Abstract
The large and vibrant literature on local public finance constitutes the basis for a normative framework on property tax, which is outlined in Sect. 2.1. Beyond that, the question of the property tax incidence, i.e. who pays the property tax, is illustrated in Sect. 2.2. Finally, based on the public finance literature, criteria for a rational local property tax are derived and reviewed in Sect. 2.1.3.
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Notes
- 1.
Depending on the spatial benefit incidence, the allocation function could also be assigned to the central government. However, decentralizing political, financial, and administrative authority is generally more efficient as the focused attention is on local preferences.
- 2.
The decentralization theorem presumes that there is no perfect information given and, therefore, the central government provides a uniform provision of public services across all jurisdictions.
- 3.
Dillinger (1991: 3) states that intergovernmental transfers (mainly revenue sharing) and local indirect taxes may play a role in stabilization and distributional policies but that they cannot be seen as prices (as is the case of benefit taxes).
- 4.
All public services with ‘private good’ character user fees are appropriate because spillovers are unlikely to exist. In the case of collective or ‘public good’ benefit, where specific beneficiaries cannot be identified, a local benefit tax is best. The property tax, for instance, covers the cost of providing services that provide collective benefits to the local community (Mohanty et al. 2007: 33; Kitchen 2013: 3).
- 5.
The revenue assignment is, however, not that easy. The vertical tax assignment structure is therefore described in literature as ‘tax-assignment problem’ (McLure 1983).
- 6.
Musgrave first clearly articulated the free-riding problem in his 1939 article “The Voluntary Exchange Theory of Public Economy“. In his book, “The Theory of Public Finances” he emphasized that public and private goods provision differs in the free-riding problem.
- 7.
Tiebout (1956: 422): “Just as the consumer may be visualized as walking to a private market place to buy his goods, the prices of which are set, we place him in the position of walking to a community where the prices (taxes) of community services are set. Both trips take the consumer to market”.
- 8.
Fiscal equivalence does not necessarily imply that taxes paid reflect someone’s individual consumption of public goods. Fiscal equivalence fits best when thinking about (relatively) various municipalities consisting of homogenous Tiebout-like groups, where public goods generate (about) the same utility for each individual within one (out of many) respective Tiebout-like group. Services would be provided at the lowest point on the average cost curve, where the ones who pay for service provision are the ones who benefit. This is also called group-related local equivalence (Haller 1981: 40; Zimmermann 2009: 142).
- 9.
The capitalization effect could be defined as the manifestation of local taxes and expenditures into property values. Oates (1969: 968) econometric evidence of the capitalization effect was based on a 1960-dataset of northern New Jersey municipalities. Oates concluded “if a community increases its tax rates and employs the receipts to improve its school system, the coefficients indicate that the increased benefits from the expenditure side of the budget will roughly offset (or perhaps even more than offset) the depressive effect of the higher tax rates on local property values.”
- 10.
According to Fischel (2001: 56) “capitalization is everywhere”. Fischel (1992: 171) argues that there is a wide range of zoning tools (e.g. minimum lot sizes, height restrictions, requirements for off-street parking etc.) that could be used by local governments to control their capital stock (zoning is imposing strict limits on housing consumption).
- 11.
In the context of private goods, the ultimate form of decentralization would be delivered by the market, with a consumer buying a tailored good from a choice of suppliers. As this in not the case with public goods, decentralization may approximate the market allocation.
- 12.
- 13.
There is a grey area with subnational governments having budgetary discretion and political leadership responding to local preferences, but they are not elected by local population as is the case in China.
- 14.
Besides, land taxation roots can be found in earlier works of Adam Smith, David Ricardo, and John Stuart Mill (Gu and Trefzger 2000: 149).
- 15.
The property tax on unimproved land (land value only) cannot be shifted, as the tax will not cause any change in the behaviour of the landowner. This holds if the market value is the assessment base. The particular use is then independent of the tax. “Whatever use would be most profitable in the absence of such a tax will remain so when the tax is levied” (Heilbrun 1983: 58).
- 16.
Lowell C. Harris is speaking about “getting richer while sleeping” in the context of urban landownership (Harriss and Oates 2001: 15).
- 17.
Therefore, the benefit tax could be seen as a non-distortionary user charge.
- 18.
“The match between incidence of the property tax and the benefits of the service it finances is clearly far from perfect: the statutory burden of the property tax is distributed according to value of property; the benefits of the service it finances are not (Dillinger 1991: 3).”
- 19.
“The tax on capital is seen as a combination of a basic (or average) tax rate applied to all capital (which capital owners cannot escape since it is levied on a fixed supply of capital) plus a local differential that varies across jurisdictions—thus working as an incentive for capital to reallocate among jurisdictions until net after-tax rates of return are equalized” (Norregaard 2013: 17).
- 20.
The property tax differential is defined as the difference between the present value of the benefits of local public services received and property taxes paid.
- 21.
In order to make the benefit principle work in general, property taxation has to be applied so that all real property benefits from local public services equal the property tax yields, which would be the Tiebout equilibrium (Musgrave and Musgrave 1976: 344); “A general tax on real property, therefore, is a poor instrument for charging for services rendered.” Musgrave and Musgrave conclude, that income and value added tax might be a better proxy for benefits for individuals and firms. Yet, in the case of different service levels among municipalities, the benefit principle fits. Given a community A with higher public service levels than community B, the difference will be capitalized in property values in A. Therefore, the argument for benefit taxation holds only for the differential. This establishes a tenuous link between ownership and service level.
- 22.
- 23.
“The relative greater stability of market values is of little consequence, if market values are not accurately reflected in assessed property values (Bahl and Martinez-Vazques 2007: 6).”
- 24.
The online seminar lecture “Designing and Implementing Property Tax Systems in Africa“, provided by the Lincoln Institute of Land Policy, gives a well-structured overview on administrative and political aspects of the property tax design (attendance, April 2014).
- 25.
While taxing land only leads to an unbiased development of residential properties, taxing buildings is not incentive-neutral (see Sect. 2.1.2). Nonetheless, there are countries taxing buildings only, this is usually the case where the land is nationalized or land is perceived as national asset belonging to the people collectively. Herewith, taxing buildings only is not considered as it is very costly to maintain the fiscal cadastre (see Sect. 2.2.5) and it would stifle land development. From an economic and administrative context, taxing buildings only is ‘nonsense’.
- 26.
Exemption and exclusions constitute only one part of tax relief. Tax relief, however, can be granted on a number of stages besides exempting or excluding property from the tax base, such as differentiating the tax rates among the taxpayers or by not valuing/billing/collecting all properties, respectively, by not enforcing all property liabilities. Property tax relief programmes are outlined by Kitchen (2013: 29ff).
- 27.
The revenue cost could be estimated if the average tax liability per property and the number of exempt properties is known. However, it has to be kept in mind that most exempt properties are well-located governmental properties; therefore, the revenue cost is a gross underestimation, see Mathur et al. (2009: 34):
RCEX=(NEX) [\( \frac{TD\ }{AP} \)];
RCEX=Estimated revenue cost of exemption
NEX=Number of exempt property
TD=Property tax demand for taxable properties
AP=Number of taxable properties assessed.
- 28.
Within the assessment, it is not required to determine an absolute value in market terms, but the relative value of properties at a common point in time (Dillinger 1991: 16).
- 29.
A well-functioning property market implies that properties can be sold and bought on an open and competitive market. In this case, the property value reflects the highest and best use of the property and market price would equal the capital/market value (RICS 2012: 32f).
- 30.
The distribution of the tax burden differs between rental value and capital value. The capital value will place a higher proportion of the tax burden on underdeveloped property such as, for instance, vacant land.
- 31.
Some counties make use of hybrid approaches, capital value for residential properties (owner occupied) and rental value for commercial property (rental occupation).
- 32.
- 33.
Market value is determined by demand and supply factors and specific location factors that include the quantity and/or quality of public services. According to RICS (2014a, b: 9) “market value” is defined as: “... the estimated amount for which a asset or liability should exchange on the date of valuation date between a willing buyer and a willing seller in an arm’s length transaction after proper marketing and where the parties had each acted knowledgeably, prudently and without compulsion.”
- 34.
Tax rate = (expenditures needs − non-property revenues)/(total assessed value).
- 35.
Whereas a minimum tax rate may avoid distorting tax competition (property tax decisions play a role in intra-regional location decisions, hence there could be a race-to-the-button), a maximum tax rate avoids distorting tax-exporting (which happens especially when setting higher rates on commercial properties) (Kitchen 2013: 17).
- 36.
The same benefit-rule applies as between municipalities where different levels of public service provision are reflected in different tax rates. They are an indicator for public service differences if Tiebout-like municipalities are given.
- 37.
Proportional rate: As the value of property rises the tax liability rises by the same percentage;
Progressive rate: As value/size increases, the tax takes an increasing percentage of value/m2;
Regressive rate: As value/size increases, taxes take a smaller percentage of value/m2.
- 38.
Dillinger (1991: 4) states that the poor performance of the property tax is partly technical. If the tax administration in developing countries would increase the coverage and collection efficiency, the revenue would increase substantially.
- 39.
Properties and taxpayers are usually identified by making use of a geographic reference system such as parcel maps or (as in United Kingdom) street maps with a street address system.
- 40.
Assessing and taxing wealth is quite complex from the administrative perspective, which would be based on the ability-to-pay principle. Therefore, it is more appropriate to tax income from property/wealth instead of wealth only.
- 41.
The frequency of re-assessment recommended by the International Association of Assessing Officers (IAAO) is four to six years for physical reviews and property re-inspection (IAAO 2013: 12).
- 42.
Assessors are still necessary within this approach as they have to test assessments according to their accuracy, equity, and uniformity by the application of standard statistical measures (e.g. ratio studies, coefficient of dispersion, and coefficient of variation) (McCluskey 1999: 29). Further, they have to identify property features that explain selling prices. Thereby, they further improve the mass-appraisal system.
- 43.
Dillinger (1991: 30) got to the heart of deciding upon central or decentral tax administration by stating: “The choice between central and local administration can be characterized […] as trade-off between indifference and incompetence.”
- 44.
Defining ownership is a difficult matter, as much of the urban periphery land in Africa has never been formally adjudicated. The same holds for Latin America, where some formally adjudicated land has been illegally occupied (Dillinger 1991: 25).
- 45.
The penalties imposed have high political and administrative costs. In the case of the administration, they may not pay off directly but perhaps indirectly by increasing the overall tax compliance/collection performance.
- 46.
The method used here is based on a simple model of ratios (see also Linn 1980; Bahl and Linn 1992; Lewis 2003). Bahl and Martinez-Vazquez (2007: 11) formulate a similar equation putting the property tax revenue to GDP, which makes the formula a benchmark for cross-referencing administrative performance among different countries.
- 47.
A combination of administrative failure on coverage, valuation, and collection/enforcement even reinforces the negative impact in a multiplicative manner on the tax revenue.
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Salm, M. (2017). Theoretical Insight on the Property Tax. In: Property Tax in BRICS Megacities. Contributions to Economics. Springer, Cham. https://doi.org/10.1007/978-3-319-62671-0_2
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