Wednesday, December 19, 2007

Fair Tax in Texas - Update

Recently I have been defending Texas Rep. Phil King's sales tax idea on Paul Burka's Blog on Texas Monthly Magazine's website. Follow the link to see my comments. Mr. Burka linked to a position paper put out by Dick Lavine the Center for Public Policy Priorities.

Below is a critique I wrote to Dick Lavine and cc:'d to Rep. Phil King and my district's Rep. Larry Taylor. I thought the line in bold was the most damning.

Mr. Levine,

I have read your “REPLACING PROPERTY TAXES WITH SALES TAXES WOULD BE BAD FOR TEXAS BUSINESSES, FAMILIES, AND PUBLIC EDUCATION“ and I have a few problems with your analysis and wanted to point out some contradictions and oversights.

While you state the obvious that if prices go up, demand will fall for retail purchase, you ignore a number of other effects of the sales taxes replacing the property tax. You state:

“Thus, if the state raised the sales tax to eliminate property taxes, Texas businesses would have trouble selling their goods and services because we would have the highest sales tax in the country.”

You are completely ignoring the costs savings through property tax elimination for retail properties. While the sales tax would increase, the underlying cost of business would decrease because, as you said, the price of rent (in a competitive market) will fall when property taxes fall. You also ignore the wealth effect on the budgets of residential property tax payers who would have more money to spend once their property taxes fell. Even though internet purchases are growing, the vast majority of retail purchases are made by locals at local retail establishments, it would be terribly inconvenient for Texans to avoid Texas retail establishments for most purchases.

You also mention on page 4 that:

“Businesses also pass on their property taxes to families and individuals in the form of higher prices, lower wages, or lower profits.”

This statement, in defense of property taxes, is not included in your analysis of who would benefit form the tax cuts. You argue that the sales tax would hurt businesses and increase prices, so the sales tax is bad. Then when defending property taxes you admit that they lead to “higher prices, lower wages, or lower profits” and this is ok? This is a blatant contradiction.

“The sales tax, which is based on consumption, is extremely regressive, meaning it takes a much larger percentage of the income of a low- or moderate-income family than of a higher-income family.“

Therefore, the sales tax is regressive because it hurts the poor, yet you also say in the defense of property taxes:

"Homeowners write checks directly, but renters also pay property taxes, which are passed on to them by their landlords in the form of higher rents. "

The poor generally rent at much higher rates than those with higher incomes. Because they are renters the property taxes calculated into their rent does not have homestead exemptions available. Secondly, renters cannot deduct mortgage interest or property taxes from their federal income tax and these extra costs pass into their rent. Their rent would fall with a conversion to the sales tax.

Your analysis also ignores the rebate mechanism Rep. King mentions, in an allusion to the FairTax, which is available to everyone. This oversight means that the sales tax, under Phil King’s plan, may actually be progressive depending on the size of the rebate.

Finally, you state:

"Property taxes do not imperil home ownership. Generally, Texas families buy homes based upon their annual income, giving the tax a rough correlation to the ability to pay."

This is a terrible contradiction. First, you claim that lower prices will not lead to higher demand for home ownership, which is patently absurd and contradicts the most fundamental principles of economics, and claim that “families buy homes based upon their annual income”. Under a switch from property tax to sales tax, the incentives would change to encourage more consumption of housing, which would be taxed less, and away from retail purchases, which would be taxed more. This would increase the level of home ownership.

While you do fine with your number crunching your economics is superficial. While you may not like the sales tax bill by Rep. King prima facie, you do a disservice to the parties you want to help by piling up evidence against a bill without fleshing out all of the effects. In the end, your points may be valid, but the gaping holes I noticed negate your entire argument for me.

Brian Shelley

P.S. I am sending copies of my rebuttals to Rep. Phil King and my representative Rep. Larry Taylor


minimum wage said...

Secondly, renters cannot deduct mortgage interest or property taxes from their federal income tax and these extra costs pass into their rent. Their rent would fall with a conversion to the sales tax.

How is the lack of a deduction a "cost" which "pass[es] into their rent?"

How would conversion to a sales tax result in lower rents?

There is ample historical evidence (e.g. California, Massachusetts, Michigan) that even huge property tax reductions or "conversions" do not result in lower rents.

Brian Shelley said...

'How is the lack of a deduction a "cost" which "pass[es] into their rent?"'

I can't be certain how everyone does it, but in the insurance world we add up all the expected costs, tack on a rate of return we want to achieve and set that as our price. Of course, we are also restricted on how much people are actually willing to pay.

If Mr. A owns a home and his total mortgage (loan + prop. tax + ins.) is $1200, and Mr. B rents a home for $1200. Mr. A actually pays less because at the end of the year he will be able to deduct the mortgage interest and property taxes from his income tax. Mr. B can not do this, nor can his landlord.

In a competitive market, pricing should happen similar to the way we price insurance. A drop in costs, allows us to drop our price and make more profits until other companies cut their price as well. Then we're back to the original rate of return. The same should be true for rental properties. If we cut property taxes, rents should fall.

"There is ample historical evidence (e.g. California, Massachusetts, Michigan) that even huge property tax reductions or "conversions" do not result in lower rents."

If you have any links or data, I would love to read them. If the property tax deductions were in a period of high inflation (70s and early 80s) then it would be more difficult to tease out the effects of the property tax change.

minimum wage said...

Okay, I understand the deductibility thing, as a low-income renter, I see infinitesimal to no bottom line benefit to renters in deductibility.

Renters would have to have aggregate deductions greater than the standard deduction, andlow-income renters simply cannot come up with enough deductions to itemize - unless they paid an exorbitanty sum in medical bills, highly unlikely.

While I haven't seen the rents quantified in this context (state landlord organizations track the numbers and probably have some historical data), the fact that a number of local rent controls were adopted in California following the passage of Prop 13 suggests that a lot of renters got no rent reductions and were pretty angry about it.

As a lifetime low-income renter, I try to read up as much as I can on the economics and market conditions.

First, there are two basic types of landlords. There are professionals who own and/or operate for a living, a substantial number of rental units. There are also mom-and-pop "weekend" landlords who own a handful often one or two SFR.

The weekend landlord, owning one or three units, places a high value on occupancy and stability. These landlords typically hold long-term, holding to fund their retirement. Because a single vacancy represents a substantial vacancy rate, they often price their rentals a shade on the low side of market, and are laggards in raising rents.

Professional landlords have an entirely different calculation. They tend to have shorter time horizons, exchanging into other properties to optimize taxes. Maximizing rent is very important, as it not only provides greater cash flow, it also maximizes price when they sell.

While the weekend landlord maximizes profit at 100 percent occupancy, the professional virtually never does: if he has 100 units and they are all rented for, say, $800/month, he can make more money at some higher rent. For example, if he raises the rent to $900 and ends up with 5 vacant units, he comes out ahead.

Also, in many areas, zoning restrictions artificially restrict the rental supply beloe what the private sector would prefer to build.

So I don't think there is sufficient competition in the market to afford renters relief - it takes a LOT of slack in the supply.

Brian Shelley said...

I'll concede the fact that low price renters would not likely be able to deduct theoretical mortgage interest from their income tax. I'll drop that claims.

However, I still believe that because they can not get the homestead exemption, which in my area cuts off the first $15K of appraisal value. They should still have lower rents.

"Also, in many areas, zoning restrictions artificially restrict the rental supply beloe what the private sector would prefer to build."

Thankfully, Houston is THE major city without zoning. However, my suburb is one of the many thousands of cities across America who use or have used zoning to restrict the supply of low income housing.

I am adamantly opposed to zoning in major cities. It is a hidden tax on the poor, by artificially restricting the supply of homes like you mentioned. It also decreases the economic vitality of the city.

I participate in a blog - where we debate this topic frequently.

"As a lifetime low-income renter, I try to read up as much as I can on the economics and market conditions."

Then come back often or send me your contact information so that I can pick your brain in the future.

Mark said...

You people are hilarious -- talking aout mortgage interest deductions,and rent "falling" with fairtax.

I got news for you. Thats like talking about if the magic pills can make your car get 100 miles on a gallon of water -- or 300 miles a gallon.

The answer is -- NEITHER.

Fairtax would only last 2-3 months, if it passed (and it can not pass).

The reason it would only last two to three months - it would take that long to throw it out.

First -- the fair tax has the remarkable farce of taxing the government - to PAY for the government. The Fairtax crowd wants to believe that the government could PAY about 500 billion in taxes -- TO ITSELF.

Heck, why don't I just pay myself 500 billion? And if the government can pay itself 500 billion -- why not a trillion? Why not 2 trillion -- and NO one has to pay taxes?

You think fairtax doesn't try to tax government?

Oh, yes it does. In fact, fairtax PRETENDs that the government is a "MAJOR" taxpayer.

Get your little fairtax book out, turn to page 148. Toward the bottom of the page, lets read together. "The federal government ITSELF would become A MAJOR TAXPAYER"

Right THEN the bells and whistles should have gone off.

And its not the ONLY fallacy, its just the lynch pin, the central fallacy.

WIthout that absurd fallacy, Fairtax can't pretend to get 2.3 trillion dollars. Only by pretending the government can get 500 billion from itself, does fairtax come up with 23%.

If you don't know why the government CAN NOT tax itself, I can't help you. You need more help than I can give right here.

But thats only the START of the absurdity. Fairtax has to pretend to get several huge "revenue streams" -- which it can not get.

Fairtax pretends it can get a revenue stream from the government -- 500 billion.

Fairtax pretends it can get a revenue stream from health care patients -- 460 billion.

Fairtax pretends it can get a revenue stream from insurance premiums (yes, all premiums are taxed) 175 billion

Fairtax pretends it can get a revenue stream on sales taxes of new houses 200 billion.

Fairtax pretends it can get a revenue stream from renters -- 150 billion.

There are other revenue streams it pretends to get. But just the above means the fairtax is an absurd fraud, if they can't really get those revenues.

Can they get 500 billion from the government? Hello no, not unless laws of math and logic are different in that alternate universe

Can they they get 460 billion from health care patients? Hello no, not unless nursing home and cancer patients, leukemia patients, and every patient, can cough up 30-40% of their medical bills as a tax.

Can they collect 175 billion from taxing insurance payments? Hello no, not when people are pissed off as hell when they see this tax.

Can they collect 150 billion from renters? Hello no.

I pity the fool renter than has high medical bills, and pays car insurance. I really do. That poor guy could make 30,000 a year, but get 60,000 sales tax on his cancer treatment bills.

Fairtax would be so wildly unpopular, it would be hated more than any tax, ever. And the people who were for it, will be laughingstock for 100 years./

I hope and pray the fairtax passes, I really do!!!! I would LOVE to see it!

Brian Shelley said...


I'm sorry you misunderstood my support of the "Fair Tax". I wrote here

that I was skepital of the fair tax at the federal level. I've never read the book, I have only made myself familiar with the concept.

For the state of Texas, I still support the idea of dropping property taxes in favor of a sales tax. Not just a sales tax, but one including the "fair tax" design element called the "prebate".

I excorciated Dick Levine because of the gaping holes and deceptive maneuverings he used in his white paper to attack the "fair tax" proposal of State Rep. Phil King for the State of Texas.

At the federal level I do not support the fair tax. It has some pleasing economic properties, but I feel that it has the same potential to be manipulated and bloated as the current income tax.