California Landed Gentry

January 26, 2020

by Steve Stofka

What is a fair share of taxes? As I noted last week, different households pay a varying share of sales tax to the city but consume the same amount of public services. Income taxes and property taxes vary as well. In California’s booming real estate market, younger homeowners are furious that they must shoulder an inequitable share of a community’s property tax.

In the 1970s, the population of California swelled and created a large increase in demand for housing. The higher demand and runaway inflation during the period led to rapidly escalating home prices. Proposition 13, an amendment to the California constitution, was sold as a remedy for older homeowners on fixed incomes who could no longer afford the property taxes on the homes they had owned for years. Commercial properties were included in the amendment as a way to protect small businesses and the stability they brought to communities.

In 1978, California voters passed Prop 13, as it was called. Annual increases in residential and commercial property taxes were limited to 2% for existing property owners. These were years of high inflation. In 1979, the inflation rate was 14%, far higher than the current 2% rate (BLS, n.d.). In the two years following passage of the amendment, property tax collections collapsed by 50%. The resulting loss of revenue and high inflation caused a financial crisis in cities and counties throughout the state (BOE, 2018). Because taxes are based on acquisition cost, not current appraised value, the law has created large disparities in tax liability between neighbors in similar housing. In addition, the law has created inequalities between homeowners of different ages. The purchase of a home would normally step up the appraised value of the property to a current value but new homeowners over 55 were exempted. Older homeowners could also transfer their house to their children without triggering a step up in appraised value. Many homes are never sold. The homeowners and their heirs rent out the homes at current rental prices and pocket the profits. The law has created a class of landed gentry in the state (Dillon, Poston, 2018).

In 1992, the Supreme Court ruled that the law did not violate the 14th Amendment (Nordlinger v. Hahn, n.d.). In the past forty years, the law has severely reduced funding for California schools and helped to create notorious budget shortfalls. In the 1970s, California ranked in the top ten states in the quality of public education. This past year, Wallet Hub ranked the state #38 (McCann, 2019).

The fixing of one problem often creates a much larger inequity in the end and that requires an endless stream of fixes to the solutions to the problem. It’s good business for lawmakers. Adam Smith, the father of economics, documented the process in his book Wealth of Nations (Smith, 1776). Labor guilds and business interests often proposed regulations which gave them an advantage in a market. The public good was often compromised by laws that favored these interest groups. Smith proposed a free market approach as the only way to protect the public from the corruption and favoritism that inevitably marks a political state. California is a living example of the same problems that Smith described in 18th century England. Human nature has changed little in the past 200 years.

In 2020, California voters may have a chance to undo that part of the law that applies equally to commercial property, but homeowners will continue to enjoy incremental changes to their property taxes (Levin, 2018). The dream of homeownership will elude many families in the state. Taxes are inherently unfair but Californians have created their own brand of unfair taxes.

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Notes:

Bureau of Labor Statistics. (n.d.). Inflation Calculator. [Web page]. Retrieved from https://data.bls.gov/cgi-bin/cpicalc.pl?cost1=1&year1=197901&year2=198001.

California State Board of Equalization (BOE). (2018, December). California Property Tax: An Overview. [PDF]. Retrieved from https://www.boe.ca.gov/proptaxes/pdf/pub29.pdf#page=5

Dillon, L., Poston, B. (2018, August 17). Must Reads: California homeowners get to pass low property taxes to their kids. It’s proved highly profitable to an elite group. Los Angeles Times. [Web page]. Retrieved from https://www.latimes.com/politics/la-pol-ca-california-property-taxes-elites-201808-htmlstory.html

Levin, M. (2018, August 4). Prop. 13 could be partly undone in 2020—here’s what you should know. [Web page]. Retrieved from https://calmatters.org/economy/2018/08/prop-13-could-be-party-undone-in-2020-heres-what-you-should-know/

McCann, A. (2019, July 29). States with the Best & Worst School Systems. Wallet Hub. [Web page]. Retrieved from https://wallethub.com/edu/e/states-with-the-best-schools/5335/

Nordlinger v. Hahn. (n.d.). Oyez. [Web page]. Retrieved from https://www.oyez.org/cases/1991/90-1912

Photo by The Joy of Film on Unsplash

Smith, Adam. (1776). The Wealth of Nations (Kindle Edition). Digireads.com Publishing (2019). Available at https://www.amazon.com/Wealth-Nations-Adam-Smith-ebook-dp-B000FC1CVE/dp/B000FC1CVE/ref=mt_kindle?_encoding=UTF8&me=&qid=

Our Fair Share

January 19, 2020

by Steve Stofka

The holidays are over. This week our city picked up Christmas trees set by the curb. The sun set after 5 PM, the first time since the time change in the first week of November. The sun is returning to the Northern Hemisphere. Despite the variations in the amount of sunshine throughout the year, we all get the same amount of sunshine over the course of a year. Not so with our tax bills.

Estimated taxes were due this week. The self-employed, retired people and others who earn income with no taxes withheld must pay estimated taxes every quarter. This past year the IRS audited less than ½% of returns, a lifetime low. That sounds great because none of us wants to endure an audit. The very word strikes fear in the hearts of many taxpayers, but most of us have a small chance of being audited regardless. We don’t pay enough in taxes for the IRS to do much more than a paper audit, a request for supporting documentation.

The IRS is not a popular agency and became less popular when the agency discriminated against Tea Party and progressive groups during the 2010 election (Farhi, 2017). House Republicans repeatedly cut the agency’s budget, but that retribution has had serious budget consequences. The National Bureau of Economic Research estimated that the government could raise an additional $1 trillion in tax revenue – that’s about 20% of total revenue – with stricter enforcement of existing law (Heeb, 2019). In 2019, the Federal deficit, or budget shortfall, was $1.1 trillion (BPC, 2020). Stricter enforcement would have effectively erased that deficit.

The race for the Democratic Party’s nomination for President promises to center around several themes. The first is the horse race against President Trump, whose incumbency gives him a distinct advantage when running for re-election. The press often seems more concerned with the contest than the underlying issues of a campaign. Taxation is a recurring discussion in each election. More or less? What is a fair share? More, more, more social programs, taxation and regulation, or less, less, less social programs and taxation and more defense spending and power for large corporations?

What is fair? As children we have a keen sense of fairness – our “monkey brain.” We are social creatures who feel scorned at what we perceive as unequal treatment. Equal and fair are not the same thing. A fair share is not the same as an equal share. If I can afford to buy $50,000 worth of goods in a year, why should I have to pay more sales tax than someone who only buys $30,000? We make equal use of a city’s public services. Why should we be treated unequally? Well, we have become accustomed to paying an equal percentage of what we buy in the stores as a sales tax.

Why don’t we follow that same approach for income taxes? States like Colorado do charge the same rate of state income tax regardless of income. Is that fair? Some cities like Denver charge a head tax, a flat fee income tax for anyone who works within the district. Should we follow the same approach throughout the nation? Warren Buffett and I would pay the same amount in income taxes. Is that fair?

Should prices for public utilities be adjusted based on income? If my neighbor makes twice what I do, should they pay twice for the same amount of water? Currently, we are charged the same rate. The income and property taxes of those over 65 are often given a discount. In some districts, a person who reaches 65 finds that they can lower their property tax by 50%. Is that fair?

Elizabeth Warren, a candidate for the Democratic Party’s presidential nomination, proposed that all student debt be eliminated. Should students who went to more expensive private schools be rewarded more than students who borrowed less because they went to a state college? Should students who borrowed less because they worked part time while going to school be penalized? Is that fair?

In Matthew 20:1–16, Jesus tells a parable of the workers in the vineyard. Workers who came to work in the morning agreed to an amount of money for a day’s work. Workers who came to work later in the day were also promised the same amount of money for working the rest of the day. Jesus was making a point that each person will be rewarded equally in the kingdom of heaven no matter when in their lifetime they come to God’s love. No matter what your religious orientation, is that fair?

Each election we get to vote on what’s fair. Some people don’t vote because they say that their opinion doesn’t matter. It certainly doesn’t if they don’t vote so they have proved their case. If I vote and my neighbor doesn’t, my vote effectively counts double. In a few weeks, the Democratic primaries will start. The first two are in Iowa and New Hampshire, states with small populations and an even smaller number of people who participate in the caucus system. The votes of a few thousand people can make or break a candidate’s campaign. In a democratic nation of 320 million people, is that fair?

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Notes:

Bipartisan Policy Center (BPC). (2020, January 9). Deficit Tracker. [Web page]. Retrieved from https://bipartisanpolicy.org/report/deficit-tracker/

Farhi, P. (2017, October 5). Four years later, the IRS tea party scandal looks very different. It may not even be a scandal. Washington Post. [Web page]. https://www.washingtonpost.com/lifestyle/style/four-years-later-the-irs-tea-party-scandal-looks-very-different-it-may-not-even-be-a-scandal/2017/10/05/4e90c7ec-a9f7-11e7-850e-2bdd1236be5d_story.html

Heeb, G. (2019, November 19). The US could raise $1 trillion more in taxes through stricter IRS enforcement, according to a new study. Markets Insider. [Web page]. Retrieved from https://markets.businessinsider.com/news/stocks/us-could-raise-1-trillion-more-tighter-irs-enforcement-study-2019-11-1028700145

Photo by Maria Molinero on Unsplash

Tax Brawl

Taxation with representation ain’t so hot either – Gerald Barzan

August 26, 2018

by Steve Stofka

The debate over taxes focuses on the size of national programs, and the Federal taxes collected for those programs. In the past fifty years, state and local government (SLG) taxes have risen to equal the burden of Federal taxes. Despite this rise, SLGs must increase tax revenues to meet obligations and historic growth rates. Republicans control most states and will turn to property and sales tax for the additional revenue.

Fifty years ago, SLG tax receipts were half of all Federal tax receipts, including Social Security. For every tax dollar a worker sent to Washington, he sent fifty cents to his SLG. During the past decade, the SLG tax share has averaged ninety cents.

StatePctFed

In the engine model I first introduced in July, Federal taxes were drained from the economic engine. Because SLGs do not have super powers to create money, their taxes stay within the engine and grease the gears. 72% of SLG taxes are under the category of mandatory business production – they are levied on goods and services received by the taxpayers. These include property, sales and business taxes and a plethora of licensing fees. A family who cannot pay their property taxes loses their home. Sales taxes are mandatory at the time of purchase. When SLG taxes are high, households must work more hours or cut expenses to meet the burden. Unlike Federal taxes, higher SLG taxes can force families to work more and increase GDP (Note#1).

For the past thirty years, SLG taxes have grown 6.6% each year, 1-1/2% above the 5.2% annual growth in spending. In the past ten years, tax receipts have grown at half that rate – 3.2%, barely above the 3.0% growth in spending. SLGs have not saved enough to meet the pension benefits and medical care promised the Boomer generation. SLGs will need to raise revenues, cut spending or both.

23% of total SLG tax receipts are taxes collected on personal income. Taxes on business income make up an additional 5%. Sixty years ago, those personal and business shares of the SLG tax pie were 7% and 3%.

SLGIncPctSLGTotal

Republicans oppose raising taxes, especially income taxes, and they control the legislatures in 32 states. In 26 of those states, they control the governorship as well (Note #2).  Democrats have total control of only six states, one of them California, where income and sales tax make up a whopping 50% of state revenues (Note #3). Many SLGs will cut spending and raise additional revenue through higher property and sales taxes and licensing fees. This lowering of the income tax share will move the mix of income and production taxes to the model of sixty years ago when production taxes were 87% of total SLG tax receipts.

In 2017, single family homeowners averaged $3300 in property taxes. Some states like Colorado have low property taxes averaging only $2000 (Note #4). Personal property taxes have averaged almost 7% annual growth during the past thirty years. Expect 8 – 10% annual growth in the next decade and a population shift to those states which can curb the growth of their taxes. Angry homeowners and taxpayers are sure to kick up a ruckus at City Councils and State Legislatures around the country.

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  1. In 2007, Christina and David Romer analyzed the effect of tax changes on GDP. They found that a 1% exogenous tax increase resulted in a 2 – 3% reduction in real GDP. They classified tax changes implemented for long-term growth as exogenous. Here is a one page summary of the PDF.
  2. One of several sources on Republican dominance of state legislatures. The Hill.
  3. Income and sales tax make up 50% of California’s tax revenues (CA Research Bureau)
  4. Denver Post article on property taxes

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Miscellaneous

NYT had an article on senior scams this week. Because those older than 50 own 70% of deposit balances, they are prime targets of fraud. This was novel: a retired IT pro who thought he was working from home as an employee gave his new “employer” his bank information so that his paycheck could be direct deposited. Common scams: Check fraud is still common, as are overpayments and other excuses to get you to give up your bank account information. Only you should be initiating such a transaction.

Vanguard’s projections of expected returns for various asset classes over the next ten years. Domestic stocks 3.9%. Bonds 3.3%

 

 

Lien On Me

Jerry sent me a link to a story of legal cruelty documented by the Huffington Post Investigative Fund.  Large banks, including JP Morgan Chase and Bank of America, are buying up blocks of tax liens for delinquent property taxes, adding on exorbitant legal and interest fees, which they collect when the homeowner is forced to sell.  In one example, JPMorgan collected $12,000+ for a delinquency of less than $1000 on a $67,000 house.

What can we do?  Some cities have passed laws that prevent the sale of tax liens which are less than a minimum – a $1000, for example.  Check with your city or county to see if it has such a law.  If not, write your reps to get such a law passed.

I’m too sickened to comment further.