Iowa Adopts a “Soft” Property Tax Cap

Within hours of the emergence of compromise language, legislation enacting a “soft cap” on property taxes passed both chambers of the Iowa legislature last week. The amendments, designed to assuage the concerns of localities that a “hard cap” would unduly limit local budget authority, require any property tax rates anticipated to increase collections by more than 2 percent year-over-year to be adopted by a two-thirds vote of the local governing body, and only after a public hearing. Although framed as a cap, it might better be understood as a “truth in taxation” law with a supermajority requirement.

Interestingly, while the amended legislation is less restrictive than the introduced bill in most respects—the original language required voter approval for an increase of more than 2 percent, and forbade an increase in excess of 3 percent—the 2 percent soft cap now includes newly valued properties, whereas the introduced bill kept new valuations outside the cap. This means that increased collections due to new construction (as opposed to rising property values) count toward the cap.

Property taxes are often praised by economists for hewing to the benefit principle more closely than most other taxes. Property taxes pay for local government services that scale, if imperfectly, with a property’s value. When property values rise faster than inflation, this is often a windfall to local governments, since the cost of providing services may not track with the higher property values. It makes sense to adjust each owner’s share of local property tax liability with changes to their property’s value, but it does not necessarily follow that the government must collect more overall, since, if the properties have not changed, the bundle of services local government provides will not change much. A limit on overall collections (often called a levy limit) is intended to constrain such an increase in overall collections when circumstances have not changed.

When, however, property is newly developed, this new construction does impose additional costs—which is why that newly valued property is often kept outside the levy cap. That was how the initial bill was structured, but while other provisions were softened, this one was tightened. Any local government objections to this policy have been muted, however, because the bill that passed focuses more on transparency than limits. Local budgets frequently pass unanimously, so the supermajority requirement is not likely to be particularly onerous, and a public hearing in the event of a tax increase has largely been received as a worthwhile transparency measure. Proponents of an existing truth in taxation law in Utah point to lower rates of growth since its enactment: local governments still have the ability to raise taxes when circumstances warrant, but the process of public engagement—which also includes notices to residents, unlike Iowa’s bill—appears to have made local officials more reticent to accept increases merely as a matter of course.

The bill stands in positive contrast to ongoing efforts in other states, including neighboring Nebraska, to address property tax burdens through complicated tax swaps or nonneutral tax limitation regimes. The Iowa bill now awaits action by Gov. Kim Reynolds (R).