Even after the passage of Proposition 13, the nearly universal approval by state leg-islatures of targeted relief—particularly to homeowners, and the nearly universal reduction in local dependence on the tax, the property tax ranks along with the
Figure 3–3 A sample tax statement for the overlapping taxes of a city, school district, and county
federal income tax as one of the most unpopular taxes with the public. Why does this dissatisfaction persist, and what can local governments do to alleviate it? Figure 3–4 summarizes the sources of irritation with the property tax and some of the remedies for reducing taxpayer dissatisfaction.
Property tax relief and issues of fairness and neutrality
Because it is a tax on wealth rather than on income or consumption, the property tax is particularly onerous for those who are property rich but cash poor, such as elderly residents.
And because it falls on capital assets (property) that have not been realized (i.e., sold in the market), the property tax is a prime candidate for relief under the “everybody is a special case” principle.
One of the goals of tax policy, as discussed in the preceding chapter, is neutrality: The less interference by tax policies in the marketplace, the more neutral those policies and, by implication, the more productive the market’s operation. Why is neutrality important?
Taxes, and in particular the property tax, have major implications for the way our econ-omy functions. State and local tax reform efforts in recent years repeatedly appeal for more “business-friendly” tax policies to create more jobs. Although tax relief violates the neutrality principle by creating noneconomic incentives that alter market-based optimums, many state-initiated measures of the past decade have been aimed at enabling local governments to provide that relief.
Circuitbreaker program A circuitbreaker program provides property tax relief to low-income homeowners or renters through a state income tax credit or rebate. With
Reasons for dissatisfaction Measures to reduce dissatisfaction (number of states, if known)
Tax falls on unrealized capital gains, making it punitive for those who are property rich but cash poor
Circuitbreaker program (33) Tax freeze (12)
Tax rate limit (38)
Homestead exemption (48) Tax deferral program (26) Split tax roll
Tax is collected in large, lump-sum payments
Installment option
Anxiety about reappraisal Full disclosure (13) Fractional assessment (29) Assessment cap (19)
Classification of property values (24) Use-value appraisal (50)
Acquisition-based appraisal (3) Inequitable assessment and appraisal Full-value assessment (20)
More frequent reappraisal Full-time appraiser
State oversight of local appraisal practices Figure 3–4 Taxpayer dissatisfaction
this program, unlike with other tax relief programs, the state rather than local govern-ment bears the financial cost of the tax expenditure. The drawbacks of a circuitbreaker program are its relatively high cost of administration; its adverse impact on state budgets through lost income tax revenue, especially during economic downturns; and the need for beneficiaries to file a state income tax return even if they have no taxable income.
Thirty-three states currently have some type of circuitbreaker program.32
The amount of relief varies inversely with household income up to a maximum income level, after which point relief ceases. To limit the cost of this subsidy, nineteen states target their circuitbreaker benefits only to senior citizens, usually defined as homeowners over age sixty-five.33 Kansas limits its program to homeowners over age fifty-five who have children under age eighteen. Six states—Maryland, Michigan, Minnesota, Vermont, Wiscon-sin, and Wyoming—extend benefits to all homeowners, regardless of age. Four other states—
Maine, Montana, New Jersey, and New York—use a two-tiered benefit system, with more generous benefits going to seniors than to younger citizens. Of the twenty-eight states that extend the circuitbreaker credit to renters, all but seven limit tax relief to senior citizens.
Tax freeze and tax rate limit As another approach to tax relief, states can freeze the tax base, tax rate, or tax liability. For example, Indiana freezes tax levies in counties that adopt a local income tax, but in other counties it freezes only the tax rate.34 Several states freeze property assessments, or at least severely limit annual increases in those values, which limits the effects of appreciation in property value on tax liability. Twelve states freeze the tax liability, usually when homeowners reach age sixty-five.35 Rhode Island and Tennessee make the tax freeze a local option. State law in Texas automatically freezes the tax liability for school purposes once one spouse in the household reaches sixty-five, but it gives cities and counties the option of extending the benefit to their senior homeowners.
Several states now require voter approval to increase property tax rates. Other limits restrict the amount of revenue to a percentage of the property tax base, such as the 1 percent cap in California (Proposition 13) and the 1.5 percent cap in Oregon. The most com-mon form of limitation acom-mong the thirty-eight states with rate limits is a statutorily or constitutionally set maximum tax rate for different types or population groupings of local government.36
Homestead exemption A homestead exemption provides tax relief by exempting from taxation a fixed dollar amount or percentage of a property’s assessed value. Partial exemptions have the important advantage of being easily understood by taxpayers and easily administered by local governments. After a property’s appraised value has been de-termined, its assessed (or taxable) value is obtained by deducting any partial exemptions, such as the homestead. For example, a $5,000 homestead exemption means that a house with an appraised value of $100,000 has an assessed value of $95,000. The owner’s tax liability is then determined by multiplying the tax rate (usually in mills or dollars) by the property’s assessed value.
Among the forty-eight states with homestead provisions (only Missouri and North Dakota offer none), all grant this partial exemption to elderly as well as disabled home-owners, especially disabled veterans.37 However, among the twenty-four states that extend an exemption to homeowners of all ages, the common practice is to grant elderly and disabled homeowners higher levels of exemptions than other groups. The amount of exemption varies from the first $1,000 of value in Oklahoma to $150,000 in Alaska. Homestead programs are often instituted concurrently with statewide reappraisal programs to soften the effects of the reappraisal on the homeowners’ tax liability.
The economic value of the homestead exemption depends on the level at which property is assessed. In states where property is assessed at less than its appraised value (i.e., where taxable value is set at some legally specified fraction of appraised value), the economic value of the exemption increases. For example, New Mexico assesses prop-erty at 33.3 percent of value and applies the homestead exemption after application of the assessment ratio. Thus, for a house with an appraisal value of $100,000 and a $5,000 homestead exemption, the following computation applies:
Appraised value $100,000
× Assessment ratio 0.333 33,300 – Homestead exemption 5,000
Taxable value $28,300
Organizations of veterans and the elderly are often the most vocal opponents of full-value assessments because such assessments reduce the value of the homestead exemption.
Tax deferral A fourth approach to relieving the tax burden on lower-income house-holds is a tax deferral, which, when opted for by the homeowner, delays tax payments until the property is sold or the estate is settled. Rather than being a state or local subsidy, the deferred portion of the tax is essentially a loan from the local government to the property owner. Deferred taxes usually incur an interest charge but less frequently a penalty. Currently, twenty-six states and the District of Columbia offer a tax deferral program, and in all but three states—Florida, Iowa, and Pennsylvania—the program is limited to elderly homeowners.38 Most states also impose a limit on the amount of taxes eligible for deferral; the limit is usually pegged to a percentage of the value of the property, which serves as collateral for the deferred taxes. Because deferred taxes become a lien on the estate, homeowners do not often choose this option.
Split tax roll A growing practice is the use of a split tax roll: taxing single-family residential property at one rate and all other property at a higher rate. In 1994 Mich-igan, as part of its sweeping educational finance reform initiative, basically eliminated tax rates set by school districts and in their place introduced a two-tiered rate structure levied statewide: 6 mills on all primary residences and 24 mills on secondary homes and businesses.39 Municipalities and counties continue to levy their own taxes. Although such a plan reduces interjurisdictional inequities, creating two classes of taxpayers has a high likelihood of spawning more classes as taxpayer groups jockey for preferential treat-ment under the state tax code. The plan also shifts control over school governance from locally elected boards to a more distant and centralized state authority.
In an older version of the split tax roll idea, nineteenth-century economist Henry George advocated imposing a higher property tax on land values than on improvements as a way to encourage more efficient urban development.40 Economists contend that the tax discourages landowners from making improvements on their property, a clarification that is particularly damaging to declining areas. For example, an absentee landlord has little incentive to improve an apartment complex if the result will be a higher tax liability and no increase in rental income. Vacant lots in developed urban areas go undeveloped because the expected increase in the land’s value exceeds the cost of the property tax on the undeveloped land. Several local governments in Pennsylvania, including Pittsburgh
and Scranton, have at various times implemented George’s theories. Typically, tax rates on land values are twice those on improvements, which penalizes speculators for leaving vacant land undeveloped. Because of their heavy reliance on wage taxes, local govern-ments in Pennsylvania make relatively moderate use of the property tax, so the use of split rates on land development patterns in Pennsylvania has probably had a moderate impact.
Payment methods
The general practice among local governments has been to collect the property tax annually in one lump-sum payment. This increases the tax’s visibility and may partially explain its unpopularity with taxpayers relative to other taxes.
Depending on the turnover rate in a jurisdiction’s housing market, anywhere from 40 percent to 80 percent of the property tax payments from residential owners are col-lected from mortgage lenders. Usually these lenders establish an escrow account into which each homeowner makes monthly payments against property tax liability. This both reduces the visibility of the property tax for these owners and effectively makes their tax liability payable in installments. The problem of lump-sum payments is greatest for owners who must pay their tax directly, either because they have no mortgage obli-gation or because the mortgagor does not require an escrow account.
Most states now permit local governments to collect the tax in smaller, more fre-quent installments. For example, Pennsylvania gives local governments the option of collecting the tax in quarterly installments. Some states, such as Arizona and Maryland, require semiannual payments. Local governments in Texas may, at their discretion, adopt the split payment plan. The province of Ontario, Canada, provides no statutory limits on the number or timing of tax due dates, but local governments must give taxpayers at least fourteen days’ notice before taxes are due.
One disadvantage of more frequent payments is that local governments lose interest income during the additional time that tax receivables remain outstanding. Other prob-lems are the increased administrative cost of notifying taxpayers of payment dates and the additional accounting required for partial payments. Increasingly, local governments are giving taxpayers the option of paying via the Internet with a credit card, an option that taxpayers are accustomed to having in the retail market and that thereby gives local governments opportunities for creating goodwill and enhancing taxpayer compliance.
Reappraisal
In general, taxpayer concern about property reappraisal will be the greatest where re-appraisal is done infrequently or at irregular intervals. The longer the intervals between revaluations, the greater the inequities that will develop during the intervals and the louder the complaints that will be heard from property owners who had benefited from undervaluation. However, frequent reappraisal increases the cost of administering the tax. Moreover, in a period of rapid appreciation in property values created by inflation or a population increase, frequent reappraisal may not reduce taxpayer concern, as was the case in California prior to Proposition 13.
Full disclosure Reappraisal usually leads to increases in taxable value. If the tax rate remains unchanged, taxpayers will incur higher tax liabilities. To protect taxpayers and prevent the local government from reaping a windfall that taxpayers have not approved, some states require a full-disclosure procedure, sometimes known as truth in taxation or truth in millage. Essentially, full disclosure does for the property tax what indexing
of the marginal tax rates does for state and federal income taxes. Full disclosure shifts responsibility for increases in the tax levy away from reappraisal (and the appraiser) and onto the tax rate (and the legislative body responsible for setting it).
Full disclosure originated in Florida in 1971 and is now used in thirteen states.41 Although state statutes vary widely in the specifics, full disclosure involves three steps:
1. Each taxing jurisdiction determines a tax rate that will yield the same tax levy produced in the preceding year. In a jurisdiction where taxable property values are increasing, this rate, called an effective or constant yield rate, will be lower than the preceding year’s rate. (All states exclude voter-approved debt from the computations.) 2. The effective rate is published in a local newspaper. (In Florida and Utah, individual
notices are mailed to property owners along with an estimate of the owner’s tax liability.)
3. The taxing jurisdiction then adopts a tax rate that will generate sufficient tax reve-nues to balance the current operating budget, and it advertises or individually notifies property owners of the percentage difference between the final rate (or levy) and the effective rate. Kentucky and Texas authorize citizens to petition their local govern-ments for an election to roll back extraordinarily large increases in tax rates (above 4 percent in Kentucky and above 8 percent in Texas).
Figure 3–5 is a sample notice used by Florida’s local governments to explain how proposed property tax changes will affect citizens and to notify citizens about the time and location of the public hearing where the proposed budget will be discussed.
Fractional assessment and assessment cap Two approaches aimed at constrain-ing increases in assessments—the fractional assessment and the cap on increases—have provided momentary relief for taxpayers but almost always at the expense of horizontal equity in the property tax burden. Assessing property at less than 100 percent of appraised value, which often arises because of infrequent reappraisals, creates an illusion of con-straining the tax but in fact reduces the accountability of the assessment process with property owners.
Capping assessments, as previously noted, takes several forms. But, again, assessment caps both introduce horizontal inequity and create vertical inequity as a household’s ability to pay is correlated with the value of its property.
Property classification Whereas a split tax roll always targets tax relief—often for homeowners—through the use of differential tax rates, classification of property is more closely associated with providing tax relief on the heels of a reassessment. Classi-fication involves grouping real property by type (e.g., single-family, multifamily, com-mercial, industrial, vacant land) and then treating each type differently through the application of either a different assessment level, which is the case in nineteen states, or a different tax rate, which is the case in Hawaii, Kentucky, New Hampshire, South Dakota, and West Virginia.
Where revaluation is done infrequently or enforcement of a uniform assessment level is lax, residential property generally has lower assessment ratios than nonresidential property, and a reappraisal will shift the tax burden back onto owners of single-family homes. Some states use classification to legitimize the favorable level of assessment given de facto to residential property. In almost all cases, classification grandfathers a situation created by negligent appraisal practices.
When considering the adoption of a classification system, state legislatures must address two issues. The first is the number of classes to create. Of the twenty-four states and the District of Columbia that classify property, most designate from two to four
Figure 3–5 Notice used by Florida local governments to announce proposed property taxes and public hearings
classes. Missouri law specifies three classes of real property, each assessed at a different fraction of appraised market value: residential (19 percent), agricultural (12 percent), and income-producing property (32 percent). Because political rather than economic crite-ria are the basis of all state classification policies, residential and agricultural property are almost always the most favored classes. Unfortunately, once the practice of classification is introduced, political pressures build to create even more classes. For example, Minne-sota began with just four classes in 1913 but now has possibly more than one hundred
classes, creating an administrative nightmare for tax assessors and a patchwork of assess-ments of doubtful fairness to taxpayers.
The second issue concerns the degree of differentiation among the classes. Missis-sippi assesses residential property at 10 percent, all other real and personal property at 15 percent, and state-appraised utility property at 30 percent of its value. Montana has at least thirteen classes of property, with assessment ratios ranging from 3 percent to 100 percent of market value. (It assesses coal reserves at 100 percent of value as a way to export the tax burden.) No economic criteria guide these decisions, only the relative political power of affected groups.
Use value appraisal Like classification, use value (or production value) treats par-ticular types of property more favorably, especially those that are adversely affected by a reappraisal. Use-value appraisals, first adopted by Maryland in 1960, give preferential treatment to farmland and open spaces by basing the value of the property on its cur-rent use rather than on its best possible use or market value. The intent of this approach, now used for some types of agricultural land in all fifty states, is to reduce the adverse impact of reappraisal on farmland surrounding urban areas, where the potential for future development causes land values to appreciate rapidly.
Most states impose penalties if the property’s use is changed once it has been classi-fied and valued as farmland. Some states enter into contracts with owners of agricultural property, restricting land use in return for appraising the property at its production value. While the intention is to protect farmers from the adverse effects of urban growth, owners can abuse the approach by holding their land for future development while keeping it in farm production to qualify for the tax break.
Acquisition-based appraisal As noted earlier, Proposition 13 ushered in acquisition- based appraisal, a new basis for valuing property now used in California, Oregon, and Georgia (local option). Not only are annual assessment increases capped in these states
Acquisition-based appraisal As noted earlier, Proposition 13 ushered in acquisition- based appraisal, a new basis for valuing property now used in California, Oregon, and Georgia (local option). Not only are annual assessment increases capped in these states