The Mystery of Unearned Income

The wealth gap is dividing society at an astonishing rate as the lessons from the Great Recession are helicoptered away. QE3 has worked for Wall St but little else. Over 30 nations are facing the shock and awe of property bubbles as the mobility of capital swoops in to claim what economists call “unearned income.”

Unearned income is the cornerstone to the wealth gap and is highlighted by the capital gains one sees in property, where the value of a location can jump $30,000 – $50,000 in one year – more than many people earn. The great tragedy of modern economics is that the concept of unearned income is rarely taught at university. Nor is the advantage of location. But “location, location” remains the number one rule in real estate investment.

No wonder economics fails to relate to reality.

Just to test how far the easy money making can be pushed, the new weapon of mass financial deception is upon us – rental-backed securities. This is the next nemesis for those concerned about monopoly powers in housing. Manipulation of rents in both the mortgage and rental markets has never been easier, with US vacancies a staggering 10.2%.

Blackstone Capital has bought up swathes of property for $35,000. Council appraisers valued them at $60,000, but the rents charged are akin to a $173,000 property. The MSM cheerleads this as a sign of a healthy economy, despite this being a premium of more than $100,000 above pre-crisis prices. At $60,000 they should be charging $250 per month, not the reported $720. This extra $470 in rental payments is an unearned income, AKA money for jam.

Please look the other way.While interest in unearned income is growing, few reports show just how large it is. Neo-classical economics has kept this story under wraps by removing the analytical tools from the syllabus. This happened not in the 1980s, but in the 1880s. Robber barons were concerned about the rising understanding of how they derived their magic money. Henry George’s “Progress and Poverty” had spelt out with clear logic the natural advantages the so called owners of the earth had over anyone trying to run a business or earn a wage.

The barons moved to fund the first American Economics Association (1886).

They paid academia to remove the earth, as defined by Land, from the three factors of production used to quantify a nation’s output. Thus came the transition from Classical to Neo-Classical Economics. It was as if we no longer needed a place on the earth to work, play or run a business. Instead, the great barons decided that land should become a subset of capital (as if they already owned the world). Thus today’s economic policy focus is inflation (don’t undermine capital) or unemployment (keep labor busy). The influence of high land prices on consumer spending and small business resilience are expected to be ignored.

Adding to this obfuscation is the poor quality of data in many jurisdictions. The USA’s National Incomes and Products Accounts conflates house and land valuations. This is part of the plan to focus on “housing” bubbles, ignoring the locational value of land. It also amplifies depreciation write-offs.

Australia is one of the few remaining nations with a decent data system. This allowed the quantification of unearned income in the Total Resource Rents of Australia report. This found the economic rents of all monopolies at 23.6% of GDP. This is twenty three times greater than neo-classical economists such as Paul Krugman dismiss it at. “Rent is one percent of the US income in 2004” (Economics, Paul Krugman and Robin Wells). More recently, Todd G Buchholz wrote in New Ideas from Dead Economists “The percentage [of property rent in the economy] has dropped to well under one percent today.”

This misinformation demonstrates the mastery of economic deception. It provides the barrier to analysis into companies like Blackstone making so much money “in their sleep” (as John Stuart Mill famously once said).

The quantification of unearned incomes is important because society could decide to do what economists have pointed to for hundreds of years – make monopolists pay for the running of government.

Rather than taxing our hard work, monopoly profits in water trading, cyber squatting, geo-satellite orbits, the electromagnetic spectrum, forestry, gambling, banking licenses and privatized utilities could be used as a funding source in light of their legal privilege. These are either all common gifts to humanity, or government mandated licenses. Owners of such property are onto a safe bet as society grows and develops. They do little productive work, but claim enormous, lightly taxed profits.

Consider cyber squatter Michael Kovatch, who had the good fortune to be first to buy the domain name www.iphone.com. He sold to Apple for a reported $1 million.

More needs to be asked of the monopoly rights paid by VeriSign for the legal privilege to approve .com, .net and .name websites. Was this licensed monopoly actually paid for? Are those economic rights valued yearly and taxed for their economic potential? The ability of VeriSign to exercise its monopoly power by increasing domain name registration fees at will is ‘overlooked’ as a cost to society. At present, such insiders have the best of both worlds – privatizing monopoly rights while driving through loopholes in a tax system incapable of tracing tax havens.

In the Australian state of Victoria, abalone fishing rights were sold outright for just $6 in the late 60’s. A number of these licenses are now leased out for $100,000 per year. This is a pure unearned income, allowing the owners to live a life of ski resorts and scuba diving. It is theoretically undeniable that a license holder could be taxed significantly without affecting production or importantly, pricing. The state could lay claim to some 40% of this unearned income and use this to remove damaging payroll or sales taxes. But instead of addressing this core inequality, the state refuses to give ambulance officers a decent pay rise.

The report finds prices would fall 23% when the 126 Australian taxes are streamlined down to just 24. Neo-cons would be stuck in the headlights of their own beliefs, unable to avoid the benefits of removing deadweight costs and compliance costs.

The impediment to reform, of course, is finding a politician willing to threaten the income of campaign contributors. From this we ask – why are politicians forced to pawn their policies to pay for advertising on what was once known as the public airwaves? In recognition of their monopoly status, TV and radio licenses should include a percentage of free advertising per political party per campaign cycle.

The “invisible hand”‘ was mentioned just once in Smith’s ‘The Wealth of Nations’, as was the ‘free market’. Monopoly was mentioned 64 times, land, 87, tax, 96, and rent, 102 times. For this reason it is time we looked back to the classical era to focus on the unearned incomes (rents) found in land and monopoly. This natural bounty acts as a source of government income while stabilizing the inequities derived from dominion over the earth.