Homeowners. So says a nice WSJ op-ed by Rob Arnott and Lisa Meulbroek, and a proposal by Chicago Fed Economists Thomas Haasl, Rick Matton, and Thomas Walstrum.
The latter was a modest proposal, in the Jonathan Swift tradition. Despite Crain's Chicago Business instantly labeling it "foolish," "inhumane," and "the dumbest solution yet, the first article points out its inevitability. If indeed courts will insist that benefits may not be cut, then state governments must raise taxes, and this is the only one that can do the trick.
States can try to raise income taxes. And people will move. States can try to raise business taxes. And businesses will move. What can states tax that can't move? Only real estate. If the state drastically raises the property tax, there is no choice but to pay it. You can sell, but the new buyer will be willing to pay much less. Pay the tax slowly over time, or lose the value of the property right away in a lower price. Either way, the owner of the property on the day the tax is announced bears the burden of paying off the pensions.
There is a an economic principle here, the "capital levy." A government in trouble has an incentive to grab existing capital, once, and promise never to do it again. The promise is important, because if people know that a capital levy is coming they won't invest (build houses). If the government can pull it off, it is a tax that does not distort decisions going forward. Of course, getting people to believe the promise and invest again after the capital levy is... well, let's say a tricky business. Governments that do it once have a tendency to do it again.
In sum, a property tax is essentially the same thing as the government grabbing half the houses and selling them off to make pension obligations. And unless a miracle happens, it is the only way out.
Update: We're there already, say Orphe Divounguy, Bryce Hill, and Joe Tabor at Illinois Policy. The bulk of recent increases in property taxes have gone to pay for pensions, not more teachers, police, etc.
Update 2: I should clarify, that I found this an interesting piece of economics more than anything else. I do not think this is the right solution, nor is it the only one. Most other countries around the world, having made unsustainable pension promises, find some way around them and reduce pensions. It happens. Some sort of federal bailout is not unthinkable either. Moreover, the suddenly announced surprise once and for all property tax increase is unlikely, see update 1. So the states are likely to reap many disincentive effects of expected increases in property and other taxes.
Finally, most importantly property tax payers vote! They are unlikely to sit still for such a mass expropriation of their wealth.
You've put into words something that I'd been circling around for a while, and because California property owners are protected by prop 13, I wonder if this will make CA real estate more attractive than it already is. Maybe it's already been priced in.
ReplyDeleteRemember that Sacramento constantly wants to get rid of Prop. 13 and one day will probably succeed. Sadly
DeleteProp 13 also has it's warts in very much the Henry George tradition.
DeleteRemember 2008--2009 when thousands of people in places like southern California and south Florida abandoned their houses because the liens on the houses far exceeded the value of the property? Foreclosing lenders often discovered that not only had the owner of record levanted, but that the houses had been stripped of fixtures, wiring, and plumbing.
ReplyDeleteFurther, unlike mortgage debt, real estate taxes are not personal liabilities of the record owner. All the taxing authority can do is foreclose and try to sell the property. But, if there are no buyers, the whole thing is fruitless.
I agree that the ultimate liability will be reflected in real estate prices, but there really is such a thing as too low.
The premise of the story about the goose that laid golden eggs is that dead geese lay no eggs at all.
The point here is that creditors can squeeze just about so hard and the balloon goes pop, and they wind up with nothing. If the public employee unions were run by people who were shrewd, if not smart, they would be looking for a way to climb down off their perch, before the limb they are seated on snaps.
DeleteWhat would the consequences be if we used monetary financing to fund state pensions? would it be worse than taxes, deficits or cutting the pensions?
ReplyDeleteInteresting post, but it is unfortunate that government reliance on property taxes should be evaluated in such a negative framework.
ReplyDeleteOf course, state and local government should live within reasonable means, and not kick-the-can down the road with fat pensions to attract workers (usually for fire and police, btw).
The US does this also with the VA, now a $200 billion-a-year monster, set to double in 10 years. But the feds can print money. Chicago cannot.
However, in this regrettable stew are some edible morsels.
Much of what gives property value in the US is artificially constrained supply, through property zoning. Property owners are often extracting "rent" from regional economies.
As I always say, there are no atheists in foxholes, and no free market-libertarians when neighborhood property-zoning is under review.
And property taxes, however loathsome, are better than taxes on productive behavior, such a payroll or income taxes. Payroll and income taxes are war on productive behavior.
I wish local, state, and the federal government would move to more reliance on property taxes, and much less on payroll and income taxes.
I think such a move would be good macroeconomics, but then I have discovered in macroeconomics no one is ever right or wrong.
I think property taxes are the most unfair and also amount to a tax on certain productive behaviors. If I blow a bunch of money on let's say a 2 week cruise for my family to the Bahamas, I pay some taxes on that and I'm done. But if I invest that money in say an addition to my house, I get punished with taxes every remaining year of my life. Property taxes suck. Seems the most fair would be consumption taxes on non-essentials.
DeleteProperty taxes are the worst of all taxes and can also be considered a tax on productive behavior. If I squander $1000s to take my family on a 6 week tour of Europe, I'll pay some taxes in there somewhere but then it's done. If I invest that same $1000s into an addition to my house, I am punished with taxes on that addition every stinking year afterward. Property taxes are the most unfair of all. Maybe a consumption tax on non-essentials is the fairest of all.
DeleteI am with the "property tax is the worst" crowd. It is proportional to accumulated savings (many of us buy a house as a stable investment) and yet it takes from income. It is a war on saving.
Delete--E5
I too think property taxes most heinous. You never really own your home and as you become older, getting out of debt is the goal, so in retirement you have fewer financial obligations when faced with a static income. Property taxes are a big question mark. No one could have predicted when I bought my home 30 years ago taxes would increase so dramatically. It forced me from my home, which I loved, by making renovations impractical because doing so would raise the taxes even higher. After searching for 5 years for a replacement home in my area, I ended up moving out of state. Homes to fit my needs were affordably priced but the yearly property tax burden made them out of reach. The heftiest portion of taxes were school taxes. I happened to live in a state that had more teacher strikes than the rest of the nation combined. After looking out of state, at what I could get, and what taxes were, it was a no brainer. Public sector pensions, federal, state, county, city, and school districts are going to bankrupt us. Pension reform is a must.
DeleteI feel like this would benefit from mention of the land value tax, which has no investment effects. People are deriving a lot of economic rents from holding land that appreciates in value.
ReplyDeleteFurthermore, many people who would like to invest in their property are prevented from doing so by arcane zoning restrictions. If we're going to continue to sharply curtail development, then the incentive effects of property taxation on land values are immaterial.
You write that "the owner of the property on the day the tax is announced bears the burden of paying off the pensions," but, of course, a lot of the burden will already have been borne by then as the imposition of a higher property tax will have gradually become more and more *probable*.
ReplyDeleteMy own best guess is that we will not see massive tax hikes to fund state pension obligations. The thing about Constitutions is that they can be amended. While doing so is uncommon, the sheer size of the taxes at issue here ($75K - $100k per person!) would be an unusually powerful incentive.
ReplyDeleteI'm not sure I like the prospect of reducing pension benefits retroactively, as it seems to me a cheap trick. I have friends in government who could make FAR more in the private sector (based on education and experience), but remain because they like the idea of what they perceive to be a "guaranteed" comfortable retirement. But whether I like it or not, I suspect those fairly bargained for benefits will be taken away before tax hikes of the scale being discussed will ever occur.
"Of course, getting people to believe the promise and invest again after the capital levy is... well, let's say a tricky business. Governments that do it once have a tendency to do it again."
ReplyDeleteIs this not another version of the time-consistent/time-inconsistent or rules vs. discretion policy discussion?
The pension crisis does make one wonder what part of "we'll pay you later", the state authorities and voters did not understand. Promises were made and relied on.
ReplyDeleteThere are two things they didn't understand: (1) life expectancy would jump, and (2) inflation would slump.
DeleteLook, like you, I'm in favor of paying what is owed to pensioners (I'm the anonymous from two posts up). But let's not pretend unfunded pensions are the sort of issue everyone saw coming, but were just too greedy or short-term focused or stupid to do anything about it. That certainly describes many government deficit problems, but not this one.
The solution to this "issue" is easy and straightforward. The federal govt simply issues say $1 Trillion and gifts it to the states on a per capita basis, to do with what they want. The only caveat being that the money is used for the benefit of the people of the states and make it a federal crime for state officials who try to benefit themselves or family members. (The money comes with a phalanx of Federal auditors.)
ReplyDeleteEasy Peasy. Problem solved.
This feels like a cousin of Piketty's wealth tax proposal to deal with inequality. If the tax was only levied on houses with values above a reasonably high threshold ($1 million?) it could be sold to the voters as a way for a relatively small group of wealthy property owners paying for the retirement of many ordinary workers.
ReplyDeleteInteresting thought, but not feasible in the vast majority of states. That's (in part) what makes this issue so very intriguing: the normal partisan answers are impossible. Republicans cannot just "slash wasteful spending" (the payments are guaranteed) and Democrats cannot just "soak the rich" (there aren't enough "rich" to soak in most states relative to the size of the unfunded pensions).
DeleteSo sure, maybe in New York and California you MIGHT be able to treat the unfunded pension issue like any other economic policy matter. But in other places more creative thinking will be required.
If you want another Swift-like modest proposal for dealing with pensions, think about this: Salary and non-pension benefits make up about 50% of the Chicago city budget. Pensions are said to be about 15%. Layoff about one-third of the city’s workforce and the pension problem is solved (short term you’ve got cash to fund the promises already made, long-term you have fewer pensioners). And, in true Swiftian fashion, “For preventing the Children of Poor People (No, make that 'unemployed city worker')s From being a Burthen to Their Parents or Country, and For making them Beneficial to the Publick,” consider selling the unemployed as a food for rich ladies and gentleman.
ReplyDeleteOk, bad joke, I know. But the only other possible alternative to radically raising property taxes is to radically cut city services. Is that such a bad thing?—serious question, I don’t know the answer but could you argue that the city is already performing so poorly that few workers might not matter.
Oh…and one more non-Swiftian idea: sell of Ohare and Midway.
This blog post could have been written about Greece. With pensioners numbering 2.67 million in a population of nearly 11 million, and no way to print its own money and default on pension obligations via inflation, Greece was forced to sharply increase its taxes on real estate. However, this does not mean that pensioners got spared. Pensions suffered drastic cuts, especially the most scandalously high ones. The moral in the story is that the capital levy story is not as watertight in practice, as it is in theory. The government also needs to cut entitlements at the same time it is taxing capital, in order to try to convince investors that a new capital levy will not be necessary in the future.
ReplyDeleteGeorge J. Georganas.
Just once, instead trying to guide the readers toward your preferred solution (cut the pensions or refuse to pay them altogether, I think), why don't you say explicitly what the states should do.
ReplyDeleteRather than taxing real estate and further burdening the taxpayer why not try any or all of the following to fix the pension problem
ReplyDelete*Raise the age of eligibility for government pensions, so the age of eligibility is the same for Social Security and for government pensions. You only get your full pension at age 67. (If we can retroactively change Social Security agreements then we can retroactively change pension agreements.)
*Limit/cap the maximum annual government pension payout to $100,000 annually per retiree
*Convert pensions to 401k/403b plans
*No more pensions for new employees and instead provide 401k/403b type of retirement plans
*No more raises for government workers until there is enough money to cover the pensions.
https://www.huffingtonpost.com/moneytips/federal-employees-earn-50_b_8855508.html
In 2014, the average government employee salary was $84,153, approximately 50% more than the average private sector worker earned. This discrepancy increases to 78% when benefits are included. The average federal worker cost the government (aka taxpayers) $119,934.
The Wall Street Journal did a similar study (government vs private sector workers’ pay) with similar results.
John,
ReplyDelete"States can try to raise income taxes. And people will move. States can try to raise business taxes. And businesses will move. What can states tax that can't move? Only real estate."
And states must rely on market prices to assess property taxes. So okay, I sell my house to my brother for $1.00 and he sells me his house for the same $1.00.
The market price of my house is now $1.00 and the market price of my brother's house is now $1.00. Rinse and repeat.
"States can try to raise income taxes. And people will move. States can try to raise business taxes. And businesses will move."
And you moved from the University of Chicago to Stanford University because California is a low tax state?
"If indeed courts will insist that benefits may not be cut, then state governments must raise taxes, and this is the only one that can do the trick."
No, wrong, next...
"In sum, a property tax is essentially the same thing as the government grabbing half the houses and selling them off to make pension obligations. And unless a miracle happens, it is the only way out."
No, wrong again, thanks for playing. When I sell my house, I negotiate the price that will be accepted. When the government sells my house, they negotiate the price that will be accepted.
Of course the article also illustrates why property tax is superior to income tax in the first place.
ReplyDeleteStates would be better off replacing income tax entirely with property taxes. Some already have, and they are not the states in financial trouble.
well NJ is at about 10% of gross income....for property taxes....and its economy is floundering while much of the USA florishes....it only get worse from here. Real Estate away from NYC....declines year after year...so as the public unions owned Democrats keep raising taxes the real estate continues downward....where Wall Street(some healthcare companies) money doesn't reach.
ReplyDeleteEven places like famed Short Hills, NJ still has numerous empty store fronts and failing restaurants...in this "booming" economy.
A relative and retired Illinois teacher and union member who receives more each month than he made while working, smiles and says..., "If pension fund goes bankrupt, your Federal government is obligated to pay my pension. That's the law".
ReplyDeleteWhy should taxpayers (who are having trouble paying for their own retirement) have to pay even more taxes so government employees can receive their pensions?
DeleteAnd if taxpayers can no longer afford to guarantee Social Security pensions, then taxpayers can no longer afford to guarantee government pensions either.
If the government is telling Social Security recipients that they have to take a haircut on their Social Security pension benefits then government workers will have to take a haircut on their pension benefits too.
https://www.bloomberg.com/news/articles/2018-03-14/michigan-figures-show-widespread-distress-in-local-pension-plans
Based on Detroit’s bankruptcy, pension benefits are far from secure.
There are many ways to address this issue, but the taxpayers should not be burdened with it.
"Why should taxpayers (who are having trouble paying for their own retirement) have to pay even more taxes so government employees can receive their pensions?"
DeleteOne possible answer is that the primary reasons the U.S. was able to build the greatest economy ever known are (1) rule of law, and (2) guaranteed contracts. Taking away fairly bargained for pensions might be good policy or "fair," but is a divergence from what creates our privilege in the first place.
The whole pension issue is an almost perfect example of WHY rule of law and guaranteed contracts are such difficult principles to adhere to, and why most countries therefore choose a different path. Just understand that when you take away something you promised to pay years ago because it turned out to be unfair, well, next time people will not trust your promise the same way, and there is a cost to that.
"What can states tax that can't move? Only real estate."
ReplyDeleteIn a very real sense, real estate can move. Most of the value in real estate is in the improvements. If you tax those too high, the owner will liquidate it by not maintaining it and letting it depreciate. New York "expropriated" apartment buildings through rent control and was left with empty shells paying no taxes.
Real returns on investments going forward are likely to be in the 2% to 4% per year range. The pension / retirement savings problem is a lot bigger than just a few states that were bad at math.
This whole thing is nuts. United Airlines went bankrupt because customers and banks didn't want to fund the operations of the company.
ReplyDeleteThe people who paid the price for the bankruptcy were creditors. Including defined benefit pension plans. Employees got their pensions turned over to PBGC.
The people who paid the least were customers. Close to no customer was unable to use different transportation providers (or United as it didn't go out of business).
Yet taxpayers are expected to keep on funding the bloated, overpriced provision of government services because of "fairness". I feel sorry for people who would lose their jobs and some portion of their pension. But not that much.
Another option. Take the hit on the sale of your home, move to a state where property taxes are lower and rent, use the proceeds from the sale and invest in the S&P 500. Hopefully it's more than a wash and you avoid further increases in property taxes as the pension crisis escalates. And It will!!!
ReplyDeleteWell yeah, sure, obviously. "Sell/save X, then invest the proceeds into the lowest fee S&P 500 fund available" is the default solution to EVERY financial problem for EVERY middle-class person in the U.S. under the age of 45.
DeleteTo move the ball you need some kind of edit to the baseline... maybe replace "the S&P 500" with "Initial Coin Offerings" or something like that :)
Well Yeah, sure...The point is, avoid anyway you can with any instrument that accomplishes your objective. Good point. :)
DeleteThere will be a federal solution. This will solve the "taxpayers will move" problem but create others.
ReplyDeleteProperty taxes in Illinois is just one tool of the Block Busters. Others are Blight, Crime and Violence. Illinois and particularly Chicago are the model for others around the country. Example: Palm Beach County, Florida.
ReplyDeleteThe Illinois state constitution may prohibit pension benefit cuts, but does it prohibit taxing pension benefits? When the US government taxes interest on US government debt, that is not considered a default, nor am I aware of any requirement that tax rates on such interest equal other income tax rates. So, why would a state tax on state pension benefits be considered a benefit cut? In fact, I am surprised that courts have not already employed a "saving construction" a la John Roberts by recasting potentially unconstitutional pension benefit cuts into constitutional taxes. Aren't judges supposed to defer to legislatures whenever possible?
ReplyDeleteA possible solution is that Illinois split into two seperate/new states. This immediately does away with the criminal clause that demands pensions be paid, regardless of the circumstances. In addition, The Chicago metro area has always been a 'different world' relative to the rest of the state and hence would make sense politically and economically.
ReplyDeleteA solution might be to split the state of Illinois into two new states. This immediately negates the fantasy clause of pensions being involatile. There's also a political/economic justification as well, the Chicago metro area has always been 'different' than the rest of the state.
ReplyDeleteAnother solution, can't the state just issue 100 year bonds? Surely the people currently benefiting from the overly generous pensions will be long gone by then, and what do they care if their grand or great grand children have to shoulder the burden?
Finally several commentators above correctly pointed out the moral hazard of the state defaulting on their obligations. But this default is for sure going happen! Short of a miracle there is no way the state can possibly cover this debt. It's really just a matter of how much pain the citizens of Illinois are willing to put up with before they are in the streets calling for revolution.