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Ken Henry's dangerous fallacy of taxing "imputed rent"
Gerard Jackson
As evidence that bad ideas never die Treasury boss Ken Henry floated the idea of taxing "imputed rent" on those who bought their homes instead of renting them. Sinclair Davidson (Professor in the School of Economics, Finance and Marketing at RMIT, and a fellow of the Institute of Public Affairs) thought this a silly proposal. Unfortunately Davidson got it completely wrong. What he failed to grasp is that it is based on a fallacy. (To be fair to Davidson, this fact has scarcely been noted by "professional" economists.)
Now our brilliant Mr Henry based his suggestion on the obvious fact that if homeowners had not bought their homes they would have had to pay rent. From this the likes of Dr Henry conclude that homeowners are receiving tax-exempt income in the form of 'imputed rent' which by rights should be treated as forgone income: the income or rent that homeowners sacrifice by not renting out their property. We are clearly dealing with a frame of mind that thinks that by buying their houses homeowners are somehow enjoying an unearned tax advantage over their less fortunate rent-paying neighbours. They have in fact managed to reap where they have not sown.
Being a man of some sensitivity Dr Henry evidently believes that the tax system should be used to remedy this injustice. So how could this be done? As an example let us assume that you the reader deposit $500,000 in an interest bearing account. You will pay taxes on the interest because it is treated as income. However, if the money were used to buy a house it will now be clear to Dr Henry that because you no longer pay rent you have obtained an untaxed income stream. That a tax on this fictitious stream would be a tax on savings and social mobility would never occur to Dr Henry any more than it would occur to him to build on his favourite wombat sanctuary.
The logic of his argument leads to the conclusion that this 'unearned income' should be taxed at the marginal rate. If the imputed rent is calculated, for example, at $20,000 pa then this would be added to the house owner's normal income and taxed at the marginal rate, regardless of the fact that the property is already being taxed by local authorities. The fallacy in this approach should be glaringly obvious to anyone with some training in economics, including Sinclair Davidson.
The price of a house — like that of any economic good — is the discounted sum of the value of its stream of future services. Therefore anyone who buys a house is simply paying the sum of its future discounted rents. Hence, to claim — as Dr Henry does — that the house owner is not paying rent is only true in the sense that he has either paid the rent in advance as a lump sum or is paying it in the form of a mortgage. This money equals the capitalised value of the house. In plain English, instead of paying for the services of the house in the form of weekly or monthly payments called rent (these are time payments) the house owner decided to purchase the discounted value of the sum of these services.
Economic analysis makes it perfectly plain that the house owner is neither receiving manna from heaven nor is he getting an unearned income. To force people to pay a tax on imputed rent is simply to misunderstand what has really happened. It should now be plain that the price of any economic good (except the services of labour) is nothing more than the discounted sum of the value of its future services — and that the unit value of these services are rents. Therefore, buying a good is an act of buying the total stream of its discounted rents.
From what has been said, it is clear Dr Henry committed an appalling economic error in arguing that home buyers are living rent free. Taken to its logical conclusion Dr Henry's reasoning would apply to all durable goods including cars, televisions, computers, furniture, machinery, cruise ships, airplanes, factories, trucking companies — that is, just about every economic good you can think of. In reality, his proposal amounts to a sweeping wealth tax.
No wonder so many people sneer at so-called rational economics (free market economics) when this kind of nonsense is seriously peddled by economists who are paid a great deal to know better. (Nearly as bad are those economists who oppose the proposal and yet cannot see the fallacy.) It is a little known fact that it was the Austrian school that fully developed the idea of imputation and it is only Austrian analysis that has exposed the destructive use to which the concept has been put by 'progressive' economists.
Imputed rent is not the only area where our orthodox economists have let us down. We also have the concept of "economic rent" which is another dangerous fallacy and one that has largely gone unchallenged by mainstream economists. However, on one occasion Sinclair Davidson actually did try to pick up the gauntlet. (Textbook example is not grounded in earthy reality, Sinclair Davidson, The Age, 13 March 2009.) He failed miserably. It utterly eluded him that the concept of "economic rent" is a complete fallacy, as anyone with a respectable knowledge of the history of economic thought ought to know. (In fairness to Davidson even Wesley C. Mitchell badly erred on this topic.)
At the risk of being labelled "unbelievably stupid", "a liar", "senile", "a fool", "dishonest", etc., by a Davidson surrogate, (Mr Davidson and his admirers appear to believe anything is fair — including abuse, lies and distortions — in dealing with critics they think lack influence) I suggest that the basic problem is that our rightwing have succeeded in strangling anything resembling a meaningful economic debate.
For those who think I exaggerate allow me to draw attention to Sinclair Davidson's expressed opinion that one needs to be a "professional" to have one's economic opinions treated seriously. Therefore, according to Davidson's narrow definition of a professional, the economic views of Maynard Keynes and the remarkable Henry Hazlitt are not worthy of consideration because neither actually took a formal course in economics. (Keynes did one semester under Alfred Marshall.) However, Sinclair Davidson is flexible in his definitions if nothing else.
In collaboration with Chris Berg of the Institute of Public Affairs he wrote
Thumping the Table: Key Questions for the Labor Party's 'Industry Policy'. Both Berg and Davidson took great offence at my critique which eventually resulted not in a civil exchange but a stream of invective personally directed at me by a surrogate. Nevertheless, I remained unwaveringly civil despite the provocation. Since then I have learnt that Mr Berg is also not a "professional" economist, even though Mr Davidson made it abundantly clear that he deals only with professionals. No doubt readers will draw their own conclusions regarding Sinclair Davidson's lack of consistency as well as his professionalism.
Perhaps Davidson thinks his status at the IPA and RMIT gives him the right to be dismissive of those who have the temerity to disagree with his economic views and those of his friends at the IPA. Be that as it may, what cannot be disputed is that it can never give him the right to be disingenuous or dishonest.
His torpid response to the greens' dangerous push for so-called renewable energy is also deserving of censure. To simply label green energy proposals as creating inefficient production techniques is inexcusable. If he had done his homework he would have responded with the Betz limit, the third power, insolation and Austrian capital theory. (Siemens to use green energy hoax to ripoff taxpayers and Carbon taxes energy production and technology: more green nonsense.)
Unfortunately Sinclair Davidson is horribly inept in the field of Austrian capital theory — irrespective of any contrary impression he may try to convey — not even understanding that Austrian capital theory cannot be divorced from Austrian monetary theory. Truth be told, he is totally incompetent to discuss Austrian economics on any level. He is so bad he even called for Austrian economists to dump von Mises, a man rightly considered one of the greats of the Austrian school. Enough said — for now.
The Treasury wants to impose the fallacious rental resource tax on mining companies
Gerard Jackson is Brookesnews' economics editor
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Monday 26 April 2010