Gov. Ron DeSantis has proposed eliminating property taxes in Florida, which does not have a state income tax. Property taxes are being reevaluated over fairness concerns.
Let’s consider state and local public finance first. Economists analyze state and local taxes and spending together due to differences in local government taxing authority. State tax revenues could be misleading.
Sales, individual income, and taxes together provided almost 90 percent (33, 26 and 30 percent respectively) of state and local government revenue in 2021. Shares differ significantly, as nine states have no individual income tax. Alabama uses all three, with the sales tax providing 49 percent of revenue.
No income tax states like Florida and Texas still collect more revenue per capita than Alabama and raise 40 percent of revenue from property taxes.
Recent property tax objections are ethical as much as economic. Economist Vance Ginn observes for the Texas Public Policy Foundation, “Texans will never have the peace of mind of owning their home until property taxes are eliminated. Until then, Texans are renting from the government, always living with the fear that exorbitant taxes could take their home away.”
To see how, consider a family farm in a prime location for development. Let this land be worth $500,000 as a farm and $5 million if subdivided for homes. The family does not want to sell. Because market transactions are voluntary, the family’s refusal to sell should end potential development.
Except that the developers’ could increase the assessed valuation to $5 million. Farming income may be insufficient to pay tax on a $5 million property. The family might have to sell to avoid losing the land over taxes. Transactions forced by taxes are not fully voluntary.
The problem arises because the tax rises quickly and can be avoided by limiting the annual tax increase to inflation. Property owners can then determine if they can afford property, including taxes.
The economics of taxation offers three perspectives on property taxes. Any tax transfers wealth from taxpayers to government. For instance, $1,000 in government revenue necessarily leaves taxpayers with $1,000 less.
But taxpayers’ cost likely exceeds $1,000. Taxpayers must bear record keeping and filing costs, as with the income tax. More significantly, people respond to taxes. A $5 per gallon tax on gasoline makes people drive less, but not because the gas is truly so costly. Drivers fail to take valuable trips.
The full burden of the tax might be $1,200, with an “excess” burden of $200. Economists seek taxes with the smallest excess burden. We recommend a tax raising $1,000 with $200 excess burden over a tax with $500 excess burden.
Excess burden increases more than proportionally with the tax rate. Doubling the rate from 5 to 10 percent more than doubles excess burden. This suggests using all three major taxes and not relying on only the sales tax, as Florida and Texas might.
An easily avoided tax, or when the tax base is elastic, has larger excess burden. Theory recommends taxing inelastically demanded or supplied goods more. Land is inelastically supplied, supporting the use of property taxes. Nineteenth century economist Henry George proposed funding government through a land tax.
We get less of whatever we tax. The big three taxes hit income, consumption (the sales tax), and real property. Which do we least mind having less of? Economists observe that income and factories contribute to future prosperity, while consumption does not, recommending sales taxes.
Yet sales taxes are regressive. Regressive and progressive refer to the average tax rate, or tax paid divided by income. A tax is progressive (regressive) if the average tax rate increases (falls) with income.
Low-income households pay sales tax on basically all their earnings. Higher income households pay a lower average tax rate because of savings.
An income tax becomes a consumption tax if households can deduct net savings and investment. Increasing marginal tax rates then yield progressivity.
States without income taxes should only eliminate the property tax if also slashing spending. I do not favor soaking the rich, but we should not make lower income families pay a disproportionate share of government with the sales tax.
