What If We Replaced Income Taxes with Property and Sales Taxes? Would Real Estate Investing Even Work?

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Today, we don’t question income taxes as a part of life, as unavoidable as death or, well, any other type of taxes. But before World War I, the U.S. only sporadically flirted with income taxes. Most of the government’s revenue came from excise taxes and tariffs. 

So what would happen if we got rid of income taxes today? Would society collapse in Mad Max-like anarchy?

Not at all. Different governments use different types of taxes to fund themselves. Nine state governments already do this: They don’t charge income tax, funding themselves through property, sales, and excise taxes.  

Regressive or Progressive?

Because our hyperpolarized society lives in political echo chambers and views everything through its own tribal lens, the first question people wonder is, “Wouldn’t getting rid of income taxes be regressive?” (Regressive meaning less weighted toward taxing the wealthy.)

No, not necessarily. It depends on what you replace it with. 

That actually makes this thought experiment politically agnostic. You could take it in either a regressive or progressive direction. 

For example, imagine you removed income tax and replaced it with excise taxes on tobacco, alcohol, marijuana, and gasoline. That would be regressive, because it would put a relatively high tax burden on lower-income Americans. 

Now imagine a scenario at the opposite extreme: You replace income taxes with a steep tax bracket ladder for property and sales taxes. For instance, the government imposes no property taxes on homes worth less than $200,000 but adds 1% in property taxes for each $200,000 in value above $200,000. So homes worth $350,000 owe 1% in property taxes ($3,500), those worth $550,000 owe 2% ($11,000), those worth $750,000 owe 3% ($22,500), and so on. 

You could do the same thing with sales taxes. Perhaps the government imposes no sales tax on groceries but puts laddering tax brackets in place for clothes, cars, boats, luxury goods, etc. For instance, you pay a higher tax rate on a luxury car than an economy sedan. If you wanted to bend the tax rules in a green direction, you could charge a higher sales tax on vehicles that get worse gas mileage. 

The bottom line? You could structure these tax brackets however you wanted, to make them as flat or progressive as you like. The concept itself doesn’t tilt in any direction politically.  

Advantages of Eliminating Income Taxes

First, eliminating income taxes would make the tax code far simpler. We wouldn’t need thousands of pages of rules, exceptions, exemptions, and loopholes. 

Don’t like that the wealthy pay a relatively lower percentage of their income in taxes, compared to working professionals? That happens precisely because the tax code is so complicated. The wealthy can afford to hire savvy, expensive tax attorneys to find every loophole in the system and exploit them. 

Property taxes and sales taxes are clear and transparent. If you own a mansion worth $10 million, there’s no getting around the property tax bill. You pay a certain percentage of the assessed value, hard stop. 

In fact, the main reason we need the IRS is the complexity of enforcing income and corporate taxes. Ditch them, and you can (mostly) ditch the IRS and the $16.1 billion spent to run it last year. You don’t see municipal governments struggling to enforce property taxes: If someone doesn’t pay, they put a lien on the property and auction it off. 

Finally, income taxes create an accounting and tax preparation nightmare for millions of Americans. The average American spends 13 hours preparing their tax returns each year, and many spend hundreds of hours. 

Think of all the time and stress that would be saved if no one had to file a tax return and we simply paid our taxes every time we swipe our credit card or pay our property tax bill!

Downsides and Risks

By this point, you’ve probably come up with a dozen objections. Here are a few to consider.

First, a federal sales tax would incentivize under-the-table and black-market transactions. If the sales tax jumped to 15% overnight, suddenly everyone would take an interest in cash payments. 

Similarly, bartering would rise in popularity. If two people each discover that they each have something the other wants, perhaps they reach an accommodation that doesn’t involve money changing hands. 

That forces us to reconsider our assumption that we don’t need the IRS as an enforcement agency just because the tax code is simple and transparent. Sure, sales taxes are both—but if everyone suddenly starts dodging taxes by paying for goods under the table, we’d still need agents to force people back in line. 

And those rich people who’d owe huge sums in sales taxes when they buy luxury goods like yachts? Maybe they just hop on their jet and go buy that yacht in another country. 

Put another way, perhaps sales taxes are easily enforceable because they’re relatively low. 

The Impact on Real Estate and Investors

Finally, higher property tax bills raise another set of questions for real estate investors.

We run a passive real estate investment club, where we get together every month and vet different types of properties for us to go in on as a group investment. Different property types come with different risks—and would definitely be impacted differently by a sudden federal property tax.

At first glance, you might assume that adding a hefty property tax bill would put downward pressure on home values. It would raise the total cost of ownership, after all.

But I’d push back on that assumption. Remember, owners would no longer have income tax bills. They still need a place to live, so they’ll pay the going rate for housing and have the savings on income taxes to spend on property taxes. 

That logic holds together well enough for residential and industrial real estate, but gets shakier when you apply it to potentially nonvital property costs like office space. Imagine a company that maintains an office footprint because they like the idea of their team getting together physically at least a few days each week. But if their office rent jumped due to higher property taxes, that calculus might shift to “Screw it; let’s just go fully remote.” 

Then again, you could argue that’s not such a bad thing. Maybe those buildings would better serve our cities as housing supply, reducing commutes and greenhouse gas emissions in the process. These are all debatable points. 

Governments Rarely Give Up Revenue Sources

There is no major political party fighting for fiscal conservatism anymore. The Trump administration spent far more than the Obama administration did. This means the government will keep spending enormous sums of money unchecked, and the federal government will never give up income taxes now that they’ve trained us to accept them. 

Tax benefits are one of many reasons I love real estate investments. In particular, I use the lazy 1031 exchange strategy to minimize my income tax bill. It works because I can invest small amounts in new syndications every single month through SparkRental’s Co-Investing Club. All this should get you thinking about your tax strategy: The more of your income that you keep in your pocket and out of Uncle Sam’s paws, the faster you can secure your financial future.

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Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.

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