Taxation Of Real Estate
( Originally Published 1924 )
What part of the tax burden of government is carried by real estate? In what instances is it impossible for owners to shift taxes on real estate? What kinds of taxes are raised chiefly from real estate? How are taxes levied against property within a city or other governmental unit? What objections can be urged against the present method of levying taxes against the selling value of real estate? What argument is used for the appropriation by the state of all increase in land values? What arguments can be urged against it? Why does the amount of revenue to be raised for government every year constantly increase? Is this likely ever to change? What is the fallacy in the principle of raising revenue chiefly by taxing the rich? What arguments can be advanced for indirect taxes? Why should local taxes be raised chiefly from taxes on land? Should revenue from real estate be based on land only or on both land and improvements? Should taxation of real estate be in proportion to selling value, progressive or regressive? Why should care be exercised in levying special assessments? What would be the advantages of an economic and cadastral survey?
ONE of the large items of cost in the ownership and utilization of real estate is that of taxation. Taxes are levied to defray public expenditures; that is, the cost of government and of all the activities conducted by the government. Since real estate is the most tangible, fixed, and apparent form of possession, it has long since been required to bear a large portion of the taxes. The basis for taxation of property is this: Property rights are established by the sanctions of government; property in turn yields up to government a portion of the benefits which it conveys.
The percentage of the annual gross income of real estate which is contributed to government indicates the extent of the load caused by taxation. In New York City, according to Bolton,' the following percentages of gross incomes are paid in taxes by the type of building indicated :
High Low Mean
Offices 18.1 11.8 15.5
General average 15.00
An independent investigation indicates that 18% of the net incomes from 4,575 Wisconsin farms is paid in taxes, and another examination of 18 New York City blocks indicates that from 1891 to 1921, 22% of the net income they produced was taken in like manner.'
Another way of looking at it is this : In 1910 the real estate of New York City bore 95% of all the taxes levied, and 98% of the entire budget of the city.' In 1922, 85% of the total tax income of the same city was reaped from real estate, and the same year in Boston 89% came from this source.' These figures are sufficient to illustrate the point. It may be added that in some places there is considerable agitation for repeal of the tax on personal property and for raising the entire government income by taxes on real estate. Such a procedure would obviously increase the burden on real estate to a large degree.
It is maintained by some that taxes levied on real estate do not affect its value or income ; they are simply shifted to those who use the land, and in turn to those who use its products. This may be true, generally speaking. But at least in three cases, it is not. In the first place, the owner of vacant land, whether it be urban or rural, has no opportunity to shift such a tax. He may, however, be performing a useful service in holding the vacant land.' In the second place, although the tax may be shifted to some extent, it may become so heavy as to make shifting impossible. The real estate is fixed, immovable; those who occupy it are always more or less free to elude burdensome charges by moving.' Thus the landlord may find himself at least partially unable to shift the tax because of the danger of losing his tenant.
Finally and most important of all, the home owner cannot shift his taxes. He owns property for his own use; there is no opportunity for him to shift the taxes to another when no one else ever uses his property. The man who rents, either business or residential property, and the one who uses his own property for commercial purposes may be able to devise means to pass on a burdensome tax to others. But there is no opportunity for the home owner to do so. A large and burdensome tax on city real estate, therefore, operates under the present system as a deterrent to home ownership. Doubtless many who would otherwise own homes are kept from it by inability to pay high taxes, or fear of inability to pay. The man who borrows money to invest in a home and then is obliged to add to the six or seven per cent he pays for money two or three per cent for taxation faces an additional burden that must give him pause. This aspect of city taxation is frequently overlooked in discussion of the shifting of taxes on real estate.
Kinds of Taxes, and Method of Raising. The kinds of taxes commonly assessed are federal, state, county, and local or municipal. Federal taxes are levied chiefly against incomes, imports and customs such as the tax on tobacco, liquor, etc. In very few instances does real estate pay a federal tax, except when it changes owner-ship. Then the price received becomes subject to the Federal Income Tax, and in case of inheritance, it may have to pay an inheritance tax.
State, county, and local or municipal taxes are levied against the property within the jurisdiction of the levying authority. The process by which they are fixed and collected is as follows : First a budget of expenditures is prepared. The budget contains all the items which constitute the expenses of the unit during the current year, including the expenses of schools, interest on bonded indebtedness, salaries of employees, etc. All in-come from sources other than taxation is then deducted from the amount of the budget; the balance represents the sum to be raised by taxation.
Under the present system of taxation, taxes are assessed against property according to its selling value or some fixed part of that value, such as one-half or two-thirds, which is uniform against all property in the jurisdiction. The next step in levying taxes, then, is to find out the total value of the property. This value is found by assessing it. Ordinarily an assessor or a board of tax commissioners is charged with the responsibility of making the assessment or appraisal. As soon as the work is completed the lists of property and assessed values are open for inspection by the public. In case any property owner feels that his property has been assessed at too high a figure, he may file protest with the tax officials, showing upon what grounds his opinion is based. If, after hearing his arguments, the officials still believe the assessed value is just, he has recourse to the courts which, upon the filing of an appeal, will examine the records and ascertain whether the assessment has been fixed according to law.
When all complaints have been heard and adjustments made, the total value of the property to be faxed is obtainable. Now if the amount to be raised by taxation be divided by the total assessed value of the property to be taxed, the result will be the tax rate for the year. For example, if a city had a budget of $12,000,000, $1o,000,000 of which had to be raised by taxation, and the total assessed value of the property was $500,000,000, the rate would be fixed by dividing $10,000,000 by $500,000,000; the rate thus would be .02, or twenty mills on every dollar of value, or $2.00 on every hundred dollars of value. The amount of taxes against each piece of property is found by multiplying the value of the property by the rate. In the instance shown, a property worth $1o,000 would be taxed $200.
As soon as taxes are thus fixed, a date is set at which they become 'due. Immediately upon their becoming due, they become a lien against the property upon which they are assessed, and they may be recovered by the government through whatever means necessary to secure them, such as a forced sale. A penalty which is usually attached to delinquency in payment, however, obtains in the majority of cases the desired promptness in meeting this obligation.'
Two objections to this method of tax procedure are frequently met with. The first is that the method of valuation results in injustice through a lack of uniformity in appraisals. It is pointed out that selling value is in every case a fictitious amount, never exactly determinable except at the moment of sale. The appraisal is, therefore, but the expression of an opinion. A variation in valuations obviously causes an unequal sharing of the burden of taxation. Undoubtedly this objection is valid; many property owners escape their just share of the load while others groan the more under the excess they thus are obliged to carry. That a system does possess in-equalities, however, does not necessarily condemn it; when another is proposed that will remedy those defects, the less adaptable should be discarded.
The second criticism passed upon this method of taxation attacks the selling value as the basis for fixing the tax rate even though it could be accurately ascertained. It is urged that selling value, while it represents wealth in the hands of the owner, does not represent income nor ability to pay. The payment of taxes on vacant unimproved property might easily force the owner to sell the property. In case he were unable to realize the approximate value of the property through such a sale, that part which he failed to realize would be virtually confiscated. There are doubtless many cases in which the payment of taxes on selling value has forced an abandonment of farm properties as well as city real estate. One suggestion which has been made regarding a substitute for selling value is that taxes be based upon the use to which land is put. In some countries this plan is followed, improved city land being more heavily taxed than unimproved, or farm land. Another suggestion is to base the tax solely on income received. Vacant, unimproved property would then be exempt. The objection to this plan lies in the fact that it would be too easy to withhold property from the market and from its highest, socially most desirable use. For the sake of an increase in price, vacant lots or larger tracts of cultivable land might be held in private hands long after they should have been built upon or turned into productive fields.
Another common suggestion regarding taxation has to do with the increase in the value of land. It is pointed out that the value of land is largely dependent upon in-creases in population and other social forces which the owner neither directs nor frequently sees. The increase in value, therefore, being due to no effort of the owner but to society, should not be given to the owner but should be paid to society in the form of taxation. By many it is believed that such a tax would provide all the revenue needed by government. There are two points that must not be overlooked, however, in this connection. In the first place, there are many instances in which an increase in value is not due to social forces but to private initiative in developing a site to its highest use. Such development frequently requires keen insight, sound judgment, and at least a modicum of daring. It may well be questioned whether the appropriation of the increase in real estate values would not stifle this initiative and the consequent development of real estate sites. Secondly, if society is going to. profit exclusively from increases in value, ought it not also to bear the losses due to decreases in value? That thousands of such decreases occur cannot be denied, and any proposal for appropriating increases must dispose of the decreases as well.
Special Assessments. The custom of levying assessments for improvements against the property benefited is used very largely in America. When improvements, such as sidewalks or street pavements, are made, a part of the cost is assessed against the property that benefits most. In order for the assessment to be legal, the improvement must be requested by petition from a majority of the property owners affected. After the improvement is completed, the cost is assessed according to the size of the property held. Such an assessment is legally a lien on the property and may be collected in the same way as taxes. Not infrequently, however, the entire cost assessed against the property is made payable over a considerable number of years to prevent too heavy a charge falling at one time on the property owners. Special assessments may be considered as a form of taxes.
Some General Principles of Taxation. It will already be clear that the study of land taxation leads into the whole subject of taxation, which is greatly involved. As soon as one form of taxes is lightened, other forms must be increased. This is not the place, however, for a discussion of all forms of taxation. The subject has been widely studied and written about and will probably remain the cause of great controversy. There are, how-ever, some general considerations which all should keep in mind in discussing taxation.
Some of these principles have been expressed as follows by an able authority on the subject. First of all, people must get the right attitude toward taxes. Taxes should be regarded as necessaries. What one pays in taxes should be looked upon in the same light as what one pays for bread and meat. This is a logical outcome of the activities of the modern state and community. Things that the individual formerly did privately are done to an ever-increasing extent through public agencies.
The man who cannot pay for the services which he receives through private agency we call a pauper. To treat large classes in a community as though they should be exempt from taxation is to treat them as paupers. A man may be poor and still pay his debts. Poor is a relative term, and all who are not paupers should expect, and should. be expected, to bear a proper share of the public burdens, and this means a large development of indirect taxation. A man may complain, and perhaps justly, in some cases surely justly, because his income is inadequate to meet his expenses; but he should not complain because he is expected to pay taxes just as he is expected to pay his butcher and his baker. It is really an insult to the workingman to treat him as a tax-exempt person.
Secondly, the most outstanding fact in the present problem of taxation is the need for public revenues. There was a time in our history when one of the pressing problems of federal finance was the problem of the yearly surplus, but today the outstanding need is public revenues for cities, states, and the nation. War is undoubtedly the chief cause of the staggering growth of public expenditures. It would be pleasant to believe that it is a temporary cause and that war expenditures will be unnecessary in the future. But wars have been going on since the world began and there is little hope that there will be no more wars in the future. It would be folly in framing long-time fiscal policies to overlook war.
Thirdly, the need for public revenues, apart from war, will continue to increase. The expenses of the federal government for the "promotion of the public welfare" may be but a small part of all public expenditures, but they are growing rapidly. In the case of the states and local political units, especially cities, they form the biggest items in the budgets and are increasing by leaps and bounds. Note, for instance, the increased expenditures for education, for the development of agriculture, for the promotion of recreation, pleasure, and health.
Fourthly, such expenditures must increase with the growth of civilization, liberty, and with honesty and excellence in administration. The French political philosopher, Montesquieu,1 laid it down as a law, invariable and without exception, that liberty increases public expenditures. As society advances, there is an expansion of social relations and that involves common needs to be satisfied by public agency. Honesty and excellence of administration strengthen the arguments for those sorts of desired common action that carry with them increasing public expenditures. That is, the more efficient the administration of public agencies, the more willing society is to grant to public agencies those functions now con-ducted privately, and that means greater public expenditures.
Fifthly, the benefits of public services are being more widely diffused without a corresponding broadening of taxation. "Public welfare expenditures" bring a. great return to the individual and to society, returns for which the individual had to pay privately before the public assumed these functions. But methods have not been evolved for getting into the treasury a sufficient portion of these private and social gains that result from such public expenditures. Public education may easily increase a man's earning power by $500 a year for a period of thirty years, or public medicine keep a man at work at $3 a day for 250 days whereas without such attention his lowered efficiency may allow a working year of only 20C days with an earning power of but $2.50 a day. We could take by taxation from $50 to $150 a year and the individual would still be the gainer.
As a result of advancement, enormously high standards have been established for the masses in comparison with earlier standards. But no way has been devised of getting a return for the costs into the public treasury. Where tangible property results, taxation is employed, but inadequate taxation. Where there is an income tax, as in some of the states, the income of the individual is a source of public revenues, but the exemptions are large, and the income taxes do not reach the great mass of people who receive these increasing benefits from public expenditures.
Sixthly, "swatting the rich" will not provide enough revenue. Aside from the questions of the violation of sentiments of justice, the weakening of ethical standards, and the discouragement of talent, the fact cannot be avoided that the rich are too few to bear the burden.' They may be taxed to the point of bringing them down to a common level, but the problem of insufficient public revenue is still an unsolved one. Such a policy will have only dried up one of the sources of revenue.
Seventhly, the "masses" have a surplus that can be taxed. This suggestion may not be a popular one, yet it is true that there is a widespread ability on the part of the great mass of people to contribute to public revenue. On every hand can be seen an enormous surplus of in-come over needs of subsistence. The expenditures of the public for prize fights, "movies," ice cream, candy, tobacco, chewing gum, perfumery, and beverages of all kinds run into, the hundreds of millions, yes, even billions of dollars every year.
This widely diffused surplus wealth could be made to contribute toward public expenditures without necessarily causing any harm or any real sufferings to the contributors. Only to a very limited extent is this source tapped. There is, then, a contradiction and lack of harmony between present progressive programs and systems of taxation. There is, likewise, a lack of harmony between administrative machinery and public needs. It would seem impossible, without ruin, to meet growing governmental needs by direct taxation, but systems of taxation must be devised which spread abroad among the great masses of people public burdens that have some kind of relation to public benefits.
Eighthly, taxes on consumption and various indirect forms of taxation must be employed to a larger extent. A few years ago Switzerland passed over to an increasing use of indirect taxes as a necessary means of accomplishing her desired progressive programs.' The time has surely come when thorough consideration should be given the possibility of securing a wider diffusion of taxes by a levy upon what may fairly be classified as luxurious consumption. Indirect taxes have the advantage of being spread over the whole year, of being collected in small sums hardly noticed by the taxpayer. It has been recommended that direct taxes be paid quarterly instead of annually, thus becoming more like indirect taxes.
The subject of indirect taxation is one that needs careful study and critical examination. It is unfortunate that the subject is muddled by ignorance, prejudice, and popular clamor.'
Recommendation. Land should be used chiefly as a source of local revenue. Land is of such a nature that it can be best handled in comparatively small units, and, moreover, land is most affected by local conditions. Land owners are those who are chiefly responsible for local improvements. Land owners are generally the leaders in public improvements that add to the value of the land, and are called upon for contributions to public enter-prises that will develop the community where the land is located. There should be some state taxation of land and with it state control over local taxation'
Secondly, land taxation should be real estate taxation. Practical experience shows that what is needed in taxation is the legal concept real estate. When a man puts up a building, he considers not only the return on the land, but a return on the building, and he amalgamates the two. Very likely he sacrifices real estate value for the sake of land utilization. He calculates that the land may increase in value and offset a certain depreciation of the building. Putting the two together, he finds that he may hope for a modest return on his investment. The land furnishes the security without which the building would not be constructed. It gives borrowing power, and this is especially so if land values are stable, and still more so if there is a tendency to a moderate, slow increase in land values.
Among the many reasons why the value of the land and the value of the, improvements should not be taxed separately is the difficulty of separating the two values. Improvements, in both urban and agricultural land, be-come in many cases so blended with the land itself that they are indistinguishable and inseparable. Administrative and general economic difficulties were so great that the attempt at separation was abandoned in England.'
While, in general, land taxation should be real estate taxation, temporary exemption of buildings from taxation may be advisable. If there is special need for new buildings, that is to say, if that investment of labor and capital is more urgent than other investment of labor and capital, sometimes this is the case; sometimes not—it may be desirable to exempt new structures from taxation for a limited period, say three to five years; not ten as in New York State. This does not increase the final bur-den upon the land, inasmuch as the buildings very soon come upon the tax duplicate, as it is generally called.
The third recommendation is that taxes if fixed in proportion to the selling value should not be progressive. It is suggested that a rate of taxation of one and a half per cent on the selling value of the land ought to be the regular normal upper limit under normal economic conditions. There can be little doubt that this would be an equivalent to an income tax of twenty-five per cent, if total values in the United States are compared with total rents.
In the case of land, benefits from government should be considered primarily; and if this standard is taken, there is no reason for a progressive rate. It has been urged that land occasions less expense on the part of the government and receives relatively less benefits than some other forms of wealth, and consequently that the rate of taxation on land should be regressive rather than progressive. It is difficult, however, to accept this point of view, against which more can be said than in its support. American experience, also, would not clearly seem to indicate a departure from the rule of one uniform rate. If it is departed from at all, it should be in the direction of substituting, to a certain extent, rental value for selling value as a basis of taxation.
A fourth recommendation is that special assessments should be used with caution even in cities, but especially in rural districts. Special assessments anticipate increments in land values, and in foreign countries they are regarded as something very radical. In taxing a portion of increments in land values by special assessments this nation goes even beyond what progressive thinkers in France evidently consider rather daring. The additional burdens upon land are a stimulus to proper land utilization. They have been used to only a limited extent in rural districts, and their use should be extended, but with great caution. To put upon the land owners the cost of improved roads would mean, in many cases, more than confiscation of the entire land values. Also, there are cases where the improved, costly modern road may pro-duce a decrement rather than an increment of value, on account of excessive amount of traffic, increasing the danger of theft, particularly to growers of small fruits and orchards, bringing noise, dust, etc. Zoning units may be developed for special assessments, but even in cities, while accepting the principle, caution must be employed.
Lastly, there should be a cadastral and economic survey of the land as one necessary step in the solution of our land problems in general and of our problem of land taxation in particular. France made such a survey, but what is needed is something more than a cadastral survey. It should be economic and social as well.
1. A large part of local taxation is borne by real estate ; in some cases the proportion is as high as ninety per cent while eighty-five is not unusual.
2. Taxes can be shifted on property that is rented, unless they become so great as to cause the removal of business from the city. But they can never be shifted by the home owner. In a large degree the taxation of residential real estate tends to discourage home ownership.
3. Taxation is based upon the selling value of property. The assessment is made by an expert appraiser and the tax rate is determined by dividing the amount to be raised by taxation by the total assessed value of all property within the jurisdiction.
4. The chief objections raised against the present system of taxing real estate are two, that it is impossible to appraise real estate accurately and uniformly, and that selling value is not a just basis for taxing. Income received would be a more adequate index of ability to pay. In some cases taxation according to selling value amounts practically to confiscation.
5. State appropriation of the increases in value of real estate is urged by some as a means of raising revenue and securing to society the benefits of increases in value which society itself is directly responsible for. Such a program however, must not be so drastic as to check initiative in developing real estate, and it must provide for the absorption of decreases in value as well as increases.
6. Special assestments are levied against real estate for the purpose of raising funds for special purposes. They should be used with caution to prevent hardship.
7. Some general principles regarding taxation which every one should keep in mind are (1) taxes are a necessity and a boon, not a burden ; (2) the need for public revenue is going to continue to increase ; (3) not all who are benefiting from the expenditure of public funds bear their part in the burden of resulting taxation ; (4.) sufficient funds cannot be provided by taxing the rich never so heavily; (5) indirect taxes will raise a large amount of revenue without working any hardship on anyone.
8. Some general recommendations may be made regarding taxation of real estate : (I) land should be taxed chiefly for revenue for local purposes; (2) land should not be taxed apart from the buildings and equipment on it—the two are one and inseparable for taxation purposes; (3) all property should bear the same rate of taxation; (4) special assessments should be used with great caution ; (5) there is need for a survey of natural resources and of ownership and holdings of land in this country.