January 26, 2006

True Tax-Lien Reform: Ending the Government's Claim that it Owns Your Home

Carroll Andrew Morse

Rhode Island’s current tax-lien sale system is based on the idea that the government owns all property and that individuals can never move beyond renting from the government. What Rhode Island calls “property taxes” are really rents paid to a government landlord. How else is it possible to interpret a system that holds, no matter how much money you have invested in the purchase of home, even if you have fully paid off your mortgage, you can still be evicted without compensation if you stop paying your rent?

Like anyone else, the government should have to pay fair market value when it wants to take control of a home. Here’s what this should mean for a tax-lien sale. Suppose a house is valued at $100,000 and that the owner has fully paid off the mortgage but is delinquent on $500 worth of taxes. If the government really needs that $500, it should be required to buy out the owner for $99,500 ($100,000 value of the home, minus the $500 in back taxes). It can then flip the home for the full $100,000, netting the $500 owed.

In addition to being more fair, ending the assumption of universal government ownership creates the proper economic incentives. The incentives of the current system are perverse. The most attractive targets of tax-lien predators are those who owe the smallest amounts. A real deadbeat, on the other hand, someone who owes tens-of-thousands of dollars of back taxes is not an attractive target because the return on the lien-purchaser's investment is significantly reduced by the large up-front amount needed to pay off the lien.

When there is true citizen ownership of property, the incentives are reversed. Delinquent owners owing the most taxes become the top priority in tax-lien machinations. For example, if someone owes $80,000 in back taxes on a $100,000 home, then the government would only have to cough up $20,000 to buy out the owner and get its $80,000. This, obviously, would be a higher priority to the government (one would hope) than spending $99,500 to get $500.

I’m not yet sure what Governor Carcieri’s full package of tax-lien reforms will look like, but whatever it is, it should include a strong rejection of the idea that the government owns your home and you just live there.

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This is a very good point that a lot of people do not understand. Furthermore it only comes up in certain cases because if the house is still mortgaged then often the mortgage company shows up and bids for the house equal to at least the amount of the mortgage and the taxes. So it is only when a house is owned free and clear that a house gets lost to the government for the amount of the taxes only. It is something that so many people take for granted. In my experiance as a real estate investor I have heard the following comment made in my reading. "If you think you own your land, try not paying the taxes". I would be very interested to do some research and see if there any states that use the formula mentioned in the posting instead of just taking the land for the tax bill.
Great post. It really got me thinking.

Posted by: Rebekah at January 26, 2006 11:26 AM

It's an interesting idea, but I think there are few flaws in your reasoning. There are other costs that go into buying/selling property. (i.e. real estate agents fees, attorney fees, etc.) So either the government has to absorb these costs, which generally run into the thousands, and hence cost the taxpayers even more or the state has to turn around and include those costs into the sale price of the property. However, if the house is not worth the required price for the government to break even, then the taxpayers lose b/c of lost revenue.

Property taxes are too high as it is and I would prefer to see property tax rates reduced. However, I would also rather see an investor purchase the property even if they are going to make a slim margin than the government more into the real estate business. Perhaps the investor should have to turn over a % of the capital gains to the home owner. Besides if we are talking about such a small bill ($500) with so much equity in the house, then the homeowner should be able to get an equity loan and pay off their taxes. (I hate taxes, but we still have to pay them....Just ask Richard Hatch)

Also, there is no guarantee that the government wouldn't seek to foreclose on more homes and attempt to make a profit off of the sale to increase revenues.

Posted by: tcc3 at January 26, 2006 11:34 AM