Usually the Best Available Tax, but It's a Complex Question

IntroductionThe property tax is a highly unpopular tax. Not only do survey respondents consider it unfair, states across the country have long imposed limitations of various kinds on property tax revenues. Not surprisingly, local government reliance on property taxes in the United States has declined during the past few decades. In 1977, the year before California enacted Proposition 13, property taxes accounted for 81 percent of local government tax revenue and 59 percent of the own-source general revenues of local governments. In 2010, these percentages stood at 75 and 48 percent, respectively. Nevertheless, the property tax remains the mainstay of local government finance in the United States, with local government collecting $462 billion in property tax revenues in the 12 months ending July 2012 (U.S. Census Bureau, 2012).Attempts to further restrict property tax use may accelerate in the near future. The sharp drop in housing prices in many parts of the country, the continued economic uncertainty, the aging of the population, and the retirement of the baby boom generation are all likely to increase political opposition to the property tax.The Point oj Contention statement implies that a shift from the property tax to alternative sources of revenue will result in a reduction in the overall efficiency and the fairness of local public finance in the United States. Although a strong case can be made on both efficiency and equity grounds for the superiority of the property tax relative to a local sales tax, continuing uncertainty about both the efficiency and incidence of the property tax prevents us from making definitive statements about the superiority of the property tax relative to a local income tax.EfficiencyAny tax levied by a local government could potentially influence individuals to take actions to avoid the tax. As long as tax rates differ across jurisdictions, high property tax or local income tax rates may encourage households or businesses to move to a lower tax jurisdiction. If sales tax rate differentials are large, high local sales taxes are likely to encourage some consumers to make their purchases in places with lower rates.1 Because avoiding local sales taxes is in most cases relatively easy compared with moving to a community, one can conclude that property taxes and local income taxes are superior on efficiency grounds to local sales taxes. Comparing the efficiency of income and property taxes is much more complicated.Whether any tax is likely to distort behavior depends on demand and supply elasticities and, consequently, on the incidence of the tax. Although economists generally agree that the burden of the income tax falls on those who earn income, the incidence of the property tax remains quite controversial. Probably the most widely accepted theory of property tax incidence is the capital-tax view, which was previously called the new view. Under this view, if the supply of capital in the United States is inelastic and if all real property is taxed at the same rate, capital would flow away from real property in the long run, and the burden of the property tax would fall on all owners of capital. Under the more realistic assumption that capital will flow out of the country in response to a lower rate of return, some of the property tax burden will likely be shifted to labor.The property tax, of course, is not a national tax, and property tax rates vary substantially. According to the capital-tax view, the incidence of the deviations from the national average property tax rate will be borne by the users of capital, because capital will tend to flow from jurisdictions with above-average tax rates to places with below-average rates. These so-called excise tax effects will lower wages on (immobile) labor, raise local prices (including rents), and reduce the returns to land in jurisdictions with above-average tax rates, with the opposite effect in jurisdictions with below-average tax rates. …