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Free Liberal: Coordinating towards higher values

Free Liberal

Coordinating towards higher values

Florida Going Tax-Backwards

by Fred E. Foldvary

In June 2007, Florida's governor signed into law a ballot measure that would enact a big reduction in the state's property taxes. There will also be a referendum on an additional tax cut in January 29, 2008. Local governments are required to shrink their property tax rates and put in a tax-increase cap. The combined $32 billion tax cut would be the largest in the state's history.

Some have questioned whether this tax slash is constitutional, since the Florida constitution authorizes the cities and counties with the exclusive right to raise revenue through property taxes. Governor Charlie Crist seeks to go further; pushing for a constitutional amendment on the ballot in January to expand the homestead exemption from $25,000 to a super-exemption of $195,000 on a $500,000 house.

Florida's land values have zoomed up during the ozo years (2000-2009). So Florida real estate owners are paying higher property taxes. The situation is similar to that of California during the 1970s, when rising land values fueled a property tax revolt and Proposition 13 that cut the state's property ax.

They call the reduction "tax relief," but it is really only half a relief. Real estate is like a hamburger. You buy it as one good, but it is really several goods: meat, bun, mustard, and possibly tomato slices and lettuce. Real estate is also like coffee with cream; you buy it as one good, but it is really the two goods mixed together. The two goods in real estate are land and improvements. All constructed goods like buildings, pools, and fences are improvements to the site. Land is like the meat and the improvements are like the bun, the mustard, and the lettuce.

So the real-estate property tax is really a tax on two quite different types of assets: the land, and the improvements. Buildings and other improvements have a cost of production, so the property tax on structures adds to the cost of having these. Reducing taxes on buildings is indeed a relief.

But a cut in taxes on land is not a relief. Since land has no cost of production, the price of land is based on the rent kept by the owner, including the rent an owner-occupant pays to himself as tenant. If the tax on the land value is cut, the owner keeps more of the economic rent, and the price of land goes up. For a new buyer, the lower tax is offset by higher mortgage interest. The relief is an illusion, a false belief.

The landowner gains from a tax cut, because he pays less tax, but if other taxes are raised to make up for the cut, if the landowner is also a worker and consumer, his total gain evaporates. Also, those who would face large net losses from an increase in a land tax could be rescued by JamesBonds.

The taxpayers of Florida should learn from what happened in California, which raised income and sales taxes and put in real estate taxes, such as on square footage, that go around Proposition 13. Another problem in Florida is that long-time real estate owners have a large grandfathered property tax exemption. This locks them in, as selling and buying elsewhere would create a big tax increase, and this raises the tax for others, who have to pay more to make up for the grandpa owners paying less. The more effective remedy is to eliminate grandfathering and exempt the entire value of all the improvements.

Cutting the levy on land value is tax-backwards. The problem is that most folks are ignorant about economics and don't see real estate as two properties with different qualities.

Suppose that there is a fixed amount of hamburger meat. A tax on meat would not reduce the amount, because by premise, it is fixed in quantity. Even with a big tax, the person who buys the hamburger would pay the same total amount as before, because the burden of the tax would be on the seller. If he raised his price to pass the tax on to the buyer, he would sell much less, and there would be hamburger meat sitting around unsold. The merchant would have to reduce the price to get sales. But the merchant would really have no burden either, because when he buys new meat, he too pays a very low price.

The only burden from a land tax is on current owners when the tax is increased. But this would be offset by not having to pay a tax on the improvements. Even better, eliminate Florida's sales tax and have only the tax on land value. If homeowners don't like the land tax, they should have the option of creating neighborhood associations that would take over the local services and have a monthly assessment, based on site values, to pay for them. It might make them feel better to be assessed rather than taxed.

Florida's voters should reject the January ballot measure and tell their legislators to go back to the drawing board to have a more fundamental tax reform that exempts buildings, eliminates the grandpa exemptions, and shifts to public revenue from land rent or land value.

This article first appeared in the Progress Report, Reprinted with permission.

Dr. Fred Foldvary teaches economics at Santa Clara University and is the author of several books: The Soul of Liberty, Public Goods and Private Communities, and the Dictionary of Free-Market Economics.

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