What taxes are “fair”?

“Don’t tax me. Don’t tax you. Tax that man behind the tree!”

Recent disasters and folks looking to buy houses are driving renewed concerns over resilience, affordability and sustainability. The “supply” of houses is low and mortgage interest rates are relatively low, so builders and sellers are asking top-dollar. Low property taxes also help lift prices. But what taxes are “fair” to buyers and sellers – and even tenant owners?

Local governments have long depended on two or three legs of public revenue: taxes on labor (income taxes), property and consumption (sales and “sin” taxes).

The economy and related tax revenues rises and falls. States tend to want to control income taxes as a reliable, broad-based source of revenue. Local governments lean on reliable property and more volatile sales taxes. Property taxes endure even when incomes fall, hurting those who lost their jobs or had to leave their jobs. And local property taxes are burdened by irregular, uneven and unreliable assessments, and opaque pricing data. Some states publish current sales, but others don’t out of a stated concern for buyers’ and sellers’ “privacy”, a discrete and polite way to hide wealth in land.

Sales tax is a disproportionate burden on the poor who spend most of their income on daily needs. The well-to-do spend a fraction and can bank the difference. Eliminating sales tax on food and medicines is one step in relieving that burden, but simply shifts the taxes onto other items, like household goods. Taxes on services (as in New Mexico and Hawai’i) are seldom used but expand the tax base, as services become a larger share of the U.S. economy.

Local property (or ad valorem) taxes, as applied in the U.S. today, are inherently unfair and discriminatory. If you live in a rich suburb or town, low taxes give you good schools and local services. If you live in a poor suburb or district, high taxes give you poor schools and local services. That’s part of the system we’ve built over the past 100 years in America. Now we’re paying the price in aging schools, streets, parks, sewers and more. We’re also seeing the effect of locking in on a single kind of low-density housing pattern, our “Great Suburban Experiment” as described by James Howard Kunstler in his seminal The Geography of Nowhere. How do we grow and change without decay and upheaval? Gentrification is a relatively recent concern.

Another element of ad valorem taxes is how value is divided between the land itself and the “improvements” on it. Most assessments don’t look at potential rental income as a basis of value. A common rule-of-thumb is that land is one-third of the value, improvements are two-thirds. This benefits surface parking lot barons who, with little improvement, reap tremendous rent income from downtown properties. A few cities in Pennsylvania changed to a “Land-Value Tax” (LVT) where land is assessed at 90% of the value and the improvements are only 10% of the value. This idea captures the old real estate adage of the value of a lot is “location, location, location!”

Our post-War suburbs are showing their age. The perennial question is how (and who) pays to fix and sustain all that infrastructure our grandparents built. President Reagan said government can’t do it. That leaves the rest of us to do it. The failure of a condominium tower in South Florida suggests we aren’t prepared to cope with old age alone.

Before the Model Zoning Code in the 1930s and the FHA Minimum Property Standards that followed, we built neighborhoods mixed with detached houses and traditional small-scale, “middle” housing – duplexes, stacked triplexes, rooming houses, rowhouses, even modest apartment buildings. Downtowns might have long-term hotels and “single room occupancy” (SRO) apartments.

The model zoning code, as adopted across the country, discriminates against the poor, limiting builders to more expensive one- and two-story, detached, single-family houses on large suburban lots, that are unaffordable to many. Post-War zoning also required driveways, garages and parking on the lots to accommodate our wealth of new personal cars and trucks.  This adds to the cost of new houses. Today, builders will divide new neighborhoods and even house blocks by price and size, thus by wealth and income.

Affordable housing advocates are calling for new, more affordable “missing middle” homes and accessory dwelling units (aka “mother-in-law apartments” or ADU) to be allowed in post-War and newer neighborhoods.

The benefits of amending the zoning code to allow these traditional housing types in meld into mid-century and even younger single-family neighborhoods are manifold:

  1. A new ADU allows a widowed mother-in-law to live next door without living in your spare bedroom. She might even want to live in the same neighborhood she’s lived in for the past 40 years, but can’t afford anymore.
  2. A new rentable studio apartment might offer a local college student to live in a safe, established neighborhood rather than the “student ghetto”.
  3. Subdividing a lot to create a new duplex offers an incremental way to build wealth for existing homeowners.
  4. Adding residents to the neighborhood encourages new shops to open and expand within walking distance of your house. But that might require also allowing a house to be converted into a corner store.
  5. The new sales and property tax revenues in the neighborhood can pay to replace broken sidewalks, sewers, streets and playgrounds.

With property taxes, some states have tried to “protect” selected classes by restricting tax increases. The infamous California Proposition 13 capped annual increases due to rising appraisals. The largest outcome was a disaster for local governments and public school districts as growth in population and inflation outran their tax revenues. Other states have implemented policies to cap taxes on seniors and veterans in their homes which simply shifts the tax burden onto younger home owners and buyers.

There has been a lot of change in the past 70 years across our cities and suburbs. We currently tax some change we want – increasing labor income and land improvements, and some we don’t like – like consuming stuff.

Leaving income taxes off the local table, some possible corrections to our flailing American experiment are to:

  1. Change our property tax policy to follow Pennsylvania’s example and better capture the value of the location of land,
  2. Increase transparency of property sales to expose false assessments and pricing,
  3. Expand the range and variety of housing and services available in your neighborhood,
  4. Remove sales tax on day-to-day needs. Expand sales tax to include services.

Every community and state is implements and impacted by taxes differently. If you could change anything, what would you tell your representatives to do? Because from where I stand, we need a comprehensive tax strategy that positively impacts all communities and everyone they serve.

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