12 Apr 2016

Death, taxes and the one percent

The Panama papers "scandal" has surprised people who thought that the rich and powerful declare their assets and pay their taxes like the rest of us.

For others, the scandal is not the existence of so many offshore "tax-efficient" entities but the lack of shame, reaction or explanation from those named (so far) in the leaks.

A few years ago, I read a chapter on "tax avoision" that Arthur Seldon wrote in 1979. In that chapter he merges (legal) tax avoidance and (illegal) tax evasion into one concept that captures the "grey area" where citizens are not exactly breaking the law but also not following it.[1]

Although death and taxes are often described as inevitable, it's much easier to change the amount of tax you pay than change the amount of death you incur, so people put a lot of time into tax avoision.

How much time depends on how much effort you need to go through to save a dollar (or million dollars). Thus, it's uncommon for people to do very much about avoiding sales taxes when buying clothes or groceries or try to avoid income taxes when they work for a tax-paying company. In the first instance, it's not worth the effort to buy milk on the black market. In the second, it's not easy when the company tells authorities about payments to you (business expense deductions to them).

The cost-benefit criteria change when there's a lot of money involved for people who are self-employed or who have lots of income generating assets, e.g., drug dealers and trustafarians real estate developers and investment bankers. For these people, it is easier to hide income and wealth, and one of the most common ways to do this is by transferring money among various offshore (and onshore!) tax "structures" like those mentioned in the Panama Papers.[2]

So now we have the weapon and the motivation. What remains is a trial by a jury of peers to determine whether the people named in the leaks are actually guilty. Although Tyler Cowen argues that these people may deserve "privacy" in the same way as we deserve privacy from the NSA and its various national cousins, I side with the leakers in thinking that few of those named would have been caught via normal means. Even worse, to me, are the chances that those named will be found guilty of anything. I predict that some will resign in shame while most will deny and stonewall until their friends in power (their peers) can safely drop the matter.[3]

That said, I have a small hope that these discussions may lead people to ask deeper questions about the efficiency of income taxation that discourages work, confuses normal people, and misses the rich and criminal. Wouldn't it be better, for example, to replace income taxes with taxes on real property?[4]

A few years ago, I wrote out my ideas on just such a proposal, but here are the quick highlights:
  • It's easy to assess and hard to dodge with a property register and auction-for-nonpayment, respectively
  • It's fair and accurate when it's based on some combination of purchase price and current market value (via sales of similar properties)
  • It's pro-privacy, since nobody cares who owns the property as long as taxes are paid
  • It's fair to renters who split tax costs (like other property expenses) with owners
  • It's progressive because it raises more money from rich people living, working and shopping in expensive locations
Bottom Line Property taxes are low in most countries because wealthy people want to shift tax burdens onto wage workers. If you want to tax the one percent (they own half the world's wealth), then tax property.

  1. The Dutch love Kings Day for many reasons. One is the entire lack of taxes on goods and services citizens sell that day. In California, I know that the state asks citizens to pay "use" taxes based on their (self-reported) purchases from outside California (including souvenirs brought in foreign countries!)
  2. Don't forget that the US and UK are world leaders in providing legal ways to hide one's wealth or that one man's change of address can destabilize a state's finances!
  3. Those that do not will be offered bribes and perhaps just eliminated if they carry on.
  4. California's property taxes are distorted by Prop 13, but they need only increase from (roughly) 1 to 3 percent of a property's value per year to provide enough revenue to replace corporate, income and sales taxes. The only losers I'd see from this change are tax lawyers and shopping center developers who play with loopholes and lobby for subsidies from property tax-starved cities, respectively. A rough estimate is that the property tax bill on a $500k house would go from $6,500 to $19,500/year. Yes, that's a lot of money, but not nearly as much as is spent, wasted and lost in the current system. (The Federal Tax code, btw, is over 70,000 pages long.) Even more, the burden on the middle class would drop if property taxes were levied on all property (including that of "non-profits" such as churches).


Wayne Lusvardi said...

Ah, but there is a market phenomenon called "tax capitalization" where the price of a home adjusts due to a higher tax rate. California has a 1% property tax base rate and Texas has a 3% tax base rate. So in California a million home would have $10,000 in property taxes while in Texas it would be $30,000, if it weren't for tax capitalization. What really happens is the market adjusts for higher taxes. So a $1 million home in California adjusts to about $400,000 to $500,000 in value in Texas. I have personally compared near identical homes in San Antonio and Houston to those in Southern California.

Additionally, in California property taxes are adjusted upwards for monetary inflation each year with a cap of 2% per year (in recessions the yearly adjustment is typically only 1% upwards instead of 2%). So a $1 million home in California would have a $10,000 property tax but by year 2 after its resale it would have a $10,200 property tax.

BCZ said...

Good thing the wealthy can't adjust their spending away from property toward services. Good thing there are no lower income folks dependent on property investment for capital and wealth accumulation to enhance mobility. I mean, in a world where the rich can't afford to live in a luxury hotel, there are no farmers, and the rural poor don't exost, this should work great at making the tax take more equitable.

Oh... Wait. These people do exist!

It sure seems like a simpler tax code, lower corporate tax rates, and closed loopholes is a more straight forward and simpler solution.

David Zetland said...

If they "spend on services" then those services will generate revenue that will *partially* show up in other property rents (i.e., the housing and shopping habits of the service providers).

I'm not buying "lower income folks" dependent on property investment unless you mean <$100k income is lower income. $20k/year property owners? Where did they get the capital if they are poor. (Further, taxes are just part of expenses passed to tenants.)

Your prescriptions (simpler, lower, closed) has been offered -- and distorted and defeated in the US for the past 30 years -- so I think it's not realistic. Corporate taxes are especially dangerous as (1) Corps have far more lobbying power (Olsen) and (2) Individuals are the ultimate beneficiaries.

David Zetland said...

Yes, RE prices would fall to reflect the greater burden (D side). Just as wages would fall to reflect the lower tax burden (S side). Overall, relative prices might be the same, but vastly more simple. There's no need to adjust for monetary inflation when market prices show ACTUAL changes in value (I forgot to mention that some version of 5 year moving average is a good idea, but that can be achieved with the blend of purchase price and market price). The 2%/year thing is just a desperate grab for revenues from a Prop 13-starved government.

Wayne Lusvardi said...

Prop. 13 does not starve local governments of revenue anymore. If LA County is a proxy for the rest of the state, the percentage of old base year assessments (prior to 1975) has been reduced from 75% of commercial properties in 1980, to 33% in 1990, and to 16.3% in 2013. Single family home old base year assessments have been reduce from 63% in 1980 to 14% in 2013. Multi-family residential old assessments have also gone from 60% in 1980 to 14% in 2013. Extrapolating this trend to the future, by 2020 the gap between assessed values and market values will be negligible.

Also, during economic recessions Prop. 13 puts a safety valve on the amount that total assessed values can fall.

One also has to be reminded that Prop. 13 inflates the base value of homes because there is not a huge amount of negative tax capitalization as there is in states like Texas with 3% base assessment ratios. According to Trulia.com, home prices are inflated by 15% in LA and Orange County and 11% in the Inland Empire ("So Cal Housing Markets Among Most Overvalued", LA Times, Oct. 1, 2014). So if the median home value in LA County is $520,800 (according to Zillow.com) then $78,120 is the portion overvalued which translates into $781 in higher taxes per year per home. That is $408.5 million in higher taxes collected per year in LA County alone ($781 x 523,000 SFR homes) and that is solely from owner occupied single family homes which only comprised 37% of the County housing stock. California receives a tax dividend or bonus but it does so from higher home values not higher tax rates.

David Zetland said...

@Wayne -- not sure if all those numbers add up. How about share of revenues from property vs income vs sales taxes? Property is most stable and least likely to "over-Mall" a community

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