Real Estate

Why Economists Love Property Taxes and You Don't

Rising bills can force homeowners to make some unpleasant decisions.

Out of reach in Silicon Valley.

Photographer: Michael Short/Bloomberg

When the value of land rises, it's generally not because of something the landowner has done. The resulting rents and other monetary gains, 1 Adam Smith wrote in 1776, "are a species of revenue which the owner, in many cases, enjoys without any care or attention of his own."

This made the landowner, Smith continued in "The Wealth of Nations," an excellent target for taxation:

Though a part of this revenue should be taken from him in order to defray the expences of the state, no discouragement will thereby be given to any sort of industry. The annual produce of the land and labour of the society, the real wealth and revenue of the great body of the people, might be the same after such a tax as before.

This favorable view of taxes on land -- especially if levied just on the unimproved value of that land, regardless of what has been built on top of it -- has resonated with economists ever since. Here's another version of the reasoning, from the Concise Encyclopedia of Economics entry on 19th-century land-value-tax crusader Henry George:

Most taxes, noted George, stifle productive behavior. A tax on income reduces people’s incentive to earn income, a tax on wheat would reduce wheat production, and so on. But a tax on the unimproved value of land is different.

If designed well, such a tax could actually encourage productive behavior by goading landowners into getting the most out of their property by, for example, putting bigger buildings on it. Just last month, my Bloomberg View colleague Noah Smith proposed a land-value tax as a solution to the housing squeeze besetting cities in California and elsewhere, arguing that such a levy "is an efficient and fair way to take a city that now works only for lucky prosperous landowners, and turn it into a place where the working class can afford to make a decent life." Even Milton Friedman, who generally didn't like taxes at all, called the land-value tax "the least bad tax."

In the same 1978 question-and-answer session where he said that, though, Friedman also acknowledged that property taxes -- not exactly the same as land-value taxes but pretty close, especially for homeowners -- were extremely unpopular. That they are. Here are the results of a Gallup Poll on the topic from 2005: 2

The Least-Fair Tax

"Which do you think is the worst tax — that is, the least fair?"

Source: Gallup, April 2005

Why so unpopular? Here's Friedman's theory:

It's not unpopular for good economic reasons. It's unpopular in my opinion for one simple reason: It's the only tax left on the books for which people have to write a big check.

Income taxes and Social Security contributions are withheld from paychecks before the recipients get their hands on the money. Sales taxes (and value-added taxes outside the U.S.) are remitted by merchants and other business. It's only with property taxes that a regular person gets a bill and has to pay it.

There's clearly something to that, although for many homeowners property taxes are bundled into mortgage payments and thus a bit less obviously visible. 3 Still, I can think of at least two other reasons for property taxes' unpopularity that are actually side effects of what economists like about them. To wit:

  1. Property tax bills can rise without property owners doing anything, and
  2. Rising tax bills can push property owners (homeowners in particular) to make economic decisions they might prefer to avoid.

People can adjust their spending, and often their income. But they can't help it if, say, house prices go up 80 percent in just three years -- as they did in California from 1975 to 1978. Well, actually, they could help it, by going to the polls in June 1978 and approving Proposition 13, a set of restrictions on property tax rates and assessments that have shaped the state's economy and government ever since.

They've almost certainly misshaped it. Proposition 13 has starved schools and local governments of funding, and left the state too dependent on volatile income tax revenue. By holding assessments steady until a property changes hands, it has also created a big disincentive for long-time homeowners to sell, exacerbating the state's housing shortages.

But while it would surely be better for the state's economy if empty-nesters weren't given such an incentive to stay in their four-bedroom houses instead of downsizing, pushing old people out by raising their property taxes is not what you would call a plan with political legs. That relates to the second reason why people don't like property taxes. When taxes rise because of rising land values, they put pressure on those who bought back when land was cheaper to sell or come up with new ways to generate enough revenue to pay the bills. Again, either move would be better for the economy than staying put. But for the homeowner (or her neighbors) it can be a pain.

Also, taxing property is in general more problematic politically than it was back when Henry George's ideas were in vogue in the late 1800s and early 1900s -- because homeowners have gone from a minority of the U.S. population to a majority with an especially high propensity to vote.

Homeowners in the Majority

Owner-occupied units as percentage of total housing units in U.S.

Sources: U.S. Census Bureau, DQYDJ

Note: Dotted lines represent missing years; before 1940 only decennial data is available.

Homeownership rates are now similarly high in most other developed countries, 4  and property taxes similarly unpopular. Even as real estate prices skyrocketed in many countries starting in the 1990s, property tax revenue barely budged as a percentage of gross domestic product among the affluent members of the Organization for Economic Cooperation and Development.

Taxing Property Less

Property taxes as a percentage of gross domestic product

Source: Organization for Economic Cooperation and Development

In the U.S., property tax revenue fell in the U.S. in the 1970s and has been pretty flat since. But its share of GDP is still high compared with the rest of the OECD, possibly because property taxes here are used mainly to fund local governments and schools. Homeowners can thus see a direct link between what their property taxes pay for and the value of their homes. These vigilant "homevoters," as Dartmouth College economist William Fischel has dubbed them, demand high-quality services and are willing to pay for them. But they're never going to favor tax policy aimed at pushing homeowners in expensive places to downsize or replace their houses with apartment buildings. In fact, one of the top priorities of modern homevoters seems to be keeping developers from putting up apartment buildings.

So that's where things stand. Taxes on land seem to make lots of economic sense, but not much political sense.

If rising land prices pushed renters back into the majority, though, the political equation could change. The U.S. as a whole is nowhere near that point. Look what's happening, though, in the country's most expensive housing market, metropolitan San Jose, California, aka Silicon Valley: 5

Silicon Valley Goes Rental

Owner-occupied units as percentage of total housing units

Source: U.S. Census Bureau

*Decennial census data for San Jose before 2005 (dotted line represents missing years), after that rolling four-quarter averages.

San Jose is also far and away the most affluent metropolitan area in the U.S., with a median household income of $110,040 in 2016. 6 But the unforgiving economics of limited land are nonetheless pricing more and more of the region's residents out of homeownership. Paging Adam Smith, Henry George and Milton Friedman: Silicon Valley needs your advice.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
  1. Thanks to the work of Smith and his intellectual successor David Ricardo, "rent" has for economists come to have the specific meaning of unearned income from a resource whose supply is fixed. Or something like that. By that definition, income from land ownership other than rent payments (capital gains from selling land that has appreciated in value, for example) also amounts to "rent." But I thought it would be confusing to get into that in the main text.

  2. It's the most recent poll I found, and does seem to have been affected a bit by the fast-rising home prices (and property tax assessments) of the time. But property taxes have been the least popular tax almost every time Gallup has asked over the years.

  3. In Ireland, property taxes can even be deducted at source from salary or occupational pensions.

  4. The big exceptions are Germany and Switzerland, where the homeownership rate remains well below 50 percent.

  5. The quarterly numbers for individual metropolitan areas are based on smallish samples and are thus quite noisy; I went with four-quarter averages to smooth things out a bit.

  6. The neighboring San Francisco metro area came in second, according to the Census Bureau, at $96,677.

To contact the author of this story:
Justin Fox at justinfox@bloomberg.net

To contact the editor responsible for this story:
Brooke Sample at bsample1@bloomberg.net

Before it's here, it's on the Bloomberg Terminal.
LEARN MORE
Comments