Econ 551 Government Finance: Revenues Fall 2019 Given by Kevin Milligan Vancouver School of Economics University of British Columbia Lecture 11: Property Taxation ECON551: Lecture 11 1
Agenda 1. Land value taxation 2. Capitalization of taxes 3. Property taxation 4. Empirical Example: Gallagher et al. (2013) ECON551: Lecture 11 2
Land value taxes Humans have been taxing land for a long time: 2 Kings 23:35 - And Jehoiakim gave the silver and the gold to Pharaoh, but he taxed the land to give the money according to the command of Pharaoh. He exacted the silver and the gold of the people of the land, from everyone according to his assessment, to give it to Pharaoh Neco. This propensity to tax land likely derives from its easy observability even in pre-industrial societies. ECON551: Lecture 11 3
Economics of land taxation Economists have been talking about land taxes ever since there have been economists. "Both ground- rents and the ordinary rent of land are a species of revenue which the owner, in many cases, enjoys without any care or attention of his own. The annual produce of the land and labour of the society, the real wealth and revenue of the great body of the people, might be the same after such a tax as before. Ground-rents, and the ordinary rent of land are, therefore, perhaps the species of revenue which can best bear to have a peculiar tax imposed upon them." Smith: ‘ground rent’ tax is non -distortionary; efficient. ECON551: Lecture 11 4
Why is a land value tax efficient? Back from commodity taxation, remember the way we characterized the efficiency of taxes? Optimal taxes would shift the demand for each commodity in equal proportions. This led to an inverse elasticity rule. 𝑢 𝑙 = 𝜄 𝑟 𝑙 𝜁 𝑙 Q: How much does the quantity of land used change when we change the price of land? Since the quantity of land is fixed, you cannot distort how much there is. Important caveat: we are talking only about the value of the land, not any improvements on it. Q: Why do we need this caveat? ECON551: Lecture 11 5
Henry George American popular economist: 1839-1897 “I asked a passing teamster … what land was worth there. He pointed to some cows grazing so far off that they looked like mice, and said, ‘I don’t know exactly, but there is a man over there who will sell some land for a thousand dollars an acre.’ Like a flash it came over me…With the growth of population, land grows in value, and the men who work it must pay more for the privilege. ” Basic idea: If land is fixed, then economic surplus will go into bidding up the price of land, making the cost of living more expensive. People got land rights by luck — why should they keep all the benefits of appreciation? ECON551: Lecture 11 6
The ‘Single Tax’ What Georgist ‘single taxers’ advocated: Fixed supply of land belongs to ‘the people’. Land value should be taxed; some advocate handing it out to all citizens as ‘basic income. This single tax is preferable to taxes on productive activity. Opposed tariffs; all that is needed is land value taxation! Georgism kind of died out in 20 th century, but seems popular on the internet. They have conventions, factions, and tend to hang out with other people handing out pamphlets on street corners. ECON551: Lecture 11 7
Agenda 1. Land value taxation 2. Capitalization of taxes 3. Property taxation 4. Empirical Example: Gallagher et al. (2013) ECON551: Lecture 11 8
What is ‘tax capitalization’? Let’s hand it back to Adam Smith: “ Ground-rents are a still more proper subject of taxation than the rent of houses. A tax upon ground-rents would not raise the rents of houses. It would fall altogether upon the owner of the ground-rent, who acts always as a monopolist, and exacts the greatest rent which can be got for the use of his ground. … The more the inhabitant was obliged to pay for the tax, the less he would incline to pay for the ground; so that the final payment of the tax would fall altogether upon the owner of the ground-rent ” Wealth of Nations, Book V. Basic idea: As the tax on land goes up, you are willing to pay less for the land because the obligation to pay tax is now attached to the land. This concept applies much more broadly than just land taxes; any asset that is taxed might see the asset value change in response. Makes a large difference for incidence. Existing asset-holders at time of tax change get windfall gain or loss; subsequent purchasers not so. ECON551: Lecture 11 9
Math of tax capitalization Annual benefit of owning an asset: B Number of years asset held: A Interest rate: r Value of asset: V 𝐵 𝐶 𝑊 = ∑ (1 + 𝑠) 𝑏 𝑏=1 𝐶 As A gets large, we can approximate this as the value of a perpetuity: 𝑊 = 𝑠 . Now impose a tax t on value V every year: 𝐵 𝑊 = 𝐶 𝑢𝑊 = 𝐶 𝑠 − 𝑢𝑊 𝑠 − ∑ 𝑠 (1 + 𝑠) 𝑏 𝑏=1 Solve for V: 𝐶 𝑊 = 𝑠 + 𝑢 ECON551: Lecture 11 10
Oates 1969: capitalization of taxes and benefits “ The Effects of Property Taxes and Local Public Spending on Property Values: An Empirical Study of Tax Capitalization and the Tiebout Hypothesis” Journal of Political Economy , Vol. 77, No. 6, pp. 957-971. This paper builds on the then-fairly-recent Tiebout (1956) model of local public goods in which communities engaged in horizontal competition for citizens: Communities offer different tax/local public good mixes to perfectly mobile consumers. Consumers have perfect information and make the community choice based on the offered tax / benefit menu. People “Vote with their feet.” This paper is highly cited because: First empirical test of the capitalization hypothesis. Treats symmetrically the idea that benefit of local public goods could be capitalized into prices as well. ECON551: Lecture 11 11
Oates 1969: capitalization of taxes and benefits Empirical approach: Cross-sectional data on 53 bedroom communities in New Jersey in 1960s. Gathers information on characteristics of the communities to act as controls. Key variables: municipal tax rates and schooling expenditures. Two-stage least squares If cost of service is constant, higher values may lead to lower necessary tax rates. Schooling expenditures might be correlated with house values through unobserved channels (wealth and income, he says). Therefore, need an instrument set for these two RHS variables. I don’t know much about history of econometrics, but this is a rare pape r from the 1960s that is recognizable to modern eyes. Instruments: the median number of years of school completed by males of age twenty-five or more, population density, percentage of dwellings owner occupied….etc Well, this was still 20 years before Angr ist…. ECON551: Lecture 11 12
Oates 1969: capitalization of taxes and benefits Tax rate comes in negative Education expending comes in positive. He goes through the math to figure out the implied capitalization rates: about 2/3 rd of the tax ends up capitalized into prices. Comments: How do we measure output in the public sector? Assuming balanced budget, is tax less benefit always going to net to zero? ECON551: Lecture 11 13
Agenda 1. Land value taxation 2. Capitalization of taxes 3. Property taxation 4. Empirical Example: Gallagher et al. (2013) ECON551: Lecture 11 14
Property taxation Add the value of improvements (buildings etc.) to land value to get property value. Q: What is disadvantage here? Q: How mobile is capital invested in land improvements? Q: Why would you use this instead of just land value? ECON551: Lecture 11 15
Property taxation in the United States, 2014. ECON551: Lecture 11 16
Property taxation in Canada Source: Finances of the Nation, 2010. ECON551: Lecture 11 17
Property taxation in Canada Source: Finances of the Nation, 2010. ECON551: Lecture 11 18
Three Views of property taxation This follows Zodrow (NTJ 2001). He also has a recent 2014 paper in Regional Science and Urban Economics that has a good literature review. Also a 1989 JEL literature review. He posits three ‘views’ for looking at property taxation: 1. Traditional view. 2. Benefit view. 3. Capital tax view (aka the ‘new’ view) He then brings them together in a kind of synthesis. ECON551: Lecture 11 19
Traditional view of property taxation Think of one municipality in a country raising its tax rate. This is a partial equilibrium approach. Capital has outside options that pay some other fixed ‘world’ rate of return. So, capital is pulled out of this town until the after-tax rate of return is brought to equality with rate of return elsewhere. Hurts local workers and others who are immobile. ECON551: Lecture 11 20
Benefit view of property taxation Imagine a Tiebout world, with municipalities competing for citizens. Each municipality funds public good with a property tax. There is zoning that imposes a minimum house size in order to constrain free-riding. No one wants a house bigger than this mini mum because they don’t want to subsidize others. If they want a bigger place, they choose a different municipality. Taxes fully go to pay for benefits. There are no distortions; no distributional consequences. ECON551: Lecture 11 21
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