The Property Tax: Is George Washington Still Paying Out on Mount Vernon?

Why is the property tax so hated? A recent USA Today article stated, ?Property taxes are taking center-stage in the debate over taxes. Many homeowners are grumbling about skyrocketing tax bills, which are driven by higher home prices. And many state legislatures are looking for new ways to tame the most unpopular of all taxes.? The ?most unpopular of all taxes? seems a strong sentiment towards a tax that, could, in theory, exactly what we want in a tax. Americans pay three major types of taxes, a consumption tax (in the form of a general sales tax), an income tax, and a wealth tax (in the form of a property tax). Why might we like a wealth tax, at least in theory? The answer might lie in the idea of tax progressivity.

Simply stated, a progressive tax is a tax where people with higher incomes pay higher taxes. Unfortunately, there are different ways to interpret this. One way is to say that as a person?s income increases, they pay a higher share of their income in taxes. For example, our income tax attempts to be a progressive tax system under this definition. People with higher incomes pay a higher rate than people with lower incomes, and if we get the rates correct, wealthier people will pay a higher share of their income towards taxes. Progressivity can also be measured as wealthier people pay a greater share of the overall tax bill. A flat income tax is progressive under this system?the number of dollars paid into the system is greater for a wealthy person than for a poor person. Note, that a flat tax is neither progressive nor regressive under the first definition because everybody pays the same share of his or her income. However we choose to measure it, it is clear that most Americans are comfortable with a progressive tax system.

So what about a tax on wealth, such as the property tax? Since a progressive tax is one in which as income increases, the share of income paid to taxes increases, we need to examine which segments of the population bear the cost of a property tax. This requires some understanding of the concept of tax incidence, which shows that the person actually paying the tax does not necessarily bear the economic cost of a tax. One example of this is gasoline taxes being passed on to drivers in the form of higher prices. Tax incidence is a major topic in public finance, but we will suffice with the knowledge that property taxes can either be paid by those that own the property, or they can be passed on in the form of higher rents or lease rates. So who pays? Economic theory is mixed. The current theory shows that owners pay for the average property tax level, but the difference between the national average and the actual local rates are borne by the renters. The upshot, is that property taxes are probably neither strongly progressive or strongly regressive, and after all the dust settles, the tax is probably somewhat progressive.

So if the property tax is not regressive, why then do we hate the property tax? Another reason is that the property tax costs a lot more money than we, or city councils, think it does. Get this: the property tax is a permanent tax that is paid by the current owner of the property FOREVER, even after they have long sold off their property. Here is why. Let?s say the net rental income for a piece of property is R (remember if you live in a house you own, you are paying rent to yourself, since you could always rent the place out and live somewhere else). Therefore, the value of the property is the value of R summed up into the future: R for this year plus next year plus next year, so on and so forth. Now let?s say there is a tax increase of t dollars per year, now the rental income is R-t for each year. When you sell the property, any bidder know that they will not actually get R, instead they will get R-t, and so they will pay t dollars less summed up into the future less for the property. The point is that in the form of a reduced sales price, the current owner is going to pay for the tax increase forever. This is called tax capitalization, and makes it very difficult to pinpoint the actual burden of a property tax. Current landlords may actually write the checks, but the landlord at the time of the increase bore the burden in the form of a lower sales price. No wonder we all hate property tax increases on our watch, since, in some sense, we pay for them even after we die, something we don?t necessarily do with sales or income taxes. So, all property owners are paying out on property they owned when taxes were increase, meaning that the ancestors of George Washington might still be paying out on Mt. Vernon.