The Theory of Property Tax

Lecturer: Jack WuThe Theory of Property Taxation1OutlineTopic I: What Are Property Taxes?Topic II: Property Tax IncidenceTopic III: Property Tax CapitalizationTopic IV: Property Tax Competition and Provision of Local Public Goods

2What are Property Taxes? 1.What are Properties?2.Defining Property Tax3.Why levying property tax?4.Mechanics of Property Taxation5.The Property Tax Process6.Economic Issues of Property Tax 31. What are Properties? Property v.s. WealthTaxonomy of Property

4Property v.s. WealthProperty: A. something that someone ownsB. any tangible or intangible possession owned by someone C. real estate (land or building) that someone ownsWealth: the money value of property

5Taxonomy of PropertyProperty can be classified as:Personal (Movable) property v.s. Real property Tangible property v.s. Intangible property6A Taxonomy of Property

72. Defining Property Tax Narrowly Defined Property TaxesProperty Tax in Tax StructureBroadly defined property taxesProperty Tax Revenues

8Narrowly Defined Property TaxProperty tax is the tax on the property holding. (note: acquiring, holding, transfer) Property tax is an ad valorem tax that an owner of real estate or other property pays on the value of the thing taxed. (note: it is difficult to levy a tax on personal or movable property)9Property Tax in Tax StructureNational Tax/ Central TaxMunicipal and County Tax/ Local TaxIn most countries, property tax is the most important local tax.10Taiwans Central and Local Taxes

11Broadly Defined Property Tax According to OECD classification, taxes on property include:1.Recurrent taxes on immovable property2.Recurrent taxes on net wealth3.Estate, Inheritance, and gift taxes4.Taxes on financial and capital transactions5.Other non-recurrent taxes on property6.Other recurrent taxes on property 12Taiwans Property TaxesNarrowly defined property taxBroadly defined property taxAgricultural Farmland Tax ()Agricultural Farmland Tax ()Land Value Tax Land Value Tax House Tax House Tax Estate, Inheritance and Gift Tax()Deed Tax Security Transaction Tax()Future Transaction Tax ()Stamp Tax Land Value Incremental TaxLicense Use Tax 13Distribution Ratios of Current Taxes14

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1999125 2009531 A40% (1) 18%() (2) 2% 200811100% Table: 1515Property Tax Revenue

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16Property Tax Revenue/Total Tax Revenue

17Property Tax Revenue in USA

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20203.Why Levying Property Tax?Canons of TaxationVirtues of property tax21Canons of TaxationSimpleEquitable (horizontal, vertical, inter-generational, and process equity)StableNon- or least distortionLow administration and compliance costs22Virtues of Property TaxAn old taxA stable taxAn easy-to-administer taxA benefit taxA tax that allows local controlA visible tax23An Old TaxAn old tax is a good tax. Principle of good tax policy: a tax system should change infrequently.

24A Stable TaxStability and reliability are considered two requirements for creating a sound tax system.Few taxes are more reliable than those on real property. Unlike other local taxes, the property tax base cannot be moved. The revenue from such a captive tax base can be relied on to a greater extent than either wage or sales taxes both of which have highly mobile tax bases. The steady growth of property tax revenue (real property values appreciate over time) can meet future public service needs.25An Easy-To-Administer TaxThe governments administration of property tax and taxpayers compliance with the property tax are relatively straightforward and inexpensive.The tax is easy to administer because the underlying tax base is immobile and easily identifiable. Moreover, taxpayers cannot easily hide or move property. Thus, the property tax is hard for property owners to evade.Most taxpayers (property owners) face minimal compliance cost because they do not need to fill out any property tax form. 26A Benefit TaxProperty tax revenue is raised locally to support local public services. Thus, the connection between the source of revenue (property) and what is being provided (public services) has stayed strong. The local public services provided benefit the owners of property within the jurisdiction.The beneficiary of the public services is the property owner, and under the benefit principle of taxation, it is the property owner who should be paying for the services.Many economists have recognized property tax is a benefit tax. 27A Tax that Allows Local ControlThe property tax is the best available independent source of local revenue. The property tax has given local constituencies control over their financial matters. Local fiscal autonomy is a direct result of reliance on property taxes. Central government does not levy tax on real property. Thus, theoretically, local governments should have greater flexibility with the property tax system than with other major taxes.28A Visible TaxTaxpayers know the amount , the frequency, and the purpose of the property tax. Unlike sales taxes (which are paid to vendors) or income taxes (which are generally withheld by employers), property taxes are generally paid to the government.294.Mechanics of Property TaxationMajor issues of Property TaxProperty Tax BaseValuation MethodsProperty Tax RatesProperty Tax Relief Measures30Major issuesTax base issue: How is the tax base defined and measured?Tax rate issue: What political groups have responsibility for setting tax rates and how those rates are measured?Economic effect issue: What policies are used to reduce overall property taxes or to alter the distribution of tax among different types of properties and taxpayers? 31Property Tax BaseMarket value of property The tax base of property tax is the market value of propertyAssessment value of property:Not all of properties are not transacted in the market in the given year, so it is necessary to assess the value of property annually by tax assessors. 32Valuation MethodsMarket Value approach Income capitalization approach Replacement cost approach33

Market Value Approach

Use the observed market prices for properties to estimate value for a subject property. Suppose that we want to value a three bedroom, two bath home in the Dogwood Subdivision. We could analyze the sales prices for all such comparable homes over the past year to value the subject property.

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Income Capitalization Approach

For income producing properties, we can estimate value by computing the discounted present value of the net income stream generated by the properties. We need information on net income to do this.

35Replacement Cost ApproachTo estimate the value of property by computing the replacement cost and subtracting depreciation. This is the only alternative for unique properties, or properties for which an active market has not developed, or for which no net income data is available.36Three approaches to valueIn theory, all three approaches to value should lead to the same conclusion, or very nearly the same conclusion.In practice, they differ and it is important for the assessor to understand the strengths and weaknesses of each approach. 37SummaryIn most instances, the market value approach is used to assess single-family homes and land for which there are often numerous sales, while the replacement cost and income capitalization approaches are usually used for commercial and industrial properties. 38Assessment Ratio RuleAn assessor computes the assessed value of each piece of property from an estimate of the propertys market value according to a specific set of procedures , usually established by law. Given that estimate of market value, the assessed value is specified by law or common practice as some specific percentage of market value, called the assessment ratio rule, or at least must be within some specified range of percentage of market value.39Classified Property TaxesIf different types or classes of property are assessed according to different assessment ratio rules, the tax is called classified property tax. Residential property are usually assessed at a lower ratio than commercial and industrial property. In addition, some types of property may be exempt from property tax. The assessed value of these properties is set equal to zero.40Property Tax RatesHow to set the tax rate? Property tax rate and Local Public ServicesNominal tax rate and effective tax rate41How to set the tax rate?Property tax revenue= tax rate*Tax baseGiven the total assessed value of all properties in a taxing jurisdiction, the local government sets a tax rate sufficient to generate the desired property tax revenue. Central laws constrain the local government in setting the property tax rate by limiting the tax rate, property tax revenue, or both.42Property Tax Rate and Local Public ServicesMany local governments rely on the Property Tax to fund local public services. Hence, the Property Tax rate is actually a combination of many rates. Each local government unit sets its own rate, taking into account desired public service levels and the tax base.

43A combination of rates

44Nominal Property Tax RatesThe nominal tax rate is t = T/Va T the tax paid Va the assessed valueThe assessed value Va is a fraction of the market value. Let a the assessment ratio, Va = aV a = Va/V.

45Range of Land ValueMarginal Tax RateLand Value < Starting Threshold (ST) 1%ST< Land Value < 5*ST1.5%5*ST< Land Value < 10*ST2.5%10*ST< Land Value < 15*ST3.5%15*ST< Land Value < 20*ST4.5%20*ST < Land Value5.5%Nominal Tax Rate of Land Value Tax in Taiwan46ClassificationMax. RatesMin. RatesActual Rates Enforced by the majority of counties (cities)Residential Houses2.0%1.2%1.2%Business Houses5.0%3.0%3.0%Houses for other purposes*2.5%1.5%2.0%Nominal Tax Rate of House Tax in Taiwan47Effective Tax RateThe effective tax rate, the ratio of tax to market value, is a usual way to characterize property tax levels on different properties or in different jurisdictions. Because tax is compared to market value, the effective tax rate corrects for any difference in assessment ratios. 48Effective Property Tax RateThe effective tax rate is the ratio of the tax paid to the market value of the property: t = T/V.Substitution for V gives the relationship t = at.Hence, the effective tax rate is a combination of the nominal tax rate and the assessment ratio.

49Evidence from USA

50More Evidence from USA

51CountryTax BaseNominal Tax RateEstimated Effective Tax RateAustriaAssessed standard value Basic Federal rate of 0.2%0.5%FinlandTaxable value0.22%~0.5%0.36%FranceNotional rental valueCertain coefficients to half0.5%GermanyTaxable value0.35% federal rateMunicipal coefficient:2.8~61.5% on average(0.98%~2.1%)GreeceAssessed valueProgressive rate 0.3%~0.8% (State)0.025%~0.035%(local)0.57%ItalyImputed rental income0.4%~0.7%0.5%NetherlandsPublic valuation0.1%~0.9%0.5%PortugalValuation code0.7%~1.3%1%SpainCadastral value0.4% urban,0.3% rural0.4%Evidence from EU52Evidence from Taiwan

53DistrictMean tax rateMedian tax rateStandard deviationDatong0.1142%0.1026%0.0444%Wanhua0.1105%0.1074%0.0367%Zhongzheng0.0930%0.0844%0.0471%Zhongshan0.1105%0.1040%0.0419%Daan0.0911%0.0824%0.0382%Xinyi0.0867%0.0789%0.0331%Songshan0.0924%0.0821%0.0412%Nangang0.1069%0.0895%0.0471%Neihu0.0836%0.0805%0.0246%Shilin0.0779%0.0726%0.0281%Beitou0.0828%0.0774%0.0280%Weshan0.0860%0.0804%0.0282%Whole Taipei0.0912%0.0829%0.0364%Taipeis Effective Tax Rates I54Taipeis Effective Tax Rates IIZoneMean tax rateMedian tax rateStandard deviationOld West0.1118%0.1050%0.0397%New West0.1059%0.0979%0.0439%Central0.0901%0.0813%0.0377%East0.0887%0.0818%0.0324%North0.0802%0.0743%0.0282%South0.0860%0.0804%0.0282%Transaction Year20020.1099%0.1003%0.0377%20030.1140%0.1018%0.0446%20040.0904%0.0818%0.0353%20050.0828%0.0760%0.0302%20060.0781%0.0712%0.0286%House TypeTall building0.1099%0.1023%0.0389%Low apartment0.0737%0.0702%0.0222%Single house0.0661%0.0654%0.0217%55Equalized Tax Ratethe equalized property tax rate can be measured based on either of the following two ratio definitions: the ratio of assessment value to market sale value and the ratio of assessment value to taxable value.

5620002004200729.634.434.4817.925.630.89202829.51192426.4218.7526.2524.8314.1220.824.5817.9623.824.2516.8519.3823.9519.820.921.7515.3416.8620.8214.319.5220.601517.4520.0012.1616.6118.7212.5515.3518.4315.114.5217.1111.1812.9716.9111.515.616.8815.114.8216.727.3715.315.2411.5412.9814.7011.6212.9514.1811.913.2113.285.971110.7991210.614.416.568.1117.3519.0457, 2007.1.1057Taipeis equalized tax rateequalization rateMaxMinAverageMedianStandard DeviationShilin0.9591630.0727660.2271450.2081280.094281159Datong0.9820540.0856540.2859190.2613330.123517493Daan0.8659280.0780710.2451730.2241390.097422656Zhongshan0.9455370.064310.2661690.2473470.104440393Zhongcheng0.938370.1158590.2682090.2419190.117056327Neihu0.6403070.0713910.2050710.1950970.061785022Wenshan0.915050.0305810.2256890.211340.075738607Beitou0.6556230.0286080.227250.2094180.08756853Songshan0.5873630.0225340.2382320.2234470.080671151Xinyi0.8096580.0622740.256480.2367670.103844435Nangong0.5369570.1081820.2111490.1952890.069300413Wanhua0.9858360.0175670.2922250.2734330.113861420020.98580.06230.27770.25900.103920030.95920.07060.28270.25870.108720040.98210.03780.23710.21710.091220050.88780.02250.22500.20820.083820060.94550.01760.20910.19330.0785Tall building0.94550.06430.21980.20370.0791Low apartment0.98580.02250.25600.23600.1025Single house0.65540.01760.28750.27630.115658Property Tax Relief MeasuresLocal government uses a variety of measures to reduce property taxes for specific classes of property or specific types of taxpayers. These measures include:Limits on assessed valueExemptions of assessed value for homesteadsstate government credits or rebates for local residential property taxesIndividual income tax deduction for property taxesSpecial assessment methods for farmland

59Actual or true marketValue of propertyAssessed or taxable Value of propertyRuling elected bodyOf taxing governmentReferendum(required or optional)Tax collectorProperty tax levyProperty tax revenueAssessment ration ruleExempt propertyActual or true marketValue of propertyAssessorRuleAgentTax variable 5. Property Tax ProcessFisher (2007, 3e), Figure 13.1, p. 321. 6061

Source: Florida Department of Revenue. http://dor.myflorida.com/dor/property/infographic07.pdf 6162

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Source: Michigan Department of Treasury, http://www.michigan.gov/documents/868f_2682_7.pdf Fisher (2007, 3e), Figure 13.2, p. 325. 6667

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Source: The County of Isabella, http://www.isabellacounty.org/news/hearing061907.pdf 6869

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736: Economic Issues of Property Tax SystemThe Property tax system for the nation as a whole depresses the return on capital and changes the cost of capital to higher-tax communities and decreases the cost of capital to low-tax communities.74IssuesEfficiency IssueThe effects of the Property Tax on the amount, type, and location of property. Equity IssueThe effect of the Property Tax on the distribution of the tax burden.Policy ImplicationsThe design of the tax systemProposals of tax reformThe Extent of Property Tax CapitalizationThe Property Tax Competition

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