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Posted: September 14, 2012

The Economist: What’s so bad about rent?

Tucker Hart Adams

It’s been a while since I’ve used this column for an economics lesson, but today it is time. Our topic is economic rent. Try to contain your excitement, please!

Most of us know what rent is. It’s what we paid our landlord for an apartment before we bought a home. Or a car company when we used its car on our last vacation. Or the payment for the glass and silver we borrowed when our daughter got married.

The bible of economic textbooks, Paul Samuelson’s "Economics," defines rent as the return to a factor of production that is completely inelastic; in other words, quantity doesn’t change as the price varies. The most obvious example is land – supply is fixed and doesn’t vary no matter the price. (Oh, all right, you can dump landfill in the bay and create a bit more acreage, but let’s not be picky.) Pure economic rent is earned when quantity is fixed and the factor has no other uses. That probably exists only in some economist’s ivory tower.

Henry George, a 19th century printer/economist, argued that rent (he was talking about land) is a surplus that can be taxed heavily without distorting production. In theory, at least, the land owner pays the entire tax. But since he didn’t deserve a return in the first place on nature’s windfall gift, it isn’t a problem and won’t affect his behavior.

This isn’t what the media are talking about when they rage against the economic rents being received by greedy bankers on Wall Street. Or at least it is only loosely related. The charge is that these people are being paid an excess over the value they add, at times tens of millions of dollars.

Samuelson provides an example of that. Babe Ruth, he points out, was paid $100,000 a year to play baseball. In any other job he would have earned no more than $5,000. So, he received $95,000 in pure economic rent. How times have changed! But, the principle holds true. Today’s top sports stars earn millions in economic rent. As do entertainers. And taxi companies.

Taxi companies? Wait a minute. As my father would say, "Now you’ve stopped helping and gone to meddling." But in many cities the cost of the medallion required to operate a cab is hundreds of thousands of dollars. The supply is fixed. Last year, two of New York City’s 13,273 medallions changed hands for $1 million each. When New York issued its first batch of medallions in 1937, the going price was $10 even, or $159.36 in today’s dollars.

So back to our greedy bankers (and entertainers). Should they be allowed to earn an economic rent? Are they being paid more than the return on the real value of what they produce?

What about Steve Jobs or Bill Gates? People didn’t often rage about the billions they made from Apple and Microsoft. I think the difference is that they were perceived as providing real value, that the products they invented made a great contribution to society. One of the great things about the United States is that we seldom begrudge an individual something we think he/she deserves.

But those bankers! The products they sold – subprime mortgages and collateralized debt obligations – did they add value to society? Don’t be too quick to answer no. Subprime mortgages enabled many people to own homes who otherwise would still be renting. If half of them defaulted, half were successful. CDOs kept markets deep and liquid for a time. It was the excesses, not the products themselves, that were the problem.

Should shareholders demand that their top officers be paid less? Absolutely! Along with entertainers and sports figures. I don’t believe anyone is "worth" the amounts those individuals earn. I’m guessing they’ll do the job for a lot less.

Which brings me to a conclusion that troubles me. Why shouldn’t the true economic rent be taxed away, as Henry George suggested? Shouldn’t a family be able to struggle along on $5 or $10 million a year? I’m not a fan of a progressive income tax, at least not on payment for the value one adds to our economy. But if you earn more than that? I’ve got to think about that one.

Tucker Hart Adams, president of the Adams Group, monitored and analyzed the Colorado economy for 30 years. She can be reached via her website, coloradoeconomy.com.

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