TCS Daily

Two Tax Myths

By Benjamin Zycher - September 25, 2003 12:00 AM

The vacation season is past. The days are getting shorter. The new school year looms interminable. No more barbeques, ice cream, and beer. Dieting can be postponed no more. Work beckons rudely, and the boss -- tan, rested, ready -- has a sharply renewed interest in the bottom line. No more paid holidays until a barely perceptible Thanksgiving. Even leisure time will be disturbed by the California recall cacophony.


Ah, yes, the recall election. Among the many underlying issues is taxation, an unsurprising focus in that Californians are taxed heavily, in return for which our public services are less than stellar. This combination of high taxes and mediocre schools, infrastructure, and the like is an obvious source of displeasure on the part of the electorate toward the political class. Those seeking to counter this unhappiness can find no way to deny the obviously poor quality of many state services; and so it is unsurprising that two tax myths now have emerged, to wit, that California taxes in fact are not particularly high, and that the Proposition 13 constraints on property taxes are "unfair."


The argument that our tax burden has been exaggerated finds its support in a recent study by the Federation of Tax Administrators, showing that California ranks 19th among the states in terms of total state and local taxes and fees as a proportion of personal income. As an aside, the inclusion of fees (state college tuition, campground fees, etc.) is curious, in that such fees are prices (whether low or high) paid by the direct beneficiaries of state services. After all, no one would argue that payments to the Postal Service for stamps are "tax" revenue. If, properly, we exclude such fees, California ranks 8th rather than 19th; only Hawaii among western states ranks higher. Over the period 1991-2001, the average annual growth in California tax payments was more than double the average annual growth in income.


More important, tax revenue as a proportion of income is the wrong measure. In order to see that, suppose that California imposed truly onerous tax rates on individuals with higher incomes and on successful businesses, so that many left the state. Total tax revenue would plunge, and tax revenue as a proportion of income would decline; but the true economic burden of taxation would be high.


Accordingly, the relevant parameter is the rate at which incomes and sales are taxed, examination of which yields a very different answer. Only Montana and Vermont have higher tax rates for individuals. Alaska and California have the highest corporate tax rates among western states. The California state sales tax is the highest in the nation.


Under Proposition 13, property values are reassessed fully only at the time of sale, rising 2 percent per year at most in the interim. (The tax rate is approximately a flat 1 percent.) Owners of identical properties thus may pay substantially differing amounts in property tax depending upon the length of time that they have owned their respective homes or buildings. Hence, the purported "unfairness" yielded by the current system.


The unfairness argument is incorrect because it confuses the size of the checks that the respective property owners send to the government with the economic burden of the tax. An individual who purchased a home recently sends a relatively large check to the government; but he does not bear a relatively larger burden of property taxation. That is because he knows when bidding for the home -- the real estate market knows - that forthcoming property tax bills will rise substantially upon purchase of the property, so that market prices for real estate are bid down from levels that they otherwise would reach, by the "present value" of the higher stream of anticipated property tax bills.


Therefore, even though the new homeowner annually sends a big check to the government, it is actually the seller of the house who bears the burden of the higher future property tax bills. That burden takes the form of a market price lower than otherwise would be received. More generally, Proposition 13 yielded economic benefits for those owning real estate when it was enacted in 1978, in the form of reduced tax bills and an increase in property values. Those purchasing homes thereafter have paid lower property tax bills each year than would have been the case without Proposition 13, but have not received most of the economic benefits of that environment because they had to pay for the privilege. And new homebuyers do not bear the burden of the higher payments attendant upon reassessment to current market value.


Counterintuitive though it may seem, the true economic burden of property taxation under Proposition 13 is the same for all regardless of the size of the checks that they must write. Yes, Proposition 13 has weakened local control and yielded greater centralization and bureaucratization, and government services are both more costly and poor in quality. In particular it has strengthened the teachers' unions and the statewide education bureaucracy. Nonetheless, the passage of Proposition 13 was absolutely necessary as a popularly imposed constraint upon an utterly unresponsive political class, and as a clear signal that the public sector (that is, interest group) claim on private wealth must be limited because government serves the taxpayers rather than the reverse. And that is why Proposition 13 must be defended today.


On October 7, Californians should vote early and often. But they should not be misled by tax myths.


Benjamin Zycher is a senior fellow at the Pacific Research Institute.


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