Questions About Property Tax Reform

May 2, 2007

Property tax reform has taken off across the country, gaining the most momentum in Florida, as well as some smaller states such as Indiana and Arizona. During the run-up in housing values from 2000 to 2005, many local governments failed to respond with adequate rate cuts. Instead they just spent more, and as a result, angry homeowners are paying dramatically higher property tax bills. State-level politicians are now jumping in with promises to do what local officials have not: lower property taxes. However, that gift is often wrapped up with other new taxes.

Unfortunately, most of the commonly cited arguments for abolishing or lowering property taxes have little economic justification and don’t qualify as “tax reform.” But these emotional pleas for reducing high property taxes are politically powerful nevertheless. Let’s take a look at a few of the most common complaints.

Why should I have to pay property taxes when I don’t have any children in school?

This is a common argument, especially among the elderly population whose children are grown, and it’s true that public schools are the biggest local expense. But the problem with this logic is twofold. First, followed to its logical conclusion, even younger people would deserve property tax relief if they didn’t have children in public school. In any community at any given point in time, the fraction of the public with children in public school is fairly small, and it’s mostly middle-aged couples. They could never pay the freight for the public schools, and if they did, we would have essentially eliminated public education and replaced it with private education.

Secondly, schools aren’t the only public spending that disproportionately flows to the young. Following this line of reasoning, the younger generation, who will have many more years to enjoy the expenditures currently under construction, such as roads and airports, should shoulder a larger tax burden to pay for almost all of these expenditures (with the exception of health care, which isn’t usually a major expenditure for local governments). However, extending such benefit-principle logic to other taxes/services would push the entire tax burden onto the youngest in our society, and it would also be an argument for large amounts of deficit-financing of present-day spending.

Why should I have to pay a higher property tax just because my home’s value increased?

Many people find it unfair that they could earn the same cash income from year to year, or even less, but still have to pay higher property taxes because their home values rose. The hard truth of the matter, though, is that rising home values are “income.” The practical problem is that to extract that income, a homeowner has to sell or rent the house, and most elderly people are fighting to stay in their homes, not to get out of them. Nevertheless, there’s no denying that people are better off financially when their property increases in value, and we can’t really expect renters to be sympathetic when homeowners are complaining that their home values have skyrocketed.

Properly understood, this complaint is an argument against using property as the base of a tax. When people ask this question, they’re really arguing that local spending should be funded by taxes on cash income. The practical effect, once again, is that those with disproportionately lower housing expenditures relative to income will bear a larger share of the total tax burden.

Why should somebody have to sell her home to pay her property taxes?

Nothing outrages property owners more than a news account of someone being forced to sell a home to pay the property tax bill. This happens most often to elderly people on fixed incomes whose houses are located in an area with skyrocketing home values. Many localities try to prevent these on a case-by-case basis with an appeals process, and this can be effective, but it involves depending on local officials’ judgment. Alternatively, some local governments try to prevent forced sales by enacting so-called circuit-breakers—that is, exempting some fraction of a home’s value for elderly people earning no wages. But at the state level, politicians are jumping in with a different approach: imposing a cap on the level of property taxes or a cap on the annual rate of increase.

While tempting, these caps are by no means problem-free. Property tax caps are often not proposed in isolation but along with other major tax hikes. But even if they were proposed with no other tax hike, property tax caps would have to be accompanied by spending cuts, or local governments would merely raise the property tax rate to offset the revenue lost to the assessment caps or the circuit-breaker policy or look for some other tax source.

When a cap has been in place for several years, as in California, taxable value is eventually significantly lower than market value. But that property does eventually turn over, and when it does, the cap is reformulated. As a result of the significant reduction in the base, the tax rates on those reformulated properties must be significantly higher to make up for that lost revenue. As a result, the new, higher property taxes (that are forced up because of the cap on current homeowners) reduce the amount that a prospective buyer is willing to pay for the house. Therefore, much of the current savings to homeowners are merely offset by a lower selling price when the person eventually sells the house (or when the person passes away and the heirs pay the price).

In summary, property tax caps for existing homeowners can be funded two ways unless spending falls. New taxes on income or sales or other sources can take up the slack, which overall will tend to reduce the burden on homeowners by shifting much of it to those with lower-valued homes and/or renters (depending upon how commercial properties are treated in the reform). Alternatively, the statutory tax rate on property can go up. If that is prevented by law, then current property owners will eventually pay when the house is sold (and thereby reassessed), and how much each ends up paying will depend upon the state of the housing market at the time of sale.


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