Adam Smith critiques the Deficit Reduction Commission December 6, 2010 By Michael Hudson What would Adam Smith have said about the Bowles-Simpson economic report last week? What a pity the great free marketer was not around to serve on the Deficit Reduction Commission. He not only would have rolled over in his grave, he would have risen up wielding an ax to the fiscal proposals that are diametrically opposite to the fiscal principles that he and his original free market contemporaries urged. Writing in the wake of the French Physiocrats with their ImpÃ´t Unique to collect the revenues that Franceâs landed aristocracy drained from the countryside and towns, Smith endorsed the idea that the least burdensome tax was one that fell on land rent: A more equal land-tax, a more equal tax upon the rent of houses, and such alterations in the present system of customs and excise as those which have been mentioned in the foregoing chapter might, perhaps, without increasing the burden of the greater part of the people, but only distributing the weight of it more equally upon the whole, produce a considerable augmentation of revenue. (Wealth of Nations, Book V.3.68) If Britain were to become a dominant economic power, Smith argued, its industrial capitalism would have to shed the vestiges of feudalism. Groundrent charged by its landed aristocracy should be taxed away, on the logic that it was the prototypical âfree lunchâ revenue with no counterpart cost of production. He noted at the outset (Book I, ch. xi) that there were âsome parts of the produce of land for which the demand must always be such as to afford a greater price than what is sufficient to bring them to market.â In 1814, David Buchanan published an edition of The Wealth of Nations with a volume of his own notes and commentary, attributing rent to monopoly (III:272n), and concluding that it represented a mere transfer payment, not actually reimbursing the production of value. High rents enriched landlords at the expense of food consumers â what economists call a zero-sum game at anotherâs expense. The 19th century elaborated the concept of economic rent as that element of price which found no counterpart in actual cost of production. and hence was âunearned.â It was a form of economic overhead that added unnecessarily to prices. In 1817, David Ricardoâs Principles of Political Economy and Taxation elaborated the concept of economic rent. Under conditions of diminishing soil fertility in the face of growing demand, value was set at the high-cost margin of production. Low-cost producers benefited from the rising price level. Ricardo helped clarify the concept of differential rent by applying it to mining and subsoil wealth as well as to land. Heinrich von ThÃ¼nen soon added the more helpful concept of rent-of-location (site value). The important classical point was that economic rent was produced either by nature or by special privilege (âmonopolyâ), not labor effort. Hence, it was that element of price that could not be explained by the labor theory of value, except by marginal costs on what Ricardo hypothesized to be ârentless landâ as recourse was made to poorer soils. Ricardoâs follower John Stuart Mill explained that being income without labor or other costs, such rent formed the natural basis for taxation. The Progressive Era developed the view that public utilities and other natural monopolies rightly belonged in the public sector, where governments would provide their basic services at a subsidized price or even freely as in the case of roads. The idea was to keep user fees no higher than the actual cost of production, so as to avoid rent seeking. This pejorative term means extracting income by placing tollbooths on the economyâs key infrastructure. To leave roads and railroads, electric and power utilities in private hands ran the risk of private owners ârack-rentingâ the population, adding to the cost of living and doing business. U.S. policy is just the opposite. Commercial real estate has been regressively âfreedâ from taxes â leaving the rental value to be pledged to banks as interest. This un-taxing of land rent has been a major factor inflating the real estate bubble on credit, much as deregulating monopolies has helped inflate their stocks and bonds on credit. This is the policy that the Bowles-Simpson Deficit-Reduction Commission endorses. Its regressive tax proposals would shrink the economy, pushing it further into debt. This transfer of revenue from labor and business to property owners â and from them to their bankers and bondholders â threatens to force up the governmentâs fiscal deficit (as states and municipalities are seeing today) and turn the United States into a Third World type neofeudal economy.