Taxing “dead capital” to make it more productive

Essay written in May 2016 for the Hayek Essay Contest organized by the Mont Pelerin Society.

Competition is “a procedure for discovering facts which, if the procedure did not exist, would remain unknown or at least would not be used
– Hayek, F.A., 1968/2002. Competition as a discovery procedure. (Marcellus S. Snow Trans.) Quarterly Journal of Austrian Economics 5, 9-23.

In what other areas of modern societies is competition underutilized as a discovery procedure?

At least since the birth of modern capitalism in eighteenth-century Europe, competition has been recognized by many economists and other theoreticians of ethics and social sciences as an essential driver of progress. Either applied to trade, politics or science, competition, they claimed, stimulates innovation and confronts products, services, parties or ideas on a marketplace that rewards the best and sanctions the worst, alike a permanent race where spectators are also expected to be voters, as it should be the case in liberal democracies.

Contrary to common thought, even communism, despite its traditional opposition to capitalism, values competition, but only in certain realms of the society like sport, education or work. Communist thinkers and political leaders indeed warned against “wild” competition, for example in the form of arms races, colonial wars or trade conflicts, because they considered them to be wasteful of resources, but recognized competitive mechanisms as useful to increase productivity, physical performances and encourage hard-working behaviours. That is one of the reasons why communist regimes have created so many medals and distinctions of all sorts, in apparent contradiction with their egalitarian aspirations.

Competition is less often understood as a instrument to build knowledge. Friedrich Hayek, who has been remembered firstly as an economist of the so-called “Chicago school”, did not gain so much fame – in a positive or negative way – for his works in the field of epistemology, though they have been in a sense more groundbreaking than his purely economic contributions. In particular, his defence, against central planning, of the “free” market as the best of known instruments to gather information and take decisions accordingly found broader applications long after the first publication of “The Use of Knowledge in Society”, in 1945.

Wikipedia, applications that alert drivers about the proximity of speed detectors or the evaluation system of the platform are all examples of how open and decentralized solutions can harness “circumstantial knowledge” and use the “wisdom of crowds” (James Surowiecki) to generate in a very fast manner enormous quantities of information at a relatively low cost and with a fairly high level of accuracy.

These innovations, made possible thanks to the wide diffusion of Internet and later on, smartphones, are in the end much more convincing arguments in favour of market-based mechanisms than price systems and stock exchanges, whose efficiency as information aggregators has been questioned by the strength of “animal spirits” (John M. Keynes, more recently George A. Akerlof and Robert J. Shiller) and the overweight of certain participants to the detriment of the dispersed character of knowledge sources.

Competitive or cooperative marketplaces?

Yet it is noteworthy that while crowd-based services are actually building on Hayek’s theory, they are not exactly competitive. True enough, they are decentralized and open in the sense that every individual can join the platform and bring their contribution or challenge others’, but they do not organize competition between participants – higher ranks for the most active commentators being rather an additional feature to encourage people to write rather than a part of core activities.

They are rather cooperative in that way that their usefulness results first and foremost from the number of inputs, similarly to theories on the wealth of networks, whereas selection and elimination of low-quality elements tend to be rare. That makes these platforms different from stock exchanges or other price systems, which are aggregative but not cumulative. Consequently, they are expected to deliver signals that are valid only at an instant t, when information available at that time is processed, but with no reference to past outcomes or forecasts – these elements can nevertheless be integrated by market participants in their own inputs to the system.

This cooperative dimension will later serve in my development on an area of modern societies where, in my opinion, competition is underutilized as a discovery procedure: namely the use of material resources. In his article on the subject matter, Hayek observed that “market theory often prevents access to a true understanding of competition by proceeding from the assumption of a “given” quantity of scarce goods. Which goods are scarce, however, or which things are goods, or how scarce or valuable they are, is precisely one of the conditions that competition should discover: in each case it is the preliminary outcomes of the market process that inform individuals where it is worthwhile to search. Utilizing the widely diffused knowledge in a society with an advanced division of labor cannot be based on the condition that individuals know all the concrete uses that can be made of the objects in their environment. Their attention will be directed by the prices the market offers for various goods and services.

In a strange paradox, though Aristotle already acknowledged that economics were closely linked to the notion of scarcity, modern capitalism tried to conciliate this idea with a firm belief in unlimited growth, seeking ways out in productivity gains, technological progress or the use of so far untapped resources. This combination went relatively unchallenged until the 1970s, when the Club of Rome advanced the hypothesis of a finite world and its inability to support a constantly rising population with higher and higher comfort standards, even if accompanied by technological progress. The assumed finite character of our planet has not yet become fully mainstream, but together with climate change, they are considered with enough seriousness nowadays to be discussed at the highest decision-making level and be integrated to various extents into public or corporate policy.

In search for new value deposits

The limit is less clear on the demand side. Marxist analysts have rightly pointed out that capitalism has constantly been pushing away frontiers, expanding first geographically – for instance in colonies conquered by European powers in the 19th century or the American Far West –, then demographically with the broadening of a consuming middle class.

The next step of this process can probably be dated at the corner of the 1960s and 1970s, that is when the post-war industrial society began to decline under the double pressure of societal revolutions and oil shocks. While the expression of “post-industrial society” (Daniel Bell) may be more easily associated with the supply side, the development of services is evidently intertwined with changes in consumers’ habits. In particular, this is the moment when post-industrial capitalism found a new field for development in people’s free time, liberated in the previous decades thanks to progressive reforms in labour law, democratization of leisure and home appliances. A number of activities then started to enter the money nexus, for example wellness and tourism.

Because of increasing competition between working and leisure time, the first being necessary to afford the pleasures offered by the latter, this path was not sustainable. One of the solutions found was therefore to extract more value from activities already present in the money nexus. Products and services were redesigned to embody the mottos of 1968, such as freedom and authenticity, and consumption became a way for greying revolutionists to join their old aspirations with comfort through fair trade and slum tourism. At the same time, basic activities like jogging or cooking were made more capital-intensive with more or less useful gadgets like high-tech running shoes or sophisticated utensils and machines. Last but not least, an enormous industry of self-help books and trainings emerged to advice people on how to save time in order to work more... or spend more money on leisure.

It is difficult to predict what the next frontier will be in relation to people, but there is certainly one regarding things that is being pushed away and is meeting the limit mentioned above in terms of production. Many items around us, like our cars, vacuum clearers, drillers or even our homes are currently being used only a small fraction of time and stay idle during ther rest.

This reserve of availability was certainly useful at a period when we did not have very advanced coordination mechanisms, therefore it was better to own a product and be able to use it whenever needed, even if that meant leaving it aside for the majority of time, rather than relying on others and carry the risk not to be able to get access to the idem when required. But does this remain true today, at the age of Internet and smartphones?

The boom of the so-called functional economy, or sharing economy, tends to demonstrate that we have crossed both a technological and psychological barrier by allowing strangers to sleep at our places (AirBNB) or drive our cars (OuiCar), on in the other direction to trust enough the strength of networks to believe that they will provide us with the desired service wherever and whenever needed. Though this still concerns a limited share of the world population, mostly located in rich Western countries, the trend is likely to continue thanks to its economic and ecological advantages.

Competition to find more optimal uses to existing material resources

From this perspective, competition is a powerful instrument to discover new solutions to extract more value from items and resources that are currently lying idle. Yet one big obstacle stands on its way: private property in its current form. In his article on “Competition as a discovery procedure”, Hayek justified its existence by the fact that “only the institution of private property, and all the liberal institutions of the rule of law associated with it, can bring about [protection of the individual from the pressure of society]”.

While this was certainly true at the time of writing (1962), one may wonder whether it is as relevant today as it was half a century ago. Alike capitalism, the institution of private property in its modern form is historically dated and the function Hayek assigned to it is basically the same as described by John Locke in the 17th century.

It should be here recalled that at the time of absolute monarchies and arbitrary power, private property was seen as a retreat against physical or economic pressure that the state could exert on its subjects. This was also a condition of independence to take part in the political life, an argument that survived until the 19th century and the progressive abolition of censitary suffrage which used to reserve voting rights to landowners.

In addition to the withdrawal of condition of fortune to vote and run in elections, the universalisation of social security schemes – at least in Europe – was an additional sign that contemporaries understood the impossibility to realize the dream of a democracy based on independent small owners, since modern industry needs large factories and disciplined, specialized employees to harness economies of scale. Therefore, rather than encouraging workers to try to save money all their lives and buy a small workshop or farm as a form of insurance against social risks, governments and employers accepted to create social security schemes in order to stabilize the workforce. From that moment, the institution of private property was deprived not only of its political function, but also to a large extent of its socio-economic role.

However, the social representation of private property has not evolved at the same pace as its practical function in society. Most people continue to consider it as a life achievement, especially since many politicians encourage this aspiration and push legislation accordingly. This, in my view, represents an important obstacle to competition and to the development of more productive ways to use capital.

Private property and social costs in a finite world

Let me be clear – the gist of this essay is not about lifting the institution of private property, and even less to pursue a nationalization policy that would go beyond means of production to capture all kinds of assets that can be made more productive such as cars, washing machines or barbecue grills. My point is that the legal definition of private property should be revised to take into consideration that in a finite world, owning an asset and enjoying the full set of rights linked to the traditional concept of property (usus, fructus and abusus) deprives other individuals from the opportunity to make a socially more productive of it.

As an example, a person can own a piece of fertile land but cannot, or does not want to, for a bunch of reasons, to exploit it. Because land is scarce, and so are the products it could create, one can question whether such a situation is adequate, especially if it is to be perpetuated from one generation to another.

Again, the solution is obviously not to seize the land and establish a state farm or redistribute it to other people who are expected to make a more productive use of it. Going back to Hayek’s theory and despite technological progress, it remains unlikely that a central authority would be wise enough to know for each and every place under its sovereignty whether there are some productivity gaps, and even less to know how to fulfill them. In that sense, competition as a discovery procedure of the unknown remains the most relevant tool to execute this function.

The problem is that at the moment, competition does play a very limited role in finding out new uses of owned assets, whether there are products, real estate or natural resources. That is because private property in its current form is essentially a static, defensive institution which, once acquired, is very difficult to challenge from outside and does not go back very often to the marketplace.

Though 20th century thinkers such as Garrett Hardin (The Tragedy of the Commons) or Hernando de Soto (The Mystery of Capital) have promoted new uses for the institution of private property, in particular management of open-access commons or collateralization to obtain loans, in practice, and at least in developed countries with well-established property registration systems and fairly effective law enforcement authorities, property remains a slowing down factor, associated with high transaction costs in the case of expensive goods (real estate, cars) but low costs of ownership and maintenance. Put it differently, individuals do not have many incentives to extract as much as value as possible from the assets they own, because after having purchasing them, they can keep them idle and pass them to their heirs with almost no loss – except depreciation. To borrow de Soto’s terminology, this is another form of “dead capital”.

A tax policy shift from flows to stocks

The proposed solution consists in shifting the focal point of tax policy from flows to stocks, in other words to decrease taxation on labour and transactions and increase it on ownership. Creating a tax on real estate or car possession would add to maintenance costs for depreciation and encourage owners to optimize the use of their goods. If they fail to do it and do not generate enough income from their work or other assets to cover the losses resulting from ownership costs, they will have to sell the item, most probably to people who will have better ideas on how to extract value from these goods.

In the example of cars, currently it costs very little to an owner to leave his vehicle idle on a parking place, and the perspective that he could actually earn money by renting it on platforms such as OuiCar is not a strong incentive because earnings foregone are not as motivational as a real loss. This has been largely evidenced by Amos Tversky and Daniel Kahneman’s experiments on loss aversion.

Yet the fact that owners bear little costs does not mean that the same goes for society. An idle car occupies space – the “high cost of free parking”, as coined by Donald Shoup – and immobilises the resources that have been used to produce the vehicle, like steel or plastics. While it is possible to put a pricetag on parking lots, the only way to reflect the social cost of immobilising material contained in a car is to price car ownership itself, and not only its purchace which is by definition a one-time operation.

After the introduction of the proposed tax, our driver would have three alternatives. If he is rich enough, he could cover higher ownership costs by incomes derived from other sources. If he drives a lot, he might find nevertheless profitable to pay the tax and keeps his car. Otherwise, he can decide to sell the car and start renting a vehicle from platforms or go on car-sharing, even public transportation. The resulting optimization of the car float in a given city is expected to free up resources (e.g. space) and reduce the amount of material stock needed to provide a certain level of service, without deteriorating quality or availability for users. The fact that cars are currently ridden only during about 5% of their lifetime is indeed difficult to defend, except by the argument that so far, technology was not advanced enough to shorten the “dead time” needed to ensure permanent availability. This has changed.

Creating a level playing field for competitors in a liquid society

Such an overhaul of the tax system would also contribute to make markets “fairer”, not only from a perspective of social justice, but before all in terms of level playing field. The fragmentation of professional life over people’s existences, and even during one single day – clerk during office hours, Uber driver during evenings or weekends –, makes existing labour regulations and associated social security schemes simply obsolete.

If it becomes more and more difficult to distinguish “professionals” from “amateurs” who practise nonetheless often enough to have their side business considered as an economic activity, a way to create a level playing field from a competition point of view between for instance taxi and Uber drivers would be to stop taxing their incomes and simply taxing their vehicles. Taxi drivers, who are expected to draw the main part of their financial resources from their car, would have to use it often enough to cover the amount of the tax or to sell it to a company or cooperative that would ensure the vehicle would be running most of the time. Uber drivers, on the other hand, would have to generate enough money from their main job to pay the car ownership tax or, again, give enough rides.

The same model can be applied to homes and apartments, which are increasingly developing a dual nature by offering a service of housing for their occupants (owners or tenants) as well as short-term guests. Were real estate for hotels and housing taxed equally, based on the physical properties of buildings and lands – size, location –, hotel and AirBNB rooms would be able to compete on a level playing field, and many owners of apartments currently unoccupied in attractive districts with scarce development possibilities would have an additional incentive to put them on the market, because they would bear a higher cost of ownership.

In the current state of the art, such a scheme could not be applied to all types of assets that can be “optimized”, because many products whose lifespan runs on several years (toys, drillers, vacuum cleaners, washing machines...) fall into the category of consumer, and not investment goods. However, systems of real estate or car ownership taxation already exist or have existed in certain countries, with proven methods for property registration and pricing. One can look for example at the Swiss property and rental value taxes or the vignette which, although originally designed as a road tax, does not differ very much in practice from a car ownership tax. Academic literature on hedonic pricing should also serve as an inspiration to better capture scarcity and social costs and reflect them in the amount of the tax.

A measure supported by the OECD

It is noteworthy to underline that the tax policy shift from flows to stocks has become one of the main recommendations1 from the OECD during the last years. The organization, which cannot be suspected of socialist leanings, has indeed come to the conclusion that increasing the share of consumption, property and environmental taxes in state revenue would have four effects:

  • first, it would support growth by giving back more money to workers and companies currently taxed to a large extent on their incomes;
  • second, it would limit possibilities of tax evasion, because physical property is more difficult to move and to hide than financial assets;
  • third, it would slow down, or even reverse the rise of economic inequalities, since over the past 30 years, they have been massively drawn by growing concentration of wealth and higher incomes derived from capital than from labour (see Thomas Piketty and its “Capital in the 21st Century”);
  • fourth, it would push our economies on a more sustainable track, because taxation of non-renewable natural resources and negative externalities would discourage polluting behaviours and encourage resource-intensive activities to become more efficient and economical.

A fifth effect, less investigated and potentially less positive, might be that property taxation leads to further concentration of wealth. Taxing ownership does not make it disappear, but it reshuffles cards. For instance, in the field of commercial real estate and corporate car fleets, a few companies have gained control on a large part of their markets and assets needed for their proper functioning. While the concentration of goods is in a sense a natural consequence of attempts to optimize their use, it should not reach such a level that oligopolistic firms can not only deny entry to new competitors, but also arbitrarily grant access or not the assets they own.

For this reason, a tax burden shift should go together with a revision of the legal definition of private property with the view of creating a “right of access”. This would counter tendencies described by Jeremy Rifkin in his “Age of Access”, whereby a few gatekeepers control access to information, culture, goods or services, according to rules which are not transparent nor democratically legitimized.

Presented in one package, the tax and property law reforms would introduce or enhance competition at two stages: first, they would partly redistribute assets in a competitive manner to increase capital productivity, then they would ensure that the new market structure will not become so rigid and concentrated that it will prevent newcomers from challenging the existing order.

Paradoxically, property taxation has been attacked both from a part of the left and some groups on the right, even if it would contribute to reduce economic inequalities – one of the key objectives of the left – and to introduce more competition and innovation in the economy – an element usually associated with the right. It is the point where Hayek’s critique addressed to those who attempt to achieve “social justice” and are in reality conservative meets our argument on “dead capital” taxation.

The consequences of this erroneous interpretation of the market order as an economy whose task is to satisfy the various needs according to a given rank ordering are reflected in political efforts to correct prices and income in the service of so-called “social justice.” Notwithstanding the various meanings with which social philosophers attempted to invest this concept, in practice it has had virtually only one: protecting some groups of people from having to descend from the absolute or relative lifestyle they have heretofore enjoyed. Yet this is a principle that cannot be implemented in general without destroying the foundations of the market order. Not only continuous growth, but under certain circumstances even the preservation of the average income level attained depends on processes of adjustment that require a change not only of the relative shares but also of the absolute shares of individual persons and groups, even though such persons and groups are not responsible for the necessity of that change.

It is useful to recall at this point that all economic decisions are made necessary by unanticipated changes, and that the justification for using the price mechanism is solely that it shows individuals that what they have previously done, or can do now, has become more or less important, for reasons with which they have nothing to do. The adaptation of the total order of human action to changing circumstances is based on the fact that the compensation of the various services changes without taking into account of the merits or defects of those involved.

In this connection the term “incentives” is often used in a way that easily lends itself to misunderstanding, namely as though their primary purpose were to induce individuals to exert themselves sufficiently. The most important function of prices, however, is that they tell us what we should accomplish, not how much. In a constantly changing world, merely maintaining a given level of welfare requires constant adjustments in how the efforts of many individuals are directed; and these will only occur when the relative compensation of these activities changes. Under relatively stationary conditions, however, these adjustments—which are needed simply to maintain the income stream at its previous level—will not generate a surplus that could be used to compensate those who are disadvantaged by the price changes. Only in a rapidly growing economy can we hope to prevent an absolute decline in the material level of particular groups.

F. Hayek, Competition as a discovery procedure, bold sentences by R. Su.

In this critique, Hayek was actually targeting wage rigidity, but in an economy where the focal point has shifted from labour to capital, his words sound no less relevant. Yet for competition to shake up the current order without turning it into chaos, it has to go hand in hand with cooperation. As Jacques Delors, a Christian trade union leader who became president of the European Commission and pushed forward the Single Market initiative, put it, we need “competition that stimulates, cooperation that strengthens, and solidarity that unites”.