THE LOCAL PROPERTY TAX
Advantages
Disadvantages
Proper Use
ADVANTAGES of the
PROPERTY TAX I
• Transparency: Individual citizens can
easily identify the property tax base.
Individual citizens can review and
challenge their property tax burdens,
compare them to those of their
neighbors, and directly to the benefits
they receive.
ADVANTAGES of the
PROPERTY TAX II
• Equity: Link between payments and
government services is direct and
unambiguous. Under local property tax,
where local government actions increase
citizen welfare and where assessments truly
reflect the market values of the underlying
assets being taxed, the beneficiaries of
government action necessarily also pay for
it.
• Moreover, The tax is hard to evade.
ADVANTAGES of the
PROPERTY TAX III
• Efficiency: Property taxes can have many of
the desirable consequences of user charges.
• Collection Cost: The costs of property tax
administration are much lower than the
costs of administering sales and income
taxes when compliance costs are taken into
account
Objections to Property Tax Reflect a
Misunderstanding of how it Works?
Often people who have the worst understanding are the
people who should be best informed -- opinion makers,
lawyers, judges, and other public officials
JQP (average citizen) knows that decisions about property
taxes and service levels directly influence the worth of
their homes
JQP (average citizen) understands that local action is
justified if, and only if, government thereby increases the
value of their property (which automatically means that the
action also increases citizen welfare more than it increases tax
obligations).
Why the Property Tax is often
Misunderstood
1. Assessments frequently do not reflect the
economic value of the asset being taxed: a
lot of land is excluded from the property tax
base and much of the rest is under or
arbitrarily assessed.
2. People often do not understand how
capitalization works. Understanding
capitalization is central to understanding
the property tax.
How does capitalization
work?
Imagine two otherwise identical towns:
Alpha and Beta
Beta does not. Hence,
Alpha has good parks
the demand for and
Some people value
the price of land in
parks and will want
Alpha will be
to live in Alpha to
greater than in Beta.
be near them.
The value of parks will thereby be
capitalized into land values
More Formally
• ”Capitalization" is the process by which
a stream of benefits or costs is
converted into asset prices.
• Benefit streams increase asset values,
and cost streams decrease them.
The Mathematics of Capitalization I
If the benefits and costs flowing from a a asset
are constant over time, the following
formula shows how capitalization works:
(1) P = B / I
• This formula says that the price of the land
(P) is equal to the annual net benefit flow
(rental value) from the piece of property
(B) divided by an appropriate discount
rate (i).
The Mathematics of Capitalization II
Since rents (B) must cover both the tax and the normal
return on the asset, a tax rate (t) on land price is
capitalized as:
(2) P = B / (i + t)
As t increases, P decreases, but B is unaffected.
The logic of capitalization says that local governments
that rely on the property tax cannot shift the cost of
capital improvements or current operations into
the future by borrowing. If municipal debt is also
capitalized, land prices will be decreased by an
amount equal to the present value of future
property tax payments
Evidence of Capitalization I
• William T. Bogart and Brian A. Cromwell,
in an article entitled “How Much More is a
Good School District Worth?” reported
finding that where other things were held
equal (including taxes and school spending
per pupil), the reputation of its schools
could add up to $50,000 to the average price
of homes in a district.
Evidence of Capitalization II
• Noelwah Netusil, in an article entitled, “Can
Public Parks be Self-Financing? Results
from Portland, Oregon,” found that homes
located within 500 meters of public parks
generated additional property tax revenues
of over $400,000 for the City of Portland.
Evidence of Capitalization III
• A. Quang Do and C. F. Sirmans, in an article
entitled “Residential Property Tax
Capitalization,” said they had found that
where other things were again held equal,
each dollar paid in property taxes reduced
housing prices about $25.
• The point is that housing prices, local
government services, and property tax rates
are interdependent.
Problems with the property tax I
The property tax can be a real hardship
for the elderly, especially those who are
retired on fixed or reduced incomes.
Most of oldsters own their own homes,
many without mortgages. They must,
therefore, pay large and inconvenient
lump sums once or twice a year or be
kicked out onto the streets.
Problems with the property tax II
Assessments often really are unfair. Often
publicly owned land, plus land occupied by
religious, educational, and charitable
institutions are exempt. Moreover, in some
jurisdictions assessments do not even purport to
represent market evaluations.
Special exemptions are given to some property
owners, including high-tech companies, farmers
and others.
Problems with the property tax III
Commercial property is not assessed the same way
as private homes are. Assessments on private
homes reflect the market value of the property
and its improvements, including capitalization
of the property tax itself; assessments on
commercial property reflect whichever is the
less of the capitalized value of the property’s
rental stream or its replacement value minus
depreciation.
Problems with the property tax IV
Taxing improvements actually discourages people
from maintaining or fixing up their property.
Houses in poor condition, for example, are often
given a discount on their assessed value.
Homeowners who maintain their homes are
often assessed at the full rate.
These Problems Arise from the way
the tax is administered I
Most problems could have been fixed by focusing
the property tax on land -- away from
improvements -- and subjecting all land to the
property tax, regardless of ownership or current
use.
For example: Taxing land rather than improvements would
mitigate the incentives to underutilize real property. A
1997 study by Oates and Schwab showed that when the
city of Pittsburgh, Pa., restructured its system of property
taxation to one in which land was taxed at more than five
times the rate on structures, it experienced a dramatic
increase in building activity.