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Chapter 17

Taxes on Wealth Property and Estates

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A Comprehensive Wealth Tax Base Real Property is property such as land and

the structures on the land.

Intangible Property is wealth that is held as paper or financial assets. 

Personal Property is wealth that is held in the form of cars, furniture, clothing, jewelry, etc.

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Measuring Wealth Market value can be used to establish the value of

most real property and intangible property, but personal property has no acceptable resale market.

Serious inequities can arise from mismeasurement of wealth and serious shifting can take place when one form of wealth is taxed while another is not.

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Assessment of Property Value

For the property tax, the assessed value of a home and the land upon which it sits is quite subjective. Real-estate markets exists for many homes but not others.

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A Comprehensive Wealth Tax

Where Ri = the return to asset I

r = the interest rate tW = the wealth tax rate

W = Wealth

A comprehensive wealth tax would tax all forms of capital equally.

If W = Ri/(1 + r)i then the effective tax

rate on savings would be ts = tWW/Ri

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Figure 17.1 Impact of a General Wealth Tax When the Supply of Savings is Perfectly Inelastic

Annual Savings and Investments

Re

turn

(P

erc

en

t)

0 Q1

D = rG

S

rG*

R1

tW WrN = rG –

Ri

tW W

rN*

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Figure 17.2 Impact of a General Wealth Tax When the Supply of Savings is Responsive to Changes in Annual Return

Annual Savings and Investments

Re

turn

(P

erc

en

t)

R1

tW WrN = rG –

Q2

rG1*

rN1*

S

D = rG

rG*

Q1

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Selective Property Taxes

Property Taxes in the U.S. are typically selective in that real property is taxed, some forms of personal property are taxed, and intangible property is not taxed.

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Wealth Taxes in an Open Economy

Capital mobility has increased dramatically in recent years.

Wealth taxes in a nation discourage foreign investment in that nation.

U.S. gross investment has declined from 22% of GNP in 1959 to 17% in 1999.

U.S. net foreign investment is negative, meaning that foreign capitalists are investing more in the U.S. than U.S. capitalists are investing abroad.

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Local Property Taxes and Tax Capitalization Property Tax Differentials are the differences between

what would be owed in one community on a particular piece of property relative to what would be owed on an identical piece of property in a different community.

If the differential is high, then people will be willing to pay less for property in the high-tax community and more for a home in the low-tax community. The tax differential will be capitalized into the value of each home. The present value of the differential over the expected length of time the differential will hold will be the difference in the prices of the two pieces of property.

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Figure 17.3 Impact of a Property Tax on Housing Rents

D=Gross Rent

Q1

100

S

120

60

Q2

Net Rent = Yt-tVt

Re

nt

pe

r S

qu

are

Fo

ot

(Do

llars

)

Housing Rented per Year (square feet)0

$60

tVt =

Y

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Capitalization and the Elasticity of Supply Full tax capitalization only occurs if there is no

supply elasticity.

Land is perfectly inelastic but structures are not.

A differential tax will cause more building in one area and less building in another.

After such shifting, less than full capitalization of the tax differential occurs.

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Property Taxes in the U.S. Fractional Assessment is the practice of assessing a

property at only a fraction of its true value. Typically this implies that the tax rate is higher.

Nominal Tax Rates are the rates of tax per assessed value that a property owner must pay.

Effective Tax Rates are defined as the taxes owed per true market value.

For instance, Newark N.J. has a nominal tax rate of 23.85%, but the assessed value of a piece of property is typically only 16.4% of its market value. Thus, the effective rate is 3.91%. The average U.S. effective rate is 1.67%, the median 1.42%.

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Reliance of the Property Tax by Local Governments

The property tax is an important source of revenue for most local governments.

It raises more than 95% of all local revenue in CT, ID, MA, MN, MT, NH, NJ, RI, VT, WI.

In no state does it provide less than a third of local government revenue.

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Property Tax Preferences

Communities often enact “circuit-breakers” that do not allow assessed evaluation to increase more than a fixed percentage in a period of time to help the elderly living on fixed incomes.

  Agricultural land is also taxed at a much lower

rate than residential and commercial land.

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Land Taxes

A criticism of property taxes is that they reduce the incentive to build on a piece of property.

A solution is to impose a tax on the land rather than the buildings on it.

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Figure 17.4 Impact of a Land Tax

tV

RN = RG – tV

R*N

R*G

D = RG

S

Q1

Re

nt

pe

r A

cre

Usable Acres of Land

Entire Tax Borne by Landlords

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Estate and Gift Taxes The estate tax places a tax on the estate of those

who have died before their assets may be transferred to their heirs.

The gift tax prevents people from avoiding the estate tax by giving away their assets before they die. You may give up to $10,000 to each person per year.

Estate taxes were substantially reduced in 2001.