9.12.2006

Picking up on a previous post on my company's recent study on property
tax abatements in Philadelphia, I wanted to elaborate on a couple of
points that were made in our report. I learned in government school
that taxes should be evaluated on two fronts: efficiency and equity.

Efficiency means that there is a minimum of distorted behavior that
negatively impacts your jurisdiction. Take for example a street, one
side of which is in your jurisdiction and the other side of which is
in another jurisdiction. If your wage tax is 4% and the neighboring
jurisdiction's is 1%, guess where businesses are going to choose to
locate? The other side of the street is no further for a firm's
workers to commute to and no further for its customers to get to, but
by locating there each of its workers gets to keep 3% more of their
pay. This is grossly inefficient for your jurisdiction.

Equity means that the burden of paying the tax is borne in proportion
to a person's ability to pay it. All things being equal, the richer
you are, the more of the tax burden you should bear. This is often
referred to as progressivity versus regressivity. A progressive tax
is one in which the tax rate escalates as you get richer. Our federal
income tax, for example, is structured such that as you cross certain
inceom threshholds, you pay a higher and higher percentage on each
increment. A regressive tax is one in which the tax rate escalates as
you get poorer. Let's say, for example, there was a tax that was
designed so that everyone had to pay $500. If I make $20 million a
year, that's a drop in the bucket for me; but if I make $20,000 a
year, that's a much higher percentage of my salary.

Property tax abatements for new construction are both efficient and
equitable. On efficiency, you want to tax what can't move. If what
you're taxing can move, people will make decisions to move away from
whatever's being taxed higher to whatever's being taxed lower. New
construction can move: it can be built on your side of the boundary or
the other side. Once built, it's fixed; thus, it's efficient to abate
taxes upfront while construction can move, and then collect it later
when it can't.

On equity, here's a rare housing-related tax break that actually
derives more benefit to you if you make less money. In general, our
tax code on this subject is designed to provide a greater benefit to
the rich: the fact that you can deduct your property taxes and your
mortgage interest means more the richer you are, because your marginal
tax rate is higher.

Let's use an example. Jack and Jill own identical houses with
identical values. Jack is in the 15% tax bracket and pays $3000 in
property taxes this year. Jill, who makes ten times what Jack makes,
is in the 33% tax bracket and also pays $3000 in property taxes. The
deduction on the Form 1040 translates into $450 back into Jack's
pocket (15% of $3000) but $1000 in Jill's pocket (33% of $3000). So
paying that $3000 in property taxes really means paying $2550 for Jack
but $2000 for Jill. And Jill's the one who makes more money!

Now, let's add a property tax abatement into the equation. That
abatement wipes away $2550 for Jack but only $2000 for Jill. In other
words, the abatement is worth more to Jack than to Jill. It is, thus,
an equitable tax incentive.

I encourage you to go to our website and download the report from our
news page. Enjoy.

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