The Physiocrats develop national income accounting
Seeking to reform the French monarchy in the decades preceding the 1789 Revolution, the Physiocrats popularized the term laissez faire, “let us be.” Coined in the 1750s to oppose royal regulations to keep grain prices and hence land rents high, the school’s founder, Francois Quesnay, extended the slogan to represent freedom from the aristocracy living off its rents in courtly luxury while taxes fell on the population at large.
Quesnay was a surgeon. The word Physiocracy reflected his analogy of the circulation of income and spending in the national economy with the flow of blood through the human body. This concept of circular flow inspired him to develop the first national income accounting format, the Tableau Économique in 1759 to show how France’s economic surplus — what was left after defraying basic living and business expenses — ended up in the hands of landlords as groundrent.
Within this circle of mutual spending by producers, consumers and landlords, the Physiocrats attributed the economic surplus exclusively to agriculture. But contra Locke, they did not characterize landlords as taking rent by virtue of their labor. The crop surplus was produced by the sun’s energy. This logic underlay their policy proposaclass="underline" a Single Tax on land, l’impôt unique. Taxing land rent would collect what nature provided freely (sunlight and land) and hence what should belong to the public sector as the tax base.
The 19th century came to characterize landlords and other rentiers as the Idle Rich. But in an epoch when France was an autocratic state whose landed aristocracy was backed by the Church and royal organs, it would not have been politically viable to claim that they did not deserve their rents. Hoping to promote a fiscal revolution by reformers drawn from the ranks of these elites, Quesnay and his colleagues used rhetorical imagery to play on the self-image of rent recipients, calling this rentier class the source of France’s wealth, with industry merely subsisting off the landed aristocracy’s spending.
Characterizing industry and commerce as “sterile” (not directly producing the economic surplus) provided a logic for why landlords alone should bear the tax burden. Quesnay’s ploy was to claim that the class that produces the surplus is the natural source of taxation. Depicting agricultural land as the ultimate source of surplus implied that all taxes would end up being paid out of it. Deeming manufacturing to be “sterile,” merely working up the raw materials supplied by nature, meant that taxing industry or the labor it hired would raise the break-even cost that business needed to cover.
Any taxes on industry or labor would simply be passed on to the source of the surplus (agricultural landlords). In effect, the Physiocrats said: “Indeed you landowners are the source of our nation’s wealth. That is why all taxes end up being paid by you, indirectly if not directly. Let us avoid the convoluted pretenses at work and tax you directly by our Single Tax instead of impoverishing French industry and commerce.”
The Physiocrats’ analysis of the economy’s circular flow of revenue and spending enabled subsequent economists to analyze the net surplus (produit net), defined as income over and above break-even costs. They asked who ends up with it, and who ended up bearing the tax?
Quesnay’s circular flow analysis describes what I call rent deflation. Like debt deflation to pay creditors, it is a transfer payment from agriculture, industry and commerce to rent recipients that do not play a direct and active role in production, but have the power to withhold key inputs needed for it to take place, or from consumers.
Adam Smith broadens Physiocratic rent theory
Adam Smith met Quesnay and Les Économistes on his travels in France during 1764-66. He agreed with the need to free labor and industry from the land rent imposed by Europe’s privileged nobilities: “Ground-rents and the ordinary rent of land are… the species of revenue which can best bear to have a peculiar tax imposed on them.” But in contrast to the Physiocratic description of industry being too “sterile” to tax, Smith said manufacturing was productive.
In his lectures at Edinburgh a decade before he wrote The Wealth of Nations, Smith generalized the concept of rent as passive, unearned income — and used the labor theory of value to extend this idea to finance as well as land ownership:
The labour and time of the poor is in civilized countries sacrificed to the maintaining of the rich in ease and luxury. The landlord is maintained in idleness and luxury by the labour of his tenants. The moneyed man is supported by his exactions from the industrious merchant and the needy who are obliged to support him in ease by a return for the use of his money. But every savage has the full enjoyment of the fruits of his own labours; there are no landlords, no usurers, no tax gatherers.
Failure to tax this rent burden shifted taxes onto commerce and industry, eroding its profits and hence capital accumulation. In addition to bearing the cost of land rents, populations had to pay excise taxes levied to pay interest on public debt run up as a result of the failure to tax landlords.
The major focus of value and price theory remained on land rent throughout the 19th century. In 1848, John Stuart Mill explained the logic of taxing it away from the landlord class: “Suppose that there is a kind of income which constantly tends to increase, without any exertion or sacrifice on the part of the owners: those owners constituting a class in the community.” Rejecting the moral justification that Locke provided for landownership — that their land owed its value to their own labor — Mill wrote that landlords
grow richer, as it were in their sleep, without working, risking, or economizing. What claim have they, on the general principle of social justice, to this accession of riches? In what would they have been wronged if society had, from the beginning, reserved the right of taxing the spontaneous increase of rent …?
The value of land rose as a result of the efforts of the entire community. Mill concluded that rising site value should belong to the public as the natural tax base rather than leaving it as “an unearned appendage to the riches of a particular class.”
Mill justified taxing land rent on grounds of national interest as well as moral philosophy. The aim was to avoid taxing labor and industry, but on income that had no counterpart in labor. In time the labor theory of value was applied to monopoly rents.
The remainder of the 19th century was filled with proposals as to how best to tax or nationalize the land’s economic rent. Patrick Dove, Alfred Wallace, Herbert Spencer, Henry George and others provided an enormous volume of journalistic and political literature. Short of nationalizing the land outright, these land taxers followed Mill’s basic logic:
The first step should be a valuation of all the land in the country. The present value of all land should be exempt from the tax; but after an interval had elapsed, during which society had increased in population and capital, a rough estimate might be made of the spontaneous increase which had accrued to rent since the valuation was made. … [A]n approximate estimate might be made, how much value had been added to the land of the country by natural causes; and in laying on a general land-tax … there would be an assurance of not touching any increase of income which might be the result of capital expended or industry exerted by the proprietor.