The Property Tax and Local Finance

By C. Lowell Harriss | Go to book overview

Optimality and Property Taxation:
An Alternative Approach

JOEL M. STERN

The property tax is a wealth tax, a fraction of an asset's value, whether that value is rising or falling. It is levied without regard for the owner's other sources of income. On a market-value basis, which is preferable, the property tax can be calculated easily by employing a simple rule, such as a fixed percent of the value. The greatest advantage of the property tax is its efficiency for collecting revenue locally for local government. In contrast to income that can be transferred geographically to other jurisdictions, property can be taxed locally for local government.

The difference between archaic and progressive property-tax policies turns on whether the basis for the levy is market value. If so, it is progressive. Almost any other basis is considered archaic. Clearly, market-value determinations are the fairest, but "progressive" might best refer to the impact the levy has on resource allocation for the economy as a whole. Therefore, a proper evaluation of the property tax requires an examination of this form of tax on savings and consumption. Even more fundamental is a study of the taxation principle in a free society. Only then can we be certain that a tax is rational and just in the sense that its impact on resource allocation is minimized and that it does not unfairly burden one segment of society more than another.

Resource misallocation will occur whenever economic agents use tax effects in judging how to allocate resources, that is, in calculating their after-tax rates of return on investment. Optimally, decisions should be tax neutral, but at the extreme this means having no taxes at all. If taxes exist, approaching optimality requires minimal taxes.

Fairness means that, given the existence of taxes, income should bear the tax, and all forms of income should be taxed proportionately, whether returns from labor (i.e., earnings) or from capital (i.e., dividends, interest, and changes in the value of capital assets, including stocks, bonds, and property). We begin to drift away from tax neutrality when tax rates differ on alternate forms of income or when wealth is taxed. For example, if tax rates on dividends and capital gains

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