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Is it economically viable to replace property taxes and consumption taxes with local income taxes? What are the downsides of such a proposal?

In the United States, most counties and cities levy property taxes and consumption taxes to fund local budgets.

Consumption taxes are regressive, and property taxes can be burdensome on senior citizens. On the other hand, a local income tax on individuals and corporations shifts the tax burden more heavily on the wealthy.

Are there any negative consequences to establishing a local income tax? In practice, would it be better or worse than the keeping property and consumption taxes?

Politics Asked on January 1, 2021

2 Answers

2 Answers

Is it economically viable to replace property taxes and consumption taxes with local income taxes?

Usually, but not necessary always.

Many local governments impose income taxes. New York City is one well known example.

The marginal compliance cost of a local income tax in a place that has a higher level of government that also imposes an income tax is very modest. Most U.S. states with an income tax use federal income taxes as a starting point and then tweak the calculation to limit the tax to only income within the locality's jurisdiction.

All one has to do is determine the amount of revenue raised by the taxes replaced and adjust the income tax rate to cover it.

The only exception would be in local government jurisdictions in which there is not enough taxable income to support the needs of the government in question (a probably that can also arise in the case of property taxes and consumption taxes).

For example, if you have a county government that is almost entirely comprised of land owned by tax exempt governmental and non-profit entities that don't use that land for income producing purposes, have no commerce to produce sales, and are also exempt from property taxes, financing that government can be a problem.

This isn't a hypothetical problem. It comes up with some frequency in the arid west where there are huge tracts of thinly arid and mountainous land owned by the federal government, or religious institutions, or other non-profits such as universities. It also comes up, for example, in cemetery districts, whose deceased residents have no income even if that income would be taxable.

These governments have to find other sources of revenue.

Cemetery districts, for example, typically generate income from the purchase of burial rights that are used to endow the governmental entity and pay its expenses in perpetuity. In Japan, cemeteries charge rent to the next of kin for the burial sites and dispose of the remains when people stop paying rent to make room for new spots.

Non-taxable governments or non-profits often make voluntary contributions in lieu of taxes to the local governments they are located in, in order to allow those governments to provide services that benefit the voluntary contributor for the most part.

What are the downsides of such a proposal?

One basic problem is that the amount of money that a local government needs to provide the services that it is mandated to provide based upon need in its jurisdiction doesn't necessarily correspond the the income that is earned within its jurisdiction.

For example, residential neighborhoods with lots of poor people in them (e.g. mobile home parks) have a high demand for local government services and a low amount of taxable income.

In contrast, an industrial park that is all part of business property owner's association that is home to lots of tech companies may have immense income and very modest needs for governmental services.

One reason that local governments have different tax structures is to reflect their different mix of service demands and taxable sources of revenue.

Another difficulty with local income taxes is that localizing where income is earned is frequently difficult and presents a serious opportunity for evasion by simply relocating "hot income" like returns on intangible assets like interest bearing accounts and stock dividends.

A third difficulty with local income taxes is that enforcing payment is often challenging. For example, shortly before its financial meltdown Greek tax collection rates, which had a large income tax component were very low, on the order of 10%. This is also a difficulty in economies (like much of the third world) where lots of participants in the economy do not maintain auditable books or use banks, such as subsistence farming economies.

In contrast, businesses upon which consumption taxes are imposed often have a physical presence in the local jurisdiction that can be shut down if the business does not account properly and pay taxes.

Property taxes are typically administered by the local government which values the property and sends invoices to the taxpayer who only needs to pay the bill. And, if the taxpayer doesn't pay, the local government takes a lien against the property which isn't moveable, and seizes to property to pay the much less valuable tax debt owed if the taxpayer does not. Sometimes, the process is further streamlined, with the tax liens sold to private investors who then handle collection of unpaid taxes privately, with interest, while the government receives income promptly from the investors. Then, the investors get the windfall in the rare cases where the liens advance to a foreclosure sale.

Also, if property taxes have some sort of homestead exemption they are only moderately less progressive than a flat income tax.

Answered by ohwilleke on January 1, 2021

This is a fairly huge question, but the short answer is yes. Income taxes, whether local or national could be used to replace consumption and property taxes. In the abstract this is a trivially simple proposition, you simply look at the income from the current mix of tax sources and then move the sliders on the income taxes to replace incomes from consumption taxes.

Are there negative impacts to this? Again, reasonably obviously there are upsides and downsides to all methods of taxation. The most obvious for shifting all taxation to income /corporation taxes is that there are major loopholes that mean those with sufficient funds often do not have to pay the headline tax.

Oxfam: Inequality and Poverty

Through a complex and loosely regulated tax system, multinational companies and rich individuals actively seek to increase their profits by storing them offshore and avoiding paying taxes in their countries.

Tax havens are at the heart of this system. They allow massive amounts of wealth to flow untaxed and in secret, out of reach from tax authorities and regulators.

Tax rates from millionaire incomes

Researchers at the universities analysed anonymised HMRC tax returns of higher earners and found that the average person with £10 million in total remuneration had an effective tax rate of just 21 per cent – less than someone on median earnings of £30,000.

The pulled out quote is most relevant here. Irrespective of what the calculated rate for those on a lower income is when consumption taxes are taken into account. The top rate of income tax in the UK is 45%. Combined with National Insurance, which is an income tax with a different name, and runs at 2% at these income levels (12% for lower incomes).

We have a marginal tax rate on the super rich being 47%. And with this handy calculator we see that should give an overall tax rate of 46.8% So thanks to the research quoted in the London Economic we can see that the super wealthy are able to (legally) reduce their tax bill by more than half.

Equally in terms of corporation taxes, it is not difficult to find stories about the low tax rates multinationals pay.

Without major reform to income based taxation to remove the legal (and the appetite to combat the illegal) methods of reducing the amount of income based tax individuals and corporations pay, the removal of consumption taxes is impossible. VAT is something that businesses do at least pay.

Wholesale changes are phenomenally difficult to implement fairly. Even assuming that incomes were declared and taxed honestly consider that 1) it is possible to be wealthy without a large income and 2) it will be harder to accrue wealth by avoiding consumption for those where discretionary spending is significant.

Answered by Jontia on January 1, 2021

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