Property tax reform: Paying for local services

Back in June, I wrote an article titled “Why abolishing property taxes is a bad idea.” It’s fair to say that it didn’t get me on many people’s Christmas card lists, but I stand by it and, if nothing else, the argument clears the ground for how we might think about real property tax reform.

What are we paying for?

Local authorities provide certain services, like schools, parks, police and fire departments, roads, etc. These need to be paid for. The question is how.

Ideally, these services would be paid for by the people who use them, pretty much as they use them, as happens in the private sector. So, you’d pay for K-12 school like you pay for driving school, you’d pay for the local park like you pay for a water park, and so on.

This principle can run afoul of reality. The cost of building fences and turnstiles around all the city parks and policing them might be prohibitively expensive. So, we pay for the parks through taxes.

Things get murkier yet in the case of “common goods” which are both “non-excludable” (if I pay for it, it still benefits you whether you pay or not) and “rivalrous” (my consumption of it leaves less for you to consume). If you pay a private security firm to drive down your street to deter burglars, your neighbors benefit whether they pay or not. As the service is not “excludable” you get the “free rider” problem. Here, people know they can get the service without paying, so nobody pays and nobody gets the service. Where the cops have more to do, policing might well be “rivalrous” – they cannot respond to your call because they are dealing with others. Roads, too, are generally non-excludable but are certainly rivalrous – you cannot drive on the bit of road I’m driving on. So we pay for the cops and the roads through taxes.

You will notice that there is no room here for “redistribution” or what the wonks call “equity.” A millionaire going to a water park pays the same fee as someone on an average income, and the same applies to city parks. Remember, what we are trying to do here is recreate as closely as possible in the government sector the private sector payment mechanism of charging service users for the cost of providing that service.

So, the first step in real property tax reform is to grasp clearly what these payments are for: they are payments for services rendered. In that respect, it is highly unfortunate that the payments are called a “property tax” as that gives rise to the notion that you are being charged for living in your house. You are not. You are being charged for the cost of providing the schools, parks, police and fire departments, roads etc.

How do we pay for it?

Given that you are being charged for the cost of providing the schools, parks, police and fire departments, roads, etc., it follows that your payment for these services ought to be tied to the cost of providing them. This is where the property tax as currently constituted is completely unfit for purpose.

At present, property taxes in North Dakota – payments for services rendered, remember – are not tied to the cost of providing these services but to the value of your house. This is economically and morally incorrect which is why I wrote another article in June titled “North Dakota should break the link between property valuations and property tax burdens.” As I wrote then:

Data from Zillow show that the Typical Home Value in North Dakota rose by 20% between December 2018 and May 2024, as Figure 1 shows.

Figure 1: Typical Home Value in North Dakota

The City of Bismarck provides a useful guide to how this increase in property values has driven an increase in property tax burdens:

To calculate annual taxes for a property, the taxable value is multiplied by the Mill Levy. 

Market Value 100,000 

Assessed Value (50% of Market Value) 50,000 

Taxable Value (Assessed Value Multiplied by 9% residential tax rate) 4,500

Annual Tax (Taxable Value multiplied by the *Mill Levy) 1,169.55

*Note: 2023 Mill Levy – .25990 (259.90 divided by 1,000) 

The mill levy is subject to change annually. 

The tax rates are 9% for residential property and 10% for commercial property.

Table 1 applies this process to the Typical Home Value in North Dakota: As we’d expect, we see that the property tax burden has risen by 20% in less than six years.

Table 1: Property tax for the Typical Home Value in North Dakota

The problem here, as I’ve written before, is that the fact that property valuations are up 20% over the period does not necessarily mean that the people in those properties have 20% more cash, and it is with cash, not assets, that we are required to pay our taxes. Raising someone’s taxes because the value of an asset they hold has increased – whether it be stocks or property – is a tax on an unrealized capital gain, and that is a bad thing.

Simply put, “the burden of the property tax — how much someone is required to pay — should not be driven by the valuation of the property.” How do we break that link?