The rise of the freeloaders

We’d all like something for nothing. In the BBC comedy series Private Schulz, the Nazis plot to undermine the British economy by flooding the country with counterfeit currency. The hero parachutes into Britain carrying £2m of fake five-pound notes, and the fun begins.

How nice it would be to own a printing press that could produce fabulous amounts of money. Common sense tells us this would be immoral and wrong—a counterfeiter creates no real wealth himself and freeloads on the economic activity of others. It also tells us that society would stamp down hard on any form of economic freeloading. But common sense is mistaken.

The ability of individuals to make something for nothing is so pervasive that it even has a special name: “economic rent.” It was identified by the great eighteenth-century economist Adam Smith as one of the three main types of income. In The Wealth of Nations, Smith divided income into wages, profits and “rent.” He refers to “rent” in a way that confuses the modern reader, so I’ll use the term “economic freeloading.”

Freeloading, once it is recognised, provokes instinctive revulsion. Recent studies indicate human morality evolved partly as a response to the damage done by “free riders.” In primitive societies, anyone hitching a free ride was lethal to the social group, since hunter-gatherer existence required everyone to pull their weight. Humans had to develop a finely tuned sense of fairness and root out free riders, or their social group would become extinct. Most people (except Private Schulz) feel guilty when they hitch a free ride on others, and therefore avoid doing so.

One group engages in economic freeloading on a gigantic scale: landowners. This group, consisting of commercial property owners and private homeowners, sucks billions of pounds out of society each year. The average homeowner would be shocked and indignant at being described as a freeloader. A house is somewhere to live. Freeloading suggests some sort of sneaky behaviour, but those buying a home are overwhelmingly law-abiding and responsible, supporting themselves and their dependents without calling on assistance from the state. But the tax system makes them freeloaders, whether they know it or not.

In a speech supporting the Liberal government’s “people’s budget” of 1909, Winston Churchill explained why this counts as freeloading:

“Roads are made, streets are made, railway services are improved, electric light turns night into day, electric trams glide swiftly to and fro, water is brought from reservoirs a hundred miles off in the mountains—and all the while the landlord sits still… To not one of these improvements does the land monopolist as a land monopolist contribute, and yet by every one of them the value of his land is sensibly enhanced.”

There is nothing a property owner can do to change the value of his plot of land. The value per square foot depends on its location. Is it near a station? A good school? All of these factors are determined by the actions of society, not the individual efforts of the owner. Any increase in the value per square foot of his plot is a pure free ride, towards which he has done nothing to contribute.

The scale of this free ride is huge. The total value of the private housing stock in the UK has risen from about £1.3tn in 1992 to about £4.2tn today. This increase is largely due to inflation and growth in land value; the stock did not substantially increase during this period. If the increase had been due to inflation alone, this would have taken the value to £2.3tn. The additional £2tn reflects the increase in the value of the land that the houses are built on. So landowners, including homeowners, have gained almost £2tn over 20 years from a rise in land values.

A specific example of landowners getting a free ride at public expense was the construction of the Jubilee line extension in London in the 1990s. This cost £3.5bn and led to an increase of £13bn in the value of nearby land. The cost of building the line was almost exclusively borne by the general taxpayer, but the £13bn benefit was pocketed by local landowners, most of whom had contributed no more to the building of the Jubilee line than any other British taxpayer.

Some of the profit made by these property owners may have been recycled back to the economy through increased economic activity. But people do not willingly spend money on a project when they see no personal benefit. When society separates reward from contribution, the contribution dries up. Money for public infrastructure projects comes from the general taxpayer; the beneficiaries are always a lucky group of property owners in particular locations. There is therefore little enthusiasm for sustained infrastructure expenditure from UK taxpayers (or for that matter from private sources). The dilapidated state of UK infrastructure is a direct result.

Private Schulz performs his counterfeiting in secret, but owning a property is a public act sanctioned by the state. Failing to tax easily identifiable free riders on windfall gains provided by society seems crazy, but history provides an explanation. In 1909, the British aristocracy blocked the attempts to tax land in the “people’s budget,” and they have sabotaged attempts to tax land ever since, along with companies owning city centre business property (which is increasingly foreign-owned). The richest British-born individual is the Duke of Westminster, whose family owns the central London Grosvenor estate. In dynamic economies, the greatest wealth is held by entrepreneurs and innovators such as Microsoft’s Bill Gates. In the British economy, a propertied ruling class sustains its wealth by playing the economic role of a currency forger. This has caused a century of social stagnation and economic decline.

The government must find the courage to tax the gains of economic freeloaders and to liberate the productive part of the economy. The solution is a land value tax, an annual tax based on the value of the plot of land. This would be very difficult to avoid paying, and would ensure those who benefit from public expenditure shoulder their share of the costs. At present, the only serious tax on residential property is council tax, which takes a lower proportion of the property value as the property gets more expensive, thus punishing owners of low-cost homes and rewarding owners of more valuable properties. Furthermore, it reaches a maximum level once the house is sufficiently expensive, so a £30m house can attract the same council tax as a family home.

A land value tax would make some infrastructure projects self-financing. There have been examples of large public improvement projects financed in this way since the 19^th century. When the city of New York decided to create Central Park, it purchased several city blocks at market prices and demolished them. The increased property taxes resulting from increased land values in the vicinity of the park more than paid for the up-front costs.

Recent calls by the Business Secretary Vince Cable to introduce a mansion tax are welcome, and are the only serious attempt by any major party to tax property progressively. However, a mansion tax fails to target freeloading since, like council tax, it is based on the buildings as well as the land. Cable is fully aware of this, but shies away from the political battle that would be needed to promote a fully fledged land value tax.

And Private Schulz’s fate? Like the best fictional scoundrels, his schemes get him nowhere. If only real life were like that.