Property tax abatement as tax expenditure?

Author:Wassmer, Robert W.
Position::Report
 
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  1. INTRODUCTION

    Tax expenditures are revenue losses resulting from provisions in tax law that allow a special exclusion, exemption, or deduction from normal payment. Property tax abatement is a full or partial reduction in the normal property tax liability owed to a state or local jurisdiction. It is suitable that this journal's special issue on generating tax expenditure budgets for property tax relief measures include an article on the practice of state or local governments selectively reducing the payment of property taxes to encourage and/or alter business activity. There are at least three reasons for this. First, property tax abatement is widely used in the United States. Second, when state or local governments in the United States account for abatement in their annual tax expenditure reports, it is only in the traditional manner of adding up the dollar value of annual property tax abatement. Third, this traditional manner of counting abatement as tax expenditure can severely overestimate the amount of additional property tax revenue available to a jurisdiction following abatement elimination. An examination of how to best account for property tax abatement as tax expenditure requires some background on the use of property tax abatement and tax expenditure in the United States.

    1.1 UNITED STATES PROPERTY TAX ABATEMENT

    Property tax abatement (abatement) is a full or partial reduction in the normal property tax liability owed by a manufacturing, commercial, or primary (agriculture, forestry, and mining) business firm for ownership of real or personal property in a state or local jurisdiction. Real property includes land, and the buildings and machinery attached to it. The defining characteristic of personal property is its mobility. Examples of personal property include raw materials, inventory, office supplies, vehicles, etc. The granting of abatement is for a limited period, though it is usually renewable. A jurisdiction grants abatement in exchange for a desired change in business activity assumed absent without abatement.

    Abatement exists as a tool for state or local policymakers to: (1) encourage new business location within a jurisdiction, (2) discourage existing business from leaving a jurisdiction, (3) steer a business to a specific location within a jurisdiction, and/or (4) improve or alter the form of property used in a jurisdiction. (2) By reducing the annual property tax payment normally owed, the intended purpose of abatement is to compensate a business for pursuing an economic activity that is not in its private interest, but deemed in the social interest of the jurisdiction. If the granting of abatement is indiscriminate, it cannot serve its intended purpose.

    A business receiving abatement can still generate revenue for a jurisdiction. If this is greater than the cost of public services provided to the firm, then the business generates a fiscal surplus for the jurisdiction. Considering this possibility, a fifth purpose of abatement can be the generation (or retention) of a fiscal surplus from the business granted abatement. However, this fifth purpose is only relevant if absent abatement the business would have not located in the jurisdiction (or left the jurisdiction). Policymakers and elected officials (and the citizens they represent) desire this fiscal surplus because it finances the cutting of taxes/fees for existing public services, and/or it funds additional public services without the need for increasing taxes/fees.

    When deciding if abatement has served its intended purpose, it is critical to consider whether the business granted tax forgiveness would have produced the desired outcome without abatement. Unfortunately, the policymaker deciding whether to offer abatement usually lacks the information and motivation necessary to determine whether the refusal of abatement would cause the targeted business to abandon a desired outcome. Take for example the use of abatement to encourage the location of a new firm to a jurisdiction. The information needed to determine the profitability for a specific firm in the jurisdiction, compared to viable alternative locations for the same firm, best comes from the firm itself. However, if asked to provide this information, the firm faces the moral hazard of only offering information that supports its request for abatement.

    Furthermore, in assessing the validity of information provided by a firm on its profitability with or without abatement, the elected policymaker faces the political incentive described by Wolman and Spitzley (1996) as credit claiming. In the political calculation of deciding whether to offer abatement, often the worse thing to do is to refuse abatement. Even if the firm locates in the jurisdiction without abatement, the elected policymaker is unable to claim credit for the result because an abatement refusal did nothing to facilitate it. The outcome of a firm deciding to locate elsewhere after denied abatement is even worse. A political opponent can argue that if only offered abatement, the firm would be still here. Therefore, the optimal abatement strategy for an elected policymaker is to offer it in all but the most egregious situations. As Rubin (1988) appropriately put it following his interviews of economic development practitioners, they, "shoot anything that flies; claim anything that falls."

    Anderson and Wassmer (2000) describe the likely scenario of a business first identifying the most profitable site without abatement. The firm then looks to a second jurisdiction for a second-best location site and negotiates for abatement there based upon a legitimate claim that it has found a more profitable site. Securing an abatement offer from this second-best location, it then takes this offer back to its first-best jurisdiction and threatens to choose the second site if not offered abatement. Given the presence of information asymmetry and the motivation to credit claim, the firm is often successful in securing an abatement that does nothing to change the location it would have chosen without abatement.

    1.2 TAX EXPENDITURE

    The Congressional Budget Act of 1974 defines a tax expenditure for the federal personal income tax as "...revenue losses attributable to provisions of the Federal tax laws which allow a special exclusion, exemption, or deduction from gross income or which provide a special credit, a preferential rate of tax, or a deferral of liability" (Public Law 93-344; USGPO 2009). This formalization of tax expenditure originated with Stanley Surrey, United States Treasury Assistant Secretary for Tax Policy, who first used the term and published a tax expenditure budget for personal and corporate taxes at the federal level in 1968. According to Surrey, as government spending represents a generation of benefits financed by taxation, tax expenditure represents a generation of benefits financed by foregoing tax receipts due the government.

    Many political Conservatives quibble with Surrey's logic that assumes government is due the full amount of tax revenue before tax expenditure. Alternatively, political Liberals describe the elimination of tax expenditures as not a tax increase, but the closing of a tax loophole. No matter how one comes down on this ideological divide, it is appropriate to try and account for tax expenditures as they: (1) exert economic effects similar to direct government spending, (2) reduce economic efficiency (because if expenditure is constant, tax expenditure requires an alternative to replace the lost government revenue), (3) usually require no annual reauthorization, and (4) are not transparent (Barro, 2012).

    The eight states that include abatement in their calculation of state real property tax expenditures calculate annual tax expenditure from abatement by totaling the annual dollar value of property tax revenue foregone. (3) As noted by Harris (1997), the use of this traditional method does not reliably forecast the revenue resulting from abatement elimination due to the interactive effects that could occur following repeal. The implication is that a jurisdiction could rescind a $100,000 annual abatement to a firm and still have $100,000 in additional annual property tax revenue. However, what if the abatement fraction was half, the firm still paid $100,000 in annual property taxes, and abatement was the deciding factor that caused the firm to locate in the jurisdiction? This being the case, the elimination of abatement would not result in a $100,000 increase in annual property revenue, but an eventual loss of the $100,000 in annual property taxes (less the annual cost of providing services to the firm). (4)

    The issues discussed here are the same as those raised for more than two decades in the United States regarding the dynamic verses static scoring prediction of revenue changes after federal tax reform. The static approach assumes a tax change will exert no influence on economic behavior surrounding the generation of tax revenue, whereas the dynamic approach accounts for predicted changes in economic behavior induced by the tax change and an ultimate tax revenue effect that can differ over time. The Laffer Curve, generated through a cut in high marginal income tax rates resulting in an increase in income that even taxed at a lower rate yields the same or more revenue, is one of the most widely discussed possibilities of a dynamic federal income tax reform effect differing from a static effect. (5)

    The remainder of this paper considers what portion of abatement a jurisdiction could reasonably expect to recapture after the elimination of abatement. At one extreme, this repeal causes absolutely no difference in business activities, and results in full recapture. At the other extreme, the repeal of abatement eventually drives the businesses previously receiving abatement out of a jurisdiction and no recapture occurs. As will be shown, the reality is somewhere between.

    Since policymakers are likely to look...

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