The 66th legislative session is over. This session brought its own unique challenges and ideas. As an economist, several proposals captured my attention, including one that seems to be debated every year: abolishing property taxes.
Do you know how many states have no property taxes? Zero.
Every state has a property tax on real property. While some states have lower personal property tax rates than others, a low rate doesn’t always translate to low taxes. For example, Hawaii has an average effective property tax rate of 0.29% with a median home value of $617,800. That means even with a low tax rate, the average annual property tax bill in Hawaii is $1,792. Compare that to North Dakota, where the average effective tax rate is 1% and the median home value is estimated at $206,200. That translates to $2,062 in annual property taxes. Even though North Dakota’s tax rate is 3-times higher than Hawaii, the two states have similar median tax bills.
Do you know how many states have no income taxes?
The answer is 7 or 8, depending on how you count. (Tennessee temporarily had an income tax but is soon returning to a zero rate.) In Texas, a state with no income tax, the average effective property tax rate is 1.7%, generating a $3,354 tax bill for a median home value of $197,300.
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Why would some states have a zero income tax rate while no states have a zero property tax rate?
The answer comes, in part, from economics.
All economists know that taxes distort the behavior of individuals and firms in a way that reduces efficiency in the marketplace. When you tax something, people demand less of it and firms likewise supply less of it. Even though there are individuals that value the taxed product more than the cost of production, some transactions between buyers and sellers are prevented due to the cost of the tax. The tax prevents some mutually beneficial exchanges from occurring. Economists refer to this reduction in exchange as the deadweight loss of a tax.
As it turns out, because the supply of land is fixed (short of dredging up the ocean floor), there will be no distortions—no deadweight loss—from a tax on land. Thus, property taxes are among the most efficient tax instruments available to state and local governments. The property tax also tends to be one of the most stable and predictable sources of revenue.
This is not true of the income tax. The income tax distorts the labor supply of individuals as well as the ability of firms to hire workers. It doesn’t affect everyone the same. For instance, I receive a fixed salary for my main job as a university professor. This labor supply is unaffected by the income tax rate. However, I also have a consulting business for which I occasionally do work. Because I know that any work I do as a consultant will result in a substantial portion going to income taxes, I must charge a client enough to compensate me both for the cost of my time and the additional income tax burden that I will shoulder. This higher price may lead the client to decline my consulting services. The income tax prevented us from coming to an agreement to do business.
Income taxes distort the labor market in a way that property taxes do not. That is why most economists favor the use of property taxes to generate needed state and local revenues. Let’s hope the end of the legislative session will finally put an end to calls to eliminate North Dakota’s property tax.
Jackson is the director of North Dakota State University's Center for the Study of Public Choice and Private Enterprise and an associate professor of agribusiness and applied economics. His views are his own.