WY Gov Wants Property Tax Relief (Good) Through a Homestead Exemption (Bad)

December 5, 2008

Wyoming Governor Dave Freudenthal has proposed granting a homestead exemption on primary residences. The exemption would apply to the first $5,000 of taxable value, but because Wyoming assesses residential property at 9.5% of fair value, that’s equivalent to about a $50,000 exemption in real terms. To qualify for the exemption, the homeowner would have to be a full-time Wyoming resident for at least three years, and the home would have to be worth less than $237,000, excluding land value. On average, qualifying homeowners would save $278 per year.

Property taxes in Wyoming have skyrocketed in recent years. By Tax Foundation estimates, Wyoming property taxes in 2008 will total $1.14 billion, a 122% increase over the year 2000. (Nationally, property taxes have risen by “only” 61% over the same period.) However, the tax rate remains modest compared to many other places, at least for homeowners. If a $50,000 exemption creates average savings of $278, then the average tax rate faced by a homeowner is 0.556% of fair value.

While Governor Freudenthal’s impulse to give property tax relief is a sensible one, a homestead exemption is a bad mechanism to do so. Homestead exemptions subject rental, commercial and industrial property to higher effective tax rates than owner-occupied homes. As with any other tax non-neutrality, this creates economic distortions, encouraging overinvestment in primary residences and under-investment in other property types. It also favors homeowners over renters, who tend to be relatively poor.

Even more problematically, homestead exemptions erode political barriers against property tax rate increases. When property taxes are neutral and homesteaders face the same tax rates as other property owners, voters (most of whom are homesteaders) face a strong incentive to hold property tax rates down. If homesteaders are given special treatment, they are more likely to be friendly to property tax increases, which they know will fall disproportionately on rental, commercial and industrial property.

This effect can be seen most clearly in New York, where homeowners get generous property tax exemptions, in many cases exceeding 50% of a home’s value. (This would be the case in Wyoming too—in 2006, Wyoming’s median home value was $148,900, meaning the median exemption would be in the range of 33%, and many homeowners’ exemptions would be much higher.) Unsurprisingly, this has created an environment where voters don’t look too closely at school district budgets—why should they, when they send much of the bill to somebody else? Since the adoption of New York’s property tax exemption law in the 1990s, voters have approved over 90% of school district budgets, and local spending has skyrocketed.

If Freudenthal thinks property taxes in Wyoming have risen too far too fast, he should look at restricting the overall increase in the property tax levy, as is done (for example) in Massachusetts. This provides a neutral solution which protects all property taxpayers, without favoring one kind of property or creating perverse political outcomes.

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A tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities.

A tax exemption excludes certain income, revenue, or even taxpayers from tax altogether. For example, nonprofits that fulfill certain requirements are granted tax-exempt status by the IRS, preventing them from having to pay income tax.

A property tax is primarily levied on immovable property like land and buildings, as well as on tangible personal property that is movable, like vehicles and equipment. Property taxes are the single largest source of state and local revenue in the U.S. and help fund schools, roads, police, and other services.

The average tax rate is the total tax paid divided by taxable income. While marginal tax rates show the amount of tax paid on the next dollar earned, average tax rates show the overall share of income paid in taxes.