Welcome back in this module. We're going to talk about property taxes Now. The outset, we first need to get some definitional matters out of the way. Generally, there are two types of property. First, there is real property, which is land and anything permanently affixed to land, including improvements. And second, basically everything else you can own, whether tangible or intangible is personal property. So if you're sitting in your house or apartment, maybe an office building right now, the building and the land that sits on is real property. Also, the items in your house or office there, permanently affixed to the building are real property as well. So, for example, your overhead lighting fixtures are real property. The trees outside your window, are real property. A fence is real property. A parking lot is real property. However, the items in your home or office like your furniture, your computer, the appliances, a lamp on the desk. All those items are not permanently affixed to the building or the land. And thus those are personal property. Your car is personal property. The stocks in your brokerage account are also personal property. Now, one rule of thumb, although not always entirely accurate about the difference between real and personal property, relates to how easily movable the property is. If you cannot easily move it, the property is more likely to be a real property. If you can easily move it, well, then it's more likely to be personal property. However, the distinction between real and personal property can become tricky for some borderline cases. And the classification of certain assets can vary by state. So, for example, whether a manufactured or mobile home is real or personal property is going to vary. And it may even depend on how it is situated on its site. Now one word of caution. Make sure you do not confuse personal property with personal use property. Another tax term you may have heard. So, for example, your laptop computer is personal property. If you use your laptop computer for business, it is business use personal property. If you use your laptop just for browsing the internet at home, then it is personal use personal property. But regardless of how you use the laptop, it is personal property. Now in the United States, property taxes are the closest thing we have to a wealth tax. Because as you would expect, wealthier individuals generally own more property. So property taxes would ideally appear to be a progressive tax. However, there are a couple of key distinctions between property taxes and a true wealth tax. For one, property taxes only include a small subset of assets owned. For example, property taxes generally only tax real property and certain limited categories of personal property like cars, boats and recreational vehicles. These taxes are usually paid when the vehicle is required to be registered with the state. A second big difference, is that property taxes are based on gross, not net values. So if you own $100,000 piece of real estate, you pay property taxes based on $100,000 of value. That's regardless of whether you own the land free and clear with a full $100,000 of equity. Or whether you have a $99,000 mortgage and only $1000 of equity. So in the United States, there are generally no federal property taxes. This is primarily because the US constitution requires that direct taxes other than income taxes and a property tax is a direct tax. Those taxes must be apportioned among the states based on state population. So a federal property tax would be quite cumbersome and politically difficult to implement. That's because two states with the same population would have to pay the same amount of federal property tax. But while two states may have similar populations, the actual value of property within those two states could vary widely. Thus, the effective tax rate in those two states could be quite different. Let's do an example. Suppose the federal government wants to institute a federal real property tax. State A has a population of 5 million people in state B also has a population of 5 million people. That means that the US constitution will require these two states to pay or contribute an equal amount of federal property tax. However, State A is generally a wealthier state and has real property valued in total at $800 billion. And state B has real property valued in total at $400 billion. If the goal of the federal tax was to raise $40 billion of tax in each state, remember their tax has to be the same because they have the same population. To raise the necessary revenue, the tax on real property in state B, would have to be 10%. Which is double the 5% tax rate that would be required in state A to raise the same amount of revenue. Of course, just because it's difficult, doesn't mean it can't be done. For example, in 1798 to help finance the Quasi-War with France, the federal government imposed a real property tax based on the number of windows a property had. And the tax was a portion, so each state was provided the revenue target based on their population. Now this window tax in the United States was just a one time assessment. But the idea was actually borrowed from England, which had imposed their own window tax since the late 16 hundreds. The rationale for a window taxes pretty straightforward properties that are more valuable should have more windows. However, a look at some older buildings in England shows us that tax and sunlight minimization strategies were adopted in response. Okay, of course recently, many politicians had advocated for a wealth tax in the United States. And you might have heard some commentators arguing against such a tax, saying it would be unconstitutional. Well, this apportionment requirement is probably what they were referring to. So it's not that a wealth tax itself would be unconstitutional. But at least based on some existing, although pretty old Supreme Court rulings, it looks like a wealth tax as a direct tax, would potentially have to be apportioned based on state population. A doable, but tricky endeavor. However, at this point in time, it doesn't look like a wealth tax is on the horizon for the United States. But as the last few years in American politics has taught us, maybe we should expect the unexpected. Now let's get back to state and local taxes. As we previously learned, the income tax and sales tax did not come into widespread state usage, until the early half of the 20th century. However, the property tax in the United States dates back to the first European settlements in North America. And until the widespread adoption of sales and income taxes, property taxes were by far the largest source of revenue for both state and local governments. Today, we know that the sales tax and the individual income tax are by far the largest source of revenue for state governments. But the property tax remains as the most important revenue stream for local governments. Making up almost half of their total not just tax, but total own source revenues. The remainder of local own source revenue is made up of various charges. Think water and sewage fees, parking meters, etc. Local sales taxes and local income taxes. Here, let's look at a chart from the Tax Policy Center, which shows just how much own source revenue local governments receive from property taxes. And just how little state governments utilize the property tax. Usually, these state level property taxes are taxes on certain types of tangible personal property. For example, cars, boats, RVs and taxes on limited categories of tangible personal property owned by businesses. But overall, personal property taxes are a small fraction of the total property taxes levied by state and local governments. The vast majority of collections are taxes on real property. And again, as I previously stressed, these are combined numbers for all the states. Each state relies on the property tax to a different extent. So take a look at the following map from the Tax Foundation. Showing the extent to which each state relies on property tax collections as a percentage of their total tax revenue. If you're located in the United States, to what extent does your state rely on property taxes for their tax revenues? And based on your personal experience, paying taxes in your state, does this map surprise you?
