Tax policy colloquium, week 6: Darien Shanske's Modernizing the Property Tax

Yesterday at the colloquium, Darien Shanske of the University of California at Hastings Law School presented his paper, Modernizing the Property Tax.

One great thing about the paper and the topic was as follows.  I have been doing the colloquium for 18 (!) years now.  At this point, it's pretty rare to get a new topic or something I haven't seen come down the pike before.  But this was pretty novel for me - probably our first real property tax paper ever, and Darien is effectively using his energy and imagination to reinvigorate a topic that for decades has seemed moribund.  So I very much welcomed and enjoyed this.

Herewith some thoughts about two of the main sets of issues that the paper raises:

1. ARE REAL PROPERTY TAXES A GOOD LOCAL FINANCE TOOL?

Paper likes them & wants to reverse their decline. E.g., it argues that they nicely correct for the federal income tax exclusion of imputed rent. Renters are taxed at the federal level, homeowners at the local level through the real property tax, & this division of the tax base could make sense as fiscal federalism.

I’m skeptical both about this division-of-the-tax-base claim & about the general merits of the real property tax at the local level.

Some points to the contrary:

(1) Since the local real property tax reaches ALL real property, arguably it fails to adjust for the federal imputed rent exclusion. E.g., it doesn’t address the home vs. rent disparity. Both pay at the local level, even & the incidence of the local real property tax is probably on renters).

So renters, unlike homeowners are taxed at both levels, & the federal disparity may not be reduced by local real property taxes.

Likewise, home use vs. non-residential use of real property isn’t addressed by subjecting both to local real property tax.

(2) Suppose the real property tax is a pure benefit tax at the margin. E.g., an extra dollar of tax means an extra dollar of garbage pick-up or other local amenities. Then it’s not really a tax, but a service fee, and again charging it at the local level does nothing to offset the federal exclusion.

(3) We may like the Tiebout-type benefits of local taxes. But these don’t require that the tax be directly on real property. Anything that’s tied to residence will do. E.g., consider income taxes that the state collects on behalf of the locality, on top of its own income tax (a la New York State and NYC / Yonkers). Not clear that this is less of a benefit tax at the margin than a real property tax, in which not just site value but also the value of improvements is being reached.

(4) Paper likes the local property tax for salience of the tax-benefit link. A la Tiebout, but operating through voice rather than exit. But why wouldn’t a local income tax that the state collects & remits for the locality work the same way? And with the real property tax, when the owner isn’t a resident you probably lose the political salience point. E.g., even if renters bear the tax, they don’t see it listed as a specific item, whereas they would be able to see the local income tax as a separately listed item.

(5) OK, there are 2 things I like about the real property tax. First, the locality can collect it by itself. But note what a bad job they tend to do with valuation. Second, a tax on site value has elements of being a lump sum tax that isn’t distortionary, if owners can’t affect site value. But taxing the improvements still is narrow & distortionary.

SO: I’m left with little reason to mourn the relative decline of the real property tax, & perhaps little motive to restore it to its formerly higher relative level. 

2.  DARIEN'S PROPOSAL

I will emphasize 3 of his proposals in particular. Note that they are largely distinct (i.e., could be adopted or not separately).

(1) Monthly property tax withholding that isn’t just through escrow for people with mortgages, but for everyone and chiefly through employment.

(2) Liquidity insurance: current real property tax liability is reduced when income declines, including from pre-planned retirement rather than surprise job loss. The avoided taxes are due with interest when you sell.

(3) Retrospective revaluation: when sell, assume value change from purchase price occurred ratably, and re-determine past year’s property tax liabilities. E.g., buy for $100K, sell in 3 years for $133.1K. This is 10%/year, so assume the value was $110K, then $121K. If a positive adjustment, collect with interest at closing. Can ratably impute negative as well as positive returns.

I question the first two, but I mainly like the third.

My responses:

(1) While moving towards monthly rather than annual payment may generally be good, escrow already covers 60% of homeowners, tilted towards those who most likely to be cash-constrained and/or to need help managing their cash flows.

(2) I question shifting this task to employers. Not just a burden they may not want, based on information they don’t automatically have, but also the employee may not want to share this information with them. Paper notes problems such as states without an income tax & commuters between states. When you add this to people who aren’t employed (including retirees), could be a mess.

(3) I question the liquidity insurance feature. Distinguish 2 situations: unexpected shock such as losing your job, planned step such as retirement.

For the former, there is generally a case for cushioning the downturn, due to the rigidity of pre-planned spending patterns. This is what unemployment insuranc purposese (UI) is all about. But why have such a program apply distinctively for real property tax? And note the efficiency tradeoff that UI generally involves (other than in the current down economy) since it increases incentive to lose job & reduces incentive to find a new one.

For retirement, I don’t see the rationale at all. Why “insure” against a planned & deliberate act? Note that the proposal might also strengthen the tax incentive to retire, or perhaps even to move to high-property tax communities when you retire.

Part of the paper’s rationale for the liquidity insurance is political economy – e.g., local residents who are seniors opposing funding for local improvements or schools. But this may reflect their self-interest, not just liquidity concerns.

(4) Under both liquidity insurance & retrospective revaluation, I’m concerned about the plan to collect amounts due at sale. Can lead to default / liquidity problems if loan to value ratio is high. Note also that people often want to reinvest by buying a new home. So this proposal is anti-smoothing, whereas the first proposal is pro-smoothing.

(5) Otherwise, I mostly like retrospective revaluation because it’s objective market evidence in a very flawed process. But 2 quick comments:

--Is extra tax due upon sale the usual case? Paper sometimes appears to assume this. But it depends on assessed value vs. actual value. Today perhaps a practice of under-valuation, as a way to curry favor with local voters or due to Proposition 13-style limits. But the new rule might encourage states to value high rather than low, figuring it solves the default problem & that they can say: don’t worry, you’ll get your money back.

--If TPs are myopic or don’t consider the tax inevitable or would face a liquidity crunch upon sale due to the maturation of deferred tax liabilities, the end result may be increased lock-in. Whereas Proposal #1 makes real property tax payments smoother, this may make them less smooth.