By Dennis Polhill
Who should be exempt from taxes? By resoundingly defeating Amendment 11, Colorado voters said that private charities should continue to be exempt from property taxes. But there is a far larger tax exemption issue that has not been debated: should government entities be exempt from taxes? Why is it fair that ordinary citizens pay the state sales tax when they buy office supplies, but the Denver City Council, for example, is exempt from the tax?
The notion of governmental tax exemption is rooted in the famous 1819 case, McCullough v. Maryland, which held that “federal properties within city boundaries are not taxable.” The logic was rooted in the English common law of sovereign immunity wherein the king is immune because the king is the law.
But sovereign immunity is inconsistent with constitutionally limited government that recognizes citizens as the true sovereign. The 1819 McCullough ruling was adequate for simpler time when governments were fewer and their purpose was constitutionally limited. Taxation among governments would constitute a transfer providing no direct benefit and unnecessarily increasing costs.
But times have changed, and the immunity from taxation premise deserves rethinking. The U.S. now has nearly 90,000 governments. Colorado will soon exceed 2,000. Within Jefferson County there are 140.
The location of the Federal Center in the city of Lakewood imposes unreimbursed, costs of traffic control, snow removal, street sweeping, pothole patching, drainage, police and fire protection and so forth. Many more similar impacts accrue when a county government locates facilities in a small town. The Grand county school district is deprived of needed operating revenue because Winter Park ski resort (owned by the City of Denver) does not pay property tax. Some governments provide more free services to other governments than they receive. This inequity creates the incentive for feudalistic-like competition among them. They quickly and aggressively compete to secure new-found revenue sources and service rights.
Some non-traditional services (like day care) find as many as five levels of government laying claim to the right to provide the service, even though the service is also provided by non-profits and by taxpaying businesses.
When the government provides a service, such as running an athletic club, and the government is exempt from taxation, then the government enjoys a huge hidden cost advantage over private competitors. The hidden costs are not efficiencies; they are cost burdens that are redistributed to other governments, to taxpayers, and to individual consumers. The government clubs may drive the other athletic clubs out of businessnot because the government club is better, but because the private clubs have the burden of sales taxes, property taxes, corporate income taxes, etc., from which their government rival is exempt.
Back in 1819, government entities did not compete directly with private business or with each other. But today, governments are without limits.
As more tax-exempt government entities drive private competitors out of business, the tax base is eroded.
Ultimately, the government tax exemption issue forces us to consider the purpose of taxation. Under one philosophy of taxation, the purpose of taxation is to pay for government services. Under this philosophy, most government tax exemptions should be abolished. For example, if a county sales tax is used to fund fire protection for everyone in the county, a government owned athletic club or day care center in that county should also pay sales taxes, since the government facilities benefit from fire protection the same as everybody else.
The other philosophy of taxation is that taxes are to redistribute wealth from the unworthy to the worthy. Since governments are (supposedly) not motivated by monetary gain, while normal businesses operate under the profit motive, it is good that taxes redistribute wealth from people who work for private business to people who work for the government. The tax exemption for government entities, by giving government entities more money to spend on salaries, amounts to an indirect transfer of wealth from private to government hands.
Until society comes to grips with the core principles, the public policy problem will continue to grow. Complexities are inevitable when society has the basics wrong.
The simplest cure for the tax-exemption problem would be to make governments subject to ordinary taxes, the same as everyone else.
Dennis Polhill is a Senior Fellow at the Independence Institute, a free-market think-tank located in Golden, Colorado
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