Fiscal Federalism

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					Property Taxation
• In the United States, more than 85,000 local
  government jurisdictions use local property
  taxes.
• The tax is levied primarily on one form of
  wealth, real estate, and the variety of tax rate
  numbers in thousands.
• Because the property tax is a local tax, it can
  influence the location of investment.
A Comprehensive Wealth Tax
          Base
• Wealth is the value of accumulated savings
  and investments in a nation.
• Persons can acquire wealth through saving or
  from gifts or inheritance from their parents or
  other relatives or friends.
• To obtain wealth, persons must refrain from
  consuming all their income in a given period.
• A comprehensive wealth tax base would
  include all wealth in the economy.
Measuring Wealth
• Wealth can be measured by determining the net
  value of financial assets, capital assets, land
  owned by citizens of the nation.
• Administering a wealth tax is complicated by
  the fact that wealth is a stock rather than a flow
  like income and consumption.
• A stock is a variable with a value defined at a
  particular point in time.
• To administer a wealth tax, the value of taxable
  assets must be determined at a particular point
  in time.
• It is difficult to determine the value of assets
  that are infrequently traded on markets.
• Without frequent revaluation of the taxable
  asset values, serious inequities are likely to
  result.
• The first approach to determining wealth
  considers the following three components:
   – All real property owned by households.
   – All tangible personal property owned by
     households.
   – All intangible personal property owned by
     households – stocks, bonds, cash, etc.
• All net incurred by households and firms has to be
  subtracted from the tax base to obtain a measure of net
  wealth.
• A second approach to measuring wealth includes the
  assets of corporations but excludes intangible property
  that represents claims on assets of such corporations.
• In addition all debt incurred by the private sector is
  deducted from the tax base to obtain a measure of net
  wealth.
• The administrative problems encountered in taxing both
  tangible and intangible personal property and have led
  to a wealth tax that falls mainly on real estate and exams
  other forms of wealth.
• In the United States, all localities exclude from
  the tax base most property owned by religious,
  educational, and charitable institutions.
• Constitutional law prohibits local governments
  from levying taxes on real estate owned by the
  federal government.
• However, both the federal and state governments
  make payments to local governments in lieu of
  property taxes.
Assessment of Property Value
• After all property subject to taxation has been
  determined, is necessary to estimate or assess the
  value of the property before the tax can be
  imposed.
• Assessment is the valuation of taxable wealth by
  government authorities.
• If assessments are to be reasonably accurate and
  fair, the asset value of the property should
  closely approximate the market value.
• Typically, the property tax is levied essay
  percent of assessed valuation.
• One method for assessing the value of real estate
  is to attempt to determine the capitalized value
  of the assets.
• This entails estimating both the net annual rent
  flowing from the land and structures thereon in
  monetary terms and the probable life of the
  structures.
• Once this is done this assessor can determine the
  present value of the asset.
• However it can be very difficult to estimate
  rentals for nonincome producing property and
  vacant lots.
A Comprehensive Wealth Tax
• A comprehensive wealth tax is one that would
  be levied on all forms of capital and land and a
  flat rate.
• A general wealth tax can be thought of as being
  levied on the discounted present value of land
  and capital services.
• Comprehensive wealth tax, W, is

                     Ri
              W 
                   (1 r )
                           i
• The wealth tax directly reduces the return to
  savings or to holding land and accumulating
  capital.
• In fact a wealth tax is a tax on interest and rental
  income.
• If a person earns an annual dollar return of RG on
  accumulated savings in any given year, the net
  return after taxes would be RN = RG –tWW.
• Example:
• Suppose total wealth in the nation amounts to
  $100 trillion.
• A flat wealth tax of 1% would yield a total of $1
  trillion annual revenue.
• If the dollar return to invested capital is $10
  trillion per year, which amounts to 10% of
  assets, the property tax revenue of $1 trillion is
  equivalent to a 10% annual tax on the return to
  accumulated savings.
 Impact of a Comprehensive
Wealth Tax when the Supply of
 Savings is Perfectly Inelastic
Return                   S



         r*G
               tWW
                Ri   {
         r*N

                                    D = rG
                                       tWW
                             rN  rG 
                                        Ri


           0         Q1
                             Saving and Investment
• Assuming a perfectly elastic supply of savings, e
  impact of the taxes to reduce to return to savings
  by the full amount the tax.
• The net return is the annual gross return minus
  the annual wealth tax as a percentage of the
  dollar return to savings.
• For example, a 1% annual comprehensive wealth
  tax is equivalent to a 10% tax on the return to
  savings and investment when the equilibrium
  gross return is 10%.
• The incidence of the tax is likely to be
  progressive because it will be paid in accordance
  with ownership of wealth.
• In most nations, the distribution of capital is
  heavily concentrated in the hands of middle and
  upper at income groups.
• The excess burden of the tax is not likely to be
  zero, even if the supply is perfectly elastic.
• This is because a perfectly elastic supply of
  savings is consistent with behavior for which the
  income effects of interest changes are offset by
  equal substitution effects.
• A decrease in the return to savings result in a
  substitution effect that tends to decrease savings
  but an income effect that tends to increase
  savings.
• Because the tax does result in a substitution
  effect that the decreases savings, it would result
  in a reduction in savings compared with that
  which would prevail under a lump sum tax.
• This is because the lump sum tax would raise
  the same revenue as the wealth tax but would
  generate only income effects.
 Impact of a Comprehensive
Wealth Tax when the Supply of
 Savings is Relatively Elastic
Return
                        S


         r*G1
         r*G

         r*Ni

                                   D = rG
                                      tWW
                            rN  rG 
                                       Ri


            0   Q2 Q1       Saving and Investment
• When the supply of savings is not perfectly
  elastic, either because the economy is open so
  that the capital can be exported or because
  savers are willing to substitute consumption for
  savings, the tax would result in increased in the
  gross return to savings and investment.
• Nevertheless, there is a fall in the net return to
  savings and investment.
• The fall in the return to capital in this case is less
  than annual wealth tax expressed as a percentage
  of annual savings.
• The increase in the market rate of interest cause
  by the tax shifts the burden to those other than
  savers.
• Higher interest rates increased costs of
  production and could result in increases in the
  price of goods and services, which shifts the tax
  to consumers.
• The annual reduction investment caused by the
  tax eventually could reduce the capital-labor
  ratio in production, thereby lowering worker
  productivity in the long run.
• This would shift the burden to workers in the
  form of lower wages.
• The substitution effect of the tax induce declined in the
  net return to savings is larger than when the supply of
  savings is perfectly inelastic.
• As a result, the excess burden on the tax is
  correspondently greater.
• In general, if the supply of savings is moderately
  responsive to its return, the incidence of the general
  wealth tax would be borne largely according to
  person’s holdings of capital, with some shifting and to
  labor as wages decline in the long run in response to
  decreased productivity attributable to lower capital-
  labor ratios.
Selective Property Taxes
A National Tax on Real Property
• A selective tax, which mainly affects property
  held in the form of real estate, can be viewed
  as a discriminatory tax on investment income
  from the taxed assets.
• However, consider a case where all real estate
  is tax nationally at the same rate.
• The long run impact of such a tax can be
  analyzed with the aid of a model similar to
  that developed by Harberger for analyzing the
  incidence of the corporate income tax.
• Using this model, it can be demonstrated that
  a national tax on real property would be borne
  by the owners of all forms of capital.
• The tax would disturb the initial capital market
  equilibrium by reducing the return to real estate
  investment relative to alternative forms of holding assets.
  (Assume a perfectly inelastic supply of savings)
• In the long run, investment funds would be reallocated
  away from real estate and toward investments in
  alternative assets, where the return is not subject to
  taxation.
• This would reduce the quantity of annual savings
  supplied to real estate investments, thereby raising the
  net return to holding real estate.
• The tax would increase the supply of savings for
  alternative investments, thereby depressing their returns.
• Invest will funds would continue to flow among
  the various sectors until the return on real estate,
  net of taxation, once again is equal to the return
  available on alternative investments.
• The end result would be a reduction in the net
  return to investment in all forms of capital.
• In the long run, the incidence of tax on real
  estate would be similar to that of a general
  wealth tax.
A Local Property Tax on Real
           Estate
• Other things being equal, those local governments
  where property tax rates are higher than the national
  average can expect a reduction in local investment;
  those for which the rates of taxation are below the
  national average can expect an increase in
  investment.
• The average rate of property taxation reflects the
  portion of the property tax that is common to all
  jurisdiction; there for, it cannot be avoided by
  changing the jurisdiction in which the investments
  are made.
• That portion of the tax lowers the return to capital in
  all uses similar to the way a national property tax
  would lower the return to capital.
• Property tax differentials are differences above or
  below the national average rate of property taxation.
• In states with positive tax differentials where
  property taxes exceed the national average, a
  reduction in annual investment would result.
• Investment would be reallocated to low tax
  jurisdictions.
• As this process of tax induced reallocation of
  investment continued, the stock of capital eventually
  would decline in high tax areas but increase in low
  tax jurisdictions.
• This in turn would result in shifting the tax burden
  to owners of other inputs.
• Reductions capital to labor ratio would reduce labor
  productivity and real wages.
• Reductions in the capital to land ratio caused by
  high property taxes would reduce land rents.
• Conversely, land rents would rise in low-tax
  jurisdiction that benefit from the reallocation of
  investment.
• The impact of high property tax differentials on
  prices is sometimes referred to as an excise tax
  effect.
• The reduction in the supply of capital to type text
  areas would make housing and other locally so
  services scarcer and their prices would rise.
• The impact of the property tax is twofold:
  – First, the average tax that is common to all jurisdictions
    serves to reduce the return to all capital assets, including
    land, as a result of the long run market equilibrium
    process and the investment flows that are induced. This
    portion of the tax is borne by owners of capital.
  – Second, the tax differentials among communities induces
    regional investment movement. Increases in property tax
    rates are likely to be shifted in ways that result in either
    increase prices of locally produced goods or decrease the
    income to owners of land and labor in the community
    depending on the extent of reduced investment caused by
    increases in tax rates.
Tax Capitalization
To Be Continued