The Puzzle of Local Double Taxation: Why Do Private Community Associations Exist?
Nelson, Robert H., Independent Review
The most important change in local government in the United States in the last quarter of the twentieth century was the rise of the private community association (Dilger 1992; Foldvary 1994; McKenzie 1994; Nelson 2005). From 1980 to 2000, about half the new housing built in the United States was subject to the private governance of a community association. At present, in California, 60 percent of all new housing is being built in a community association (Lyon 2004, iii). Indeed, in many areas of the South and the West today, essentially all development--other than small infill projects--is being built in conjunction with the creation of such a form of private government. As a result, 20 percent of all Americans now live in community associations, up from 1 percent in 1970. However, urban scholars have given only limited attention to this major development in urban governance, which represents the widest extent of privatization in any area of American life since the Homestead Act of 1862 sought to privatize the public lands.
One important neglected issue is why community associations exist at all, given that they are subject to a large financial disincentive in the form of double taxation. Much as business profits are taxed both as corporate income and as individually received dividends, private community associations are also subject, if in a different way, to double taxation. Many community associations deliver common services privately that are also provided publicly in other parts of the same jurisdiction in which the community association is located. The association unit owners, however, pay twice, first in the form of private assessments to cover the costs of their own privately provided association services and second through property and other local taxes to cover the costs of the same publicly provided services elsewhere in the same jurisdiction.
Just as double taxation of corporate dividends distorts business investment, the double taxation of community associations creates incentives for inefficient local service delivery. Recipients of publicly provided services receive a "subsidy," paid by the residents of the private communities, to obtain higher levels of services than they would be willing to pay for themselves. Residents of the private communities have a strong financial incentive to seek service provision in the public sector, even if private community provision is more efficient. Adding to the incentives working against private-sector provision, municipal taxes are deductible for the federal income tax, whereas community association assessments are not.
Moreover, the fiscal disadvantages of private community status extend to other matters. Local municipal governments, in part because they are regarded legally as appendages or extensions of state government, often receive large intergovernmental transfers of revenues. Overall, almost 40 percent of local government revenue in 2005 came from the states and the federal government. Although much local spending is for education and social services that community associations typically do not provide, local governments did spend $27 billion in 2005 for parks and recreation and $18 billion for garbage collection, areas of significant overlapping responsibility. Federal and state funds generally are not available to a community association, in part because the communities are regarded as a form of private activity not eligible for such public support. In one recent example, federal disaster assistance was available to municipal governments in the aftermath of Hurricane Katrina but was largely denied to nearby private community associations in similar circumstances.
So why do private community associations exist at all when significant financial advantages favor municipal public organization? One possible answer is that a private government has other advantages that compensate for the negative fiscal elements. Another possible answer is that county and other wider public governments may prefer private governments at the neighborhood level and may insist on their creation as a condition of development approval. …