Ad valorem tax
|Types of Tax|
|Ad valorem tax · Consumption tax |
Corporate tax · Excise
Gift tax · Income tax
Inheritance tax · Land value tax
Luxury tax · Poll tax
Property tax · Sales tax
Tariff · Value added tax
|Flat tax · Progressive tax |
Regressive tax · Tax haven
An ad valorem tax (Latin for "according to value") is a tax based on the value of a transaction or of property, which may be real estate or personal property. An ad valorem tax is levied as a percentage of the value of the item it is imposed on, and not on the item's quantity, size, weight, or any other such factor. This can be contrasted with direct taxes, such as excise tax, which charges a fixed rate for each unit of goods produced (for example the specific tax on gasoline or tobacco).
An ad valorem tax is typically assessed when property is purchased, in the form of a sales tax or value added tax (VAT), although it may be levied later on a set basis, such as once a year or once a quarter. Ad valorem taxes can also be assessed on estates, imports in the form of tariffs, and in other circumstances where property of value changes hands, such as inheritance tax. It may also be charged on land alone, known as land value tax.
Types of Ad Valorem taxes
Ad valorem taxes can be based on ownership of a real asset, such as property taxes, or they can be "transactional taxes," such as sales taxes. While property taxes are determined and levied annually, transactional taxes are levied only at the time of a transaction.
Ad valorem property taxes are levied on real or personal property by local government units including counties, municipalities, school districts, and special taxing districts. Real estate, real property, or realty are all terms for the combination of land and improvements. Ad valorem property taxes are typically a major, if not the major, revenue source for both state and municipal governments. Municipal ad valorem property taxes are commonly referred to as simply "property taxes."
An owner of real estate or other property pays this tax on the value of the property. The revenue is used by the local governments in developed countries to supply public services which range from those that exhibit mainly private goods characteristics, such as water, sewers, solid waste collection and disposal, public transit, public recreation, to those that exhibit mainly public goods characteristics, including local streets and roads, street lighting, fire and police protection, neighborhood parks, and so forth (Kitchen 2003).
As ad valorem means a tax on goods or property expressed as a percentage of the sales price or assessed value, these are in the domain of assessed values (as it is the only way to get an estimate of the “sales price.”) There are three species or types of property:
- Improvements to Land (immovable man made things), and
- Personal property (movable man made things).
The taxing authority requires and/or performs an appraisal of the monetary value of the property, and tax is assessed in proportion to that value. Forms of property tax used vary between countries and jurisdictions. Generally, ad valorem taxes are computed as a percentage of the assessed value of the property being taxed.
The assessed value of property generally means the annual determination of fair market value. "Fair market value" is usually defined as the price that a willing buyer would pay and a willing seller would accept for property, neither being under any compulsion to buy or to sell. It is also defined as the price at which property would change hands between a willing buyer and a willing seller when both have reasonable knowledge of all the facts necessary and neither is required to buy or sell. Most taxing authorities require periodic inspections of the subject property as part of the valuation process and establish appraisal criteria to determine fair market value.
However, there is no uniform tax base that applies everywhere. In some countries, the property tax is based on property value as determined by:
- market value,
- site value, and/or
- rental value.
In other countries, the tax is based on building area and property area - this is referred to as unit value. A mix of these approaches may also be employed.
Land Value Tax
Land value taxation (LVT) (or site value taxation) is an ad valorem tax where only the value of land itself is taxed. This ignores buildings, improvements, and personal property. Because of this, LVT is different from other property taxes on real estate — the combination of land, buildings, and improvements to land. Every jurisdiction that has a real estate property tax has an element of land value tax, because land value contributes to overall property value (Ginsberg 1997).
In 1879 Henry George published Progress and Poverty in which he promoted a single tax on land, the "land value tax," based on the unimproved value of the land, namely the value that the land would have in its natural state. His idea was based on David Ricardo's theory of rent, and it was not a new idea, having been embraced by many important figures including: John Locke, Adam Smith, Thomas Paine, Thomas Jefferson, and more recently, Milton Friedman.
George argued that this tax would be sufficient to support all government programs, thus being the "single tax." The idea was to tax the rent of land and natural opportunities—that is, to recapture rent for public use—rather than to tax labor and capital. He noted that generally taxes 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. The value of land comes from two components, its natural value and the value that is created by improving it (by building on it, for example). Because the value of the unimproved land is unearned, neither the land’s value nor a tax on the land’s value can affect productive behavior (Hooper 2008).
A sales tax is a consumption tax charged at the point of purchase for certain goods and services. The tax is set as a percentage of the value of the item by the government charging the tax. There is usually a list of exemptions. The tax can be included in the price (tax-inclusive) or added at the point of sale (tax-exclusive).
Types of sales tax include:
- Seller or Vendor Taxes: Percentage added to each sale; vendors sell to both, manufacturers and consumers
- Consumer Excise Tax: Commonly included in the price of a product, such as cigarettes or alcohol, as well as in the price of an activity, often gambling; mostly specific tax, rarely ad valorem)
- Retail Transaction Taxes: Imposed on the retail sale transaction itself, with the primary liability for paying the tax falling upon both the sellers and the purchasers. Sellers are responsible for collecting and paying the tax, and purchasers are responsible for paying the tax that the sellers must collect and pay. In essence, this type of sales tax is a hybrid of the other two types. Operationally, however, it's closer to a consumer excise tax because sellers are not given the option to absorb the tax.
- Value-Added Taxes (see below for details)
Most sales taxes are collected by the seller, who pays the tax over to the government. The economic burden of the tax usually falls on the purchaser, but in some circumstances may fall on the seller. Sales taxes are commonly charged on sales of goods, but sales taxes may also be charged on sales of services.
Ideally, a sales tax is fair, has a high compliance rate, is difficult to avoid, is charged exactly once on any one item, and is simple to calculate and simple to collect. A conventional or retail sales tax attempts to achieve this by charging the tax only on the final end user, unlike a gross receipts tax levied on the intermediate business who purchases materials for production or ordinary operating expenses prior to delivering a service or product to the marketplace. This prevents so-called tax "cascading" or "pyramiding," in which an item is taxed more than once as it makes its way from production to final retail sale.
Value-added tax (VAT)
The Value Added Tax (VAT) is a form of consumption tax that taxes all business profit and labor. It was invented in 1954 by French economist, Maurice Lauré, joint director of the French tax authority. By the end of the twentieth century it had been adopted throughout the European Union and in many countries in Africa, Asia, and South America. Notably, the United States did not follow suit.
VAT is an indirect tax because the retailer is responsible for paying the tax, though the consumer will pay higher prices. VAT is different from sales tax in that VAT is charged to the consumer only on the value added by the retailer. The tax is levied on the value added to the product at each stage of its manufacturing cycle as well as the price paid by the final consumer. Commonly, the seller at each stage subtracts the sum of taxes paid on items purchased from the sum of taxes collected on items sold; the net tax liability is the difference between tax collected and tax paid.
So, for instance, if the cost is $10, and the selling price is $25, the retailer is only responsible for paying VAT on the extra $15. The manufacturer is also due to pay VAT on the value added by their stage of production. The tax is levied on the value added to the product at each stage of its manufacturing cycle as well as the price paid by the final consumer. The cost of materials, subcomponents, tools, equipment, facilities, supplies, and so forth, and any services purchased from other businesses, are not retaxed under the VAT. Those purchases would have already been subjected to the VAT by the supplying businesses.
Positive and negative aspects
Let us start with Land value tax. As there is a belief that markets generally allocate resources efficiently, the best tax is one which creates the least distortion of market incentives. A tax on the value of land meets this criterion. Furthermore, the benefits of local government services will be reflected in the value of land within the locality. Therefore, it may be deemed fair that landowners pay taxes to finance these services in proportion to the value of the benefits they receive. Henry George was right that other taxes may have stronger disincentives, but economists now recognize that the single land tax is not innocent, either. Site values are created, not intrinsic. Why else would land in Tokyo be worth so much more than land in Mississippi? A tax on the value of a site is really a tax on productive potential, which is a result of improvements to land in the area. Henry George’s proposed tax on one piece of land is, in effect, based on the improvements made to the neighboring land (Hooper 2008).
Rothbard (2004) argued that there is no such thing as a "neutral tax" — a tax that will leave the market free and undisturbed. Consumption taxes, such as sales tax and VAT, are regressive, with the result that lower income people have the greatest burden. To offset this, necessities are often taxed at a lower rate than luxury items. Advocates of such taxes contend that it is an efficient method of raising revenue, and would permit concomitant reductions in income tax. Opponents argue that, as a regressive tax, it puts too much burden on those who are least able to afford it. On the other hand, when the burden of taxation is placed on the producers, a the French economist, Jean-Baptiste Say, has pointed out: "taxes, over time, cripple production itself." (Say 1880, 447).
Nevertheless, given that some form of taxation is necessary—to finance government and government run programs which exist to benefit society—such taxation should be fair and efficient. As the above discussion has revealed, ad valorem taxes tend to be relatively high on efficiency, being hard to avoid and easy to collect, but there are issues of fairness, such as the regressive nature of consumption taxes and the issue of how to place a value on land.
As Say (1880) noted, "the best scheme of [public] finance is, to spend as little as possible; and the best tax is always the lightest." The challenge, therefore, is to ensure that ad valorem taxes cause the least possible damage to society as a whole, or at least are less damaging than alternative forms of taxation such as income tax.
ReferencesISBN links support NWE through referral fees
- Fisher, Glenn W. 2002. "History of Property Taxes in the United States" EH.Net Encyclopedia, edited by Robert Whaples. Retrieved October 21, 2016.
- Foldvary Fred E. 2006. "The Ultimate Tax Reform: Public Revenue from Land Rent" CSI Policy Study, Civil Society Institute, Santa Clara University. Retrieved October 28, 2016.
- George, Henry.  1997. Progress and Poverty. Robert Schalkenbach Foundation. ISBN 978-0911312584
- Ginsberg, Steven. 1997. Two cheers for the property tax: everyone hates it, but the property tax has some good attributes that make it indispensible, Washington Monthly, October, 1997. Retrieved October 21, 2016.
- Hooper, Charles L. 2008. Henry George (1839-1897) The Concise Encyclopedia of Economics. Retrieved October 28, 2016.
- Kitchen, Harry. 2003. “Local Taxation in Selected Countries: A Comparative Examination.” Prepared for: The Consortium for Economic Policy Research and Advice, Association of Universities and Colleges of Canada.
- Netzer, Dick. 1993. "Property Taxes: Their Past, Present, and Future Place in Government Finance," in Urban Finance Under Siege, Thomas R. Swartz and Frank J. Bonello (eds.), Routledge, 51-78.
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- Rothbard, Murray. 1977. Power and Market: Government and the Economy. Kansas City, KS: Sheed Andrews & McMeel. ISBN 0836207505
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- Schlatter, Richard. 1973. Private Property: The History of an Idea. Russell & Russell. ISBN 978-0846216971
- Stiglitz, Joseph. "Joseph Stiglitz: October 2002 Interview," with Christopher Williams, of the Robert Schalkenbach Foundation, Geophilos, Spring, 2003. Retrieved October 21, 2016.
- Swartz, Thomas R., and Frank J. Bonello (eds.). 1993. Routledge. ISBN 978-1563242250
- Vickrey, William. 1996. "The Corporate Income Tax in the U.S. Tax System,” Tax Notes 73, 597, 603.
All links retrieved June 15, 2023.
- Ad Valorem Tax Investopedia
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