Rethinking Local Taxation

Property Tax vs. PIT Sharing in Global and Ukrainian Contexts

A recent blog post has sparked discussions about the increasing international reliance on property taxes to bolster local government revenues. The post, available here, contrasts the use of personal income tax (PIT) sharing as a primary revenue source with the growing adoption of property taxes worldwide.

While some European countries continue to depend on PIT sharing, many others are transitioning toward property taxes. This shift has fueled debates on the theoretical and practical merits of these two revenue mechanisms.

PIT Sharing and Property Tax in Ukraine

In Ukraine, a heated debate revolves around allocating PIT revenues to local governments based on the taxpayer’s residence instead of their place of employment. Although preliminary research has explored the potential revenue impacts of this change, significant barriers to implementation remain. For further context, see this related article: Decentralization News.

This blog aims to clarify the theoretical and practical applications of property tax versus PIT sharing, including considerations of using PIT on a place-of-employment or residence basis.

Principles of Taxation

The following are widely recognized principles of taxation:

  1. Neutrality
  2. Efficiency (minimizing compliance costs)
  3. Certainty and Simplicity
  4. Effectiveness and Fairness (reducing evasion and avoidance)
  5. Flexibility
  6. Equity (horizontal and vertical)
  7. Ability to Pay and Benefits Received

Principles of Local Taxation

According to Paul Bernd Spahn’s 1995 study  published by the World Bank, the principles of local taxation include:

  1. Local Accountability
  2. Tax-Benefit Link
  3. Non-Distortion
  4. Regional Equity and Long-Term Efficiency
  5. Reliability and Stability of Tax Bases
  6. Tax Sharing as Implicit Insurance
  7. Administrative Simplicity

There is a dearth of research that can be found that makes a comparison of the two revenue sources with any analytical basis.  While PIT sharing has been utilized in predominantly European and Nordic countries, there seems to be very little analytical or quantitative analysis that demonstrates that PIT sharing meets many of the principles of taxation.


Analytical Comparison: Property Tax vs. PIT Sharing

Evaluation Based on General Taxation Principles

PrincipleProperty TaxPIT Sharing
NeutralityStrongWeak
Efficiency (Compliance Costs)StrongStrong
Certainty & SimplicityStrongWeak
Effectiveness & FairnessStrongWeak
FlexibilityStrongWeak
Equity (Horizontal & Vertical)Very StrongStrong
Ability to Pay-BenefitsVery StrongWeak

Evaluation Based on Local Taxation Principles

PrincipleProperty TaxPIT Sharing
Local AccountabilityVery StrongWeak
Tax-Benefit LinkVery StrongWeak
Non-DistortionStrongWeak
Regional Equity & Long-Term Eff.StrongStrong
Reliability & Stability of Tax BaseVery StrongVery Weak
Tax Sharing as Implicit InsuranceWeakStrong
Administrative SimplicityStrongWeak

Options for PIT Sharing

PIT sharing can be implemented through several approaches:

  1. Central Government-Controlled Options:
    • Pooling PIT revenues and distributing them based on a formula.
    • Sharing PIT revenues based on the taxpayer’s place of employment or business activity.
    • Sharing PIT revenues based on the taxpayer’s residence.
  2. Local Government-Controlled Option:
    • Implementing a surcharge or “piggybacking” on PIT rates.

Lack of Supporting Research

In researching the use of personal income tax (PIT) sharing based on residency, it is unclear where this concept originated. The literature contains a notable lack of well-developed and substantiated research on this topic. The only reference found was a paper published by the World Bank titled “Local Taxation: Principles and Scope” by Paul Bernd Spahn. In this paper, Spahn states:

“As long as the tax base cannot be shifted to other jurisdictions, taxation is neutral and efficient (in the sense that it does not exhibit ‘excess burden’). The argument strongly supports a local property tax and a local income tax based on the residence principle. It also favors a local business tax. In particular, a local land tax seems to be an ideal candidate under this guideline.” (p. 4) Source: Spahn, Paul Bernd (1995), “Local Taxation: Principles and Scope”, in Jayanta Roy (ed.), Macroeconomic Management and Fiscal Decentralization, EDI Seminar Series, The World Bank, Washington D.C., 221-232. Available online here.

This is the only reference identified in support of the residence-based approach, and it does not provide further detail or justification for PIT sharing based on residency.


Can Property Taxes Be a Major Source of Local Government Revenue?

The argument for using PIT sharing is often that the property tax is a very small tax relative to other sources, such as the PIT, VAT, or other sources, and, therefore, cannot be considered as a primary source for local governments.  Comparing property tax with economic based taxes, such as the PIT and VAT, would not seem to be a comparable basis.

However, in the USA and some other countries, the property tax is the dominant and largest source of local government revenue as evidenced from the data from the USA.

USA Local Government Revenues

The Urban Institute Tax Policy Center provides some data on the sources for local governments in the USA.  The following data is provided to illustrate the extent of the various revenues available to local governments.

Local General Revenue Breakdown

Taxes accounted for 42% of total local general revenues, distributed as follows:

(Source: Tax Policy Center)

Applying the PIT Sharing on a Residence Basis in Ukraine

There is an ongoing debate and effort to adopt a PIT sharing based on residency in Ukraine. There have been several analytical studies of the impact of changing the basis of the PIT sharing.  The following information is provided from the U-LEAD project that has supported the analysis of this option in Ukraine.

 Most of the regions in Ukraine have people who live and work in their place of residence as shown in the following graph. It is only in the regions with large urban areas, such as Kyiv, Lviv and Ivano-Frankivsk region, that have a large percentage of people who do not live in the same locality as where they work. In all the other regions, over 80% generally live and work in the same local area.   Further, PIT sharing in Ukraine is very unstable due to government’s decision to exclude military PIT from local sharing assignments.

Source: U-Lead with Europe, Where Ukrainians live, work and pay taxes? Figure 15

The following provides some background and a good summary of the debate about applying PIT on the basis of residence from a recent report. The pros and cons of the approach are summarized.


Conclusions & Recommendations on Information Framework for PIT Payment Reform

Decree of the President of Ukraine dated April 29, 2021 No. 180/2021 instructed the Cabinet of Ministers of Ukraine to develop and submit to the Verkhovna Rada of Ukraine amendments to the legislation regarding PIT to be allocated to local budgets based on the place of residence of individuals (taxpayers).

Making decisions on that reform need to be based on reliable calculations of its consequences, in particular to prevent risks of deterioration of the financial capacity of territorial hromadas and deepening of inequality between them.

Pros of the reform suggested:

  • PIT allocation to local budgets based on the place of residence of individuals (taxpayers) will contribute to a significant increase in the financial capacity of subsidized rural territorial hromadas (approximate increase in PIT revenues may amount 50‒70%) and reduce their need for a basic grant from the state budget.

Cons of the reform suggested (raised by opponents):

  • PIT revenue loss for those territorial hromadas that have decent job supply and thus attract labour force from neighboring municipalities;
  • Risk of decrease in local governments’ motivation to further stimulate and promote the development of their municipalities and create new job opportunities in their territories.
  • Imbalances in revenues and expenditures of some local budgets since residents of rural territorial hromadas may receive educational and medical services in other municipalities at the place of their employment (in this case, PIT will be allocated to a local budget at the individual’s place of residence, and expenditures on respective public services delivering will be made from another local budget at the place of individual’s employment).

Changes in PIT distribution require the development of the Government’s IT capacity to track all PIT payments – both made based on individuals’ place of residence and their place of work. Ensuring such opportunities for the Government as well as the assessment of the impact of different models of PIT allocation to the budget (based on the place of work, place of residence, or their combination) on the financial capacity of territorial hromadas should be an initial step towards a legislative decision on changing the current approach to PIT allocation.

Source: https://decentralization.ua/uploads/library/file/799/PIT_EN.pdf

Challenges in Applying Personal Income Tax (PIT) on a Residential Basis

There are significant issues with implementing PIT based on residence, as outlined in the following list:

  1. Would significantly distort the fiscal capacity measures of local government
  2. Would significantly impact local governments attracting economic development and employment opportunities
  3. Would not incentivize local governments to enhance their own source local revenues
  4. Would place the burden of environmental and other impacts on local governments that have developed their economic base without receiving any financial offsets to the impact
  5. Local governments receiving the PIT of their citizens working in other local government areas will be “Free Riders” of the employment benefits
  6. PIT has a weak link to most local government services, particularly the infrastructure services of streets, lighting, water, sewage, garbage collection, etc.
  7. Difficulty in developing a database of taxpayers on a residence basis connected to the place of employment
  8. High level of administration costs on employment firms
  9. Very unstable and predictable source of revenue for local governments
  10. Weakest method of empowering local government decision-making and accountability

Conclusion:

From both a theoretical and practical basis the use of the property tax as the main source of local government revenues is being increasingly recognized.  The recent IMF blog identifies that the improvements in technology is making the property tax a more efficient and effective tax source. https://content.govdelivery.com/accounts/USIMF/bulletins/3c14020

The difficulties of implementing a property tax are more political than technological. Spahn in the previously cited article states: 

“Alas, not much can be expected from the local property tax either. While it is the ideal local
tax in theory, the tax seems to raise little revenue in practice. Only the Anglo-Saxon world
appears to raise a more substantial portion of public revenue from this tax. The reasons for
the poor performance of the property tax in most countries are found in political
impediments that work at the local level, more than in administrative complexities in
determining the base. After all, people prefer to avoid the local tax burden and local
politicians often have no other choice than to collude with local citizens if they want to stay in
power. Nevertheless, a local property tax–albeit fraught with administrative and political
problems–is an important component of any system of local finance both for reasons of
efficiency and equity.” (p. 10) Source: Spahn, Paul Bernd (1995),” Local Taxation: Principles and Scope”, in Jayanta Roy (ed.), Macroeconomic Management and Fiscal Decentralization, EDI Seminar Series, The World Bank, Washington D.C., 221-232. Available online here.

Hopefully, the political will necessitated by the poor performance of the PIT sharing arrangements will increase the use of the property tax and it will continue to be developed and a more fair, equitable, and sustainable local government revenue source will be implemented. As there is intense interest in domestic resource mobilization the application of the property tax has the most potential for local governments to increase their own source revenues.


This blog was prepared by Glen Wright (Co-Chair, LPSA ECA Regional Working Group), January 2025. It aims to spark further discussion on the potential of property taxes to drive fiscal sustainability and enhance the autonomy of local governments.