BLOG POSTS ARE PRELIMINARY MATERIALS CIRCULATED TO STIMULATE DISCUSSION AND CRITICAL COMMENT. THE VIEWS EXPRESSED ARE THOSE OF THE INDIVIDUAL AUTHORS. WHILE BLOG POSTS BENEFIT FROM ACTIVE UHERO DISCUSSION, THEY HAVE NOT UNDERGONE FORMAL ACADEMIC PEER REVIEW.
By Carl Bonham and James Mak
Voters will soon be weighing in on a possible amendment to Hawaii’s constitution. The ballot question is, “Shall the legislature be authorized to establish, as provided by law, a surcharge on investment real property to be used to support public education?” 1 Unfortunately, this language provides no definition of what constitutes “investment real property” or how large the surcharge might be. The vagueness of the proposed amendment has led Hawaii’s four counties to file a lawsuit in an effort to keep the amendment off the ballot. Without specific details on what will be taxed, what the tax rates will be, and how the state would use the additional revenue, it is practically impossible to interpret the effects of such a change to Hawaii’s constitution. In a recent Honolulu Star Advertiser op ed column, HSTA president Corey Rosenlee explained that their intent is to “only place a surcharge on non-owner occupied residential properties (second homes) valued at more than $1 million, which will generate an estimated $200 million to $400 million a year for public schools.” 2 That is not what the proposed amendment says. Nor are state lawmakers obliged to abide by this definition of “investment real property” if the ballot measure is approved.
For the sake of discussion, suppose that the legislature and governor agree to a surcharge rate, and to a $1 million threshold on “non-owner occupied residential properties”. Who is impacted by these changes? If a residential property is not occupied by its owner, it must be occupied by renters, or left vacant. (A residential unit occupied by its owner as a “second home” does not meet the literal definition of “non-owner occupied residential properties”.) The American Community Survey (ACS) conducted annually by the U.S. Census Bureau estimated that in 2017 62% of Hawaii’s population in occupied housing units were residing in owner-occupied units; the remaining 38% were in renter-occupied housing units. 3 Last year over half a million Hawaii residents (527,421) were renters. In terms of occupied units, in 2017, 58.5% of the 458,078 occupied housing units in Hawaii were owner-occupied, and 41.5% (190,000 units) were occupied by renters. 4 We do not have data on how many of those rented units were valued at over $1 million. For tax purposes, a modest apartment building with several units is likely valued at more than $1 million even though each individual unit is worth much less.
Proponents of the constitutional amendment argue that one aim of the tax surcharge is to “disincentive those out-of-state millionaires and developers” from producing and buying expensive homes in Hawaii and driving up the price of housing for local residents. While close to 27% of homes purchased in Hawaii between 2008 and 2017 were sold to buyers from outside of Hawaii, we don’t know what these buyers do with the homes they purchase. 5 The homes may be occupied part time as second homes by their owners or they may be rented in the long-term or short-term vacation rental markets. Even the county tax departments don’t know. They only know whether or not a property has a homeowner tax exemption. (They don’t even know if a home is, or is not, owned by an off-shore owner.) Homes without homeowner exemptions are most likely rented out to local residents, tourists, or possibly left vacant 6 With over half a million renters in Hawaii, it is obvious that most of the rental units are rented to local residents.
Is it possible that, as proponents suggest, the surcharge will only impact out of-state-millionaires and leave Hawaii home owners and renters untouched? The short answer is no. At issue is who ultimately pays the property tax? One of the first and most important lessons from public finance economics is that the person who writes the check to the tax department may not be the person who actually bears the burden of the tax. For example, Hawaii’s prolific general excise tax (GET) is levied on businesses; but most businesses pass the tax onto consumers. Thus, the GET is actually a tax on consumption.
Surprisingly, who ultimately pays the local property tax (i.e. its tax incidence) is not clear-cut. For homeowner occupants, the incidence of the property tax is clear: the owner of the property. It is less clear for renters. Economist Richard England recently (2016) surveyed relevant literature on property tax incidence over the past half century and could not come up with a precise answer. Both theoretical and empirical problems in the existing literature confounded his effort at establishing a definitive conclusion. 7 The preponderance of the empirical research on the subject indicates that at least part of the property tax (perhaps over 60%) billed to owners is passed onto renters.
Harvard University Professor Jack Goodman wrote: 8
For rental housing, there is a sharp distinction between the legal incidence of the property tax and the economic incidence of the tax. The rental property owner pays the tax bill but attempts to recoup the cost through the rent payment of the property’s residents. In the short-run market rents are set by the current balance of housing demand with the available stock. Thus, property taxes or other expenses have no direct effect on rents in the short run. But in the long run the stock will adjust up or down depending on the relationship of rents to costs of providing rental housing. Property taxes, as one operating expense, are a part of that user cost and must be recouped through rents.
Thus, over time, a property tax surcharge on investment (residential) property owners is also, at least partially, passed on to renters.
A recent simulation study by Muthitacharoen and Zodrow (2012), which England describes as “notable for its realism,” examined whether a property tax is mostly borne my residents of a taxing jurisdiction or by non-resident owners 9. The authors conclude that, in the intermediate (i.e. relatively short) time period when residents are unable to move to another jurisdiction with lower taxes, “the total tax burden borne by residents accounts for 96.2 percent of total tax revenue.” In the long run, when residents can move to lower tax jurisdictions, about three-quarters of the tax burden falls on consumers of housing and other services.
Finally, it has been suggested that raising property taxes will lower home prices and that might be good for Hawaii residents. Why would the price of a home fall when the property tax is raised? Because the buyer is no longer willing to pay the same price for a home since he/she has to pay more property taxes. The lower price of the home is the trade-off for the higher property tax liability. The price of the home has fallen but it has not become more affordable. Furthermore, if the tax increase is only for homes priced over $1 million, a shift in demand from homes priced over $1 to lower priced homes could raise prices for all homes below the threshold.
Proponents of the amendment want to raise additional revenue to improve public schools in Hawaii by imposing a state property tax. 10 The most important reason to levy taxes is to raise revenue to pay for public services that we consume. The tax is the price of those services. Households, whether they own or rent and send their children to our public schools consume a public service that is not produced at zero cost. The current education tax surcharge proposal gives homeowners who live in their homes a discount on the consumption of public education services. What is the rationale for that? Is it because owner-occupants can less afford the additional tax than renters? According to the 2017 American Community Survey the median annual household income of Hawaii renters was $55,323, or 43% lower than the median income of owner-occupant households.
It is true that effective property tax rates in Hawaii are lower than those in other parts of the country. Then too, Hawaii is the only state in which the responsibility for public education is assigned to the state government and not to local governments, which (along with high home values) explains why Hawaii has lower effective property tax rates. 11 The idea that Hawaii’s schools are underfunded because we do not finance schools using property tax revenues is specious.
Counties in Hawaii are opposed to the amendment because they fear that, if approved, it would hinder their ability to raise revenue. However, in the U.S, many states do rely on property taxes to fund state government provided services. Among the 50 states, 18 state governments—including Hawaii—do not rely on property tax revenues, 32 of them do 12. For the entire country, on average, property tax revenues accounted for 1.7% of total state government tax revenues in fiscal year 2016; by comparison sales (general and selective) taxes accounted for 48.3% and income (personal and corporate) accounted for 42.2% of total state government tax revenues. In the U.S. the property tax is the primary source of tax revenues for local governments. Is there any advantage to assign one tax to a specific jurisdiction? According to Professor John Mikesell, a leading expert in state and local government finance in the U.S.: 13
[The] policy of dividing sources can provide useful returns to the federal system. In particular, such separation can strengthen local autonomy and accountability by ensuring access to a productive base without competition from another claimant. But probably more important is the improvement in transparency, whereby citizens can easily identify what they are paying for particular government services. When multiple governments are tapping the same base, which payment flows to which government may not be easily obvious, thus weakening the accountability chain.
While there are some benefits to reserving the property tax to local governments, in reality many state governments tap into the same base. The proposed amendment to expand the State’s sources of tax revenue is not unique. The voters will have the chance to decide whether it is a good idea.
[1] Hawaii State Legislature, “Senate Bill 2922,” https://www.capitol.hawaii.gov/session2018/bills/SB2922_HD1_.htm, accessed Oct. 11, 2018.
[2] Corey Rosenlee, “Tax would help kids and deter rich outside investors,” Honolulu Star Advertiser, September 16, 2018, p. F4.
[3] U.S. Census Bureau, 2017 American Community Survey, 1-year Estimates from https://factfinder.census.gov/bkmk/table/1.0/en/ACS/17_1YR/B25008/0400000US15, accessed October 11, 2018.
[4] U.S. Census Bureau, 2017 American Community Survey, 1-year Estimates from https://factfinder.census.gov/bkmk/table/1.0/en/ACS/17_1YR/S2503/0400000US15, accessed October 11, 2018.
[5] Research and Economic Analysis Division, Department of Business, Economic Development and Tourism, State of Hawaii. Residential Home Sales in Hawaii, Trends and Characteristics: 2008-2015, http://files.hawaii.gov/dbedt/economic/data_reports/homesale/Residential_Home_Sales_in_Hawaii_May2016.pdf, accessed October 11, 2018. Updated data for 2016-17 provided by Dr. Eugene Tian, Director of Research and Economic Analysis Division, DBEDT.
[6] The American Community Survey reported that 15.6% (84,877) of the Hawaii housing units were vacant in 2017.
[7] Richard W. England, “Tax Incidence and Rental Housing: A Survey and Critique of Research,” National Tax Journal, June 2016, 69(2), pp. 435-460, https://www.ntanet.org/NTJ/69/2/ntj-v69n02p435-460-tax-incidence-and-rental-housing.pdf?v=α, accessed October 10, 2018.
[8] Jack Goodman, Houses, Apartments, and Property Tax Incidence, Joint Center for Housing Studies, Harvard University, February 2005 W05-2, http://www.jchs.harvard.edu/sites/default/files/w05-2.pdf, accessed October 10, 2018.
[9] Athiphat Muthitacharoen and George R. Zodrow, 2012. “Revisiting the Excise Tax Effects of the Property Tax.” Public Finance Review, 40 (5), pp. 555–583.
[10] See “Schools Our Keiki Deserve”, from the HSTA Speakers Bureau, http://docplayer.net/37088521-Schools-our-keiki-deserve-from-the-hsta-speakers-bureau.html, accessed October 15, 2018.
[11] See https://www.lincolninst.edu/news/press-releases/lincoln-institute-releases-annual-50-state-property-tax-report. For a comparison of state-by-state property taxes at a glance see http://datatoolkits.lincolninst.edu/subcenters/significant-features-property-tax/state-by-state-property-tax-at-a-glance.
[12] https://www.pewtrusts.org/en/research-and-analysis/data-visualizations/2017/how-states-raise-their-tax-dollars, accessed October 10, 2018.
[13] Quoted in Joan Youngman, A Good Tax, Legal and Policy Issues for the Property Tax in the United States, Lincoln Institute of Land Policy, 2016, p. 9.