Copyright © 2002 by Thomson Learning, Inc. Chapter 17 Taxes on Wealth Property and Estates Copyright © 2002 Thomson Learning, Inc. Thomson Learning™ is a trademark used herein under license. ALL RIGHTS RESERVED. Instructors of classes adopting PUBLIC FINANCE: A CONTEMPORARY APPLICATION OF THEORY TO POLICY, Seventh Edition by David N. Hyman as an assigned textbook may reproduce material from this publication for classroom use or in a secure electronic network environment that prevents downloading or reproducing the copyrighted material. Otherwise, no part of this work covered by the copyright hereon may be reproduced or used in any form or by any means—graphic, electronic, or mechanical, including, but not limited to, photocopying, recording, taping, Web distribution, information networks, or information storage and retrieval systems—without the written permission of the publisher. Printed in the United States of America ISBN X

Copyright © 2002 by Thomson Learning, Inc. A Comprehensive Wealth Tax Base  Real Property is property such as land and the structures on the land.  Intangible Property is wealth that is held as paper or financial assets.  Personal Property is wealth that is held in the form of cars, furniture, clothing, jewelry, etc.

Copyright © 2002 by Thomson Learning, Inc. Measuring Wealth  Market value can be used to establish the value of most real property and intangible property but personal property has no acceptable resale market.  Serious inequities can arise from mismeasurement of wealth and serious shifting can take place when one form of wealth is taxed while another is not.

Copyright © 2002 by Thomson Learning, Inc. Assessment of Property Value  For the property tax, the assessed value of a home and the land upon which it sits is quite subjective. Real-estate markets exists for many homes but not others.

Copyright © 2002 by Thomson Learning, Inc. A Comprehensive Wealth Tax Where  R i = the return to asset I  r= the interest rate  t W = the wealth tax rate  W= Wealth A comprehensive wealth tax would tax all forms of capital equally. If W =  R i /(1 + r) i then the effective tax rate on savings would be t s = t W W/R i

Copyright © 2002 by Thomson Learning, Inc. Figure 17.1 Impact of a General Wealth Tax When the Supply of Savings is Perfectly Inelastic Annual Savings and Investments Return (Percent) 0 Q1Q1 D = r G S R1R1 t W W r N = r G – RiRi t W W r* G G

Copyright © 2002 by Thomson Learning, Inc. Figure 17.2 Impact of a General Wealth Tax When the Supply of Savings is Responsive to Changes in Annual Return Annual Savings and Investments Return (Percent) Q2Q2 S D = r G R1R1 t W W r N = r G – r* G1 r* G N1 Q1Q1

Copyright © 2002 by Thomson Learning, Inc. Selective Property Taxes  Property Taxes in the U.S. are typically selective in that real property is taxed, some forms of personal property are taxed, and intangible property is not taxed.

Copyright © 2002 by Thomson Learning, Inc. Wealth Taxes in an Open Economy  Capital mobility has increased dramatically in recent years.  Wealth taxes in a nation discourage foreign investment in that nation.  U.S. gross investment has declined from 22% of GNP in 1959 to 17% in  U.S. net foreign investment is negative meaning that foreign capitalists are investing more in the U.S. than U.S. capitalists are investing abroad.

Copyright © 2002 by Thomson Learning, Inc. Local Property Taxes and Tax Capitalization  Property Tax Differentials are the differences between what would be owed in one community on a particular piece of property relative to what would be owed on an identical piece of property in a different community.  If the differential is high, then people will be willing to pay less for property in the high-tax community and more for a home in the low-tax community. The tax differential will be capitalized into the value of each home. The present value of the differential over the expected length of time the differential will hold will be the difference in the price of the two pieces of property.

Copyright © 2002 by Thomson Learning, Inc. Figure 17.3 Impact of a Property Tax on Housing Rents Rent per Square Foot (Dollars) Housing Rented perYear (Square Feet) 0 Q1Q1 120 t Q2Q2 S D = Gross Rent Net Rent = Y – tVtVt $60 tV = t YY

Copyright © 2002 by Thomson Learning, Inc. Capitalization and the Elasticity of Supply  Full tax capitalization only occurs if there is no supply elasticity.  Land is perfectly inelastic but structures are not.  A differential tax will cause building in one area and less building in another.  After such shifting there is less than full capitalization of the tax differential.

Copyright © 2002 by Thomson Learning, Inc. Property Taxes in the U.S.  Fractional Assessment is the practice of assessing a property at only a fraction of its true value. Typically this implies that the tax rate is higher.  Nominal Tax Rates are the rates of tax per assessed value that a property owner must pay.  Effective Tax Rates are defined as the taxes owed per true market value. For instance, Newark N.J. has a nominal tax rate of 23.85%, but the assessed value of a piece of property is typically only 16.4% of its market value. Thus, the effective rate is 3.91%. The average U.S. effective rate is 1.67%, the median 1.42%.

Copyright © 2002 by Thomson Learning, Inc. Reliance of the Property Tax by Local Governments  The property tax is an important source of revenue for most local governments.  It raises more than 95% of all local revenue in CT, ID, MA, MN, MT, NH, NJ, RI, VT, WI.  In no state is it less than a third of local government revenue.

Copyright © 2002 by Thomson Learning, Inc. Property Tax Preferences  There are often “circuit-breakers” that do not allow assessed evaluation to increase more than a fixed percentage in a period of time to help the elderly living on fixed incomes.  Agricultural land is also taxed at a much lower rate than residential and commercial land.

Copyright © 2002 by Thomson Learning, Inc. Land Taxes  A criticism of property taxes is that it reduces the incentive to build on a piece of property.  A solution is to impose a tax on the land rather than the buildings on it.

Copyright © 2002 by Thomson Learning, Inc. Figure 17.4 Impact of a Land Tax D = R G S R N = R G – tV tV R* G N Q1Q1 Rent per Acre Usable Acres of Land Entire Tax Borne by Landlords

Copyright © 2002 by Thomson Learning, Inc. Estate and Gift Taxes  The estate tax places a tax on the estate of those who have died before their assets may be transferred to their heirs.  The gift tax prevents people from avoiding the estate tax by giving away their assets before they die. You may give up to $10,000 to each person per year.  These taxes were substantially reduced in 2001.