12/11/2012 12:20 pm ET Updated Feb 10, 2013

How to Secretly Tax the Poor (Part Two)


In Part One we looked at how the portion of payroll taxes nominally paid by employers is really paid by employees, resulting in workers who, despite being too poor to owe federal income tax, still pay a higher effective tax rate than millionaire Mitt Romney. That post demonstrated how the poor are taxed without complete recognition of where, and how much, they pay. I'll offer another example here. This time we'll look at how low-income residents are required to pay higher property taxes than those who are wealthier.

First, let's briefly review how property taxes are implemented in most states. Real estate is normally taxed "ad valorem," which means "according to value," so if you own a home worth $400,000 you might pay twice as much as a person in a home worth $200,000. This makes sense for the most part. After all, the fire department is protecting twice as much value. The police presumably protect more assets as well, if you are wealthy enough to own a more expensive home. In general those who have the more expensive houses get more value from the local government, so we can probably agree that ad valorem taxation is reasonable.

Now, although the tax paid on a property is generally based on the value, many states provide special deals for those who own the homes they live in, allowing them to pay less than those who own a property as an investment. It seems like a worthy policy to most people, in part because it encourages home ownership, a goal which Americans have become fixated on for various reasons. Also, where these policies are in place, residents are often quick to assume that the balance of the necessary local revenues will come from investors' profits in the form of their higher property tax rates. I'll address that fallacy in a moment.

One way this preferential treatment is implemented is to give owner-occupants an exemption from taxation on a portion of the value of their homes (we can exempt up to $50,000 in Florida, for example). Some states have a limit to how fast the taxes can go up for owner-occupied homes, regardless of how fast the value increases. Many states have both of these elements as part of their laws. Then there are arrangements which cut the taxes (sometimes in in half) for senior citizens, probably instituted in part because old millionaires have more time available to vote for lawmakers who offer them these discounts.

Whatever the particulars are in each state, the thing all of the schemes have in common is that those who live in the houses they own get to pay less into the local treasury. In other words, members of this special class of residents get to pay less for the necessary police and fire protection and other local services that property taxes support. The difference is made up by charging higher taxes on properties that are owned as investments. Now let's look at who really pays those taxes.

At first glance it appears that the investor who owns a rental house or apartment building pays the property tax on it, but this is only nominally true. It is easy to demonstrate who really pays those taxes. Imagine an investor is receiving cash flow of $90 per month after expenses on a small house he rents out for $700 per month. Now imagine that property taxes are raised in this locale, resulting in taxes rising $100 per month on his property. Will he simply operate at a loss? It seems unlikely, to say the least. He will probably raise the rent to $800, and since all landlords are facing an increase in taxes and so are raising their rents, he doesn't have to worry much about losing his tenant to a cheaper place.

Who really pays the tax in this case? Clearly it is the renter. In fact, when we look at how any business or investor has to operate in order to make a profit (and they have to do so, just as a worker has to get a paycheck), we can see that all the costs of providing a product or service must be paid by the purchaser before one penny of profit is made. Therefore, when costs are added by governments it is the final consumer who pays them. If we wanted to resolve this general dilemma to some extent we would focus on taxing that portion of the money taken as personal income by an investor or businessman. But let's return to our specific example.

In researching this post I found that many houses which are essentially identical have very different property tax bills. This is not a surprise. In fact, several of the condos around the one my wife and I occupy, which are all of the exact same design, will have a tax bill that is about double our own next year, because they are rented.

To understand what this means, consider any two very similar homes that are next to each other. One can have an annual tax bill of $2,400 because it's owned by an investor and rented out to a struggling family. The other might have a tax obligation of just $1,200 because it's been occupied by the owner for years and the taxes have been held down by special exemptions and annual rate increase caps. If we understand who really pays the taxes we see that the family which is renting pays an extra $100 per month in property taxes for what is essentially the same house. Their true ad valorem rate is double.

Given that those who are poor are much more likely to be renters and that all property taxes are passed on in the form of higher rent, we have to acknowledge that many who are poor are being quietly burdened with a higher tax rate than the rate paid by those who are middle class or wealthy. If we wanted to change the system we could eliminate all differences in rates. We could help the poor with tax rebates that go directly to renters or owner-occupants. We could tax investors' personal income at a higher rate if we felt they should pay more toward funding government. While agreement on specific remedies might be difficult (and I would not be thrilled about our own taxes doubling with the loss of our exemption) most of us can probably agree that there is something unjust about charging poor renters a higher property tax rate than the one paid by those who -- including millionaires -- are lucky enough to own their own homes.