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McGraw-Hill/Irwin ©2009 The McGraw-Hill Companies, All Rights Reserved Chapter 16 Local Government Revenue
©2009 The McGraw-Hill Companies, All Rights Reserved16-2 Who bears the cost of the property tax? How do local governments respond to an intergovernmental grant? Introduction: Key Questions
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©2009 The McGraw-Hill Companies, All Rights Reserved16-5 Annual tax on market value of property Value = Structure value + Land value The Property Tax
©2009 The McGraw-Hill Companies, All Rights Reserved16-6 Cast of Characters Landowners: Own lots that are fixed in size and number Capitalists: Own mobile homes (structures) Housing firms: Rent land from landowners and rent mobile homes from capitalists Housing firms: Rent housing bundle (land + structure) to consumers Pre-tax: Housing rent = $5,000 = $4,000 (structure) + $1,000 (land) Property tax paid in legal terms by housing firm: $800 (structure) + $200 (land) Model of Property Tax Incidence
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©2009 The McGraw-Hill Companies, All Rights Reserved16-8 Partial: Effect of tax in one market in single city Assume perfectly elastic supply of structures (capital) to the city To get a mobile home, housing firm pays capital owner rent of $4,000 Partial Equilibrium Effects of the Structure Tax
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©2009 The McGraw-Hill Companies, All Rights Reserved16-10 Firm pays $200 less in land rent: Shift land portion backward to land Firm collect $800 more in rent from tenants: Shift structure portion forward to consumers $1,000 tax = $200 savings in land rent + $800 extra in tenant payment Normal consequences of tax in perfectly competitive market Why Doesn't the Housing Firm Pay the Tax?
©2009 The McGraw-Hill Companies, All Rights Reserved16-11 General equilibrium: Extend analysis to other markets and other cities Where do the mobile homes go, and what happens there? Features of General Equilibrium Model Second city in region: Untax Fixed total supply of mobile homes (capital) Mobile homes move at zero cost between cities General-Equilibrium Effects of the Structure Tax
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©2009 The McGraw-Hill Companies, All Rights Reserved16-15 Consumer Mobility and Land Rent In absence of changes in land rent Price of housing in Taxton ($5,400) > Price in Untax ($4,600) Consumer equilibrium: Equal housing prices & unequal land rent
©2009 The McGraw-Hill Companies, All Rights Reserved16-16 Capital owners experience $400 decrease in return Consumers unaffected by the tax Landowners experience zero-sum changes in land rent from structure tax Owners in taxing city lose Owners in untaxed city gain Housing firms earn zero economic profit before & after the tax Taxton: Pay $800 tax, $400 less in capita, and $400 less in land rent Untax: Pay $400 less in capital & $400 more in land rent Summary of Structure Tax
©2009 The McGraw-Hill Companies, All Rights Reserved16-17 Variable Supply of Capital (structures) Some mobile homes escape market: Smaller reduction in return to capital Part of the structure tax shifted to consumers Consumers not Perfectly Mobile Perfect immobility: stay in Row #2 of Table 16-2 Between perfect mobility and immobility: Both housing rents and land rents change Change Assumptions
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©2009 The McGraw-Hill Companies, All Rights Reserved16-19 Property owners (owners of homes and rental properties) own capital & land Property owners in taxing city lose Lose as capital owners in region Lose as landowners who bear the land portion Lose as landowners because consumer mobility decreases land rent Property owners in untaxed city Lose as capital owners in region Gain as landowners because consumer mobility increases land rent Effects of Property Tax on Property Owners
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©2009 The McGraw-Hill Companies, All Rights Reserved16-21 Mayor of one of many cities Return to capital decreases by 1/50 of tax Land rent decreases by 49/50 of tax If consumers are not perfectly mobile, some of the land portion borne by them President: Effect of uniform nationwide property tax Common tax rate means capital has nowhere to flee If national supply of capital fixed, tax borne by capital owners Perspectives: Mayor vs. President
©2009 The McGraw-Hill Companies, All Rights Reserved16-22 Products replace housing services: books, haircuts, manufactured goods Structure tax borne by capital owners throughout the region Effects on consumers depends on mobility Tax exporting If outsiders consume some of city’s products, they pay taxes Limit: law of demand and firm location choices What About the Business Property Tax?
©2009 The McGraw-Hill Companies, All Rights Reserved16-23 Tiebout: Households sort with respect to property value (the tax base) Tax liability depends on level of local public good, not property value Property tax is a user fee, not a tax on housing; people get what they pay for Realism of Tiebout and user-fee view of property tax Imperfect sorting in metropolitan areas Central cities: single municipality serves large diverse population Property Tax as User Fee?
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©2009 The McGraw-Hill Companies, All Rights Reserved /3 of states limit tax rate of specific types of local government 1/4 of states limit tax rate of local government as a whole Most limits in range 10 to 20 mills (1% to 2%) Limits on Property Tax Rates
©2009 The McGraw-Hill Companies, All Rights Reserved16-26 Half of states limit annual growth rate of property tax revenue Most limits in range percent Some states peg maximum growth rate to inflation In many states local governments allow voter overrides Limits on Growth Rate of Property Tax Revenue
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©2009 The McGraw-Hill Companies, All Rights Reserved : Tax share high by recent historical standards : Dozens of states enacted new limits, dropping tax share Citizens expected tax cuts without service cuts Evidence of revenue substitution Increase in grants from state government Increase in non-tax revenue (fees and charges) Modern Tax Revolt Started in 1978
©2009 The McGraw-Hill Companies, All Rights Reserved16-29 Intergovernmental grants provide 2/5 of local revenue Local government: education (1/2), welfare, housing, highways, hospitals Municipalities: welfare & housing (1/4), education (1/5) Types of Grants Categorical or conditional grants: spent on specific program Lump-sum grant: fixed amount Matching grant: grant depends on local effort (spending) Overview of Intergovernmental Grants
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©2009 The McGraw-Hill Companies, All Rights Reserved16-32 Both grants have income effect: Expansion of budget set increases consumption Matching grant also has a substitution effect Decrease in opportunity cost of targeted good (special education) Lower opportunity cost: substitute special education for other goods Why a Larger Stimulative Effect for Matching Grant?
©2009 The McGraw-Hill Companies, All Rights Reserved16-33 Flypaper effect Grant has larger stimulative effect than increase in income Additional $ of income increases local spending by $0.10 Additional $ of lump-sum grant increases local spending by $0.40 Reason for flypaper effect: Do bureaucrats hide grants from voters? Summary: The Stimulative Effects of Grants
©2009 The McGraw-Hill Companies, All Rights Reserved16-34 National government provides grants to support local spending on welfare Old matching grant policy: $0.22 of local generates $0.78 grant New lump-sum policy $140 lump-sum grant Changes in Welfare Grant Policy
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©2009 The McGraw-Hill Companies, All Rights Reserved16-36 Principle of Fiscal Neutrality Spending on education may not be a function of local wealth Application of principle: Eliminate spending inequalities through grants Foundation grant: Lump sum grant Guaranteed Tax Base: Matching grant Intergovernmental Grants for Education
©2009 The McGraw-Hill Companies, All Rights Reserved16-37 Lump-sum grant determined by wealth of local community Grant = F - t V F = Foundation level t = foundation tax rate V = Local tax base per pupil Example: F = $5,000; t = For V = $200,000, Grant = $2,000 = $5,000 - $3,000 For V = $100,000, Grant = $3,500 = $5,000 - $,1,500 Foundation Grant
©2009 The McGraw-Hill Companies, All Rights Reserved16-38 Grant = t (G - V) G = guaranteed tax base per pupil t = local tax rate V = local tax base per pupil Example: G = $300,000; V = $200,000 For t =2.0%, Grant = $2,000 For t = 2.5, Grant = $2,500 Guaranteed Tax Base Plan
©2009 The McGraw-Hill Companies, All Rights Reserved16-39 Increase in local tax rate increases grant In Table 16-6, $ for $ match GTB as Matching Grant Program
©2009 The McGraw-Hill Companies, All Rights Reserved16-40 Court-ordered reforms reduced spending inequalities with leveling up No change in inequality in states with reforms not ordered by courts Michigan reduced inequality: Increase rural & decrease urban spending City schools: higher cost of delivering program; equalization cuts funds Recent Changes in Spending Inequalities
Chapter 17 Local Government Revenue McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
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