Can We Replace the Property Tax?

Property tax repeal would put roughly 70 percent of local tax revenue on the line—forcing states and localities to find something else. Can sales or income taxes really replace it without major rate spikes, burden shifts, and anti-growth incentives? 
 
Kyle Hulehan is joined by Jared Walczak, Vice President of State Projects at Tax Foundation, to unpack the math behind replacement plans, the trade-offs voters should know about, and why reform may beat repeal. 

Transcript

Kyle Hulehan: 0:00

Hello and welcome to the Deduction Attacks Foundation podcast. I'm your host, Kyle Hulehan, and today we are joined by Jared Walczak, vice President of State Projects here at the Tax Foundation. Now, today we're gonna talk about the property taxes and. To frame this sort of whole discussion, I wanna set us up here with, what if I told you that eliminating the property taxes, which is something that, everyone would love to do could actually make communities worse off? That's sort of the thesis for today's podcast and what we're trying to dive into and, and understand about this. Um, so Jared, as we're we're looking at this, obviously people hate the property tax, you know, why could repealing the property attacks actually make people worse off?

Jared Walczak: 0:47

thanks for having me. And you're right, of course, that the property tax is an unpopular tax. Uh, economists tend to like it. Uh, most people, most taxpayers do not. Partly that's because they feel it. Right. You know, if you look. At what you owe in property taxes, you actually know what that amount is. Do you get a bill? You, you know, you pay it maybe a couple of times a year, once a year, twice a year. Uh, you don't know what you paid in sales taxes last year. A lot of people don't even know what they paid in income to taxes last year. This is a big lump sum of money. People really dislike it. And then people have philosophical objections as well. And I take those seriously, although I don't necessarily share some of them, but certainly this is an unpopular tax, but it's also a really important tax. It's 70% of local tax revenue nationwide. In some states it's as high as 95%. So if you're going to eliminate the property tax, you need a replacement. Multiple replacements, and the reality is that anything we choose to replace the property tax with is likely to be worse and worse along multiple vectors. It's worse economically in the sense that any replacement tax is going to create more economic distortions. It's going to hurt economic growth compared to the property tax, which is relatively efficient economically. It's worse for communities because many of the replacements, uh, just don't work very well in their communities. If, you know, we'll go into some of this, I'm sure, but if we're replacing this with local tax authority, sometimes there really isn't another local tax that could suffice if we're replacing it with state tax authority and we're distributing that revenue from the state. All kinds of challenges with how the state chooses to allocate that revenue and what that does and what incentives it creates at the local level. There's a reason why every state has property taxes at the local level and why no state has ever repealed property taxes. I know that's very much being discussed right now. It's a discussion that we need to take seriously, but there are good reasons why it hasn't happened yet.

Kyle Hulehan: 2:48

So to dive a little further into that, given how much the governments rely on property taxes, what actually breaks when we try to replace them?

Jared Walczak: 2:56

A lot of things potentially break. I mean, obviously if we don't replace the revenue, everything breaks. I mean, local governments. Fund a significant share of local roads. They often have obligations for local schools, or at least a major portion of that. Uh, police, fire, uh, local utilities in some cases. Uh, all the things that you rely on at your local level from parks to waste disposal, local taxes fund a substantial share of this. So we need that revenue. We can always have the debate about is local government funded at the right level? Could they be more efficient? But there's no question that they need a substantial amount of revenue, and the property tax is the way that they're getting a lot of that right now. So it has to be replaced, at least substantially replaced. And what breaks essentially is the ability to generate it from some other source. If we. Provided local sales tax authority in lieu of local property tax authority. That may work in an area with high retail concentration, where there's lots of shops, lots of stores, um, it doesn't really work in a bedroom community. It doesn't really work in an agricultural area. There's just really not a sales tax rate that you can set. That's even remotely reasonable, that would generate enough revenue. And if you have a highly unreasonable sales tax rate, well people are probably gonna just drive across the border to a county that has a slightly more reasonable one, or maybe to a state that has a more reasonable one. You're going to see that sort of casual evasion of the sales tax. Uh, same goes for local income taxes, and if you put it on the state, then not only are you going to have really high taxes in some other category, really high income taxes or really high sales taxes, but. As I'd like to get into with you throughout this, uh, you're gonna see some real distortions and some real perverse incentives that are created around distributing and allocating that revenue to local governments.

Kyle Hulehan: 4:49

And, and real quick just to follow up on this, for our audience, have you seen, or is there anything in your mind that we've done here at the Tax Foundation or worked on that kind of backs up the idea that behavior will change based on certain tax rules, like the things that you mentioned right there?

Jared Walczak: 5:04

Well, there's a broad literature on the way that people respond to tax changes, and you can respond in a lot of ways. So if you have massive sales tax differentials with, uh, a county border or a state border, you are certainly going to see people crossing state lines to purchase things in a lower tax. Uh, businesses can do less of this because they're going to have to pay the use tax regardless at the local rate. Although you may see them simply shift their actual operations in response to incredibly high sales taxes on their business inputs, their intermediate purchases rather than their final sales. Uh, you know, with income taxes, you will see people move somewhere else. You take examples like, say, Washington, Oregon, across that border, Oregon has no sales tax. Washington has no income tax. There's a lot of population right on that band of living in Washington and purchasing things in Oregon because they're taking advantage of those tax differentials. We also, just on a more general basis, see people moving to lower tax jurisdictions, setting up their businesses in those places, and they respond particularly on income taxes, far less on property taxes. So if, for instance, the income tax had to raise. Substantially to offset a property tax reduction or elimination. You'd see some behavioral effects there where you'd actually have migration and you'd have changes in business locations and business activity in response to that.

Kyle Hulehan: 6:32

Yeah, so you do a really great job of discussing this in your paper, which everyone needs to go on tax foundation.org and check out your work there., So why do we see, uh, with some of these alternatives, they, they don't seem practical. You know, you give this awesome example in the paper about, um, Florida statewide sales tax needing to jump from 7% to 15%. You know, why does it such a massive jump? You, could you break that down for us?

Jared Walczak: 6:59

The property tax is a really significant source of revenue. I mean, in Florida it raise is about$56 billion a year. It's projected to raise about 60 billion in the next year or so. You need to replace that revenue and that is more. Then the state currently raises from its sales tax. So the state has a 6% sales tax. You add in the local taxes that already exist and it gets to a hair over 7% on average, and you need to add, uh, another 8%. top of that to be able to offset the property tax collections that are currently in place. So you have two choices here. You could put in about a 15% state sales tax and then allocate revenue back to localities. Or you could tell the localities, Hey, you can raise your sales taxes in your local jurisdiction to whatever rate you need to replace the property tax revenue. That latter option really, really doesn't work. Uh, we mapped out, this is in the paper what the replacement sales tax rate would be, all in current rates, plus the new rates in every county in Florida. And you can find one tiny little county that basically has almost no population, but has a big truck stop. In it. Lots of, uh, you know, lots of people coming through and spending money. They would only need like a 9.8% rate. That's doable. I mean, there's plenty of jurisdictions in the South that have rates that are around 9.8%. another jurisdiction that needs a 35% rate. That's just not doable. No one can have a 35% sales tax rate, and of course there's a lot in between. There are a lot of other jurisdictions that would have high sales tax rates because they're bedroom communities, or they're rural or they just don't have that retail concentration. Everyone would get some sales tax, but in many cases there's just not enough locally to replace the property tax.

Kyle Hulehan: 8:47

in the paper you discuss, uh, an example with Ohio on income taxes. Could you break that down for us? I think that's a good example for our listeners

Jared Walczak: 8:54

Yeah, so in Ohio, again, you have a choice. You can have a much higher statewide income tax, or you could have local income taxes. And Ohio already has local income tax authority. They're one of the few states that significantly relies on local income taxes. So. If you were to have a statewide tax, Ohio is phasing down towards a flat 2.75% income tax, which will be really low at the state level. They still have the locals. If you were to replace the sales tax, you would need to bring that to a 12.6% flat tax. would be paying 12.6% on all of their income. That's pretty close to the top rate in California on income over$1 million. And this would be in Ohio. Uh, I just don't think that's viable. And it would be even more challenging if you were to do this with local tax authority. There you would see rates ranging from 9.75% to about 27%, and some of those highest rates are actually right along the Ohio River on the border with West Virginia, along the West Virginia panhandle. So you could just drive across the border to West Virginia. You could live there. Um, even if your job was in Ohio, you could live in West Virginia. And I'm sure you would see some of that. I'm sure just generally you'd see people leaving the state because it's just not viable to have taxes on income at these levels. Uh, there's reasons why we. Typically have multiple taxes in a jurisdiction. Um, and doubling down on income taxes like this just doesn't seem like a realistic solution.

Kyle Hulehan: 10:30

So then what new risks emerge when states take over some of that local funding? Especially for, for fairness, growth, and, and community control.

Jared Walczak: 10:40

Yeah, there are a lot of problems when the state assumes this authority because they need to, in some way decide how to. Return this money to the local governments. they could just take the final year of tax collections in any jurisdiction and use that as the baseline and provide that revenue to them in perpetuity, probably with some adjustment. What that does, of course, is reward the jurisdictions that had the highest tax rates in the past because you have some areas, often more affluent areas that have chosen to have relatively high property tax rates, but they also get the services that are associated with being a more highly funded jurisdiction you shift this to state authority. Those places continue to get all of the revenue. having higher taxes, but they're not paying more. Now. Everyone has that cost. Everyone is bearing the cost of subsidizing them. That's probably not going to be very attractive to all of the jurisdictions that historically had lower taxes. The flip side, of course, is if you choose some other way to allocate this, if you choose some other formula based on need or population or something that's not about what. used to be raised. Now you have these dramatic gaps where a jurisdiction that used to get a certain amount might be getting dramatically less. Another place might be getting dramatically more because of this new funding formula. Uh, that's going to create some crises too. Uh, you know, if suddenly you're getting 30% less revenue. What are you going to do with that? That's a real issue. Um, and then the question is, what do we do going forward? We can't use property values as a determinant of the allocation in future years because who is going to be assessing properties without a property tax? So we have to use something else. We could do an inflation adjustment. We could do inflation in population. There's a variety of things that we can do, but all of them are potentially deeply flawed. Essentially we're in some ways locking in the system as it existed when we eliminate the property tax. A jurisdiction that grows rapidly gets not just new population, but new investment and requires new services to be provided to them. Might not get the increases associated with that when the state is providing this by formula that they would, if they were generating new property tax revenue from all that new activity. So now. The dollars get spread thin. The more you grow, the faster you grow, the fewer dollars per capita you're getting, that actually encourages you to shrink. Instead of promoting economic dynamism, instead of saying, growth allows us to either have more revenue or to lower property tax rates and make the place more competitive. Now you're saying growth means that each dollar. cover as many people that like that every person is getting less than they used to. That encourages you to shrink rather than to grow. That's the exact opposite of what you would want to see.

Kyle Hulehan: 13:34

Well, it sounds like what you're saying is this will increase complexity quite a bit. What do you think maybe people are, are misunderstanding about the, the value of the property tax?

Jared Walczak: 13:47

Despite its unpopularity, the property tax is a pretty good tax. It's closer than most taxes to passing what we call the benefits test, where you are paying more in proportion to receiving greater value, uh, in local services. If you have a more expensive property, the value of the roads and the schools and everything else actually is worth more to you. They also have a feedback effect. Better schools mean your property's worth more, uh, so it's not a perfect tax. it's pretty good and it's very economically efficient compared to other taxes because there are fewer responses, economic responses to the property tax. The land's not going anywhere, so you can't pick up and move it in the same way that you can, a person or a job or a capital investment. So. It's good in that it doesn't distort behavior as much. Again, not perfect, but we're in the realm of taxes. Nothing is perfect. we shift to is going to create more economic drag. It's going to reduce economic growth and output. It's also going to require these really hard choices about where the revenue comes from, how high we want another tax to go, and how much shifting. We're willing to allow if everyone is paying more in income taxes or more in sales taxes, and then it's transferred through the property tax, that means radically different distributions. It's not like you as an individ individual, pay more in income tax, pay less in property tax than it's a wash. You may be paying more in income tax while your jurisdiction because you know either. had lower property taxes to begin with, or the new formula leads to a lower allocation. You're paying way more in income taxes than you're getting in property tax replacement revenue. Um, you know more than you were paying in property tax previously. Someone else might have the opposite. They may love this, but of people are going to find they're paying more. Some people would pay less. A lot of jurisdictions are going to find that they're cash strapped, that they're not getting the revenue. They thought while others might be awash with cash, even though they're shrinking in population, which is not where presumably we want to, you know, have this additional, you know, revenue just fundamentally, it's really hard to plan around. There's a lot of complexity to it. Any choice the state makes, potentially changes behavior in very undesirable ways. Things that just don't make a lot of sense.

Kyle Hulehan: 16:05

So why do you feel like some of these campaigns to repeal the property tax maybe don't? Uh. Live up to their expectations or, or what voters should want. Maybe they're not detailed enough or they don't provide enough clarity.

Jared Walczak: 16:22

So again, property tax repeal is popular. If you simply lead with that, wouldn't it be great if we eliminated your property taxes? I think a lot of people are going to sign up for that. They're gonna say, yeah, that sounds great, and what a lot of the proposals are missing. A serious discussion of replacement revenue. fact, many of the ballot measures that have been proposed even have that. They simply say the property tax will be repealed, and then it's incumbent upon the legislature once it's gone to figure out what the replacement revenue is. And I think that's backwards. I don't think you can have a serious discussion about this without talking about what the replacements are going to be and whether they're better or worse, and I really don't think that it's acceptable to have a situation where this revenue stream is just eliminated. And then after the fact, the legislature has to rush in and find something else. Again, there's a reason that no one's done this. It's really, really hard and we can have a discussion and a debate around whether there is a better alternative. I don't believe there is. I think the economic evidence is pretty clear. I think the alternatives. Speak for themselves when you really look at them, and that's what this paper is meant to do. We take six states where there's been a serious discussion about property tax elimination, and we show all these different ideas about how you might replace the revenue and what happens with that. How the distributions change. How the tax rates change. And I think people can look at that and say, maybe that's not what we wanted, but they're not being given that opportunity. Some of the ballot measures that are out there, and I worry about a situation where voters say, yeah, absolutely. Get rid of my property taxes. And then the legislature goes into session and has to come up with a replacement for potentially billions and billions of dollars of revenue overnight. Do we think that's going to work well? Do we think people are going to be happy with the results? And then what does happen when you are one of those loser jurisdictions that's down 30 or 40 or 50% in your revenue? What do you do now? Uh, what does that look like? And do we have another crisis? The legislature has to respond to the following year.

Kyle Hulehan: 18:24

there's A through line here with, uh, politics and sort of the popular. What's a popular idea and what's good policy? We've had president Trump propose all the no tax ons, and those things are very complicated and complex and, but they sound really nice and, and it sounds nice. It sounds like, oh cool, we're gonna eliminate the property tax. This would be great. But actually it's. Really harmful for us, and it doesn't benefit us in the way we'd like. It's a nice tagline, but it, it doesn't actually do much for us. Um, and, and so right now I, I'd wanna switch real quick into, I made this little lightning round because there are things I've heard my friends say, and I just kind of wanted to do like a myth or fact with you real quick. Um, and so we'll lightning around this. I'll give you a quick second to respond. So, is this. Is this true or false? Is it myth or fact? Uh, sales taxes are more pro-growth, so just switch.

Jared Walczak: 19:17

Well, in fact, they're not. Um, sales taxes are more pro-growth than income taxes, but less pro-growth than property taxes. So doubling down on the sales tax to the exclusion of the property tax is actually less pro-growth. And part of that's just the way we design sales taxes in this country where they're taxing a lot of. multiple times over. If we had a better sales tax, the difference wouldn't be quite as much, but no, uh, the answer is no. Um, false. This would actually make the tax code less competitive if we shifted away from property taxes, even to sales taxes. But it's even worse if we shifted into income taxes.

Kyle Hulehan: 19:52

So myth or fact, renters don't pay property taxes taxes.

Jared Walczak: 19:56

Essentially myth. Uh, they don't obviously write a check. Uh, renters are not remitting property taxes to the local jurisdiction. The landlord is, but you know, there's a large literature on this and there are some disagreements on the exact amount that the renters bear, but everyone agrees that a very substantial portion of the property tax shows up. In your rent payment, and you can even see this when property taxes go up, that rent prices increase faster. Um, it can take a couple of years. Again, it's not always perfectly one-to-one, but over time, most, if not all of the cost of the property tax is born by the renter themselves. Sometimes there's these proposals that just provide relief to homeowners and that really leaves renters out. And some states even make it worse by taxing commercial property at higher effective rates and often classing, rental units as commercial property, which means that of the lower income individuals who are renting are bearing higher property taxes than the owners of homes, um, but certainly everyone's paying property taxes if we eliminated the property tax, that provides relief for everyone there. But it also, of course, means a vast array of new taxes that everyone will be paying as well.

Kyle Hulehan: 21:16

So as we're wrapping up here, Jared, uh, why is the property tax despite being so unpopular, as we've talked about the most stable, fair and growth friendly option that we have?

Jared Walczak: 21:25

The property tax, as we've discussed, is on largely fixed immovable assets. You cannot move your. Land. Um, you can choose where to build structures. You can choose some of these things, but the fact that it's a fairly fixed asset means that there will be fewer behavioral responses to it. Also, the fact that, as we've discussed, it better passes the benefit test means that. You're getting more for your money when you're paying more, uh, in a way that's not always true of the sales tax or the income tax, and therefore you're more willing, you may not like it. I mean, none, none of us really likes paying taxes. But when you look at the alternatives, you may find that your willingness to pay that as higher, even if you do complain about it, um, you know, certainly we see that with businesses. We see it with a lot of individuals where they locate. This is what, you know, economists call revealed preference. Um, you know, because you have your revealed preference of you actually do as opposed to your stated preference of what you dislike. You can say, I don't like property taxes. I don't want to pay them. Your revealed preference is sometimes you're not going to the lowest property tax jurisdiction in the same way that you might go to a lower tax regime for income taxes because of what the property tax is doing. And then finally. There is a local responsiveness to this tax that you don't have with others. When you don't like that your property taxes have risen. You can go to city council, you can go to your county board of supervisors or commissioners or whatever you have, and you can complain about this and you may have a real impact on them. If the state takes over this authority with a higher income tax or a higher sales tax and they allocate this, it's going to be way harder. For you to petition on this and even if you would be willing to accept lower government services or if even if your local government really cares about efficiencies and they want to be better with their money, they can't control what comes to them or what taxes are imposed on you to do this. So that local responsiveness piece is important and is fundamentally missing if we move away from the property tax.

Kyle Hulehan: 23:24

All right, well, before we sign off, if you have any burning questions on tax, you can send them our way or drop a comment on YouTube. You can email us at podcast@taxfoundation.org. You can slide into our dms at Deduction Pod on Twitter. Thank you so much for listening, and thank you, Jared, for being here today.

Jared Walczak: 23:41

Thank you.