Caplan’s Entrepreneurial Critique of Georgism
It’s fair to say that I ascribe to a different microeconomic foundation to political economy than Bryan Caplan. The primary difference between our approaches was discussed in a previous post, The Irrationality of Politics. Caplan roots the problem of liberal reform in the low cost of irrationality vis a vis voting which incentivizes a class of pandering politicians who otherwise would act more rationally in terms of public policy. In short, the politicans are slaves to the voters. I, on the other hand, root the problem of liberal reform in a bias that is product of a political economy moral framework that arises from rent-seeking agents seeking legal recognition via political means. In short, voters are slaves to the politicians, or more accurately, the political/economic system. Both of us would cite the empirical discrepencies in the classic public choice model(Tullock,Buchanan) to support our positions.
My little blog, “liberal and libertarian,” is more or less an exercise in a libertarian deconstruction of the failure of the liberal model. By liberal, of course, I mean the political-philosophic defintion and not the modern partisan one. However, I am a liberal, both philosophically and sentimentally. My critique of it is not its ends, but rather its (actual) means. Specifically, my critique, as tersely summarized above, is grounded in economic rents secured and protected by political means. But it’s not a utilitarian objection. That is, it’s not based on a calculation of the social waste that results from rent dissipation in political competiton. On the contrary, it’s derived from observation that rent dissipation is not the empirical equilibrium model for political competition. This lends itself to a class analysis of the State which, of course, is a model of the State as protector of artificial rents.
To me, it is clear the fundamental role economic rents play in liberal political economy. This is why I do identify as a Georgist. A regime whose fiscal source is georgist rent is likely to exhibit stark differences from one that bids out Tullock rents. I can’t say that Georgism is a necessary or sufficient condition to avoid “liberal violations,” but I would suggest it is one means to potentially avoid the catastrophic failures of political competition.
This leads me back to Caplan. Caplan and a co-author have published a new working paper that proposes an entrepreneurial critique against Georgism. Caplan denotes this criticism as a “Search-Theoretic Critique,” meaning that georgist rents disincentivize entrepreneurial discovery for more valuable uses of land. A less academic treatment was posted at his blog. Caplan summarizes the argument:
I can explain our argument with a simple example. Clever Georgists propose a regime where property owners self-assess the value of their property, subject to the constraint that owners must sell their property to anyone who offers that self-assessed value. Now suppose you own a vacant lot with oil underneath; the present value of the oil minus the cost of extraction equals $1M. How will you self-assess? As long as the value of your land is public information, you cannot safely self-assess at anything less than its full value of $1M. So you self-assess at $1M, pay the Georgist tax (say 99%), and pump the oil anyway, right?
There’s just one problem: While the Georgist tax has no effect on the incentive to pump discovered oil, it has a devastating effect on the incentive to discover oil in the first place. Suppose you could find a $1M well by spending $900k on exploration. With a 99% Georgist tax, your expected profits are negative $890k. (.01*$1M-$900k=-$890k)
What Caplan is actually arguing in his working paper is that there is no such thing as land rents. Land rents are only quasi-rents. Therefore, georgist rent(or “land tax”) is distortionary. Now, indeed, if there is no such thing as land rent, then I would have to concede Caplan’s critique. Georgist rent is more or less a tax on the opportunity cost use of land. If land indeed were identical to capital, then taxing the use of a resource at 100% of it’s opportunity cost use would simply result in deadweight loss(the minimum of the worst result). Of course, the classical treatment of land distinguishes it from capital as a factor of production because of the inelasticity of supply. It’s a simple exercise in textbook economics to graphically verify that that taxes on these types of goods simply shifts producer surplus to public(or government) surplus without any deadweight loss or loss of consumer surplus. In the classical paradigm, the privilege of exclusive use of these type of goods/resources is supposed to be the fiscal source of government.
Caplan dismisses the classical paradigm and more or less extends the neoclassical treatment that casts land rent to be no different from interest(or dividends on stocks, etc). Land, like capital goods, has to produced. In Caplan’s paper, production means “discovery of best use” via an entrepreneurial process modeled on expectations of returns as a function of search. So Caplan will write something like:
V= E[I(S)] – E[C(S)] – P
which simply means the expected value of land is the expected income from the property minus the current price. The value of land is the expected income from a search minus the expected cost of the search minus the current price. The boundary conditions of the model are defined by four partial differential constraints which would be typical for a neoclassical model, regarding marginal cost and marginal revenue, if we think of “Search” being the quantity produced(S=Q). So competitive equilibrium can be written along the familiar model of marginal revenue =marginal cost,except now a “Search good” will be produced until the marginal increase in expected income of the Search equals the marginal cost of the “Search good.”
Now that Caplan has a “Search good” that acts roughly familiar to a standard capital good, he is able to demonstrate that a “tax” discourages and distorts the production of the Search good in the same way as a tax against a capital good. Indeed, the Georgist 100% tax results in no production of “Search goods.”
There is an obvious empirical problem with Caplan’s model. Frankly it’s particularly disingenuous and an example of piss poor scholarship–only mitigated by the fact it is a working paper–to use the example of Idi Amin as a positive demonstration of the model’s prediction. I have no idea what Idi Amin has to do with Georgism but there are are plenty of historical examples, each with varying degrees of success, that provide a counter-factual to the model. And really, all you need is one. For example, you are not going to find any counter-factual in all of human history of a 100% tax on capital goods not producing disastrous distortionary results regarding production output. However, you can easily cite examples of relative degrees of success regarding georgist implementations. For example, here. The empirical evidence alone discredits any model that attempts to concoct some “Search good” equivalence with “capital goods” in terms of expected use of land.
The conceptual problem resides in a normative modeling of what is “rational.” Algebraic manipulation doesn’t necessarily predict the rational behavior we should end up with. For example, the contention that the landowner, in order to obtain quasi-rents, must engage in productive activity. Well, my experience informs me that quite a bit of this “Searching” goes on in City Hall and in the corridors of Washington, DC. Indeed, you can almost define local government as a joint private-public conspiracy between local real estate developers and corrupt city boards. Nationally, we have an unprecedented banking oligopoly contrived from a failed financial paradigm that specialized in sucking economic rents from subsidized home ownership. To me, its form of reality denial to make a claim that there is no such thing as “land rent.”
Another problem for Caplan is his tendency to subtly shift back and forth between quite divergent microeconomic foundations, depending on context. For example, in his anticipation of “Georgist Responses,” he claims that the problem of transaction costs of current occupation(current use) against entrepreneurial search goods for “new and improved” use can be remedied by “changing the laws.” But that’s waiving the magic wand and pulling a rabbit out of the hat. We should recall that Caplan’s thesis of “rational irrationality” is an attempt to explain why we empirically never see “rational political reform.” All of a sudden, we can expect rational political reform in this context. Of course, this then would be the counter-factual that disproves his “rational irrationality” foundation.
Caplan executes the subtle microeconomic foundation shift again at the end of his blog post when he rhetorically ponders:
The big puzzle for me: Why do tax economists spend so much time discussing mere curiosities like lump-sum taxation, excess profit taxation, and land taxation, when the completely realistic option of taxes on negative externalities is right in front of their noses?
In terms of political economy, that statement makes little sense. Taxes on negative externalities would serve a purpose of correcting the injustice of the externality, of internalizing the externality. These types of taxes are not the source of public good financing. Frankly, it is the conflation of public good rationales with ubiquitous arguments of the social costs of human activity that I would pin at the foundation of his “rational irrationality” thesis. But there he is, postulating away, as if he has succumbed to his own fit of irrational bias. When he wakes up, he can the explain how a public goods rationale for taxes on negative externalities would fare under a supposedly biased electorate whose individual members can purchase their own negative externality rationale for government at the low, low price of the opportunity cost of a vote.