Monday, January 21, 2008

Balance California's State Budget Deficit Using a "Windfall Profits" Tax on Home Sales

I started to write the following editorial for submission to the Los Angeles Times. Rather send it there, I decided to shirk and publish it here. The gist of the idea is that California's home prices have soared in recent years and a 5% sales tax on the 500,000 homes that sell each year in the state would generate enough revenue to balance the budget. Would Henry George approve? Is this tax progressive? Is it distortionary? As a renter and as a UC employee, self interest motivates me to support this public policy. Note that Michigan or Missouri would be unlikely to be able to use my idea to balance their budget but California is special --- this state is paradise and the home owners who were smart enough to buy early would still get to keep 95% of their asset.

Should academics be writing editorials in the first place? Don't forget my editorial debut

Balance our State's Budget Through a Property Sales 5% Windfall Tax

by Matthew E. Kahn

Facing a state deficit of $14 billion dollars for the 2008 fiscal year, California may soon release convicts early from jail, prune down the size of its regulatory staff, close parks, and repudiate recent efforts to build up public education at the elementary and university level. Is this good public policy?

Assuming that it is unconstitutional to confiscate Britney Spears' or Paris Hilton's assets, there still remains a revenue source that can be tapped into. In case you haven't noticed, home prices in California have increased by xx% since 2000. While some of this growth may be due to home improvements, the bulk of this real estate appreciation was an unexpected windfall generated by a combination of low interest rates, low exchange rate, and a growing demand for living the California lifestyle and the supply side conditions such that it is difficult to buld new housing in the desirable areas in the state's leading cities.

I propose that home sellers must pay a 5% tax on capital gains from real estate sales. Suppose a Los Angeles household bought their home in 1982 for $55,000 and sold it in 2008 for $1.1 million. To calculate this household's windfall tax, the original sales price would be converted into 2008 dollars using an inflation adjustment. Given the consumer price index (CPI), measured in 2008 dollars this home was purchased for $210,000. This household would be taxed .05*(1.1-.210). Is this communism? The household is able to keep 95% of its capital gains. If the average house seller nets $500,000 then his tax bill will be $25,000. If 500,000 homes in the state are traded each year, then this tax would generate $12 billion dollars in revenue.

The Windfall Profits tax was first introduced in the 1970s as the price of gasoline soared and oil company profits sharply increased. These profits were viewed as "unearned". Is the situation different today?

Who would be the winners and losers from this proposition? People whose homes have appreciated the most would pay the bulk of this tax. In subprime areas of Riverside and San Bernardino, this tax would equal $0 while in Santa Monica or Brentwood the tax would add up to some revenue.

This tax would help to counter Proposition 13. Permit me to quote Wikipedia;

"The proposition's passage resulted in a cap on property tax rates in the state, reducing them by an average of 57%. In addition to lowering property taxes, the initiative also contained language requiring a two-thirds majority in both legislative houses for future increases in all state tax rates or amounts of revenue collected, including income tax rates. Proposition 13 received an enormous amount of publicity, not only in California, but throughout the United States.[1] Passage of the initiative presaged a "taxpayer revolt" throughout the country that is sometimes thought to have contributed to the election of Ronald Reagan to the presidency in 1980. However, of 30 anti-tax ballot measures that year, only 13 passed.[2]

A large contributor to Proposition 13 was the sentiment that older Californians should not be priced out of their homes through high taxes.[3] The proposition has been called the "third rail" (untouchable subject) of California politics and it is not politically popular for Sacramento lawmakers to attempt to change it.[3]"

Prop 13 protected households from rising property taxes but no symmetry , California has not asked incumbent home owners to sacrifice to keep the state going. In the absence of Prop 13, home owners would have paid higher property taxes as their asset appreciated. In the absence of the "Kahn Tax", such households enjoy the benefits of asset appreciation without paying "their share".