Debt Peonage

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Concept by Michael Hudson.


Interview excerpt:

"MW: What exactly do you mean by “modern debt peonage”?

M Hudson: This is what happens when wage earners are obliged to turn over all their income above basic subsistence needs to the FIRE sector – mainly for debt service but also to pay for compulsory insurance and, most recently, the tax burden that finance and property have shifted off themselves. The distinguishing feature about peonage is its lack of choice. It is the antithesis of free markets. As I mentioned above, many families today find themselves locked into homes that have negative equity. Their mortgage debt exceeds the market price. These homes can’t be sold – unless the family can pay the difference to the banker who has made the bad mortgage loan. The gap may exceed all the income the family earns in an entire year – just as it was making on paper a price gain larger than its annual take-home pay.

But what did all this matter, in retrospect, if the house was for living, not for buying and selling? This dimension of use value was left out of account by focusing on paper wealth.

In a nutshell, debt peonage is the other side of the coin in a rentier economy. The negative equity we are seeing today is a key component of debt peonage. It forces debt peons to spend their lives trying to work their way out of debt. The more desperate they get, the more risks they take, and the deeper they end up. In Kansas City, one of my students wrote his class paper on how the immediate cause of many mortgage defaults is gambling debt. Missouri has a lot of fundamentalist Christians who think of God as watching carefully over them. Being good people, they want to give God a chance to reward them for living an honest life. So they go to the gambling boats that are moored along the river. But the odds are against them, and it looks like Einstein was wrong when he said that God doesn’t play dice. Gambling – and much financial speculation – is all about probability, and the odds are as much against gamblers as they are against debtors. Being laws of nature, the laws of probability are like the privilege of land ownership: a gambling license provides the house with an opportunity to rake economic rent off the top.

Debt deflation and the tax shift off finance and property onto labor

MW: In the short run it looks like slow growth and deflation will be bigger problems than inflation. Commodities, including gold and oil, are tumbling almost daily, while bank assets are being steadily downgraded, foreclosures are soaring and the stock market is reeling. The financial crisis that began in the real estate market has triggered a boycott of structured products and is now rippling through the broader economy. The Federal Reserve has already dropped interest rates by 3.5 per cent and has used up half its balance sheet ($450 billion) to shore up the faltering banking system. But the situation keeps getting worse. The banks have curtailed their lending, and consumer spending is off in nearly every area. It looks like the Fed is out of ammo. Is it time to consider fiscal alternatives to the present downturn, such as cutting payroll taxes to give families more money to increase demand, or initiating massive infrastructure projects?

M Hudson: By “deflation” I assume you mean debt deflation – draining purchasing power as a result of rising debt service and compulsory insurance, plus the wage squeeze that the government praises for “raising productivity” to “create wealth” for the CEOs who pay themselves what they have cut back from labor’s paycheck. There will be less consumer spending – but even so, consumer prices may not come down if the dollar resumes its fall, especially if monopoly pricing continues to be permitted. Your solution is indeed what is needed, and Mr. Obama has promised to raise the wage and salary limit subject to FICA withholding. I think that an even better idea would be to go back to the original 1913 income tax and exempt wages that merely cover subsistence. I would restore a cut-off point at $102,000 in today’s dollars, matching the terms of America’s 1913 income tax. People earning less would not have to file an income-tax return at all.

This truly conservative idea would free income to be spent on improving living standards. Instead, high income brackets and property are being un-taxed today, and their tax savings are being spent mainly in making loans that are used to bid up the price of wealth and luxury goods. This is what the classical economists warned against, yet the tax shift off property onto labor is being done hypocritically in their name. To get the kind of free markets they advocated, taxes should fall on the FIRE sector (finance, insurance and real estate) and monopolies, not wages or bona fide industrial profits stemming from tangible capital investment and employment.

MW: This June you wrote a groundbreaking paper for a recent Post-Keynesian conference at the University of Missouri in Kansas City, where you’re an economics professor. Its title was “How the Real Estate Bubble drives Home buyers into Debt Peonage.” You earlier wrote a now famous May 2006 Harpers cover story on debt peonage. Your Kansas City paper produces charts showing how tax favoritism for real estate and other clients for the banking and financial sector stimulates asset-inflation, leading to massive equity bubbles like the one we are currently experiencing in the housing market. Would you give us a brief summary of your thesis?

M Hudson: My paper explained how the money the tax collector gives up is “freed” to be paid to banks as interest. This is the motto of real estate investors: “Rent is for paying interest.” The FIRE sector has adopted a populist rhetoric to persuade homeowners to believe that lowering the property tax will end up giving them more money. It seems at first blush that this would happen. But in practice, new buyers – and speculators – come into the market and pledge the tax cuts to bid up housing prices all the more. The winner in this new anti-tax marketplace is the buyer who pledges to pay the tax cut to the banks as interest on a mortgage loan to buy the property.

As my paper describes:

“Tax favoritism for real estate, corporate raiders and ultimately for bankers has freed income to be pledged to carry more and more debt, which has been used to fuel asset-price inflation that raises the price of home ownership, corporate stocks and bonds – but not to increase production and output. ... Shaping the marketplace to favor finance and property over industry and labor does not create a ‘free market.’ It favors the debt-leveraged buying and selling of real estate, stocks and bonds, distorting markets in ways that de-industrialize the economy. [And] shifting taxes off property and finance is more a distortion than a virtue, unless debt leveraging is deemed virtuous.

"This is the tragedy of our economy today. Credit creation, saving and investment are not being mobilized to increase new direct investment or raise living standards, but to bid up prices for real estate and other assets already in place and for financial securities (stocks and bonds) already issued. This loads down the economy with debt without putting in place the means to pay it off, except by further and even more rapid asset-price inflation. This is largely the result of relinquishing planning and the structuring of markets to large banks and other financial institutions, political lobbyists have rewritten most of today’s tax laws and sponsored general public deregulation of the checks and balances that were being put in place by the late 19th century. At that time, just over a hundred years ago, it seemed that wealth – and banking – were being industrialized, while landed wealth and monopolies would become more socialized and their rents fully taxed. Instead of real estate prices rising, the rental ‘free lunch’ would provide the basic source of public finance. Technology and productivity would increase industrial capital formation and raise labor’s living standards. These policies would free markets from rent extraction and also from taxes as the fiscal burden was shifted back onto property.

But this is not what has occurred. The financial system has used its power to extract fiscal favors for real estate and to press for deregulation of monopolies as the major source of its interest and collateral for its loans.”

MW: What do you think the positive effects would be of taxing property rather than income and industrial profit?

M Hudson: It would have two major positive effects. First, it would free labor and industry from the tax burden. And by the same token, it would require the economic rent currently used to pay interest and depreciation to be paid instead as a property rent tax. This would free an equivalent sum from having to be raised in the form of income and sales tax. That was the classical idea of free markets. As matters stand today, the tax subsidy for real estate and finance leaves more net rental income to be capitalized into bank loans. This is a travesty of the “free markets” that lobbyists for the banks and the wealthy in general claim to advocate.

Replacing income and sales taxes by a land-rent “free lunch” tax would make real estate prices more affordable, because the interest now “free” to be paid to banks to support a high debt overhead would instead be collected and used to lower the tax burden on labor and industry. This would reduce the cost of production and living, I estimate by about 16 percent of national income.

Homeowners and renters would pay the same amount as they now do, but the public sector would recapture the expense of building transportation and other basic infrastructure out of the higher rental value this spending creates. The tax system would be based on user fees for property, falling on owners in a way that collects the rising value of their property resulting from the rent of location, enhanced by public transportation and other infrastructure, and from the general level of prosperity, for which landlords are not responsible but merely are the passive beneficiaries under current practice.

A Neo-Progressive fiscal policy would aim at recapturing the land’s site value created by public infrastructure spending, schooling and the general level of prosperity. The debt pyramid would be much smaller, and savings could take the form of equity investment once again. Slower growth of debt, housing and office prices, and lower taxes on income and sales would make the economy more competitive internationally." (