Few topics spark as much controversy as taxes, and especially an increase in taxes. But what really constitutes a tax increase? Or, in other words, are all tax increases created equal?
To some the answer is easy: A tax increase happens whenever taxes paid rise. By this way of thinking, if Joe Smith paid $1,000 in taxes last year and this year he pays $1,200, a tax increase has occurred. End of story.
But what if we’re talking about the income tax, and what if Joe’s tax payment rose only because his income rose? Should this still be considered a tax increase, especially if the percentage of each of Joe’s dollars taken in taxes has remained the same?
It’s time for a little terminology to more clearly see the issue. Taxes paid result from multiplying whatever is taxed (called the tax base) by the percentage of that tax base taken in taxes (called the tax rate). For example, how much sales tax you pay equals the dollar amount of your retail spending multiplied by the sales tax rate (cents of sales tax per dollar of spending).
So, an increase in taxes paid can occur for three reasons: the same defined tax base rises, the tax base is defined to be larger, or the tax rate is increased. The question is, which should be considered a true tax increase?
A case can be made that the first example doesn’t constitute a tax increase, but the latter two do. If you pay more sales tax only because you spent more at retail stores, logic would say this isn’t a tax increase. But if the state expanded the sales tax base to include spending on services and didn’t lower the tax rate, or if the state simply increased the sales tax rate, a legitimate tax increase has occurred.
Most taxpayers understand these differences with one exception — the property tax. Like all taxes, property taxes paid equal the property tax base (here the value of property recorded by the county, called assessed value) multiplied by the property tax rate (cents of tax per dollar of assessed value).
However, there are two characteristics that make the property tax different. One is that the tax base (assessed property values) is not updated every year. Indeed, in many North Carolina counties the time between assessments is eight years. Yet, when reassessments do occur, the increase in property values can be large because it represents the accumulated change in values over several years.
Second, there is no assurance property values and owners’ incomes will change at the same rate. In fact, in recent years property values have been rising much faster than incomes. This can create a problem for owners who pay their property taxes from their current income.
As a result, when property values are reassessed and the property tax base rises by a substantial amount, owners will often perceive this as a large tax increase, even if the property tax rate has remained the same. Consequently, counties will often lower the property tax rate in reassessment years to soften the blow. Yet because the costs of many local infrastructure projects, such as schools and roads, are tied to property values, placing such a lid on property tax revenues can create backlogs in school and road funding.
So what’s the solution? One option is to better educate property owners about why the long lags in property reassessments create periodic big jumps in property tax payments. Another is shorter time periods between reassessments, so owners could adjust to more frequent, yet smaller, payment increases.
A third option is to develop some creative ways to pay property taxes. For example, rather than paying them out of income, some share could be paid from profits realized when the property is sold. This could be particularly helpful to property owners with high wealth yet low income.
Taxes are a more complicated process than at first glance. Keep your eyes on the underlying fundamentals of the tax base and tax rate to see where taxes are headed.
Michael L. Walden is a William Neal Reynolds distinguished professor at North Carolina State University and an adjunct scholar of the John Locke Foundation.