Property tax

Property tax, is an ad valorem tax that an owner of real estate or other property pays on the value of the property being taxed. The role for this tax is that the local governments in developed countries supply a range of services, 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 (local streets and roads, street lighting, fire and police protection, neighbourhood parks, etc.) from it.

Historical Overview of Property Tax

The Physiocrats’ credo, in 18th century, more or less was:

“…….It is from the right of property, maintained in all its natural and primitive fullness, that all the institutions which make up the essential form of society necessarily flow: you can think of the right of property as a tree, and all the institutions of society are the branches which it shoots forth, which it nourishes, and which perish when they are detached from it…” ( Schiatter, 1951 ).

Quesnay’s Fourth Maxim claims: “…..That the ownership of the landed properties and the mobile wealth be assured to those who are their legitimate possessors; for the of property is the essential fundamentals of the economic order of society…..”( Oncken, 1888, p. 331).

When Quesnay argues that “the security of property is the fundamental essential of the economic order of society,” the reason he advances for its necessity is that: “…….Without the certainty of ownership, the territory would rest uncultivated. There would be neither proprietors nor tenants responsible for making the necessary expenditures to develop and cultivate it, if the preservation of the land and produce were not assured to those who advance these expenditures. It is the security of permanent possession which induces the work and the employment of wealth to the improvement and to the cultivation of land and to the enterprises of commerce and industry…..” ( Oncken, 1888, pp. 331-332).

But Physiocratic property theory also encompassed the reasoned modification-reconstitution of such rights as necessary to maintain and strengthen the same social interest by which private property itself was sanctioned.

The evidence recorded below suggests that the Physiocratic theory of property rights is more nearly a theory of “social utility” than a theory of exclusive or absolute private dominium.

Such a view was propounded by de Tocqueville, when he observed that the Physiocrats had neither concern nor respect for contractual and proprietary rights. Such claims are minor, compared with the social interest: “…..there are no longer private rights, but only a public utility…..”( de Tocqueville, 1955, p. 159).

With respect to property, the role of the state was thus seen as an active manipulator, rather than a passive securer.

Turgot’s attitude towards “property foundations,” an attitude comparable to the Anglo-Saxon "law of perpetuities," is that “…... the government has an incontestable right. . . to dispose of old foundations, to extend their funds to new objects, or, better still, to suppress them altogether.... …Public utility is the supreme law, and it ought not to be nullified by any superstitious respect for what we call the intention of the founder - as if ignorant and short-sighted individuals had the right to chain to their capricious wills the generations that had still to be borne…….” ( Stevens, 1895, pp. 227-228 ).

When private right or private interest is not coincident with social interest, then “…public utility is the supreme law…..”( ibid. )

The major tenor of Phisiocrats ideology are the following Quesnay’s two restricitions on the use of property :” …… That a part of the sum of incomes not pass to a foreign country without returning, in money or in merchandise….. and ,that they prevent [evite] the desertion of inhabitants who would carry their wealth out of the kingdom...."( Oncken, 1888, p. 233).

In so far the property ( land ) taxes the Physiocrats were not unduly hostile to taxation per se; rather they attribute to taxation (and government) considerable positive social significance.

In short,taxation becomes less of a nemesis and more of an instrument of social utility. Indeed, L. Einaudi expresses as a principle of Physiocratic tax theory that:

“…..Tax, if kept within its rational limits, is not a burden at all. On the contrary, is a condition toward the maximization of the national dividend…, and …..., taxation for the Physiocrats was …a problem not of a burden laid on individual producer’s shoulders for the sake of keeping the consumptive governmental machine going, but... a problem of distribution between productive agents --- the State being counted among them according to his (its) proper nature --- of a total national dividend produced by the same agents……”( Einaudi, 1933, pp. 131-135 ).

It is also clear that the reconstruction of the tax system proposed by the Physiocrats would have necessarily involved the abrogation of valuable and privileged property rights of long standing.

A typical position “……The expenses of the government having for their object the interests of all, all ought to contribute to them; and the more one enjoys the advantages of the society, the more ought it to be held a matter of honor to participate in these charges……”( Shepherd, 1903, p. 108 ).

And :”…… Taxation being subject to considerations of public utility, privilege would have to give way to a rational tax administration. That such a reconstruction involved a concomitant reconstitution of property rights goes without saying ……”( ibid, p. 109 ).

To conclude: For the Physiocrats it was axiomatic that the state was responsible for the development of property, that it was through the agency of the state that property was to be reconstructed continuously in the social interest. The role of the state was thus to manipulate property law, thereby manipulating the bundle of rights that constituted property.

From the perspective of the individual holder of property, the un-interfered-with use of private property was contingent upon the consonance of that use with the public interest as defined by the state. The concept of social function was thus correlative to that of private right, and for practical purposes the former would govern the latter ( Tawney, 1920 ).

Causal relation between the Physiocrats and the modern property tax

Property taxation finances local government in the United States and other countries—not fully, but enough to make the fiscal independence of local government meaningful. This permits to decentralization of government, which may be considered a benefit because it enables citizens to exercise choice over the public services they receive. Local governments in developed countries supply a range of services , from those that exhibit mainly private goods characteristics (water, sewers, solid waste collection and disposal, public transit, public recreation and so) to those that exhibit mainly public goods characteristics1 ( local streets and roads, street lighting, fire and police protection, neighbourhood parks, etc.).

Canadian Property Tax example

The federal government of Canada, pursuant to the Constitution Act, 1982 and the British North America Act, 1867, has exclusive jurisdiction over aeronautics, shipping, telecommunications, as well as typical top-level jurisdiction over immigration, national defence, taxation, criminal justice, fiscal and monetary policy and postal services to name a few. On the other hand, the provinces have jurisdiction over property and civil rights. Accordingly, planning legislation, property tax legislation, municipal government, most highways, hydroelectricity are all provincial jurisdictions.

All but the most sparsely populated areas of Canada are governed by local municipal governments which, in most cases, exercise, through zoning and other controls, the most influential powers over land use. These powers are exercised in accordance with senior government policy and master policy plans as determined and laid down by the municipal council. These regulations are unique to each municipality, based on local preference. No generalizations can be made about the scope and nature of such local controls.

The Ontario Development Charges Act authorizes the municipalities to apply specific taxes or charges in order to pay for the infrastructure costs which the municipality might incur in any new development. These charges are intended to offset the additional costs and to ensure an adequate level of infrastructure and services for new developments.

It is the landlord who is generally liable for the payment of realty taxes to a municipality. However, the majority of office, retail and industrial leases contain clauses requiring the tenant to pay its share of realty taxes. In most provinces, realty taxes are determined by a two-step process. First, the value of the entire property is assessed by a provincial agency. Second, the realty tax is imposed and collected by the municipalities.

The assessor determines the value of the entire property by the use of one of three methods: (1) capitalizing the income stream; (2) the cost method -which is the market value of the land plus the net replacement cost of the building; or (3) direct comparison approach - comparing recent sales of similar types of property. A realty tax bill reflecting this assessment is rendered to the owner of the property (i.e.. the landlord), not to the tenants. The assessment is then apportioned amongst each separately occupied premises.

What is the Role for a Property Tax

Local governments in developed countries supply a range of services – from those that exhibit mainly private goods characteristics: water, sewers, solid waste collection and disposal, public transit, public recreation and so, to those that exhibit mainly public goods characteristics: local streets and roads, street lighting, fire and police protection, neighborhood parks, etc.( Kitchen, 2003 )).

• For services with mainly private goods characteristics, individual beneficiaries can be identified, income redistribution is not a goal, spillovers are unlikely to exist, and operating and capital costs can be measured and recorded. Here, a user fee would be relatively easy to administer and would be the best financing instrument for satisfying the principles of efficiency, accountability, transparency, and fairness( ibid.)

• For services providing mainly collective or ‘public goods’ benefits (specific beneficiaries cannot be identified), user fees are inappropriate. Instead, these should be funded from a local tax imposed on residents (or exported to the same extent services are) with necessary adjustments through the use of grants to account for spillovers; that is, benefits from these services that spill over into neighbouring communities should be funded from something other than a local tax.

Evaluation of the property

All taxable properties must be identified and described on the assessment roll ( with each property assigned a roll number ) and, above all: assessed. The roll number is important for linking assessment information with tax billing and property transfer records.

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. In a few countries, a mix of these approaches is employed. Each of these systems is briefly considered below.

Market Value of property

Market value is the price that is determined between a willing buyer and a willing seller in an arms length deal. Market value estimates the value that the market places on individual properties. For properties that sell in any year, market value is the selling price. For properties that do not change hands in the year, market value must be estimated.

There are at least three estimation methods that may be used:

• First, when markets are active and similar properties are being sold in the same or comparable neighbourhoods, a comparative sales approach could be used. This assigns a market value to an unsold property by looking at valid selling prices of similar or comparable properties.

• Second, a depreciated cost approach is sometimes used. This is most appropriate when properties are relatively new, there are no comparable sales, and improvements are relatively unique. Here, the property is valued by assigning a value to the land as if it were vacant and adding the cost of replacing the buildings and other improvements.

• Third, a capitalized income approach may be used. This is primarily for properties that generate actual rental income. Here, the annual net rental income (gross annual rental income minus annual operating expenses) is estimated with this annual net income subsequently converted to a capitalized property value (market value) using a capitalization factor.

To illustrate, if net annual rental income from a specific property is $10,000 and if the current interest rate is 5 percent (current rate of return on a bond, for example), the capitalized value of the property would be $200,000 (net rent divided by interest rate or $10,000/.05). This is also the market value because an individual would be willing to pay $200,000 for a property that generates an annual net rent of $10,000 – this is a 5 percent return and is identical to the return on bonds.

Site graded value assessment

Site value assessment (SVA) is a special case of market value assessment where only land is assessed. All capital improvements (buildings, for example) are excluded from the assessment base. Under a graded SVA system, capital improvements are included in the base and taxed at lower rates (sometimes significantly lower) than land, with the level of gradation varying according to the taxing jurisdiction's policies and practices. A form of site value assessment is used in New Zealand, Kenya, Jamaica, and South Africa ( Bahl, 1998 ).

There are two potential problems with site value assessment Evidence is scarce on the effects of a system that taxes land more intensively than it taxes buildings. A recent study has evaluated economic development in Pittsburgh after the City’s decision in 1979-80 to adopt a graded system and apply a rate to land that was more than five times the rate on structures.The study concluded that Pittsburgh did experience a dramatic increase in building activity, one far in excess of any increases in other cities in the region, but it stopped short of concluding that the change in tax policy had caused the boom ( Oates, 1997 ).

On the whole, it may seem that a graded system does encourage development, much of this development tends to be at the expense of neighbouring communities that have not adopted a similar system and that replacement of the current property tax system with either a system that taxed land alone or a graded system would generate windfall gains and losses in the short run as tax bills rise for certain properties and fall for others ( Bird, 1993, p. 82. ).

Unit-value assessment based on size of property and building

On the other hand, support for unit-value or area assessment ( based on size of property and buildings) has emerged in a couple of instances. First, it would be superior to value based assessment systems in countries or areas of countries that do not have fully functioning and operational real estate markets. Estonia, Poland, Czech Republic, Slovakia, Russia, and Armenia use it for this reason.

Similarly, it may make sense to use it in parts of countries ( Canada and Russia, for example) where there are isolated hamlets and no clearly functional market for property values because the government owns most of the housing and rents it to occupants.

Single or Variable Tax Rate ?

The issue here is whether a local taxing jurisdiction should apply a single uniform property tax rate to all properties within its taxing jurisdiction or whether variable tax rates should be used; that is tax rates that vary with the cost of servicing different properties by type or by location within a municipality.

Traditionally and historically, in Canada, as in most other countries with a history of property taxation based on property values, the practice has been to apply a single tax rate to all residential properties and a higher tax rate to all commercial and industrial properties.

However, more recently, in Canada, but not everywhere, this practice has changed. All municipalities in the provinces of Alberta, British Columbia, and Ontario are now permitted to use variable property tax rates. Other countries have also moved in this direction.

The taxation of business properties (commercial and industrial) at higher tax rates than residential properties is generally done in one of two ways:

• either through the practice of assessing business properties at higher values than residential properties with the same tax rate applied to both property types;

• or through the simple application of higher tax rates on business properties ( Netzer, 1993 ).

This over-taxation of the non-residential sector has been addressed in empirical studies in Canada and in the United States. Both Canadian studies compared the property tax paid by business properties with the cost of municipal services used by them. The first study included a number of municipalities in the province of Ontario in the early nineties.

It concluded that the residential sector when compared with the business sector is the recipient of proportionately more benefits from local government services (social services in Ontario, elementary and secondary education, libraries, recreational facilities, etc.). When combined with higher effective property tax rates paid by the business sector, it concluded that the latter is over-taxed and the residential sector under-taxed.

A more recent study in the United States found similar results. Specifically, it was estimated that the “business related” share of combined state and local expenditures in the United States is about 13 percent, although there is considerable variation from state to state. These businesses, however, pay proportionately more of the state and local taxes ( ibid. )

Spacial Factor

In reality, the extent to which firms and businesses respond to property tax differentials depends on many factors. These include, for example, the importance of being in the core of the region or area for business reasons; the opportunity to shift the tax differential on to consumers (of the final service or product), employees and owners; and the enhanced amenities that may be offered by a ‘downtown location.’

An extensive literature in Canada and the U.S. suggests that spatial factors do affect the costs of development. ( Marchand, 1992 ). In particular, the density of development and its location with respect to existing services influence the costs of providing services. For example, “hard” services such as sidewalks, roads, and water and sewer mains cost less to provide in denser neighbourhoods. With water, a pipe is laid down the centre of a street and individual service lines extend from the water main to each building. In high-density neighbourhoods, there are more dwelling units per kilometre of water main over which to spread the costs. Furthermore, increasing the distance from central infrastructure facilities such as water and sewage treatment plants will increase costs.

An efficient property tax would thus reflect the higher costs associated with providing services in less dense developments. This would generally mean that property taxes based on services received should be higher in suburban municipalities than in the core. If property taxes are higher in the core and service provision less costly, the property tax creates an incentive to move to less dense developments.

Danger of Regressiveness in a Property tax

Property tax revenues ( in the U.S. ) account for about 74% of local government revenues and 30% of combined state and local government revenues. This is down from 97% and almost 80% respectively in 1927.

Notable declines in the relative importance of property taxes occurred:

• In the 1930s and 1940s as result of the increases in state government aid for education, welfare, health and highways (financed through taxes on income, sales and highway users).

• After 1965 because of a) increased aid through the state and federal governments, and b) the proliferation of non-property taxes and user charges.

This has had an unfortunate impact on municipalities that have, therefore, shifted much of the financial burden from “progressive” income taxes to property taxes, thus creating a more “regressive” tax system and less equitable distribution of tax dollars across the states.

Income taxes are based on your ability to pay; meanwhile seniors --- and this is the fast growing segment of population in developed countries --- who own their home are facing increasing property taxes without increasing income to pay those taxes.

Hence, the real “tax reform”is addressing, or are about to, this trend of, “……the historic decline in the role of the property tax by the decision, within the fifty state-local fiscal systems, to replace local property taxes with state (and, to a much lesser extent, local) non-property taxes..."( Netzer, 1993 ).

Summary

From the above text it is apparent that the most efficient, uniform, accountable and transparent property tax systems around the world exist where the following conditions are met ( Kitchen, 2003 ):

• All taxable properties are identified, described and recorded on the assessment

roll.

• The property tax base, whether assessed value or area value, is determined in a

uniform and consistent manner across a region (as opposed to local) if not across an entire country.

• Assessment is updated as frequently as possible, ideally on an annual basis, so

that the tax base is current, uniform, consistent and fair.

• Property assessment (determination of property values or property area) is the

responsibility of an arms-length regional assessment authority in order to avoid local distortions created by local pressure groups.

• Each level of government using property tax revenues to fund expenditures is

responsible for setting its own property tax rate(s).

• Variable tax rates are used when the cost of providing municipal services varies

by property type and location.

• Variable rates, as opposed to a uniform rate, are more likely to discourage urban

sprawl and to minimize the extent to which the local property tax is exported to other jurisdictions.

• Business properties (commercial and industrial) are not over taxed vis-à-vis

residential properties.

• Limits (by a senior level of government) are not imposed on tax rates set by local

governments unless it is to prevent local taxing authorities from imposing unnecessarily high rates on commercial and industrial properties vis-à-vis residential properties.

• The existence of a large number of municipalities in a region or country creates a

competitive environment (where municipalities know what the tax rates are in neighbouring communities) that provides an incentive for all competing municipalities to set their tax rate at the lowest possible level.

• Tax billing and collection is an administrative function that benefits from

economies of scale and should, therefore, be administered on a regional basis.

• Caution should be exercised in creating specific property tax relief schemes – a

better approach comes from implementing a comprehensive tax relief scheme administered by the regional or central government.

References

ISBN links support NWE through referral fees

• Bahl, Roy, “Land Taxes Versus Property Taxes in Developing and Transition Countries,” in: Dick

Netzer, Land Value Taxation: Can it and will it work today?,.: Lincoln Institute of Land Policy, Cambridge, Mass.,1998, p. 144.

• Bentick, Brian L., “The Impact of Taxation and Valuation Practices on the Timing and Efficiency of

Land Use,” Journal of Political Economy, vol. 87, no. 4, 1979, pp.859-68;

• Bird, Richard and Enid Slack, Urban Public Finance in Canada, 2nd edition, Wiley, Toronto,1993
• de Tocqueville, Alexis, The Old Regime and the French Revolution, Doubleday Anchor, Garden City, 1955, p. 159

Stephens, Walker, (ed.), The Life and Writings of Turgot, Longmans Green, New York, 1895, pp. 227—28

• Einaudi, Luigi “The Physiocratic Theory of Taxation,” in: Economic Essays in Honour of Gustav Cassel, George Allen & Unwin, London, 1933, pp. 131-35
• Kitchen, Harry “Local Taxation in Selected Countries: A Comparative Examination,” a paper prepared fro CEPRA II, part C, 2003
• Marchand, Claude and Janine Charland, “The Rural Urban Fringe: A Review of Patterns and Development Costs,” Intergovernmental Committee on Urban and Rural Research, Toronto, 1992
• Oates, Wallace E., and Robert M. Schwab, “The impact of Urban Land Taxation: The Pittsburgh

Experience” The National Tax Journal, vol.L, no. 1, 1997, pp. 1-21.

• Oncken, Auguste (ed.), Oeuvres Economiques et Philosophiques de F. Quesnay , Joseph Baer, Paris, 1888, p. 331
• Netzer, Dick, "Property Taxes: Their Past, Present, and Future Place in Government Finance," in: Urban Finance Under Siege, (ed. Thomas R. Swartz and Frank J. Bonello) , M.E. Sharpe, New York, 1993, pp. 51-78
• Netzer, Dick, American Journal of Economics and Sociology, Dec, 2001
• Samuels, Warren J., The Physiocratic Theory of Property and State, Quarterly Journal of Economics, 75, Feb. 1961, pp. 96-111
• Schiatter, Richard, Private Property: The History of an Idea, Rutgers University Press, New Brunswick, 1951, p. 217.
• Shepherd, R. P., Turgot and the Six Edicts, Columbia University, Series in History, Economics and Public Law, New York, 1903, XVIII, p. 131.
• Tawney, R.. H., The Acquisitive Society, Harcourt Brace, New York: 1920, Chaps. II and III.

External links

• Urban Sprawl and the Property Tax
• Neutral Property Taxation
• The Property Tax as a Tax on Value: Deadweight Loss
• The Local Property Tax Literature: 100 Years of Disagreement
• Property Tax Section of Taxation World
• IPT Programs
• History of Property Taxes in the United States
• HindSite provides a historical overview of state and local fiscal politics in the U.S., with a focus on property taxation.
• [1] Guardian Newspaper article on property taxes with example from Denmark.
• [2] Provides good information re the taxation of real estate in Illinois
• CAP 112 Inland Revenue Ordinance Section 5B - Charge of property tax
• HK Inland Revenue Department: Departmental Interpretation and Practice Notes, DIPN 14

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