Where does most property tax fund?

Abstract

Property taxes are a major source of tax revenue for local governments that help finance the provision of public services. The property tax base can be valued in a number of ways, including the use of land or site value, capital improved value, or rental value. Jurisdictions also differ with respect to tax rate schedules; the options include the use of progressive tax rates, flat rates, or lump sum per capita charges. Tax expenditures for property taxes come in various forms, including exemptions, rebates for low-income homeowners, deferral programmes, and deductions from taxable income under the personal income tax. Economic analysis of property taxes effective incidence has been analysed within partial and general equilibrium frameworks. A contrasting perspective argues that property taxes are more appropriately viewed as a user charge for local public services. Recent property tax reforms have been motivated by rising voter discontent with increasing property tax burdens and a perception that local governments lack accountability with respect to the services they deliver.

Effects on the Prices of Existing Dwelling

Exchanging property taxes for impact fees has a number of effects on existing property markets.

If new house prices rise due to impact fees, so will the price of existing dwellings as they are a substitute.

Reductions in property taxes on dwellings will be capitalised into their market price – causing their price to rise. This has been demonstrated convincingly in the United States where jurisdictions with high property taxes have lower housing prices, ceteris paribus. This effect is stronger for existing dwellings, for which the price elasticity of supply is close to 0.

As well, standard urban economics shows that expansion of the urban boundary will yield an unearned capital gain to existing property owners as their accessibility is improved relative to housing at the urban margin.

Since the introduction of universal impact fees in the United States and Australia, established house prices have risen very much more rapidly than the price of new dwellings. The lack of any penalty for house price rises on existing owners [such as property taxes that do not rise as house prices rise, or exemptions from capital gains tax for owner-occupiers] means that house price inflation tends to be applauded by the public and media, encouraging speculation. Impact fees are strongly associated with exaggerated property cycles and boom–bust episodes, whereas property taxes that rise with property values dampen these cycles. States in the United States that retained high property taxes, such as Texas, had much more reasonably priced housing and more stable housing markets during 2000–10.

3.16.3.5 Root Cause of the Problem

The analytical study of aforesaid Property Tax Forms revealed that all the corruption and misleading information was due to manual recording of essential parameters of a property in P.T.1 and property tax figures in P.T.8 and P.T.10. These parameters, affecting property tax assessment and collection are amenable to all sorts of manipulations due to vast discretionary powers lying with the property tax staff. All the manual records were beyond the reach of the supervisory staff, as such, there is no check on the illegal practices, causing malpractices, corruption, compromised assessments, and loss of revenue.

5.3 User Fees vs. Property Taxes vs. Alternative Means of Financing

Business districts essentially shift the costs of providing safety for an area from general tax revenues to charges imposed on the businesses that occupy that area. They operate with user fees, and such fees are one source of funding local government services. Utilities, for example, generally rely on user fees, and user fees also help pay for some portion of public transit. As discussed above, property taxes provide the main alternative source of local government funding. Local sales taxes and income taxes are also sometimes used to fund local governments. What determines the optimal mix of financing local public services?

The case for user fees is that they operate like a price and that can be helpful both for efficiency and equity reasons. The efficiency gains from user fees occur in investment, maintenance, and at the point of ultimate use. In the case of standard services, where there is a marginal cost of use [like crowding a city bus or delivering water], user fees generate efficiency at the point of ultimate use because they help deter wasteful overutilization, just like standard prices. If water is costly to provide, then charging people to use water will get them to internalize some of those costs.

One downside of user fees is just the administrative cost of charging people. For example, the London congestion system has operating costs that consume a significant fraction of the system’s revenues. We must, however, suspect that technological improvements, such as electronic road pricing, will generally make it easier to charge users at a relatively low administrative cost.

A second downside of using user fees to ration service is that this may be counterproductive if the case for public supply is based on some form of externality. In the case of water, where the externality fundamentally comes from low quality, not quantity, using prices to ration quantity seems natural and efficient. In the case of education, where the externality comes from both quantity and quality, user fees are less natural. Part of the point of public education is to induce people to get more education than they would on their own account. If individuals were charged for the full cost of education, this would eliminate a key advantage of public provision.

In the case of public transportation, theory suggests that user fees should be reduced to account for the externality in driving. It may still make sense to charge bus riders some of the marginal social costs of their transit use, but since governments do not typically charge drivers for the social costs of driving, cross-subsidizing transit is one way of reducing that externality. The subsidy should be proportional to the reduction in external social cost created by taking the bus, i.e., the reduction in the probability that the individual will drive times the social cost of driving.

User fees have value beyond individual choice. By paying providers based on usage, providers have an incentive to maintain quality. This should occur even if the government is paying with a voucher instead of the user paying out of pocket. This is one of the hopes of charter schools. User fees also create a useful discipline on investment within the political process. If projects are to be eventually funded by user fees, then the project must generate enough users to cover its costs. This will tend to cut down on white elephants, as I will discuss later in the section on infrastructure investment.

In some cases, like policing and fire, economic theory suggests that there are less likely to be social gains from user fees. In principle, it might be possible to imagine charging building owners for the firefighting costs associated with addressing a fire, but equity concerns mediate against that course. It would be politically difficult to imagine having a firefighter deliver a bill to a property owner who had just lost a child to a fire. In the case of police, the biggest benefits occur to individuals who are never the victims of a crime. As a result, it is hard to see how a user fee system could be put into operation.

Of course, it is quite possible to set fees on socially harmful behavior. In some cases, businesses are charged for the cost of a fire department visit due to a false alarm. Such fees should, presumably, create an incentive that internalizes the costs to the fire department of making such visits.

If user fees are unable to fund every service, then a tax system is necessary, and then the question becomes whether the current local dependence on the property tax is appropriate. Certainly, it is conceivable to imagine greater dependence on sales or income taxes or to follow Henry George and rely solely on a land tax. Section 4 provides the core theoretical justification for the land tax.

The primary virtue of the property tax that has made it popular for centuries is that historically, property was far more observable to local government than other forms of wealth or income. Sales transactions or earnings were hard to monitor. As such, governments relied on property taxes [or even coarser taxes based only on the number of windows]. While incomes and sales have generally become much more observable, property taxes remain dominant in local governments, perhaps partially due to historical path dependence.13

But the property tax also has several key virtues for a locality. First, property is considerably less mobile than income or other forms of wealth. Even the tiniest community, like a Business Improvement District, can levy a charge based on the amount of real property in the community. That property will not just get up and walk away, while an attempt to have a neighborhood level income tax would surely lead to considerable out-migration by the wealthy.

The immobility of real property, however, does not mean that property taxes are distortion free. If we tax real estate, we create incentives not to add value by building up. A developer can deduct the price of construction from his income taxes, but property taxes are typically proportional to adjust to the assessed value of the building.

Henry George proposed one approach to this problem—taxing only the value of land, not the value of the structure on the land. In the model above, land taxes consistently produced optimal outcomes. As discussed earlier, George’s plan does face an assessment problem—the total value of a building is easier to evaluate than the value of the land under that building. The assessment problem is only increased if the tax is meant to be only on unimproved land values, so that there is no distortion to decisions that might increase the value of a neighborhood and its land. Still, it is somewhat puzzling that pure land taxes have been so rare in the United States.

While property taxes distort the incentive to construct, they do have several advantages beyond mere observability. In some cases, the value of the property may be proportional to the cost of delivering the relevant public services, like police. In that case, the property tax becomes a de facto user fee.

Additionally, the property tax makes governments sensitive to the value of local property. This creates an incentive within the government to increase the value of local homes and businesses and that may create desirable incentives [Glaeser, 1996]. There is a long-standing result in urban economics that social welfare is maximized, under certain conditions, when local property values [or at least land values] are maximized [Arnott & Stiglitz, 1979; Brueckner, 1990].

The property tax is less redistributive than a progressive income tax, but it is not particularly regressive either. Typically, income elasticity of demand for real estates are estimated to be near 1 [Glaeser et al., 2008]. This fact means that, on average at least, the property’s tax cost rises proportionally with income.

One key question about property taxes is whether they should have the same rates for commercial and residential real estate. In many cities, such as Boston, commercial real estate is taxed at a higher rate. While the most conventional explanation for this gap is political—votes per dollar of real estate value are higher in residential properties than in commercial properties—there are potential economic justifications for this gap. For example, if commercial real estate creates greater costs for city government than residential government, perhaps by bringing in more commuters per square foot, then the gap would be justifiable. Whatever the reason, the gap does create an incentive to convert from commercial to residential uses, which is appropriate only if the net social benefit of residential space exceeds that of commercial space.

Sales taxes and wage taxes are two other forms of revenue that are used at the local level. One argument for these forms of revenue is that they charge the users of city services, commuters, and tourists, for the costs of their actions. Of course, the users of these services are already implicitly paying some taxes, because the businesses that employ them and the restaurants that serve them are already paying commercial real estate taxes. There is too little written on whether these taxes are already appropriate.

Income taxes, of course, can be far more redistributive than sales taxes and that is one of the reasons for their attraction to many cities. The problem with local income taxes is that they potentially repel wealthier individuals [e.g., Haughwout et al., 2004]. That provides one reason why many forms of local redistributive services are actually funded by higher levels of government.

Property Taxes

Most countries impose some form of property tax [sometimes called a land tax] on the owner of immovable property [land and buildings]. Usually, housing is subject to such a tax, whether owner occupied or for private rental. The specific form of a property tax or a land tax varies widely.

As stated by Adam Smith, a land tax [a tax on ‘ground rents’] is generally considered to be the most efficient form of tax because the supply of land is inelastic [or fixed], and so a land tax should not affect the allocation of resources in the housing market. The burden [or effective incidence] of a land tax is usually considered to be on the landowner because it is thought to be capitalised into land prices. Those influenced by the ideas of Henry George advocate land taxes as a main source of tax revenue. Equity arguments for a land tax may also be important where property ownership is distributed unevenly across the population, as will eventuate when low-income groups cannot afford to purchase land.

Details of the unit [and area] of land subject to the tax are recorded in an official property register, or ‘cadastre’, which also records the taxable value of the unit, as determined from time to time, and the assessments to tax each year. In general, a property tax is applied as a percentage of the recorded site value of land [see article Local Government Property Taxes]. Taxable value is based in some countries on an assessment of imputed market rent that the property or land may be expected to generate [as has been the case in the United Kingdom]. More commonly, it is an estimated sale price or market value. Revaluations should take place on a regular cycle, for example, every 3–5 years. There may be adjustments for such matters as restrictive zoning, rent control, and other limits on sale or use of the land, and in some cases the tax base is improved rather than unimproved value. There are countries, such as Chile, that levy a property tax based upon a formula reflecting ‘fiscal value’ [or estimated productivity] of land and buildings instead of market value.

A property tax may be levied at a flat percentage rate, say 1.5%, or at progressive rates, increasing, say from 0 to 6%, as the unit or aggregate value of land owned by the landowner increases. Some owners or users of property may be exempt or subject to a reduced rate. For example, it is common to exempt charitable and religious organisations from property tax.

A property tax is commonly applied by local governments, providing an autonomous revenue source for local government, with the significant benefit of being a tax base that cannot be moved to a neighbouring jurisdiction. Local property taxes are sometimes called ‘rates’. Usually, the revenue raised is hypothecated to provision of specific services by the local government. As a result, these taxes are commonly analysed as user fees rather than as taxes on land. In some countries, the property tax may be collected centrally or by provincial governments but it is invariably used to fund local services.

The design and perception of local government property taxes as user fees may assist their political acceptance and hence longevity. In the United Kingdom, the property tax is called the Council Tax and funds go into local council budgets, primarily for the provision of services such as garbage collection and road maintenance. In the United States, property taxes are the primary source of funding for local schools and other services. Owner-occupied housing usually forms a significant part of the local property tax base, together with private rental housing and commercial property.

In some countries, a tax is levied on landowners as a percentage of assessed land value in addition to a council rates that funds local services [e.g., in Australia, state governments levy a land tax that applies in addition to council rates; historically, the federal government also levied a land tax]. Ideally, such a tax should apply to all land including housing. However, in Australia, a homeowner’s main residence is exempt from this tax, a tax expenditure that amounts to nearly half the revenue collected from it in some states.

A land tax in this form may be a surrogate tax on imputed rent from homeownership. In Sweden, a reform in 1991 removed imputed rent from the income tax base but instead the central government imposed a separate real estate tax at a rate of 1.5% [later decreased to 1%] of the assessed value of the property, in principle equivalent to 75% of market value. In 2007, this tax, which was quite unpopular, was renamed the ‘municipal fee’ and capped at a cash ceiling.

The application of a land or property tax to the assessed value of housing regardless of income can cause cash flow difficulties for ‘income-poor’ but ‘asset-rich’ homeowners, such as pensioners or farmers, in an era of rising house prices. It would be possible to design a property tax which deferred payment and accrued interest until sale of the property or on death. Alternatively, some jurisdictions apply a form of income-based valuation based on current use of land. In 1978, the US state of California implemented a ‘purchase price’ system for property taxes, including a rollover for property passed to family members. This approach can have devastating effects on revenues over time, as they fail to keep pace with rising market valuation.

It is common for property tax to be deductible in a country’s income tax where rent [or imputed rent] is assessable income. Since income tax is usually imposed by the central or federal government, the deduction is effectively a subsidy or revenue transfer from central government to local or provincial government.

Local Property Taxes

The new view of property tax incidence argues that some of the incidence of the tax could be passed on to nonmobile labor or renters as capital moves in response to differences in the effective tax rates across localities. In light of this argument, Pechman and Okner provide an alternative allocation in which 1/2 of the property tax burden is allocated to capital income, 1/4 of the burden is allocated to labor income, and 1/4 of the burden is allocated to consumption of housing services. This allocation makes the property tax much less progressive than the central variant, in which all of the burden is borne by land and capital. It also seems excessive, however, as nonmobile workers and renters gain in the localities with lower than average property tax rates.

Another possibility is to argue that the local property tax is simply a benefits-received tax, a price that the citizens pay for the locally provided public services. Benefits-received taxes are never part of an incidence calculation because they cannot be a net burden. This assumption is also extreme. It might apply in a frontier environment in which people are highly mobile and towns are continually forming and reforming, expanding and contracting. In such a world, people of like tastes for public services would join together, form a town, provide exactly the public services they want, and levy taxes to pay for the public services.15 The taxes would be benefits-received taxes. But, in a more realistic setting of fixed communities and limited mobility, most people are unlikely to obtain their most preferred bundle of public services. If not, then their property taxes are not benefits-received taxes, and the incidence of the property taxes remains a relevant question. In any event, viewing the local property tax as a benefits-received tax would also make the overall US tax system less progressive.

Existing Development and Existing Infrastructure

In such cases, some cities have reformed their property tax regimes by separating the value of land from the value of the property on the land. The tax on land is determined based on accessibility to land, rather than on the value of the structures on the land. This has an added benefit of persuading owners to better utilize valuable land and, indirectly, supporting greater densities around land that is easier to access [18,19]. Pittsburg has experimented with such a split rate tax and found that while other cities in the region saw a significant drop in commercial construction in the 1980s, Pittsburg saw a sharp increase. The higher land tax was an enabling factor persuading such development [20].

These have been summarized, for ease of understanding, in Fig. 7.1.

2.3 Implementation or process evaluation

Some policies are more straightforward to implement once designed, such as property tax collection or traffic light control and coordination, as its implementation is highly determined by its original design. However, some policies deviate from its original design or purpose, and parameters such as quality of delivery, degree of execution, citizen response, or reach on the target population can vary a lot from what was initially envisaged, sometimes even causing a shift in its original goals. These problems show that well-designed policies are not enough to tackle the problem: how it is implemented is key. A common example of this is the low take-up rate of mean tested welfare benefits programs [Atkinson, 1996]. The concept on nontake-up [NTU] refers to people who are eligible to receive a benefit but do not apply; it is an implementation problem that erodes policy capacity to tackle poverty and social exclusion and that have been well documented in different contexts.

In Germany, the benefits of the Income Support for Job Seekers scheme are targeted to unemployed people, job seekers, and low-income households whose resources are not sufficient to cover their basic needs. Harnisch [2019] shows that nontake-up rate has been quite high and stable between 2005 and 2014. On average, during that period, the share of households that do not claim benefits despite eligibility amounts to 55.7% of all eligible households. Nontake-up are also present at the municipal policy level. Eurofound [2015] shows the case of nontake up in the cities of Milano and Torino, where city councils initially didn’t plan to make a public announcement about a benefit targeting low-income families with at least one minor [Nuova carta acquisti sperimentale, NSC] but rather focused on collecting applications only among households already assisted by social services. Different evaluations have shown that individual, institutional, and policy design factors have a key role explaining NTU rates [Laís, 2020].

Another perspective regarding implementation evaluation is to place the focus on the processes through which services are organized and delivered rather than on the outputs of the program or the target population. Although challenges present during policy implementation are specific to different circumstances, some general categories and factors arise in different contexts, such as financial and material resources, staff, organizational structure, norms, organizational culture, or IT. Some researchers have theorized and documented the role of street-level bureaucrats in these processes.

Lipsky [1980] characterizes street-level bureaucrats as “public service workers who interact directly with citizens in the course of their jobs, and who have substantial discretion in the execution of their work”. Accordingly, this sort of frontline practitioner, through the use of autonomy and discretion, became policymakers rather than policytakers; their decisions therefore have important consequences on how policies are implemented and, as a consequence, on people’s lives. According to Lipsky’s theory, street-level bureaucrats use coping mechanisms to deal with their clients’ demands and limited resources available. The relevance of this perspective is to use knowledge about street-level bureaucracies to improve the conditions and incentives under which public servants operate.

12.6.3 Government Support

The U.S. government supports access to housing and home ownership through a variety of government programs and financial incentives. Many of these programs are housed in the U.S. Department of Housing and Urban Development [HUD]. HUD was created in 1965 by the Department of Housing and Urban Development Act as one of the Great Society programs under the administration of President Lyndon Johnson.

The Incidence of Local Property Taxes

The supply elasticity of capital has figured prominently in the literature on the incidence of local property taxes in the United States. The local property tax is a combined tax on land and capital. The taxes are levied on the total value of each parcel of land, which includes both the value of the land itself and the value of the structure on the land. The value of the structure is usually much greater than the value of the land, so that the local property tax is primarily a tax on capital.

The original, or “old” view of the incidence of the local property tax had long held that it was a regressive tax overall. The portion of the tax on the value of the land itself is progressive. The supply of land is virtually perfectly inelastic, so that landowners bear the entire burden of this portion of the tax, and the distribution of land ownership is skewed heavily toward high-income households.

The progressivity of the land portion is overwhelmed by the regressivity of the much larger capital portion, according to the old view. The local capital market was seen as in Fig. 16.8, with the supply price of capital given to the locality. The tax on the structures was therefore assumed to be passed on to others by the apartment owners to their renters and by the commercial and industrial firms to their consumers or to labor. The property owners escaped, and the larger portion of the tax was regressive.

The “old” view came to be replaced about 35 years ago by the so-called “new” view, which held that local property taxes were progressive after all. The new view accepts the old view's characterizations of the markets for land and capital. The supply of land is perfectly inelastic, therefore, landowners bear the incidence of the land portion of the tax. The market for capital within localities is as pictured in Fig. 16.8, with the supply of capital perfectly elastic to each locality. What the old view failed to consider, however, is that all localities have property taxes. Therefore, capitalists cannot escape the average rate of the property taxes across localities. Since the overall supply of capital in the nation is viewed as fixed, the capitalists bear the average rate of the local property taxes, and the incidence of the capital portion is therefore progressive.

The germ of truth in the old view of the capital market, according to the new view, is that capitalists respond to differences in tax rates across localities. Capital would move from jurisdictions with above-average property taxes to jurisdictions with below-average property taxes, until the returns to capital were equalized in all localities. Renters and [immobile] labor in the high-tax jurisdictions lose as the capital leaves, and renters and labor in the low-tax jurisdictions gain as new capital enters. But the differences in local property tax rates are typically much smaller than the overall average tax rates. Also, the incidence resulting from differences in the rates is at least partially a wash, since some renters and consumers gain while others lose. Therefore, the incidence of the capital portion is almost certainly progressive. Since the land portion is also progressive, the local property taxes are progressive, perhaps even highly progressive.

The “new” view of 35 years ago was itself challenged by the advent of dynamic models of tax incidence, which showed that even taxes on land could be regressive. We will return to the property tax in Chapter 17 when we analyze dynamic tax incidence.