Myth of economic rent tax

Bookmark and Share Economics & Deregulation | Sinclair Davidson
The Australian Financial Review 24th January, 2011

Proposals to tax "economic rents" should be viewed with the utmost suspicion - the tax system is complicated enough with easy-to-understand tax bases.

Everything has a cost and very decision a consequence. In recent times, the idea of a free lunch in taxation has become quite popular. This is the notion of taxing rents.

John Passant has proposed that taxing rent could give rise to revenue while penalising monopoly capitalism ("Economic rent ripe for tax", AFR, January 12). It is not enough to simply point to the discredited Marxist idea of monopoly capitalism, the idea of economic rent as a basis for taxation itself needs to be confronted.

Economic rent is usually defined as being a return over and above some minimum return necessary to keep a factor of production working. Economists refer to this as economic profit or super-normal return. In classical economic theory rent was designated as being the return to land, one of the three factors of production; the other two being capital and labour. Land was defined as the bounty of nature. In that framework taxing a bounty had no consequence - if you acquire something free it shouldn't worry you to lose it to the tax man.

But nature doesn't surrender its bounties free. Value is created through the application of capital, labour and entrepreneurial insight.

The classical economists didn't understand value - they thought it was created by labour inputs or costs. They quickly ran into the problem whereby some apparently homogeneous assets - farm land in particular - were more valuable than others despite labour inputs. This differential they called "rent".

Economists now better understand value. We understand the value of any resource is determined by an entrepreneur's 'ability to employ it to create a good or service that can be profitably sold in the market. Taxing rent is a tax on entrepreneurship and innovation - something the classical economists didn't understand well. Modern economic theory does recognise the notion of a quasi-rent - a temporary source of super -normal profit. But we know capitalism is characterised by creative destruction and temporary tax bases would be a very poor basis for funding the long-term needs of the modern welfare state.

Taxation is an intensely practical matter. The government seeks secure and stable revenue while taxpayers seek clear definitions and certainty. Economic rent does not meet any of those considerations. This is the great lesson of the bruising mining tax debate. The government could not define the actual tax base, nor explain what it was doing, and had no idea how much revenue it would raise. The new mining tax is no different.