Although the property tax is largely the domain of local governments, especially for funding public education, fifteen states still collect a property tax statewide for their operating and debt service purposes.2 Heaviest users include Michigan, Minnesota, and New Hampshire, all of which have assumed greater or complete responsibility for funding public education. In 2001, for example, Minnesota adopted a statewide tax on business property dedicated to public schools as part of a measure designed to bring tax relief to homeowners. Nevada’s statewide tax of 17 cents per $100 assessed value is dedicated to servicing the state’s general obligation debt.
Historically, county governments have depended on the property tax much more heavily than cities have because counties generally have less access to alternative taxes.
But while the tax declined in its relative importance to both municipalities and counties during the 1980s and 1990s, it has seen a resurgence in the twenty-first century (Table 3–1).
Whether it continues to grow in importance depends on several factors. If federal and state aid continues its precipitous decline, local governments will probably increase their use of the tax. Alternatively, if state legislatures continue to allow municipalities and counties greater access to sales and, to a lesser extent, income taxes, local governments will have revenue sources to replace lost federal and state aid and will thus be able to reduce their dependence on the property tax.
Do municipalities and counties rely too heavily on the property tax? The combined annual yield from that tax for all local governments—cities, counties, townships, spe-cial districts, and school districts—is now over $400 billion. Although school districts depend even more heavily on it, their dependence has grown in recent years, too. How-ever, the evidence in Table 3–1 indicates that taxpayers’ remaining resentment against the property tax is probably motivated by factors other than local governments’ overre-liance on it.
Table 3–1 Property tax revenue as a percentage of local government general revenues, FY 2002 and 2007
Revenue source FY 2002 FY 2007
Counties Municipalitiesa Counties Municipalitiesa
Property taxes 38.4 22.8 40.1 27.8
All other taxes 17.2 24.2 18.1 24.0
Current charges 29.1 20.4 28.3 19.0
Utility charges 2.1 21.5 2.1 18.6
Other nontaxes 13.2 11.1 11.4 10.6
Total 100.0 100.0 100.0 100.0
Total general revenue
(in millions)b $161,483 $255,220 $223,203 $394,622
Sources: U.S. Census Bureau, State & Local Government Finance, Historical Data: 2002, Table 2, census.gov/govs/estimate/historical_data_2002.html, and State & Local Government Finance, Historical Data: 2007, Table 2, census.gov/govs/estimate/historical_data_2007.html.
a Combines cities and townships.
b Combines general revenue from own sources and utility charges.
Changes in the property tax base
The property tax is really a collection of taxes on several different types of property, which can be grouped into two broad categories: real and personal (Figure 3–1). Real property is immobile and includes land, natural resources, and fixed improvements to the land. Personal property is mobile and includes tangible property (furni-ture, equipment, inventory, and vehicles) and intangible property (stocks, taxable bonds, and bank accounts). Because of the difficulty of establishing ownership, only a few states still include intangible property in the tax base. A third, smaller category is state-assessed property (railroads and other public utilities), which spans several local jurisdictions and whose specialized use makes appraisal by state government more cost-effective and equitable.
The property tax base (TB) comprises the assessed (or taxable) value of all prop-erty subject by law to taxation. Tax liability (TL) is the product of the tax base and the locally determined tax rate (TR). Thus, TB × TR = TL. The effective property tax bur-den is measured as the ratio of property tax liability to the market value of a property or, in the aggregate, as the ratio of total property tax revenue to the sum of the market values of all taxable property in a taxing jurisdiction.
Shift from personal to real property Over the past four decades, the property tax base has shifted away from personal property toward real property. This shift is attribut-able to the complexity of discovering and valuing personal property and to the much greater growth in the value of real property. Although the exact proportion is difficult to know, at least 85 percent of the tax base is now real property.
Twelve states exempt all machinery, equipment, and business personal property from state or local taxation.3 Thirty-eight states exempt business inventories from the prop-erty tax.4 A number of states set the taxable value of inventory at less than 100 percent of its true value: West Virginia assesses inventory items at 60 percent of value, Georgia at 40 percent, Indiana and Oklahoma at 35 percent, Arkansas at 20 percent, and Louisiana and Mississippi at only 15 percent. In some cases, the exemption—sometimes called a freeport exemption—applies only to finished goods destined for out-of-state markets.
Real property Land Farmland Open spaces Timberland Minerals Improvements
Buildings (residential, commercial, industrial)
Infrastructure
Underground improvements
Personal property Tangible Inventory Equipment Vehicles Jewelry Artwork Furniture Intangible Stocks
Taxable bonds and notes Insurance policies Bank deposits (CDs, time deposits)
Patents, copyrights, trademarks Figure 3–1 Types of property
Georgia authorizes counties and cities, with voter approval, to exempt from 20 to 100 percent of the value of goods in transit.
Agricultural personal property (farm equipment and inventories) is exempt in sixteen states, mostly in the Midwest. In general, the trend toward state exemption of personal property has benefited the business sector far more than the residential sector because a far greater proportion of business fixed assets is in equipment, vehicles, and inventory.
Shift from business to residential real property Significant shifts have also occurred within the real property component of the tax base. Residential real property, espe-cially single-family homes, represents a rapidly growing share of the tax base, while business real property continues to decline in relative importance. Although nationally aggregated data are not available, the trend in Texas is likely indicative of what is happening across the nation. In 1981, real residential property (single and multifamily) represented 31.5 percent of the tax base in the state, increasing to 41.3 percent in 1990 and peaking at 52.8 percent in 2008 before the housing market collapsed.5 In other words, in this thirty-year span, real residential property increased from one-third to over half of Texas’s tax base.
By contrast, real commercial and industrial property in Texas (including utilities and min-erals) declined from 41.5 percent in 1981 to 25.8 percent in 2009.6 The principal cause of this change was the rapid appreciation in residential real property values relative to busi-ness real property values that occurred from 1981 until the housing bubble burst in 2007.
The 2007–08 crash in the housing market exposed just how vulnerable local budgets are to the value of housing. Researchers at the Lincoln Institute of Land Policy found that property tax yields have about a three-year lag, on average, behind changes in the housing market.7 They also found that cities offset about three-quarters of their lost property values by increasing their property tax rates.
In short, the property tax is no longer a general tax on all types of property but is increasingly limited to property—real property—that is easiest to discover and appraise and has the greatest potential for appreciation in value.
Economic growth and the property tax base
The relationship between property taxes and business investment is a primary concern for local government managers. Research indicates that taxes increase in importance as a relocating business narrows its choice from a regional to a local level.
For example, several studies have examined the effect of property taxes on employ-ment growth and on the property tax base, and have concluded that higher property tax rates diminish economic growth and encourage the out-migration of households and businesses.8 Over the long term, cities with higher-than-average property tax burdens have lower property values. For cities experiencing declining property values, an even higher tax rate must be imposed if a comparable level of services is to be provided.
For businesses (and households) seeking to maximize after-tax profits, the greater the differentials in regional property tax rates, the more important the tax becomes to their locational decisions—although some of these differences may be offset by higher-quality public services, such as a better educated workforce. Conversely, cities and counties experiencing rising property values can levy a lower effective tax rate and still provide the same level of services.
Capital-intensive industries, such as manufacturing and wholesale trade, are likely to weigh property taxes more heavily in their locational decisions than are less capital- intensive firms, such as those in the construction, retail, finance, real estate, insurance, and service industries. This difference is mostly attributable to the fact that the latter industries
follow consumer markets, whereas manufacturing and wholesale trade firms are more conscious of the cost of production, which includes local taxes.
Of the three types of tax bases—property (wealth), consumption (sales), and income—
the property tax base is the most sensitive to population changes. Such changes can have profound effects on a community’s dependence on property tax revenues.9 A population increase usually creates higher property values as households and businesses bid for the limited supply of desirable land and buildings. Similarly, property values usually drop with declines in population as the demand for property, especially residential property, declines; at that point, other things being equal, the remaining property owners incur a higher property tax burden to sustain public services. For communities that rely heavily on the property tax, population losses can have highly destabilizing effects on local bud-gets if appraisals are kept current with property values.
Balancing residential and nonresidential property taxes
Governments have considerable discretion in distributing the property tax burden.
Using such devices as homestead exemptions, circuitbreaker programs, classification of property, use-value appraisals, tax abatements, tax freezes for certain classes of property owners, and preferential assessment practices, a local government allocates its property tax between residential and nonresidential sectors. This gives rise to three questions:
• How does the proportion of commercial and industrial property to residential prop-erty affect the tax burden of homeowners?
• Do local governments tend to shift the tax burden to business property?
• Does the shift from a manufacturing to a service-based economy affect the property taxes borne by the business sector?
Taxing commercial and industrial property A widely held assumption is that the revenue from property taxes on the business sector generally exceeds the cost of provid-ing public services to that sector. Other thprovid-ings beprovid-ing equal, expandprovid-ing the commercial and industrial share of the tax base reduces the property tax burden on the residential sector. For this reason, property tax rates tend to be highest in cities and towns that are mostly residential.
A corollary is that jurisdictions experiencing rapid increases in business activity, as measured by the number of private sector jobs, will generally tax business property more heavily than they tax residential property. Studies support this conclusion. In a 1987 study of the seventy-eight largest U.S. cities, Katharine Bradbury and Helen Ladd showed that those with higher levels of employment per capita generally taxed business property more heavily by providing more tax relief to residential property owners.10 Conversely, where job growth was slow, property tax relief favored business owners over residential owners. Apparently, cities that wish to attract business investment tend to impose a relatively lower property tax burden on that sector.
A later study, which examined the ninety-three largest cities in Texas, found that those with greater concentrations of industrial property had comparatively higher per capita property tax burdens, specifically for operating purposes, apparently in recogni-tion of industry’s greater ability to export its tax burden forward to nonresident con-sumers or backward to stock owners.11 By contrast, cities with higher concentrations of commercial property (shopping malls, retail stores, business offices) had relatively lower property tax burdens than other cities in the study, controlling for all other factors.
These cities relied on a local option sales tax, which provides a mechanism for tax exportation, especially in the case of regional shopping centers.
Allocating the property tax burden In many communities, the relative political strength of homeowners compared with business property owners, many of whom are absentee, creates pressure that effectively shifts the tax burden to business. A 2012 analysis of metropolitan areas in the United States found that, on average, commercial property pays $1.70 in property taxes for every $1 paid by a homeowner12—a disparity that has remained relatively constant for the past twelve years. Even multifamily apart-ment units incur an effective property tax burden of 1.3 times that of homeowners.13
These findings suggest that local governments use discretionary measures to stra-tegically allocate the property tax burden between the residential and nonresidential sectors to maximize the competitive position of the jurisdiction. Informally, this shift of the property tax burden to commercial and multifamily (and likely industrial) property occurs in part because of the de facto classification system created by differential assess-ment practices among the different types of property, a practice explained more fully in the next section.
What are some of the formal measures that jurisdictions use through their legal pow-ers to favor either the business or the residential sector? Exemptions, such as those for inventory or equipment, benefit the business sector by lowering its effective tax burden.
Tax abatement, tax increment financing, and freeport exemptions (discussed in detail in Chapter 6) provide preferential tax treatment for new or expanding businesses.
For the residential sector, one of the most commonly used measures is the home-stead exemption, which is available in all fifty states. This partial exemption reduces the taxable value of the primary residence of property owners, thereby lowering the effective tax burden on this type of property. Some states permit local governments to classify property by use and then apply a different tax rate or level of assessment to each class, a practice commonly known as a split tax roll. Such classification schemes generally favor residential property over income-producing property, although Nebraska assesses all non-agricultural property at 100 percent of value but all non-agricultural property at 80 percent.14
Local governments may also use the frequency and methods of appraisal to shift the tax burden. In the absence of state regulation of assessment practices, the tendency is for local governments to underassess residential property and overassess commercial and industrial property.
Another measure for shifting the tax burden is the granting of a full exemption from the property tax. In the Supreme Court’s landmark ruling in McCulloch v. Maryland (17 U.S. 316 (1819)), Chief Justice John Marshall established the doctrine of tax immu-nity: state and local governments do not have the power to tax federal establishments.
Marshall ruled that “the power to tax is the power to destroy.” States have extended this principle to include exemption of all government property from local property taxation.
As a result, substantial amounts of property—national forests, military bases, universities, schools, courthouses—do not incur any tax liability. Nonprofit organizations, especially charitable and private educational institutions, may be exempt although the qualifying organizations vary widely among the states. One study concluded that the largest loss of property tax revenues comes from the exemption of government property, which has the greatest impact on state capitals.15 Some local governments particularly affected by such exemptions have begun negotiating with the exempt organizations for payments in lieu of taxes (PILOTs).16
Impact of growth in the service sector According to Bradbury and Ladd, growth in employment in the service sector decreases the share of property taxes borne by the business sector.17 This is because service firms have a lower investment in property-
intensive facilities for manufacturing, warehousing, and transporting finished goods.
Service-oriented businesses may also receive favorable tax treatment because they are generally more mobile than manufacturing firms, so local governments must make efforts to stem their emigration to jurisdictions with lower taxes.