How Stuff Works: Property Tax Paradox

Today in our occasional series on “How Stuff Works” we have a tragic example, brought to us by a genuine tragedy: the fertilizer factory explosion in West, Texas. In light of the injuries, loss of life and all of the associated pain and suffering it seems heartless, if not downright cruel, for the City, County and State to go on taxing the residents affected by the explosion, and in particular to demand property taxes be paid on homes that were damaged or destroyed by the blast. And it sounds completely outrageous that those property taxes are based on the valuations of the corresponding properties as of January 1, months before the blast occurred. Until you realize that property taxes in West are paid on the previous tax year, just the way income taxes are – and without those tax payments the town itself may not be able to recover…

You can pick up the news story from the Waco Tribune site if you want to, but the concept is ultimately very simple. Like many places in the U.S. West (and the county in which it is located) run on property tax revenue, and those taxes are charged for the previous year at the values assessed on January 1 of the next year. Unfortunate as it may be, the people of West are being billed for the full year (2012) during which their homes were not damaged by chemical explosions or anything else, but during which they received all of the services the city and county provide. And however much the city or county governments might like to release the residents from those obligations, doing so would eliminate 20% of the property tax revenue at a time when the community needs all of the help it can get…

Estimates of the damage put the losses in West at about $29 million, or roughly 20% of the taxable property in the area. Without those funds the city has no hope of building the infrastructure improvements (such as an expanded sewer system) slated for this year, but they also will not have the funds they need to repair non-taxable property such as schools, water systems, roads and so on. The city and county governments can apply for state and Federal disaster relief assistance – and already have – but even if such funds are granted and repairs can be made, the local governments will still not be able to provide the necessary public services with 80% or less of a budget that was barely adequate in the first place…

I called this a paradox because in this case there is nothing the local governments would like better than to give their constituents the funds needed to repair all of the homes and businesses damaged in the blast, cover everyone’s medical bills, replace everything that was destroyed, and bring the community back to normal – or, at least, as close to normal as it will ever be again. But to do that these governments will need money, and their primary source of funding is the people who are at this moment demanding money from the governments…

Let’s just hope that there is state, Federal or private disaster relief funding available for the folks out in West, because this probably isn’t something they’re going to be able to solve on their own…

Pro Bono Publico

Over the years I’ve been asked a lot of tax questions, considering that I’m not an attorney or an enrolled agent (tax preparer). For reasons that probably pass understanding, a lot of otherwise sensible people seem to believe that anyone who went to business school must know about these things, and that anyone working as a management consultant can also provide them with free information about finance, accounting, tax law, municipal law, recycling, charitable donations, green business, depletion of the ozone layer, the detailed management of every type of business that could possibly exist (whether or not it actually does), U.S. history, world history, engineering, high-energy physics, cooking, entertainment, script writing, movie production, education, squirrel migration patterns, the relative probabilities of everything from the success of their new business venture to how well their favorite team will do in the Super Bowl (or NBA Finals or World Series or Stanley Cup or World Cup) and whether their spouse is committing adultery and with whom they are doing so…

That said, probably the most common fallacy you encounter in the consulting business is that people who are self-employed (and free-lance consultants in particular) can write off time they donate to charity, since they are in effect donating their stock in trade. I try to avoid answering any of the questions referenced above (unless I actually know something about the question, and sometimes even then), but most of the time people don’t really ask me this; they just assume that I will be willing to donate MY time to their cause – since I can just write it off on my taxes and enjoy the deduction. Alas, this is not true. You can take a look at the annual Fox News story about things not to try deducting if you don’t believe me (it’s about two-thirds of the way down), but the simple fact is that I’m limited to deducting my mileage and any out-of-pocket expenses I can prove I made on the charity’s behalf, just like anyone else…

Unfortunately, most people who run non-profits (and especially small and/or recently-formed ones) generally know a lot more about the cause they’re incorporated to work on than they do about tax law, and I will almost invariably be accused of holding out on them. I always wonder if these are the same people who keep being prosecuted for trying to claim their home telephone land-line as a business expense (you can’t), deduct their clothing and dry cleaning bills as business expense because they wear those clothes to work (not allowed; IRS assumes that you would have to wear something regardless) or attempt to claim their pet as a dependent (a classic; not possible unless you’re a Warner Brothers cartoon character). Even the people who grasp the idea that trying to get me to help you because I have professional knowledge that could help you and then failing to listen to me when I tell you something is patently illegal is stupid will sometimes try to get me to try this anyway, in the hope that the IRS will miss it…

Now, before you accuse me of going all emo on you, keep in mind that most other professionals have the same problem. Some people (notably lawyers) do gain professional benefits from doing pro bono work; some are even required by their state bar association (or other professional organizations) to do so. But even if it was possible for me to get a break on my taxes by doing charity work, there would still be the matter of how do I make a living in the first place? If you’re asking me to moonlight for a charity I suppose I could use the tax break to offset withholding on my day job, assuming I could get such a break in the first place, but otherwise this is nothing more than an elaborate way of asking me to do something out of the goodness of my heart…

Deficit Thinking or Thinking Deficit

Ever since the midterm elections the debate about the national debt has been heating up again, to degrees not seen since the mid-1980’s arguments about the same topic. This blog isn’t supposed to be political, but taxes, and especially business-related taxes, do relate to our primary topic, and there was an article this week in the Wall Street Journal that points out one of those traditional blind spots in which neither side of the political spectrum appears to have much of a grasp on reality: deficit spending and increased taxation…

The linked article follows up on a classic study in economics from the 1980s, which showed considerable support for the contention that every dollar of new taxes leads to more than one dollar of spending by Congress. In fact, the Vedder and Gallaway article found that for each new tax dollar, our Federal government generated $1.17 of new spending (17% more than the tax increase). The updated study is considerably more sophisticated, taking into account a much longer time period, and controlling for a range of different variables, but the alternative models suggest a tax-to-spend relationship of between $1.05 and $1.81, depending on where, when, and how the data is arranged. Nor does this pattern appear to be changing – in the years from 2008 to 2010 the present Congress has approved over $ 1 trillion, which violates all of the existing budget rules…

Now, as a political moderate, I’m not going to claim that the bailout wasn’t needed, or that we can just start slashing social programming without horrible long-term repercussions, or that our military spending is out of line with post-Cold War conditions, or any of the other standard formulae that people like to spout instead of actually wading through millions of pages of dust-dry government documents; I’m just pointing out that regardless of what you think of deficit spending (whether you’re for it or against it), our government has NEVER been able to reduce the deficit by raising taxes. It’s always possible that conditions will be different somehow this time around, but after 65 years and 13 Presidential administrations, no one has ever succeeded in doing so. Which makes the present call for things like a 6.5% national sales tax nothing more than political grandstanding…

From a business standpoint, there’s no reason to expect any member of Congress to show any fiscal responsibility, simply because there is no benefit for any of them to do so. On the contrary, the way most of our representatives continue to get elected is to bring economic advantages (e.g., jobs, entitlements, benefits and pork) to their home districts and/or states. Any member of Congress who could somehow manage to bring funds to their constituents while making somebody else pay for all of them would be elected for life, and in fact many of our longer-serving politicians have spend decades in office doing just that, or at least creating the illusion of doing so. By all indications, the problem with the current system isn’t that we aren’t being taxed enough, or even that we’re being taxed too much, but rather that our taxes are being spent on the wrong things…

Several authors have noted that deficit spending by our national government is, in effect, taking the benefits and making someone else pay for them – in this case, someone else being whoever the tax-paying public is twenty to fifty years from now. Personally, I believe that our government can dig itself out of the hole it’s currently in, by investment in industries and enterprises that will raise our tax base under existing tax law (and coincidentally create jobs, raise our standard of living, improve our trade balance, and fix our broken economy), and that might even be true. The two things that history teaches us about this issue are that whatever else tax-and-spend policies might be able to do, they won’t be able to reduce the Federal deficit – and that people never listen to history, of course…

License to Blog

An article on the Business Insider web site this week was talking about bizarre government regulations, at various levels, which led me to this story on The CNN Money Page about the City of Philadelphia requiring bloggers to pay for a business license if operating within city limits. As the license is $300 (or $50 per year) and most bloggers make rather less than that (I have yet to realize any profit on this one, for example), this probably seems a little harsh. On the other hand, there are blogs that make money; there are a few of them that make quite a lot of it. The larger question is really about businesses licenses, and who should or should not pay them, and that seemed like a subject worthy of a closer look…

First off, most cities and some counties require business licenses in order to fund city operations. The logic is fairly straightforward: if your business operates within city limits, then you are benefiting from various city services (street maintenance, police and fire departments, pro-business advertising campaigns, various public works) and it’s only reasonable that you should chip in for those. Things that are regulated by the county will usually be licensed by the county government instead, such as in the case of food preparation health certificates being issued by the County Department of Health. Here again, you want the place in which your business operates to be known for food that is safe to eat (and to actually HAVE food that is safe to eat), so it’s not unreasonable to ask you to help pay for those regulatory agencies. But what if your business places no demands on city, county, or state infrastructure whatsoever?

For the most part, a blogger operating in Philadelphia has exactly the same impact on city and county services as a blogger operating on the other side of the world – which is to say, nothing. The person writing the blog might use some city services, but he or she is already contributing to the city’s finances through sales taxes, property taxes and other fees. Some cities agree with this position and don’t include bloggers in their licensing requirements, but others have pointed out that in order to be fair all municipal business laws should be applied to all businesses equally, and gone on requiring license fees. Complicating the matter still further, some pundits have suggested that blogging is protected as free speech under the First Amendment, and that applying any restrictions to it are therefore unconstitutional…

Personally, I am reminded of a client I worked with under the SBDC program who had gotten a letter from the City of Los Angeles demanding business license fees going back a decade or more, plus a ridiculous amount of penalties for non-payment all of those years. My client ran a small consulting business out of her home, and spent most of her time in the field – hence, did very little actual work in the City of L.A. The amount the City was demanding was out of reach – it was more than the business brought in over multiple years – and the letter was threatening prosecution and jail time if she didn’t pay…

I suggested that she try calling the City office (using the telephone number on the letterhead) and explaining the situation; if they could work something out it would be better for all parties involved than going to court would be. So my client made the call, explained that she hadn’t been working in the City hardly at all, and had only lived there for a few years in the first place (not the dozen or so the demand letter wanted her to pay for), and after some wrangling and arm-waving, the clerk she spoke with offered to let her purchase the appropriate license for that year (it was under $100) and pay an extra $50 or so to have the license back-dated eighteen months to cover the delinquency…

It’s not as perfect a solution as the City dropping the whole case, of course, but anytime I can shave three zeroes off the end of somebody’s bill (e.g., take it from $50,000 to $50), I always feel as if my day was not a total loss…

I don’t know how these various municipal blogging cases are going to turn out. Unless I’m very badly mistaken, these sorts of actions are going to precipitate whole new areas of case law, and it may take some time for all of the legal precedents to shake out. I just know I’m going to be very careful to check on the local ordinances if I ever decide to monetize this blog…

Pay As You Throw

As waste management becomes an increasingly critical problem in the U.S., we’re seeing more and more communities having to get creative about paying for their trash collection (and dumping) services, since not everybody has a convenient canyon they can fill up or a convenient ocean to dump everything into. One of the more pragmatic (or mercenary; it depends on your point of view) schemes we’ve encountered so far is the “pay as you throw” or PAYT program: the city will only collect garbage if you put it in approved trash bags (usually a special color and/or marked with the city’s logo), which you are required to purchase at the supermarket for a dollar or two. The idea is that this way you are only paying for the amount of garbage collection service you actually use, and the city does not have to take the waste management fees out of their (already scarce) property taxes. Which is okay, as long as you’re not the store that gets stuck with selling the bags…

A story which turned up in the Concord Monitor online site notes that stores which carry the PAYT bags do not receive any payment for doing so; all of the money is sent to the company in South Carolina which manufactures the bags, which in turn shares some of the funds directly with the city using the PAYT program. Meanwhile, the stores have to pay for the costs associated with stocking and selling this “product” for free – and at a loss, in fact, if the customer pays for the bags with a credit card. According to the article linked above, some of the stores in Concord (and some of the other communities using this system, apparently) are refusing to carry the bags. The store managers say that the minor loss in public relations is more than offset by the money they are saving by not carrying this product in the first place…

Here in East Lansing there’s a similar system in operation, but it’s a hybrid that I think works a lot better. All homeowners in the City of East Lansing are issued one (1) large (64-gallon) rolling garbage can and one (1) smaller blue tote bucket (around 15 gallons) for recycling by the city. If you need to throw away additional waste, you can purchase 20-gallon plastic PAYT bags in a package of 5 for $5 at most grocery stores; if you need to throw away extra yard waste (leafs, lawn clippings) you can purchase brown paper bags, also about 20 gallons, also at 5 for $5. Most of the funding for trash collection still comes from your property taxes, but if you need to dispose of some extra waste the city isn’t on the hook for it, and if your neighbor is throwing away lots of extra waste YOU aren’t on the hook for it. And the local markets don’t seem to mind, because the number of bags they have to carry is small enough to represent a trivial expense…

In the Concord example, the obvious solution would be to allow the markets to raise the price of PAYT bags by just a few cents each (say, to $1.09 and $2.09, respectively) to cover stocking and handling expenses, or else cut them in on a similar amount of the money the town is making on the bags. You’re still going to have a problem with people buying generic trash bags and throwing them into dumpsters (or leaving them by the side of the road), but at least you won’t be placing what is effectively an unauthorized, unilateral tax burden on businesses that only make a 1% to 1.25% profit margin in the first place. And I’m really not sure what the town is going to do if some of the people commenting on the linked news story make good on that threat to start making counterfeit PAYT bags and selling them for half of the usual price…

Maybe the East Lansing model is a better idea than I thought…

They Diverted What?

Just two weeks ago my wife and I got our “Economic Stimulus Package” from the Federal government. It’s a whopping less than half a week’s total pay which will, in fact, not even cover the costs of our trip to Michigan later this week. I mean the gas, hotel bills, meals and car maintenance, here; the whole check does not represent even 5% of our total relocation costs. Still, having part of our travel expenses covered by a cheap political stunt is better than nothing, I suppose, and we will definitely be pumping back into the economy – paying for goods and services at gas stations, hotels, and roadside food stands. If there’s any left I plan to use the residue to purchase a snow blower once we arrive in East Lansing…

Have you gotten your “Economic Stimulus” check, otherwise known as a tax rebate, yet? Well, if not, you should probably check with any State, Federal or local agencies whom you owe money (at least if you haven’t been making your payments for a while). According to an article in USA Today about $2 billion of the rebates are being confiscated to pay child support, student loans, back taxes, and other things that the government thinks need the money more than you do. I’ll admit I have mixed feelings about this whole affair…

On the one hand, I don’t have much sympathy for deadbeat parents (we’ll be egalitarian here and include the tiny number of deadbeat mothers in with the vast majority of deadbeat dads) in the first place, and if you paid enough in taxes to qualify for one of these checks, you probably weren’t counting on it to survive anyway. I’m a bit more sympathetic to those who are defaulting on student loans and farm loans; the fact that some of these people have not been successful enough to repay the loans isn’t always their own fault, and in some cases I suspect that these folks need the money more than our government does. Especially since the whole $2 billion will only go to funding another two or three days in Iraq, anyway…

But there we come up against the big problem with this whole program. The country does, indeed, need some economic stimulus if we’re going to snap out of the current recession. It might seem as if one way to create more consumer spending is to just give money to people (and let them spend it), but somehow this never seems to work correctly; it didn’t earlier in the current administration, it didn’t during the Reagan years; in fact, it never has. This is because money pumped into the economy this way is only spent once, effectively: by the consumers who received it. If they spend it on the right products, it may have a small “ripple” effect, as retailers pay their distributors who pay manufacturers, but that’s as far as it is likely to go…

Suppose that instead, those same funds were spent on a Federal project to do any of the infrastructure development we desperately need in this country. For example, suppose we replace a few of those decaying highway bridges. The companies we hire to do the work have to pay their employees, their suppliers (people who make steel, concrete, paint and what not), and all of the fees, permits and insurance costs required. All of that spending results in additional spending, as suppliers pay their vendors, employees pay rent and buy consumer goods, and tax revenues are generated for cities and counties to support their own operations – not to mention what they might save on building new bridges…

This concept is called the “Multiplier Effect,” and is a common principle of macroeconomics. Depending on the conditions at the time, money injected into the economy in this fashion will generate between 2 and 5 times the impact of just giving money directly to the taxpayers (currently it’s about 4). It’s much more effective than a simple tax rebate in every sense except the political; politically the poor people see it as free money from the government and the wealthy see it as another opportunity to line their pockets at taxpayer expense. But at least this way our government is getting some of its overdue loan and tax payments back…

The Ethics of Tax Breaks

A few weeks ago at breakfast, a question came up about the stores across the street from our usual breakfast place, which have been empty for months now (and in some cases years). I’m working for UCLA Extension these days, and thus we’re eating breakfast in Westwood Village, just south of the campus. It’s an expensive part of town; in fact, the rents are so high that most small businesses have been forced out of the Village altogether. Most of the space, retail, food service and commercial, is now taken up by regional or national chains (which can absorb the overhead) and high-margin/low-volume retailers who can operate in very small square footage while making very large amounts of money on each sale. If you can afford to operate in Westwood in the first place, however, the tremendous population density (from both the campus and the office buildings along Wilshire) can make for an extremely lucrative business.

Past experience indicates that the primary barrier from this market is, in fact, the high cost of renting space in the Village. One could, of course, lower the rents until they become affordable to a customer without quite as much working capital, on the principle that 75% of a preposterous rental fee is better than 0% of the same fee. What a number of these landlords have chosen to do, however, is maintain the high rent level, wait for a client who can afford the rent they are asking for, and take the loss based on the empty (e.g. unrented) space as a tax credit. As a result, a number of storefronts, some in absolutely prime locations, are just sitting fallow.

Now, I’m not going to argue against the tax credits allowed for business losses; without those laws, most conventional business models would never work. And I’m not going to complain about extending those laws to include landlords who have rental properties sitting fallow; anything else would mean massive numbers of foreclosures and bankruptcies every time there was a downturn in the real estate markets. What I’m pointing out is that those laws were never meant to encourage property owners to just leave their buildings empty in order to maximize prices. Even worse, leaving all of those stores empty effectively lowers the overall property values in the area, both because the average rental income is lower and because the empty storefronts are unattractive to potential shoppers and residents.

So the question is, do those landlords have any obligation to their peers, to the other businesses in the neighborhood, or to the residents of that neighborhood, to actually rent those spaces to deserving businesses? Or should they be allowed to keep the rents artificially high and take the tax credit in order to improve their overall bottom line?

Before you answer that, there’s another problem. If we decide that the landlords DO have a responsibility to find tenants, then how do we enforce such a policy? Do we really want all of the knavery, chicanery and buffoonery that come with Rent Control? Do we really want to punish small landlords in other parts of the city who are having trouble renting? Do we really want to start passing laws that affect only one part of the city, or even worse, one 12-block area? It’s a well-known principle that passing laws, even local ordinances, to deal with one specific problem is bad government, and ultimately more trouble than it’s worth, but is there any other way to compel a private citizen – or even a private company – to do what we want them to do and not what they feel is in their best economic interest? At some point the good of the community must override the business interests of the few, but do we really want to bring that point down to something as trivial as setting the rents on a few commercial spaces in Westwood Village?

It’s worth thinking about…

Another Tax Cut

I don’t know if you’ve been following the national news regarding the latest in tax cuts, but if not, there’s a new one and you can read about it here until CNN takes the story down. Now, I know this blog is supposed to be about business and not politics, but this particular bit of political nonsense is based on a faulty business premise, and that brings it into my area of expertise. I can’t really comment on whether or not this is an astute political move, or on whether or not it constitutes good governance on the part of the President and his advisors; I only know that our current President’s own father once referred to this type of tax cut as “voodoo economics” – and he was right…

The basic idea behind any tax cut – especially a “tax rebate” like the one being proposed this week – is that the people who receive the money will spend it on new houses, major appliances, new cars, and other major purchases, which will benefit large companies that produce consumer products. These companies will then pay their suppliers and hire more workers to handle the increased demand, and the suppliers will also need to purchase more materials and hire more people, thus creating even more jobs. In economics, this basic concept is called the Multiplier Effect, and the general idea is that by injecting money into the economy through the increased purchase of goods and services, the money gets spent many times over (as opposed to just giving the money to one person or organization, who may just keep it).

This is the basic idea behind the Supply-Side Economics so beloved of the Reagan Administration in the 1980s. Massive tax cuts were given to the very wealthy, who were expected to take the money and invest in new factories, purchase masses of consumer goods, and generally stimulate the economy. These economic benefits would therefore “trickle down” to the people who owned the factories, supplied the factories, and worked in the factories, thus indirectly benefiting everyone who worked for a living in the United States.

It’s a pleasant enough idea, but ultimately nonsense. If you suddenly discover that your tax bill for this year has dropped by $800 it’s always possible that you’ll apply that amount to a new stove or a new refrigerator – assuming that you can find one for that amount, or that you have the extra to cover the cost of something you’d actually want. It’s more likely, however, that you’ll just have to pull 800 fewer dollars from your savings to cover the cost of the tax hit. Or borrow 800 fewer dollars to keep your household afloat. But since almost none of these “tax rebate” dollars will be given to people making between $25,000 and $40,000 per year (which is to say, almost 40% of the country!), it’s unlikely that this tax break will mean very much to anyone who gets it.

The fact is, it really doesn’t do anyone earning $40,000 per year much good if people richer than them get to spend less on their taxes, and it does no one any good if the people in the top 1% in incomes get to buy large estates in the country – except for those 1% of the people, who can almost always be relied upon to donate money to the political campaigns of the party that enabled them to buy their large estates in the country. Which is really the point I’m driving at here. I realize that the richest people in the country also account for the majority of the income taxes paid, and I understand that any potential tax break will have to be made proportionally, which means those same richest people will be the ones who will benefit the most from the tax cuts. But anyone who has spent even a few minutes learning how economics actually works will already know that the idea that this sort of tax cut program will actually stimulate the economy is nonsense. Or, in the words of Harvard economist James Tobin, “The idea that tax cuts would actually increase revenues turned out to deserve the ridicule..."