The Power of Taxes To Bend Behavior, Often in Unexpected Ways

Taxes are incredibly powerful things.  Tax something and you will get less of it.  But you might also get more of something you did not expect.  Taxes are the king of generating unintended consequences.  A huge part of human ingenuity (unfortunately) seems to be constantly geared towards evading taxes.  This is one reason I favor completely eliminating the corporate income tax -- way too many otherwise productive resources are marshaled towards managing the consequences of these taxes.

Last weekend I was in Cabo visiting a few friends and practicing my Spanish.  Many of the buildings in town (at least away from the resort areas) look like this:

This is a small retail commercial building with going concerns on the first floor (actually finished pretty nicely) but rebar and stuff sticking up from what looks like an unfinished second floor.   This is just one of many, many buildings that look like this.  My friend, who has run a resort in Cabo for decades, asked me what I thought was going on.  I said I assumed it was some sort of third world thing, perhaps a lack of financing that meant the first floor has to operate to generate cash flow for the second floor.

He answered that yes, there was very little financing for small business and real estate development so that sort of thing did happen.  But what was really going on here is tax management.  Until construction is completed, this structure is taxed as raw land rather than as a valuable commercial building.  It was typical practice to get approved for a two story building in the original plans, then stop construction after completing the first floor (which was all that was wanted anyway) and act like the building is still under construction.  Wala Voila (ed: lol, oops) -- ugly building but hefty tax reduction.

For those of you who want to write this off as a third world phenomenon, I will offer a similar example from personal experience.  Some years ago, because I did not have enough value-destroying investments in my life, I bought some raw land in Hawaii.  It is actually in a gated community, about half-built-out, but if you drive past my land you will likely see a cow on it.  What is a cow doing in a gated community on residential land?  Well, that is the point.  Without the cow, the land gets taxed as residential land.  With the cow, the land gets taxed as ranch land at perhaps a tenth the rate.  The homeowners association helps those of us with raw land to split the cost of the cows.

Update:  Here are the Hawaiian cows, next to one of my neighbor's front gate.  While they are more attractive than the exposed rebar on the building in Cabo, they serve the same purpose.

  • Bill Workman

    We saw a form of this in the border towns, Hilldale, Utah and Colorado
    City, Arizona. Most (all?) of the occupied houses are still not
    finished - e.g., missing siding, trim, etc. We were told this is a
    strategy to delay the raising of property taxes to the level applied to
    finished residences.

  • EDM

    "Incentives matter."

    I thought one couldn't buy land in Hawaii, only lease it? Or did Magnum PI mislead me?

    -Ed

  • Christopher Michael

    I like to give my Intro Economics students the example of why old homes in Amsterdam are all so narrow, sometimes comically so, and very, very deep. Well, guess how property taxes were levied in Amsterdam back then? That's right: By the width of the property only.

  • JTW

    My father decades ago did something similar.
    He wanted to buy a nice plot of land adjacent to our home to expand the garden. What he did was ask for, and get, subsidies to create a new "nature preserve". This required him to plant only native species of plants, and never to build a garden shed on the property, he didn't care.
    Added benefit is that nature preserves are excempt from property taxes.

  • GoneWithTheWind

    I agree. After the tax on sodas and other drinks with sugar in them I fully expect to see some people go to jail for buying Pepsi outside of the city limits and "smuggling" it into the city. When I was young I lived South of the New Hampshire border and North of Boston. The Massachusetts state police would put a plain clothed detective in the parking lot of liquor stores just over the border in NH to spot cars with Mass plates. He radioed this to his fellow state troopers on the Mass side of the border who would stop the car once it was in Massachusetts and if they had the "contraband" they would be arrested and or fined. I suspect there was a constitutional issue involved in this not to mention the letter of "life, liberty and the pursuit of happiness".

  • auralay

    Hmmm.
    Would Pepsi be allowed to sell a soft drink kit - ie a bottle say 2/3 full plus a bag of sugar with a handy funnel spout?

  • ErikTheRed

    Funny - some friends of mine were discussing the exact same phenomenon in a different tropical destination country. Apparently it's an extremely common practice.

  • ErikTheRed

    There is a similar phenomenon that can be spotted in ultra-wealthy communities in California like Rancho Santa Fe - small orchards on the property that allow for certain agricultural tax breaks.

  • CC

    In the US, having horses can make your land a "farm" under certain conditions, with a much lower property tax rate (so I have been told, do not have one personally). Also, vacant land with plans to build in my town often has corn growing on it even though it must be a huge hassle for the "farmer", for the same tax reasons.

  • CC

    At one time in England there was a window tax, so there was some work around people came up with.

  • sean2829

    Already happening. Remember the African American guy who died of an asthma attack when he was roughed up during an arrest in NYC a couple years back? He crime was selling loose cigarettes that had not had the $10 per pack taxes assed.

  • Kurt Droffe

    You will see the same thing in - who’d a-thunk it - Greece, just pay visit to Crete; as far as I know for exactly the same reason. OK, I admit there is a certain rationale behind it, don't tax it before it is generating revenue; what makes it look third world is that there is no effort to close the loopholes and stop the evident misuse or whatever you may call it (doesn't classify as real fraud, I think).

  • johnmoore

    No, even haolis can buy land in Hawaii.

  • Joe Mama

    You can make a credible case that we would be speaking Spanish right now if the Spanish port taxes in the 1400s and 1500s had not been based on deck size. The ship owners/builders gamed the tax structure by adding two small, raised, exposed decks. The added elevation became fatal when the Spanish Armada mounted many tons of cannon and ball on the elevated decks. They was not time to cut ports in the sides of the ship so lower decks could be armed. The raised center-of-gravity resulted in many ships capsized due to side winds and while maneuvering during battle. The British won. Most of us in the US speak English.

  • DaveK

    You find the same thing with "agricultural land" in Florida. Pastures, complete with a few head of cattle, in rather urban settings. Yes, it's the taxes.

  • DaveK

    There was also such a tax in Belgium... A lot of second-story windows were bricked in.

  • DaveK

    Not positive that the cigs were illegal... He was selling singles, and could still have mad a profit even if his supply had been already taxed. Of course, the profit on out-of-state cigarettes would have been higher, only taxed at maybe $5 per pack.

  • SamWah

    I recall reading that closets were taxed as rooms, hence armoires.

  • randian

    "Taxes are the king of generating unintended consequences"

    I would argue that, in many cases, they are "unintended" only in the sense that those involved in their design want to avoid any responsibility or blame. Otherwise, they are exactly what was intended.

  • esoxlucius

    Wala?

  • curious

    I'll bite - real estate on the islands has ballooned with the rest of the constrained housing markets. How was this not a good investment?

  • Sam P

    Cigarette smuggling can be a crime, both federal and NY State, but the numbers to put the act into felony territory are moderately large (10,000 cigarettes, about one case). But I think you can be charged for a misdemeanor for selling as few as one.

  • In San Jose, people will tear down a house to rebuild, but leave one wall standing which makes it into a remodel instead of new construction.

  • Matthew Slyfield

    They kind of already do.

    Sodastream sells machines for carbonating your own waters along with various flavor concentrates for different types of sodas.

    https://www.sodastreamusa.com/how-it-works.aspx

    You can buy Pepsi soda concentrates for Use with Sodastream.

    https://www.amazon.com/SodaStream-HomeMade-Variety-Regular-Cherry/dp/B01AWM2EPE?th=1

  • Matthew Slyfield

    That happens all over the US. The issue there however is not taxes, but a less burdensome process for remodeling permits vs permits for new construction.

  • Stan Forron

    I think he meant "viola."

  • Tom Nally

    I think it was intentional. Within my family, there was a 5-year-old nephew who famously said, "Wala, you have it!" Many of us started using it when something semi-surprising happened.

  • frankania

    I live in Mexico because in 1988, I was trying to build an underground concrete dome in rural PA. The govt. busy-bodies would not let me alone. Finally, after months of complying with dozens of rules, I sold the land, and moved here to Mexico, where I can build whatever I want. (and I do leave some parts unfinished to pay less tax!) . The property tax is quite low anyway--we pay $35/year on our large suburban property with 3 buildings on it.

  • Jim Collins

    A friend of mine needed to replace his garage, but, the City wouldn't give him a permit because they had changed the law on the distance that a new building had to be away from an existing property line. I think my friend could have built a two foot wide garage. So he got a permit to replace the roof of his garage. He built the roof so that it was supported by posts inside his garage. The next year he got a permit to fix the walls of his garage. When he was done he removed the poles from the roof and set it on the new walls.

  • Milo Minderbinder

    The Commonwealth of Pennsylvania used to send undercover LCB agents into Maryland looking for folks loading up on cheap liquor.

    The State of Maryland objected to this action.

    Of course at the same time the State of Maryland had its own agents in DC on the lookout for Maryland residents trying to load up on even cheaper booze.

  • dave schutz

    In Geneva Switzerland you will often see sheep trailered in to graze on undeveloped parcels for a few days a year. Same thing.

  • J Crain

    When we were in Egypt 10 years ago, rebar risers on buildings were very common - especially on multi-story residences. They actually seemed to be more common than not: in Cairo, in the countryside, wherever we went.

    Based on what some locals told me, I assumed the rebar stubs were left for adding more stories as the family grew. But maybe they were another example of Unintended Consequences, as in Mexico.

  • Bryan Townsend

    I don't know anything about how things work in Baja California, where Cabo is, but I have been a realtor in central Mexico for going on sixteen years and I have to say that this is not correct. I entirely agree with your point about taxes and unintended consequences, it is just that this example doesn't work. The truth is that a lot of properties are not plastered or painted on the outside and they leave a lot of rebar sticking up. In the case of the rebar, the likely cause is that, in the absence of the proper electric saw and blade, it is a lot of very hard work to cut of the rebar sticking up. So they just don't bother. And no, leaving rebar does not exempt you from paying taxes.

  • drobviousso

    "It is actually in a gated community, about half-built-out, but if you drive past my land you will likely see a cow on it."

    I almost spit out my water thinking this was a fat joke. If only i had some water!

  • It is a kind of tax, as permits require fees which are a tax on homeowners.

  • Matthew Slyfield

    As I understand it, the fees are the same, but the paperwork is easier for a remodel permit vs a new construction permit, and fewer approvals are required for a remodel.

  • kidmugsy

    In Britain many such windows are still bricked in to this day, a reminder that abolition of a bad law won't necessarily reverse its effects. See also Prohibition.

  • Joshua

    I think you meant "Voila".

  • Stan Forron

    Nope, I'm pretty sure he was referring to the stringed instrument slightly larger than a violin. 🙂

  • Methinks1776

    Ah. The distortionary effects of taxes. I know them well.

  • Methinks1776

    I know it's a typo, but "assed" is right.

  • Methinks1776

    charged with a misdemeanor or killed.

  • Methinks1776

    Likely for adding stories. I'm married into an Egyptian family and it's common to build a building and have separate apartments for family members and their families. As the family grows, so does the compound. My FIL built one. I don't remember any tax consequences that would preclude finishing the roof.

  • TruthisaPeskyThing

    In days gone by, Boston did not consider property to be fully developed until the house was complete. So home builders did not complete the back stoop. Thus these houses did not get fully taxed.

  • No doubt. Fees are used charges for services. If you don't use the service, there's no fee. However, if you remodel, you are required by code to pay for the service of waiting for them to inspect and approve. Of course this often adds delays as the homeowner must often wait for an inspection slot. To tax is to burden, and permitting is more of a burden than a service.

  • Eric Hamilton

    As i understand it in several countries that have so-so banking systems, people will have their home, small busness, partially built. As they get extra cash, the money goes into adding a little more on to the basic building. Since saving doesn't do any good it is a resonable way to do something with the extra cash.

  • rst1317

    My understanding is that a big chunk of construction in China happens for similar reasons. Gov't decides some area will be developed. So local farmers and villagers hurridly build multistor concrete homes. They're slapped together fast and sloppipily for the sole purpose of getting more $ out of the government since they're compensated by the size of the house, not it's actual value.

  • rst1317

    It could be but I doubt that. Most of the properties were owned by a Trust that used to be ran by the Fundamentalist Church of Latter Day Saints. Google it for youself. It's interesting as the state of Utah took over some of it while back. I suspect a lot of the frozen construction stemmed from a combo of adding to the house when you had the cash along with the previous trust freeze and legal problems. I can't imagine people were able to get loans / mortgages to build on land they didn't own but rented from the trust.

  • Rick C

    If that were true you'd probably see rebar sticking out the sides, too.

  • Bryan Townsend

    Actually, no. Rebar is in the form of a square column used to reinforce the walls. It is placed vertically every three meters and filled with concrete. Rebar is also used on ceilings, but I have rarely seen any sticking out.