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Analyzing Oregon’s tax reform ideas

December 31, 2013

Oregon Economics Blog

Fred Thompson,Recently, two very able young legislators, Sen. Mark Hass and Rep. Tobias Read, authored a blueprint for state/local tax reform in Oregon. This is quite remarkable. Who can remember a major reform emanating from the sapless branch of our state government, not forced upon it by popular initiative?

The centerpiece of Hass-Read proposal is 5 percent sales tax combined with a substantial cut in personal income tax rates. They claim that adoption of their proposal would create 50,000 new jobs and raise nearly $500 million a year in net tax revenue. Frankly, I believe that the need for and the benefits claimed for this proposal are greatly over estimated. But that isn’t the subject of this blog. There is no need to beat a dead horse; the response to the main part of the Hass-Read proposal has been overwhelmingly negative, albeit largely uninformed. Rather, I want to speak to one of its elements, which has been given a generally positive reception, the $50,000 homestead exemption.
Chuck Sheketoff, executive director of the Oregon Center for Public Policy, for example, claims that Hass and Read “rightly recognize that property taxes take a disproportionate share of income from low- and middle-income households. So their plan includes a long sought-after homestead exemption to lower the property taxes of those with the least ability to pay them.” This claim reflects two very serious misunderstandings: first, that property taxes “take a disproportionate share of income from low- and middle-income households” and, second, that a homestead exemption is a good way to deal with the perceived inequities of property taxes.
No matter how you measure income, if property owners pay the tax, property taxes are inherently progressive. Real property ownership is much more unequally distributed than income. Ten percent of property owners (mostly corporations, which are owned almost entirely by the top quintile of taxpaying households and well over half by the top 1 percent) own 58 percent of the taxable property in Oregon by value (versus 35 percent of taxable personal income). The bottom 10 percent of those who own any property at all, own less than 1 percent of the total property value. Moreover, forty-plus percent of potential taxpayers in Oregon own no taxable property; very, very few have no income (think Phoebe and Joey from Friends rather than June and Ward from Leave It to Beaver).
In response, Chuck observes that “property taxes are not based on ability to pay – thus they are regressive. Two homeowners with homes of the same value and same property taxes … where the homeowners have different incomes make this clear. Exempting the first $50,000 of assessed value of property that is taxpayer’s owner occupied principal dwelling as proposed … would be good for low- and middle-income households. Who says it wouldn’t?”
Chuck is clearly confusing horizontal and vertical equity. Tax progressivity is concerned with vertical equity, i.e., the income elasticity of tax payments. Where property taxes are concerned the best evidence is that the elasticity is > 1 (progressive). That the correlation between income (ability to pay) and tax payments is imperfect is a matter of horizontal equity. (Property taxes do poorly on that measure where AGI is the independent variable; they do about as well as income taxes where the Haig-Simons income definition – income equals household consumption plus the change in its net assets, the definition preferred by economists – is used; and somewhat better using permanent or lifetime income. In other words, these definitions affect the degree of covariance of income and property tax payments, but not the slope of the logged relationship, which measures vertical equity.) Besides, given the fact pattern Chuck cites, exempting the first $50,000 of assessed value of property would not affect the progressivity of the property tax. (The proposal could have a positive effect on the progressivity of the property tax, overall. I think there is a good that it would. However, you really cannot tell without running the numbers).
Ultimately, the progressivity of the property tax depends upon its incidence, which is debated, and not just the distribution of property ownership. According to the Institute for Taxation and Economic Policy, the bottom income quintile in Oregon pay an average of 4.4 percent of their income in property taxes while the top 1 percent pay only 1.9 percent. ITEP is probably wrong about that. In the first place they assume more of the tax is shifted forward to consumers than do most economists. Second, they ignore most of the property taxes paid by businesses and therefore business owners. I have a great deal of respect for ITEP’s “Who Pays?” They have taken on a question nearly everyone else has ducked and I think their relative state rankings are probably pretty much spot on.
But the key issue here is whether property taxes are paid by property owners or by consumers/renters. ITEP assumes that a substantial portion of the tax is shifted forward to renters/consumers. Most of my colleagues do not agree. That doesn’t mean ITEP is wrong, but on this point that they are wrong seems more likely than not. As for my second point, given that they were looking at all 50 states using Census and US tax data, I don’t see how they had any alternative, but so far as we are talking about a specific state and tax, it’s not right.
There are inequities associated with property taxes, especially where homeowners have low or fixed incomes, cannot deduct their property tax payments from their income taxes, and do not fold their property tax payments into their mortgage payments. But many of the objections to property taxes go to their inconvenience (e.g., property wealth is not easily convertible into disposable income) or sound like special pleading (home ownership is different from owning other assets). As an economist, I would insist that anyone, who owns an asset, can convert it to cash, either by selling it or borrowing against it. I am not persuaded by the claim that if you sell your home, you won’t have anywhere to live. If you take the standard deduction on your personal income tax, you are probably financially better off selling and renting (for a business that’s comparable to a sale and lease back arrangement); if not, a reverse mortgage is currently a very attractive option, but there are a panoply of mortgage-backed, tax-deductible debt instruments available to property owners.
As for being different from other assets, homes are, but that is an argument for, not against, property taxes. Where residential property is concerned, the implicit cash flow accruing to homeowners, in the form of rents avoided, is exempt from income taxation. This exemption was vouchsafed when the personal income tax was established, in part, because state and local governments had already claimed the property tax base, by subjecting the returns to property ownership, and generally those returns alone, to a wealth tax (in this particular case it is easier to measure wealth, property value, than income, rents avoided, although they pretty much amount to the same thing). Fortunately, nearly everyone concerned avoided the double taxation that would have resulted if the feds had taxed the returns to real property or states/local governments had subjected financial assets to property taxes. The resulting division of tax powers is arguably one of the glories of America’s unique system of federalism.

So, how would I deal with the inequities of the property tax? Rather than exempting the first $50,000 of assessed value of property across the board, I’d address the fairness problem directly by linking the benefit to the personal income tax, which would make it a lot easier to calibrate its distributional properties to the precise ends sought. For example, the state could grant a tax credit equal to $750 (indexed for inflation) multiplied by their property tax assessment ratio (TAV/RMV) to homeowners who take the standard deduction on their personal income tax. Not only would this be targeted at the folks most unfairly treated by the property tax and have better distributional consequences than an across-the-board exemption, it would shift fiscal responsibility to the state where it belongs rather than further depriving local governments of resources.

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Bill Sizemore December 31, 2013

There are several problems with this analysis. Although I agree that an across the board homeowners’ exemption would benefit homeowners without regard to their incomes, the reality is the property tax guarantees that no one will ever truly own their own home but will always be renting it from the government. This might be reasonable if all property taxes imposed were directly related to home ownership, but they do not. Police and fire do to some degree, though the correlation to the extent it exists is not elated to the value of the property. Taxes imposed to pay for schools and libraries on the other hand are not property related taxes.

The writer of this column apparently accepts the assumption that property owners should have to make life impacting decisions based on the tax code, i.e. should be coerced into selling their property because it makes more sense for them to rent if they cannot afford their property tax. I reject that assumption and if given my preference would eliminate the property tax entirely. Property is no longer a proxy for wealth as it was a hundred years ago. For most, residential property is a place to live and raise a family, not a source of income. And no one should have to sell their home because a bunch of politicians have determined that it makes more sense for them to sell their home and rent. A tax that increases when the value of the property increase, at a time when the income of the owner is not increasing, forces the owner to pay a tax that he or she has no additional income to pay. If that is not regressive, what it?

To that extent, the property tax is a threat to individual liberty and takes the decision of where to live out of the hands of the homeowner and places it in the hands of the county assessor or the state legislature.

Logan Boettcher January 3, 2014

Bill is definitely off base here. He says that he rejects “the assumption that property owners should have to make life impacting decisions based on the tax code,” but that is what all decisions as to what to tax do. If Bill prefers a flat income tax, a sales tax, or whatever he prefers, if his preferred alternative becomes law, all residents, both property owning and not, will make life impacting decisions based on that tax code.

Since Bill wants to “eliminate the property tax entirely,” I presume he wants to tax incomes or consumption via a flat tax. In this vein, this means that Bill wants to punish the creation of private wealth. The problem with Bill is that he wants to allow for the consumption of benefits accruing to a location without the appropriate payment for them.

He says that “Property is no longer a proxy for wealth as it was a hundred years ago. For most, residential property is a place to live and raise a family, not a source of income.” This is true, but a residential property has a flow of benefits accruing to it, including being in a police or fire jurisdiction, proximity to infrastructure and proximity to population, so paying the current market value of those benefits is both economically sound and morally prudent, not “a threat to individual liberty.” Failure to charge the current market value means that the property owner is receiving a subsidy. Bill would rightly condemn a solar company not having to pay the full amount for its inputs as receiving an inappropriate subsidy, but a property owner who doesn’t have to pay the same amount as a renter of an identical property next door somehow escapes condemnation of being a subsidized entity. Bill condemns “a bunch of politicians [that] have determined that it makes more sense for them to sell their home and rent” and “a tax that increases when the value of the property increase, at a time when the income of the owner is not increasing,” but there is no such indignation for landlords who kick out renters who see no increase in their income while the market value of their rent goes up.

Bill should really bone up on his conservative bona fides also. It was Milton Friedman who said that “The property tax is one of the least bad taxes, because it’s levied on something that cannot be produced — that part that is levied on the land.” Also, if Bill wants to be square with the basic tenet of supply-side economics, which says that we should not tax things so that their supply goes down and prices go up, then we should be taxing those things that are in fixed supply, such as land (the object in the aforementioned quote by MF).

I wonder if Bill ever thinks about why taxes would go up on a property. Given that a property is part building and part land, if the property value goes up and no improvement has been made to the building, then it is obvious that the land portion is the part that has increased. Did the property owner do anything to improve the land’s value? In all but the most limited cases, it is a big NO. So in what universe does Bill think that it is morally prudent that property owners are entitled to the rising value of land?

Unfortunately, until the body politic realizes that taxing incomes, sales and property improvements to subsidize land owners is a lesson in folly, they will continue to suffer the twin indignities of deadweight-loss caused unemployment and the double payment of rent and taxes for the same services.

Logan Boettcher January 3, 2014

And Bill, this means that my preferred tax policy is no income tax (personal or corporate), no sales tax, no taxes on property improvements (a 100% exemption on the improvement side, if you will), and a very high rate of tax on the value of land (at least 50%, if not a 100% tax). And before you spew coffee all over your keyboard, just remember that free-market Asian Tiger darlings such as Hong Kong, Singapore, and Taiwan either outright own all the land or levy a significant land value tax so that they can maintain low taxes on incomes.

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