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December 10, 2011

Tax Hell

It is fairly clear that as property values have declined, tax assessments have not declined apace. As a result, the effective tax rate has risen in many property tax jurisdictions. In almost all US jurisdictions, there is an ad valorem property tax. This means that the property tax rate is applied on all property value across both land and capital that is “permanently affixed” to the land. But in the long run, you cannot tax capital because it is mobile. The long run here is when we must redevelop land because fixed capital is deteriorating and/or its uses are changing. So the long run is not very long.

You cannot tax toilets, kitchen sinks, windows, and lumber in the long run. What happens when you apply a tax to the value of this physical capital? The impact of the tax falls instead on land. The value of land moves toward zero. That is, developers will not pay for it to redevelop property. The jurisdiction ends up like East St. Louis. This is Tax Hell.

How much property tax is too much? There are probably different opinions about this, but I would say that between 1% to 2% is generally tolerable. Here I am writing about dividing the tax bill by the market value of the property; don’t fret about assessment ratios and all that technical stuff. Lately, I’ve been noticing rates that are MUCH higher. Jurisdictions that engage in using inappropriately high property tax rates will be unsustainable.

Regardless of the method of taxation, we should always think about our capacity to actually increase tax revenues. For example, when thinking about taxing the 1 percenters, the millionaires and billionaires, we cannot think in terms of static analysis. Who better can convert their income from dividends to capital gains? Who more easily can leave their income in foreign assets? Who is more mobile? Who is better suited to hiring tax avoidance specialists? Do you really think that we have the ability to add taxes on this group with no consequences in terms of lower growth and less-than-expected revenues?

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