Erosion of the Property Tax Base : Trends, Causes, and Consequences [1 ed.] 9781558442696, 9781558441866

Citation preview

TRENDS, CAUSES, AND CONSEQUENCES

Cover image © Don Hammond/Design Pics/Corbis

ISBN 978-1-55844-186-6

AU G U ST I N E , B E L L ,

Cover design by Graciela Galup

B R U N O R I , A N D YO U N G M A N

Increased reliance on residential property to generate tax revenue and volatile property values in many parts of the country have placed pressure on local officials to respond to concerns about higher property taxes. The result has been erosion of the property tax base through a variety of policies designed to relieve residential property tax burdens and accomplish other social and economic goals through property tax exemptions or abatements. Although the property tax remains the largest single source of state and local revenues, the extent of the decline of the property tax is clear. This erosion of the property tax raises serious concerns about the future health of our federal system of government and the continued ability of local governments to protect what de Tocqueville called America’s passion for popular sovereignty.This book, based on a 2007 collaborative conference between the Lincoln Institute of Land Policy and the George Washington Institute of Public Policy, advances our understanding of the property tax and strengthens policy recommendations for its improvement. The book provides background and analysis on recent property tax trends, examines several responses to the increasing importance of residential property, estimates the extent of property tax base erosion and its effects, and considers other topics related to changes in the property tax base.

E R O S I O N O F T H E P R O P E R T Y TA X B A S E

Erosion of the Property Tax Base

Erosion of the

Property Tax Base TRENDS, CAUSES, AND CONSEQUENCES

E D I T E D B Y N A N C Y Y. A U G U S T I N E , M I C H A E L E . B E L L , D AV I D B R U N O R I , A N D J O A N M . YO U N G M A N

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Erosion of the

Property Tax Base

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Erosion of the

Property Tax Base TRENDS, CAUSES, AND CONSEQUENCES

EDITED BY N A N C Y Y. A U G U S T I N E , M I C H A E L E . B E L L , D AV I D B R U N O R I , A N D J O A N M . Y O U N G M A N

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© 2009 by the Lincoln Institute of Land Policy All rights reserved. Library of Congress Cataloging-in-Publication Data Erosion of the property tax base : trends, causes, and consequences / edited by Nancy Y. Augustine . . . [et al.]. p. cm. Includes index. ISBN 978-1-55844-186-6 1. Real property tax—United States. 2. Tax exemption—United States. 3. Local taxation—United States. I. Augustine, Nancy Y. II. Lincoln Institute of Land Policy. HJ4181.E76 2009 336.22'20973—dc22 2009009962 Designed by Scott Kindig Composed in Minion by Westchester Book Services in Danbury, Connecticut. Printed and bound by Puritan Press, Inc., in Hollis, New Hampshire. The paper is Rolland Enviro100, an acid-free, 100 percent recycled sheet.

manufactured in the united states of america

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CONTENTS

Foreword

vii

GREGORY K. INGRAM AND HAL WOLMAN

1 The Property Tax Under Siege

1

NANCY Y. AUGUSTINE, MICHAEL E. BELL, DAVID BRUNORI, AND JOAN M. YOUNGMAN

2 Overview of the Trends in Property Tax Base Erosion

17

JENNIFER GRAVELLE AND SALLY WALLACE

Commentary

RICHARD M. BIRD

47

3 Property Tax Exemptions, Revenues, and Equity: Some Lessons from Wisconsin

51

RICHARD K. GREEN AND ELAINE WEISS

Commentary

ROBERT M. SCHWAB

4 Residential Property Tax Relief Measures: A Review and Assessment

69

73

JOHN H. BOWMAN

Commentary

JOHN E. ANDERSON

5 Assessment Limits as a Means of Limiting Homeowner Property Taxes

111

117

TERRI A. SEXTON

Commentary

JON SONSTELIE

143

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Contents

6 Tax and Expenditure Limitations and Local Public Finances

149

BING YUAN, JOSEPH CORDES, DAVID BRUNORI, AND MICHAEL E. BELL

Commentary

TRACY M. GORDON

7 Efforts to Override School District Property Tax Limitations

192 197

GARRY YOUNG, MARGARET SALAS, KELLY BROWN, AND JESSICA MENTER

8 Property Tax Abatement as a Means of Promoting State and Local Economic Activity

221

ROBERT W. WASSMER

Commentary

NATHAN B. ANDERSON

9 Preferential Tax Treatment of Property Used for Social Purposes: Fiscal Impacts and Public Policy Implications

260

269

WOODS BOWMAN, JOSEPH CORDES, AND LORI METCALF

Commentary

JULIA FRIEDMAN

10 The Politics of the Property Tax Base

295 307

JOHN F. WITTE

Commentary

MICHAEL A. PAGANO

335

Contributors

345

Index

349

About the Lincoln Institute of Land Policy

359

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FOREWORD

T

he property tax is a major source of revenue for local governments in the United States, now comprising nearly half of own source revenue and underpinning the provision of core local government services. Yet it remains a highly visible and unpopular tax, and public debate about the tax often is disconnected from the services it provides. Thirty years after Proposition 13 initiated a dramatic series of property tax limitation measures, the continuing attention to tax rates and tax bills has not been matched by similar attention to and concern about the appropriate base for the real property tax, the continuing erosion of this tax base, or indeed what is to replace the property tax as a source for local government services if the erosion continues. Every taxpayer receives a bill, and the rate of tax is public information. The tax base, however, is continually constricted by exemptions and preferential assessments that are of interest primarily to the affected property owners. The combined impact of these base reductions is rarely debated or even calculated. This volume examines the forces that have contributed to this diminution, analyzes its impact, and considers the possibilities for future change. The desirability of taxes with a broad base and low rates is rarely disputed in principle, but in the case of the property tax it is ever more rarely supported in practice. Decades of property tax rate limitations have not been balanced by any expansion of the tax base. This reduction of the tax base has many diverse causes, from the capital mobility that has encouraged business location tax incentives and the exemption of personal property to the desire to foster socially desirable nonprofit enterprises. This includes the use of assessment limits as a means of extending homeowner tax relief. Each of these measures can command a strong constituency and marshal political support. The cumulative effect of increased revenue pressure on a smaller tax base is a collective problem with no natural interest group committed to its mitigation. In fact, the need for higher tax rates to maintain revenue from a narrowing base only heightens pressure for further exemptions and limitations. This book, and the 2007 conference at which these papers were initially presented, are part of an ongoing collaboration between the Lincoln Institute vii

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of Land Policy and the George Washington Institute of Public Policy to advance understanding of the property tax and to strengthen policy recommendations for its improvement. A major part of this effort involves gathering and disseminating data on the operation of the property tax. Publications such as this one use these data to analyze how the tax functions and to draw scholarly attention to its policy challenges. Gregory K. Ingram President and CEO Lincoln Institute of Land Policy Hal Wolman George Washington Institute of Public Policy George Washington University

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1 The Property Tax Under Siege NANCY Y. AUGUSTINE MICHAEL E. BELL DAVID BRUNORI JOAN M. YOUNGMAN

T

here is strong support for the decentralization of government functions; many scholars agree that public services should be provided by the jurisdiction covering the smallest area over which benefits are distributed (National Conference of State Legislatures 1997; Gramlich 1993; Oates 1972). Bird (1993, 211) argues that “so long as there are variations in tastes and costs, there are clearly efficiency gains from carry ing out public sector activities in as decentralized fashion as possible.” Yet to realize the benefits of decentralization, local governments must have an independent source of revenue within their political control (Peterson 1995) that is also adequate to meet local needs for goods and services. As Bird continued: “Local governments should not only have access to those revenue sources that they are best equipped to exploit— such as residential property taxes and user charges for public services—but they should also be both encouraged and permitted to exploit these sources without undue central supervision.” A strong and vibrant local property tax can be essential to fully realizing the benefits of such localism. This volume explores the theoretical, practical, and political issues raised by the erosion of the property tax base by exemptions, incentives, and tax limitation measures. Increased reliance on residential property to generate tax revenue, coupled with soaring property values in many parts of the country in the last decade, has placed pressure on local officials to respond to concerns about higher property taxes. The result has been erosion of the property tax as a source of local revenue through a variety of devices designed to relieve residential property tax burdens (e.g., tax and expenditure limitations and circuit breakers) 1

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and to achieve other social and economic goals through property tax exemptions or abatements (e.g., local economic development incentives). In many cases, state and local governments have contributed to the erosion by reducing the property tax base through exemptions and establishing mechanisms that reduce the tax on specific classes of property or for specific classes of owners. Although the property tax is the largest single source of state and local revenues, the extent of the decline of the property tax is clear. State and local governments raised $335.7 billion in property taxes in 2005, compared with $263 billion from the general sales tax and $240.9 billion from the personal income tax. Local property taxes accounted for 72.4 percent of local tax revenues in 2005 and 45.8 percent of total local general own-source revenues. Fifty years ago, local property taxes raised $14.4 billion in local revenues, which accounted for 87.2 percent of local tax revenues and 69.5 percent of total local own-source general revenues. The declining relative importance of the local property tax can be attributed to long-term trends, many of which are beyond the control of local policy makers. The shift from a manufacturing to a high-technology, information-based economy has a profound impact on local property taxes. When heavy manufacturing drove the national economy, local governments benefited inasmuch as a large part of their property tax base consisted of business land, plants, and equipment. By contrast, information-based businesses often have fewer plants and less equipment than large manufacturing firms (Bonnet 1998). These businesses do not own significant amounts of real property, thereby decreasing the relative importance of business property in the local property tax base and shifting property tax burdens from business to residential properties (Strauss 2001). A 2004 report by the National League of Cities, Cities and the Future of Public Finance: A Framework for Public Discussion, echoes these concerns. The report argues that many sources of economic growth and wealth do not contribute to local public revenue, especially property tax collections, because the economy has shifted from one based on goods to one based on services and is now moving toward one increasingly based on knowledge and information. The report takes the position that because local governments are dependent on a traditional goods-based economy and its tax bases, some sectors, such as housing, bear a disproportionate share of the burden of financing local government. The residential share of the property tax base has increased significantly over time. According to census data, in 1956 the residential portion of gross assessed values was 40.5 percent, increasing to 52.1 percent in 1986. Thus, over this period the relative share of the property tax base accounted for by residential property increased nearly 30 percent (Bowman 2007). While the Bureau of the Census stopped collecting such information after 1987, there is

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anecdotal evidence that this trend has continued over the last 20 years as well. For example, Bowman points out that • in the 1987 Census of Governments, single-family nonfarm residential property accounted for 60.6 percent of the real property tax base in Virginia, while an estimate developed at the University of Virginia for 2004–2005 places this figure at 71 percent; and • the 1987 Census of Governments data show that all residential property accounted for 67.7 percent of the real property tax base in Ohio in 1986, while state data for 2004 place the residential share at 72.9 percent (Bowman 2007, 32). The increasing relative importance of residential property in the local property tax base, combined with increased competition for jobs and residents, restricts local property tax revenue. Competition for jobs has resulted in tax incentives for some businesses in order to attract economic activity, which is increasingly mobile. Such competition can be a zero-sum game if it simply shifts investment and jobs between locations, or a negative-sum game for the governments that lose tax revenues. In response to rising residential property taxes, citizens in many states have become more vocal in resisting tax increases as residential property becomes a larger share of the property tax base and homeowners bear a greater burden of financing government through the property tax. Many states have enacted a range of limitations on local governments’ ability to raise revenues from the property tax and have fueled voter resistance to tax increases. Voter resistance to tax increases may have been inadvertently exacerbated by efforts to reinvent local government in America after Proposition 13 in California in 1978. As a result of government officials’ effort to reconnect with citizens after Proposition 13, some elected officials approach citizens as customers for government services, with an increasing emphasis on improving customer satisfaction. Crenson and Ginsberg, however, argue that there are crucial differences between citizens and customers that have tended to undermine trust in government. Specifically, “citizens were thought to own the government, while customers merely received services from it. Citizens belong to a political community with a collective existence and public purposes. Customers, however, are individual purchasers seeking to meet their private needs in a market. Customers are not involved in collective mobilization to achieve collective interests” (Crenson and Ginsberg 2002, 8). The chapters in this volume were originally presented as papers at the inaugural Property Tax Policy Roundtable, cosponsored by the Lincoln Institute of

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Land Policy and the George Washington Institute of Public Policy (GWIPP). Scholars in the field of property tax policy research were asked to address various aspects of the erosion of the property tax. Taken together, the chapters provide background on recent property tax trends, examine several of the important responses to the increasing importance of residential property, estimate the extent of property tax base erosion and its effects, and consider other topics related to property tax base erosion. In chapter 2 Gravelle and Wallace establish a context for the other chapters by taking an in-depth look at trends in the growth and composition of the property tax base. Confronted with serious data limitations because the Census Bureau no longer collects information on assessed values by state and land use type, Gravelle and Wallace develop alternative measures of the relative importance of residential property. For example, using data from the Bureau of Economic Analysis, they document the significant growth in residential fixed investment as a share of gross domestic product (GDP) since 1991, with particularly strong growth following the 1991 recession and even stronger prolonged growth since the early 2000s. They also look at the value of housing stock of all residential property and owner-occupied property as a share of GDP; this proportion declined in the early 1980s and remained relatively flat from the mid1980s to about 2000. Since 2000 there has been a clear upward trend in both owner-occupied housing and total residential property as a share of GDP. These general trends are confirmed when Gravelle and Wallace analyze data from the Federal Reserve Board Flow of Funds. Overall, the growth of property tax revenues relative to GDP has been relatively flat over the past two to three decades, and the authors consider some possible explanations. For example, there is little evidence that growth in taxexempt property has contributed to any erosion of the property tax base. However, economy-wide declines in the capital-to-labor ratio may have reduced the growth in some types of taxable property. In addition, a variety of tax limitations, exemptions, and other forms of special treatment has had some impact on reducing the growth of property tax revenues. In chapter 3 Green and Weiss explore the implications of various property tax exemptions on local property tax bases, revenues, and equity. They point out that the property tax often appears to be regressive, especially to policy makers at the state level, and to threaten taxpayers with loss of their homes. In response to these concerns, state policy makers have enacted a variety of policies intended to provide relief to low-income families, the elderly, farmers, businesses, and, in some states such as Minnesota, to all homeowners. Using Wisconsin as a case study, Green and Weiss take the first steps toward developing a tax expenditure budget for property tax relief mechanisms that

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estimates the cost to local governments and other taxpayers of various tax relief measures. For example, Green and Weiss cite a report estimating that total property tax exemptions for religious establishments, nonprofit organizations, and the like reduce the property tax base for local governments by $22.5 billion annually in Wisconsin, and that personal property exemptions reduce the property tax base for local governments by another $12 billion annually. Green and Weiss add their own estimate that taxing farmland at use value, rather than market value, reduces the local property tax base by another $1.6 billion annually. Overall, Green and Weiss estimate that if all property were subject to taxation, and taxes were levied on a uniform basis, those properties currently paying full rates on full values would pay about 8.6 percent less in property taxes than they do now in Wisconsin. According to Green and Weiss, the situation is even worse in Kansas where 15 percent of the property tax base is exempted from paying property taxes. The market value of agricultural land in Kansas is about five times greater than its taxable value, and the share of taxable values attributed to residential properties is less than its share of market value. At the same time, commercial properties’ share of the tax base in Kansas is 80 percent higher than its share of market value, causing substantial shifts in property tax liabilities. Green and Weiss conclude that most states do not have the detailed information necessary to estimate the revenue costs of property tax exemptions and preferences given to certain owners or uses of property. This creates a serious lack of transparency, inasmuch as decision makers and the general public are not informed of the foregone revenues and shifts in the tax burden resulting from such exemptions and preferences. Green and Weiss encourage states, counties, and cities to develop the capacity to provide the tools necessary to measure the tax expenditures associated with various property tax exemptions and preferences, so that policy makers and the general public can make more informed decisions about how the property tax burden should be distributed across all property owners. The next three chapters look at various tools used by state and local governments to provide property tax relief, primarily to residential property owners. Of course, one type of property tax relief is the substitution of other revenue sources for property tax revenue. Bowman provides evidence that there have been substantial shifts of this sort over the last century. For example, considering state and local general revenues from own sources, the property tax share has declined from 77.7 percent in 1902 to 37.5 percent in 1957 and just 21.2 percent in 2005. As a source of local tax revenue, however, property taxes have maintained a significant role, declining far less steeply from 88.6 percent of local taxes in 1902 to 86.7 percent in 1957 and 72.4 percent in 2005.

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As noted above, the residential share of the property tax base has increased over the last 50 years, and as a result there are pressures to provide property tax relief to residential property owners and renters. In chapter 4 Bowman provides an overview of a number of measures typically used by states to provide property tax relief to residential property owners and in some instances to renters. Bowman traces the history of residential property tax relief from the emergence of the general homestead exemption in the 1930s, followed by classified rates that bore more heavily on business property than on residences. Currently, 22 states have some form of classification for real property tax purposes. The 1950s and 1960s saw an emphasis on property tax relief for elderly homeowners and farmers. By 1973 all 50 states provided some form of residential property tax relief for the elderly. In 1964 Wisconsin pioneered another form of residential property tax relief for the elderly, often referred to as a circuit breaker. This extended to renters as well as owners in an amount that declined as income rose. Bowman quotes Glenn Fisher explaining the growth of tax relief for homes and farms: “The universal truth about taxation is that people want government without paying for it. The history of taxation is the story of a struggle among individuals and groups intent upon achieving that goal for themselves or for their groups” (Fisher 1996, 187). Such efforts have resulted in some states having 10 to 15 programs providing residential property tax relief to different groups. As a result, there is less uniformity, which has resulted in sometimes substantial differences in effective property tax rates across properties. For example, under classification in the 1980s, the highest prescribed effective property tax rates (relative to value) were 27.5 times greater than the lowest in Minnesota and 20 times higher than the lowest in Arizona. Bowman concludes that the number of departures from the standard of a uniform effective property tax rate should be minimized. Considering the impacts of residential property tax relief mechanisms, Bowman concludes that such relief favors residential properties, giving them a lower effective tax rate that may cause some bias in favor of investment in residential property relative to other types of property. Broad relief will cause a greater bias than relief targeted narrowly on claimants’ needs. According to Bowman, an important concern with locally provided property tax relief is its impact on revenue adequacy to provide needed goods and services. For example, if there are large concentrations of households needing relief within a jurisdiction that has comparatively low per capita fiscal capacity, meaningful property tax relief may be impossible. Thus, his preferred approach to residential

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property tax relief is to aim limited relief at those most in need through a statefunded circuit breaker with the following features: • Threshold formula, preferably of the multiple-threshold variety found in Maryland and several other states, to provide narrowed targeting of benefits • Very broad definition of income • Coverage of owners and renters of all ages • State-reimbursed homeowners property tax credits and state-issued checks for renters; no income or benefit limit • Tax relief limited to the property tax on the first $X of a home’s market value In chapter 5 Sexton explores another policy program that provides relief to residential property owners by reducing the base of the property tax for local jurisdictions. Specifically, she examines the increasing importance of assessment limitations as a means of limiting property taxes on homeowners. According to Sexton, under the most common form of assessment limit the annual increase in assessed value of each individual property cannot exceed a specified percentage of the prior year’s value. She identifies 20 states that have some form of assessment limit, as does the District of Columbia. These programs vary from state to state along several different dimensions, such as the type of property that is eligible for the limit (residential, owner-occupied, all properties) and the specific limit. Some are statewide limits while some are available as a local option. Ten states have assessment limits established by constitutional amendments; while in the other 10 states assessment limits were created through legislation. The primary motivation for assessment limits is that they correct inequities that arise when property values, especially housing values, rise rapidly and government does not respond by reducing tax rates. The popular perception is that such limits will prevent the tax burden from shifting to homeowners. Sexton looks at the impact of assessment limits on the property tax base, property tax revenues, and the equity of the property tax. Overall, assessment limits reduce the local property tax base, with a consequent loss in property tax revenue. The lower the assessment cap and the greater the rate of increase in property values, the greater will be the erosion of the tax base. It was estimated that the 2 percent assessment cap that was established in California with the passage of Proposition 13 in 1978 resulted in a 44 percent reduction in the tax base for 1992. On the other hand, revenue losses resulting from assessment limits are difficult to estimate because local governments may increase the tax rate to adjust for the reduction in the tax base.

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Specifically, local governments may impose a higher property tax rate in the face of a reduced base than they would have otherwise, making the equity implications of assessment limits less straightforward and obvious. Sexton argues that in such cases the property tax burden is shifted to types of properties not protected by the limit and within the protected class, from high- to lowappreciating properties. This situation could benefit owners of relatively lowvalued homes if they are the properties appreciating in value the most. Sexton points to Maryland, where properties valued at less than $200,000 increased an average of 75 percent in price while all property increased an average of 18.7 percent. Sexton also points out that assessment limit programs that rely on acquisition value to reset assessed values put residential property at a disadvantage, because homes typically change ownership more frequently than do businesses. Thus, if the assessment limit applies to all types of property the burden will shift toward residential property as its aggregate assessed value increases more rapidly due to turnover. The net result will be significant disparities in property tax bills and effective property tax rates among owners of comparable properties, violating the principle of horizontal equity that calls for the “equal treatment of equals.” While assessment limits are believed to be the answer to both skyrocketing property taxes and the redistribution of the tax burden to residential properties, Sexton concludes that they are among the least effective, equitable, and efficient strategies available for providing property tax relief. Assessment limits give tax breaks to anyone whose property value increases rapidly, with the most relief going to those whose properties appreciate the fastest; they provide no relief to those whose assessed values are stagnant. The result is substantial shifts in tax burden and differences in effective property tax rates within and across property classes. In chapter 6 Yuan, Cordes, Brunori, and Bell look at a broader set of interventions intended to protect taxpayers from dramatic increases in property tax liabilities. Specifically, they look at a set of state-imposed limitations on local governments’ ability to raise property taxes referred to in the literature as tax and expenditure limits (TELs), which include assessment limits, rate limitations, and revenue and expenditure limits. While rate limitations and exemptions first appeared during the Great Depression, there has been a proliferation of such TELs since voters in California passed Proposition 13 in 1978 to hold down increases in assessments and limit property taxes to no more than 1 percent of property value; between 1978 and 1988 43 states adopted some new form of TEL. While the literature is not always consistent, there are some well-documented impacts of TELs on local public finances. For example, TELs that are legally and

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administratively structured to be binding are more likely to have measurable effects on local public finances than are TELs whose constraints are easily circumvented. In this context, binding TELs constrain growth in property tax revenue; rate limits coupled with assessment limits are particularly binding, resulting in the greatest reduction in the growth of per capita property tax revenue. Local governments have reacted to such constraints by substituting other local, though narrower, revenue sources such as fees and charges, and by increased reliance on grants from state government. Since half of all property tax revenues go to finance education, it is especially important to consider the effects of TELs on education. There is some empirical evidence that TELs have constrained local spending on public schools, as measured by a variety of indicators such as student-teacher ratios, teacher salaries, and teacher quality. TELs are not only associated with reduced spending on education inputs, but also with lower educational outcomes, as measured by test scores. Two other concerns about TELs are their impact on housing values and their distributional consequences. There is a scarcity of literature exploring these issues. However, there is at least some preliminary evidence from Proposition 21⁄2 in Massachusetts that TELs may have actually raised property and home values in jurisdictions constrained by them. With regard to the distributional consequences of TELs for individual taxpayers, there is some evidence to suggest that Proposition 13 in California may have benefited lower-income homeowners. There is somewhat weaker evidence that the TEL enacted in New Jersey had a similar effect. When considering the impact of TELs across communities, there is some very limited evidence that lower-income communities experienced larger reductions in educational outcome from TELs. In chapter 7, Young, Salas, Brown, and Menter consider how TEL override provisions actually affect the severity of TELs on school finances in Wisconsin. The authors note that despite persistent concerns regarding school quality and funding, 35 states impose some type of TEL on their school districts. Of the 35 states with school TELs, however, most (26) provide their school districts with some capacity to override the limitation, typically through a referendum held among voters in the school district. Young et al. analyze the use of referenda for TEL overrides by focusing on override attempts by school districts in Wisconsin between 1995 and 2007. They address three issues of interest to a range of scholars and practitioners. First, they provide the first systematic empirical analysis of TEL overrides. For schools and other forms of local government, TEL override provisions are common across the United States, but remain virtually unstudied. Yet, it is

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impossible to fully evaluate the actual impact of TELs on local governance, and on the use and erosion of the property tax, without understanding override provisions. Second, along with the initiative, referenda constitute a key form of direct democracy in the United States. While state-level referenda attract intense scholarly attention, the place where the referendum is most common, the local government level, receives very little attention. This is true even though local governments across the nation rely on referenda to gain approval of a wide range of statutes, tax increases, and bond sales. Finally, TELs directly affect education policy, since they potentially impose limitations on the ability of school districts to raise revenue. From 1995 through 2007, 667 revenue cap overrides were sent to the voters in Wisconsin. For the ten years from 1998 through 2007, voters were asked to approve overrides, ranging from a low of 44 in 2002 to a high of 82 in 2000 and 2001. Of the total 667 override attempts, only 285, or 43 percent, were approved. Thus, Wisconsin’s TELs seem to constitute a genuine constraint on school finances. Attempts to override the revenue cap were frequent, but these attempts failed more often than not. Wisconsin has two types of revenue cap overrides: recurring and nonrecurring. Recurring overrides persist, while nonrecurring overrides are limited to a set number of years, usually not more than five. During the period examined, there were 362 recurring override attempts and 305 nonrecurring override attempts. Only 34 percent of the recurring override attempts passed, compared to 53 percent of the nonrecurring override attempts. The authors conclude that because TEL override attempts often fail in Wisconsin, school boards undergoing shortfalls due to the revenue cap face an uncertain and difficult challenge to get additional revenues approved by the voters through an override. This reinforces the evidence provided in chapter 6 that TELs have a substantive impact on school spending, fiscal policy, and school governance. In addition, the unpopularity of recurring overrides appears to have induced school boards to shift to nonrecurring measures. Finally, the authors express concern that TELs that require a referendum to override the revenue caps change the nature of school board governance. Revenue decisions are no longer made in-house, but rely on the ability of the school board to convince wary voters to tax themselves more. This is a very different form of representative governance than that which school boards and other local governments carried out traditionally. The next two chapters look at other initiatives by state and local governments to provide property tax relief in order to encourage economic development or promote socially desirable land uses. While circuit breakers and other property tax relief measures discussed in chapter 4 lower property tax liabili-

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ties generally or for individual property owners, property tax abatement programs can directly reduce the property tax base of local jurisdictions. In chapter 8 Wassmer looks at the growth and impact of what are called Stand Alone Property Tax Abatement Programs, or SAPTAPs. Such programs allow a full or partial reduction in property tax liability for selected manufacturing, commercial, and/or retail parcels, impose a time limit on the length of the reduction, have a stated purpose beyond relief from high property taxes such as creating jobs or income, and can be used in conjunction with other state or local economic development programs. According to Wassmer, 15 states offered some form of SAPTAP in 1964. By 1979 the number of states with such programs increased to 31, and by 2004 35 states provided such programs.1 This increase in such programs is driven, at least in part, by a perception that there is an increase in the potential mobility of all business activity, that globalization exacerbates the potential or actual mobility of firms, and that there is slower industrial growth nationwide. Because circumstances vary across states, so does the design of SAPTAPs. For example, of the 35 states with such programs in 2004, 33 offered them for manufacturing firms, 29 states have programs for commercial firms, 20 have programs for future residential development and 9 have abatement programs for the primary sector (agriculture, forestry, and mining). Abatements are provided through a number of different methods, including a value freeze where renovated property is taxed only based upon the assessed value before renovation, a partial freeze that reduces property tax payments based only on the value of incremental property added to a site after abatement, property tax credits, a percentage reduction in total assessed value, and reclassification of a property for property tax purposes. In 23 of the 35 states with such programs, full local discretion is allowed in determining which firms will receive abatements. In six states discretion on a case-by-case basis for granting abatements is held by the state alone. Nine of the 35 states have abatement programs that are scheduled to end in the future unless new enabling legislation is passed. Fourteen abatement programs allow a jurisdiction to rescind a previously granted abatement to a firm if contractually promised outcomes are not achieved. After briefly reviewing the arguments for and against such property tax abatement programs, Wassmer reviews the literature that analyzes the impact of such programs. The literature falls into three general categories: surveys, case studies of representative firms, and regression analyses. He argues that 1. By 2007 at least seven other states allowed localities to offer a full or partial reduction in property taxes paid within their boundaries, but only in conjunction with a larger economic development program. That is, these are not stand-alone property tax relief programs.

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surveys of business decision makers may result in biased or vague findings, in part because such decision makers may view them as an opportunity to lobby for a public policy change that will increase their bottom line. He argues that case studies of representative firms are not often used for analysis of abatement programs. He spends more time summarizing regression studies that examine the impact of such programs. While each regression study is unique and addresses different questions in different ways, some themes emerge from Wassmer’s review of these studies: • The overall reduction of business property taxes in a jurisdiction has been more consistently shown to increase business activity in that jurisdiction than the selective use of abatement to specified firms. • There is evidence of copycat behavior among jurisdictions in metropolitan areas regarding the offering of abatements. • Such copycat behavior reduces the long-term effectiveness of abatements in a metropolitan area because if all jurisdictions offer them, abatements can no longer be the swing factor in choosing one jurisdiction over another. • Abatements are likely to generate fiscal stress through the potential revenue lost and increased business services provided after they are offered. In the final analysis, Wassmer thinks that the appropriate policy response in the case of SAPTAPs is “mend, but do not end.” He puts forward a ninepoint plan to target SAPTAPs on the areas that are most in need (depressed neighborhoods in the central city or inner-ring suburbs) and limit their use in other areas. In chapter 9 Bowman, Cordes, and Metcalf look at the use of property tax incentives to pursue social as well as economic development goals in two broad areas: support of local nonprofit organizations and encouraging open space through the preservation of land used for agricultural purposes and setasides to create green spaces. State and local governments may exempt all or a portion of the taxable value of certain property based on ownership (e.g., churches or other nonprofit organizations) or use (e.g., agriculture or provision of natural conservation easements). Alternatively, the taxable value of such properties may be based on use value or other forms of preferential assessment, rather than market value, or differential rates may be applied to different land uses. Regardless of which approach is used to provide preferential treatment to certain land uses or owners, the net result is to shift more of the burden of financing government to properties that do not receive such preferential treatment, or to lower the amount of funds that a local government can collect

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with a given tax rate. The authors describe the challenges faced in estimating the cost of such tax relief programs given the problems of assessment and record keeping that state and local governments face. In spite of these challenges the authors report estimates of lost revenues that suggest these programs are important and that their impact varies significantly across states. Using data from the Federal Reserve Bank, in the aggregate, the authors estimate that exemption from property taxation of real estate owned by nonprofit organizations lowered property tax collections in 2002 by approximately 10 percent. This is consistent with state estimates that indicate such exemptions reduce property taxes by between 2.5 and 11.3 percent in the District of Columbia and states that compute such property tax expenditures. Using data from the Internal Revenue Service, which are supplied by the nonprofits themselves when they file their Form 990 tax forms, the authors estimate that the fiscal impact of the nonprofit tax exemption ranges from just under 1.5 percent to just over 10 percent of property tax revenues, with an overall average of 5 percent. While the authors present many caveats with regard to these estimates, it is clear that exemption of real estate owned by nonprofit organizations accounts for significant lost property tax revenues and that the impact varies substantially across states. Much more limited evidence is provided about the costs of use value assessments or conservation easements. While it is estimated that some 4 million acres are held in conservation easements in 20 states, there is no estimate of the foregone property tax revenues associated with such easements. There is very limited evidence about the cost of use value assessments for agricultural lands. The authors report cost estimates for four states: Minnesota, Nebraska, Oregon, and Texas. There are both economic and political arguments for and against each of these tools for providing preferential property tax treatment to some properties. However, the authors argue that there are very limited data to evaluate the costs and effectiveness of such programs. They underscore the conclusion of chapter 3 that the first step to a useful evaluation of these preferential assessment programs is to collect and analyze data in order to actually understand current practices and their results. In chapter 10 Witte looks at the politics of property tax base narrowing, and by implication the prospects of broadening the property tax base in the future. He describes the characteristics of an ideal property tax in terms of criteria such as broad base, neutrality, fairness, efficiency, simplicity, and accountability. He then systematically documents how the actual administration of the property tax in the United States tends to violate all of these ideal conditions. In several case study states (Wisconsin, Oregon, Kansas, and Maine) he traces how

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uniformity requirements in each state’s constitution have been systematically unraveled by various interventions to provide special property tax treatment for one group of property owners or another. Wisconsin and Kansas have given preferential treatment to farmers through the implementation and expansion of use value assessment. Oregon has extended similar preferential property tax treatment to forestlands. All of these states extended homestead tax credits to all residential owner-occupants. These interventions, like the assessment limits, rate limits, revenue limits, property tax abatements, and other forms of preferential tax treatment described in the preceding chapters, undermine the features of an ideal property tax as outlined by Witte. Confronted with these trends, which undermine the property tax, Witte questions why majority coalitions do not oppose narrow, particularistic tax expenditures. He suggests four different possible explanations: • Minority benefits arise because those who gain have an intense interest in forwarding their positions while the majority is either uninformed about the consequences of such actions or indifferent to them. • There may be an overlap, either real or perceived, between the minority interests and the majority; for example, because they expect to grow older themselves, even young voters support benefits to the elderly. • More general concerns, such as an opposition to taxes, may take precedence over the particular effects of a specific measure. • Since elected officials in legislatures will have continuous and future contacts and negotiations with their colleagues on a variety of issues, such future considerations may play an important role in other decisions. Witte is concerned that reversing the narrowing of the property tax base will not be an easy task. As documented in the previous chapters, the devices used by various minorities seeking special treatment under the property tax are numerous and widespread, including but not limited to revenue limitations, assessment caps, agricultural and business exemptions, and elderly and poor provisions. But Witte does think that there are some possibilities for at least slowing down future dilution of the property tax base. His proposed strategy includes truth in taxation measures, especially as implemented in Utah and Virginia. While chapter 6 identified truth in taxation laws as being relatively nonbinding in terms of reducing property taxes, they could be made part of a broader strategy to improve the amount and content of information available to decision makers and the public regarding property taxes. For example, the truth in taxation approach in Utah and Virginia, as described by

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Witte, could be combined with some sort of property tax expenditure budget, as developed by Green and Weiss, to fully inform decision makers and the public when various proposals to reduce the property tax base are being considered. According to Witte, such transparency could provide an environment conducive to beginning the long climb back toward uniformity and a broadbased property tax. In summary, over the last 50 years residential property has become an increasing share of the property tax base. In part, this reflects economic trends beyond the control of state and local decision makers that are exacerbated by the erosion of the property tax base by preferential treatment of property for social purposes, as described in chapter 9. To some extent these trends have been exacerbated further by efforts to reduce residential property tax burdens through exemptions or assessment limits, and compounded by efforts to limit local government use of the property tax more generally through rate limits, levy limits, revenue limits, and full disclosure laws. All of these initiatives contribute to differential effective property tax rates across property use classes and across individual properties within land use classes. In fact, Bowman argues that the property tax has changed so much in the last 50 years that at times he questions whether we still have a property tax. And a number of contributors to this book, especially Green and Weiss and Witte, argue these changes have happened with very limited information or analysis to inform the policy debate over various property tax relief measures. Twenty-five years ago H. Clyde Reeves, reflecting on the trends of the past 25 years, concluded that “the erosion of tax systems may be a natural phenomenon in a political democracy” (Reeves 1983, 7). The chapters in this book document how this phenomenon has played out over the last 25 years. The net result has been a continued assault on the local property tax. In this context, Brunori (2003, 2) argues that “without significant financial reforms, local governments will play a far-diminished role in public life—a consequence that is contrary to the best interests of both the American federal system and the American public.” Brunori argues that federalism implies a theory of government based on the belief that the values of our society can best be guaranteed by a division of powers among the various levels of government—federal, state, and local. Thomas Jefferson championed local governments as the best protection of individual liberty. The erosion of the property tax described in the following chapters raises serious concerns about the future health of our federal system of government and the continued ability of local governments to protect what Tocqueville called America’s passion for popular sovereignty.

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REFERENCES

Bird, Richard M. 1993. Threading the fiscal labyrinth: Some issues in fiscal decentralization. National Tax Journal 46(2):207–227. Bonnet, Thomas W. 1998. Is the new global economy leaving state and local tax structures behind? Washington, DC: National League of Cities. Bowman, John H. 2007. Issues in state and local government finance: Questions and answers on selected topics with an emphasis on property taxes. Unpublished manuscript prepared for the Lincoln Institute of Land Policy, Cambridge, Massachusetts. Brunori, David. 2003. Local tax policy: A Federalist perspective. Washington, DC: Urban Institute Press. Crenson, Matthew A., and Benjamin Ginsberg. 2002. Downsizing democracy: How America sidelined its citizens and privatized its public. Baltimore: Johns Hopkins University Press. Fisher, Glenn W. 1996. The worst tax? A history of the property tax in America. Lawrence, KS: University of Kansas Press. Gramlich, Edward M. 1993. A policymaker’s guide to fiscal decentralization. National Tax Journal 46(2):229–235. National Conference of State Legislatures. 1997. Critical issues in state-local fiscal policy: Sorting out state and local responsibilities. Denver: National Conference of State Legislatures. National League of Cities. 2004. Cities and the future of public finance: A framework for public discussion. Washington, DC: National League of Cities. Oates, Wallace E. 1972. Fiscal federalism. New York: Harcourt Brace Jovanovich. Peterson, Paul E. 1995. The price of federalism. Washington, DC: Brookings Institution. Reeves, H. Clyde. 1983. Leadership for change. In The property tax and local finance, ed. C. Lowell Harriss. Montpelier, VT: Capital City Press. Strauss, Robert. 2001. Pennsylvania’s local property tax. State Tax Notes (June 4): 1963–1983.

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2 Overview of the Trends in Property Tax Base Erosion JENNIFER GRAVELLE SALLY WALLACE

T

he property tax in the United States has a very long history, dating back to the earliest days of the union. In the United States, it is the primary source of revenue for local governments (that is, governments below the state level), contributing over 70 percent of local government tax revenue across the United States and about 26 percent of all local government revenue. In a handful of states including New Hampshire, Vermont, and Wyoming, the state-level government also relies heavily on the property tax. As a workhorse of the local public finance system, the property tax has also come under fire over its long history. In public-opinion polls, specifically those conducted by the Advisory Commission on Intergovernmental Fiscal Relations (1987), the property tax has been rated among the least liked taxes in the United States. The tax revolts of the 1970s and 1980s that resulted in Proposition 13 in California and Proposition 21⁄2 in Massachusetts may not have been the very first of their kind, but their economic and political ramifications vis-à-vis the property tax have certainly been long-lasting. Sokolow (1998) reports that between 1970 and 1995, 42 states adopted 68 different property tax limitation measures. The debate about what to do with the property tax continues. Currently, 27 states are considering property tax reform and Georgia and Florida are analyzing all-out bans on the property tax. Various reasons have been given for the focus on property taxes including the transparency of the tax, judgmental The views expressed represent those of the authors and not necessarily those of the Government Accountability Office.

17

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assessment, the taxation of unrealized gains, the magnitude of revenue, and growth of the tax (Bahl 2007). Changes in local government fiscal structure also put pressure on the future of the property tax. For example, the use of local option sales taxes has increased, which may have created room for property tax abatements but could limit the future usefulness of sales taxes as a means to mitigate property tax pressure. Mandates associated with the public education system may also constrain local governments’ ability to react to public sentiment regarding the property tax. How important is the property tax and how has its importance changed over time? Figures 2.1 and 2.2 document the importance of the property tax over time. These figures consider only the local portion of property tax collections. As seen from Figure 2.1, the local real property tax declined sharply as a share of local revenue between 1970 and 1980, as tax revenues responded to various tax limitations such as Proposition 13. Since 1980, the tax has largely held its own. Property tax collections as a share of total revenue (own source revenue) fell from 30.7 (22.9) percent in 1980 to 28.5 (19.4) percent in 2000 and then rebounded slowly from 2001 to 2004 to 31.5 percent of total revenue and 21.7 percent of own source revenue. Figure 2.2 demonstrates that the tax has been more volatile relative to personal income, showing that it fell as a share of personal income during the 2001–2002 recession. On a real per capita basis, the tax has demonstrated an upward trend over the entire period. At present, property taxes are approximately $1,200 per capita on average across the United States ($265 per capita on a real basis, by comparison with 1970 when the level was $162 per capita).1 The current political trends to neutralize the property tax, noted above, have important potential impacts on local government spending, accountability, the equity and efficiency of state and local taxation, and the stability of local government revenue. • Spending: The property tax is the major source of tax revenue for local governments in the United States. It has been that way for a long time. The extent of local governments’ ability to absorb substantial reductions in the property tax fueled by political pressure is largely unknown. • Accountability: The property tax is associated with a unique level of local government autonomy. The tax allows for substantial accountability of local government officials, which may be hard for other revenue sources 1. A longer-term look demonstrates that the heyday of the modern property tax might well have been the early 1930s, when it constituted over 7 percent of GDP. The property tax now accounts for about 2.8 percent of GDP nationally.

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FIGURE 2.1

Percent

Property Tax Revenue as a Share of Local Sources 0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0 1970 1980 1985 1990 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 Year

Total tax

Total revenue

OSR

source: U.S. Census. State and Local Government Finances data extracted from http://www.census.gov/govs/www/ estimate.html. September 4, 2007.

FIGURE 2.2

Local Real Property Tax Per Capita and as a Percent of Personal Income 4.5

300

4 250 3.5

% PI

2.5 150 2 1.5

Per Capita

200

3

100

1 50 0.5 0

0 1970 1980 1985 1990 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 Year Personal Income

Population

source: U.S. Census. State and Local Government Finances data extracted from http://www.census.gov/govs/www/ estimate.html. September 4, 2007.

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that are more likely to be shared by state and local governments (sales and income tax in particular) to match. However, changes to assessment procedures and classifications, capping growth of assessments and tax revenue, and expansion of exemptions reduce the transparency of the tax. • Equity and Efficiency: The property tax may be more equitable than alternatives such as an expanded sales tax. In fact, the property tax can be viewed as an average tax on capital that is generally progressive (Mieszkowski 1972). Any deviations from the average property tax rate, characterized by variations in state and local effective property tax rates, represent excise tax effects that reduce or increase the net progressivity of the depending on the income distribution in a jurisdiction. Thus, compared to the sales tax (which is all excise tax), if the excise tax effects are small, the property tax is likely to be much more progressive than a sales tax, and reducing reliance on the property tax while increasing reliance on sales taxes will affect the vertical equity of state and local taxation. In addition, arbitrary changes in final assessed property via classifications, growth caps, and expansions of exemptions reduce the horizontal equity of the tax and may also reduce the efficiency of the property tax as a whole. • Revenue stability: The stability of the property tax increases the stability of local government revenue. To the extent that major reforms are made in response to temporary political demands, such changes reduce the general stability of the local revenue streams. In addition to the pressures on the property tax from taxpayers and politicians, the tax also faces economic and socioeconomic pressures associated with changes in the underlying economy. For example, the globalization of the world’s economy calls into question the ability of local governments to tax mobile capital through the property tax (or other taxes such as the corporate income tax). There may be an additional problem posed by the increase in Internet-based companies, whose income-producing property may be difficult for their state of incorporation to tax. The increasing tax competition among states and localities within the United States also puts pressure on the property tax by creating a possible “race to the bottom.” The growing elderly population has brought increased legislation aimed at reducing tax burdens, and the housing patterns of the elderly may also have an impact on the future growth of the property tax. It is beyond the scope of this chapter to tackle all of the issues related to past, current, and future use and growth of the property tax. Our aim here is more straightforward. We focus on past and recent trends in property tax collections and the property tax base to discern what has happened to the growth of the property tax relative to key indicators of local finances and the economy. We highlight major trends across the United States and offer some hypotheses to

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21

explain them. Where relevant, we summarize the literature related to the hypotheses and offer our crystal-ball look at what we might expect in the future regarding the property tax, in light of current politics and trends in the economy and demographic changes. Unfortunately, data needed to thoroughly analyze changes in the property tax base in the United States are no longer readily available, so much of our effort has been expended in gathering consistent data on the property tax base. We do not analyze the expenditure side of state and local budgets, nor do we delve deeply into what has happened to alternative revenue sources (and why it has happened). The chapter proceeds as follows. The next section provides a decomposition of the growth in the property tax. In the following section, we decompose trends in collections and bases among the states. The final section presents a summary of the trends and offers some hypotheses that may explain them, as well as thoughts on the future of the property tax. Decomposing the Changes in Property Tax Revenues To better understand the recent trends in the property tax, and to get an idea of where the tax might be headed, we begin with a straightforward decomposition of the tax as a share of gross state product (GSP). If we expand the expression of the ratio of property tax collections to income (personal income, GSP, or other measure) we arrive at a number of important relationships that help explain the growth (or decline) of property tax revenues as a share of the economy. We can do that as follows (Bahl and Linn 1992):2 Tc/Y ⫽ (Tc/Tl) ⫻ (Tl/AV) ⫻ (AV/TMV) ⫻ (TMV/MV) ⫻ (MV/Y)

(1)

Where: Tc = Property Tax collections Y = Gross state product (GSP) or other measure of income such as personal income Tl = Property Tax Liability AV = Taxable Assessed Value TMV = Taxable Market Value MV = Market Value This decomposition helps to identify the factors affecting the level of property tax collection relative to GSP and incorporates changes related to the economy

2. The revenue collection-income relationship can also be decomposed using an elasticity formulation.

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(such as a decline in the production of taxable property) as well as policy changes (such as changes in exemptions and tax limitations). In order of the identity on the right-hand side of equation (1), the change in tax collections as a share of the income measure Y is made up of the collection ratio, the tax rate, the valuation ratio, the nonexemption ratio, and the level of property development. Changes in any of the factors on the right-hand side of equation (1) will affect the elasticity and buoyancy of the property tax. Some of these changes fall under the authority of the tax administration, at least to some extent (collection rate), some are policy choices (tax rate, valuation ratio, and nonexemption ratio), and some are a function of economic factors (the level of property development). To fully understand where the property tax has been and where it is headed, we would ideally estimate each of the specific components of equation (1). This task is beyond the scope of this chapter and would be difficult due to the nuances of property tax rules, definitions or usage of terms in individual jurisdictions, and the paucity of data on the tax base. However, we can take a stab at discussing the likely direction of and reasons for change in some these factors. That is the focus of much of the remainder of this chapter. Next, we turn to an overview of collections by state and for the United States. Trends in Bases and Collections The data in Table 2.1 present property taxes per capita and as a share of personal income from 1972 to 2004. While there are many ways to cut these data, we wanted to examine major trends in the growth of property tax revenue relative to population and personal income during and after the first wave of property tax outrage in the 1970s, through the economic recessions and growth periods of the late 1970s through late 1990s, and also include the recovery period that followed that 2001–2002 recession. While the per capita amounts have increased in most states in both real and nominal terms, property tax revenues fell relative to personal income between 1972 and 1982, grew from 1982 to 1992, and then fell slightly again. The share of property tax to personal income was almost flat on average after 1972. The average elasticity of property tax collections to personal income over the period is about 1. Table 2.1 shows that there is a lot of variability among the states in terms of growth in property tax revenues. In Table 2.1, the states are reported by region. There are some outliers, such as Alaska, but in general, in the earlier period the growth in property tax was strongest in the western states, while in the more recent period it was strongest in the southern states (at 0.89 percent per

198.87

39.40

117.66

161.97

73.67

314.06

201.40

317.11

96.97

190.56

129.93

115.11

118.68

143.56

241.22

CT

ME

MA

NH

NJ

NY

RI

VT

IL

IN

IA

KS

MI

MN

4.58

3.48

2.11

2.86

2.76

3.15

1.83

5.57

4.21

5.76

2.17

415.68

231.56

255.93

243.51

289.24

534.92

182.83

570.96

393.75

305.62

153.88

268.61

485.47

76.77

340.80

3.22

2.41

2.00

2.42

2.47

3.63

1.44

3.84

3.04

2.22

1.72

2.46

2.62

0.84

2.86

827.33

449.50

480.12

543.69

692.55

1,510.57

328.90

1,247.02

670.04

587.91

255.99

585.72

980.10

151.99

674.32

3.67

2.63

1.99

2.85

3.39

5.23

1.45

4.40

3.17

2.61

1.58

3.30

4.12

0.88

3.23

1,256.52

713.37

498.32

767.41

921.67

1,421.93

496.20

1,733.80

925.34

808.59

190.99

721.80

1,217.41

285.36

935.77

3.82

2.83

1.69

2.69

3.10

3.12

1.51

4.08

2.72

2.46

0.82

2.72

3.77

1.12

3.04

1,402.75

777.40

571.16

872.36

1,048.23

1,855.55

546.02

1,943.89

1,026.14

904.52

211.13

787.73

1,233.57

318.32

1,047.24

(continued)

4.04

2.89

1.75

2.93

3.33

3.63

1.53

4.29

2.84

2.57

0.82

2.75

3.63

1.15

3.17

Property Property Tax Tax Revenue PC Revenue/PI

2004

10:44 AM

3.61

1.96

1.12

4.22

Property Tax Revenue/PI

2002

Property Property Tax Tax Revenue/PI Revenue PC

1992

Property Property Property Tax Tax Tax Revenue PC Revenue/PI Revenue PC

1982

4/4/09

US

Property Property Tax Tax Revenue PC Revenue/PI

1972

Property Tax by State Relative to Population and Personal Income, 1972–2004

TABLE 2.1

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230.88

232.01

223.15

64.72

78.15

212.62

170.79

332.10

222.11

231.62

74.47

155.63

252.89

236.78

174.62

264.73

MO

NE

ND

OH

PA

SD

WI

AL

AR

DE

DC

FL

GA

KY

LA

MD

5.99

3.14

5.23

5.84

3.50

2.34

5.02

4.47

6.50

3.23

5.51

555.22

185.55

444.08

530.02

231.31

158.48

337.97

516.37

505.28

308.00

371.23

131.60

97.91

413.15

4.62

1.41

3.91

4.97

2.08

1.92

2.80

4.47

3.90

2.30

3.74

1.25

1.02

3.42

3.92

2.90

1,338.70

444.09

717.30

657.83

392.57

355.27

779.79

875.73

871.70

613.44

824.96

263.59

205.80

722.43

723.47

577.02

6.09

2.01

3.71

3.90

2.03

2.44

3.64

4.31

3.55

2.54

4.52

1.57

1.20

3.67

3.84

3.03

1,308.07

733.20

1,008.95

737.25

679.34

574.08

977.14

789.29

1,359.79

944.40

1,437.18

425.84

376.43

910.88

980.89

969.93

3.84

2.39

3.46

2.94

2.40

2.57

2.94

2.61

3.49

2.58

5.18

1.69

1.48

3.14

3.49

3.46

1,559.76

863.62

1,146.90

835.86

743.34

627.20

846.05

978.50

1,531.80

996.19

1,562.04

493.34

405.84

1,166.45

1,079.87

973.92

4.26

2.56

3.55

3.02

2.44

2.56

2.34

3.05

3.63

2.51

5.20

1.81

1.49

3.75

3.48

3.22

Property Property Tax Tax Revenue PC Revenue/PI

2004

10:44 AM

2.18

1.75

4.84

441.09

309.94

Property Tax Revenue/PI

2002

Property Property Tax Tax Revenue/PI Revenue PC

1992

Property Property Property Tax Tax Tax Revenue PC Revenue/PI Revenue PC

1982

4/4/09

5.17

5.22

Property Property Tax Tax Revenue PC Revenue/PI

1972

TABLE 2.1 (continued)

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70.35

287.78

89.21

168.30

179.28

100.61

237.31

139.57

203.12

79.69

240.25

94.36

145.91

129.86

259.53

115.67

154.88

79.43

259.54

197.50

NC

OK

SC

TN

TX

VA

WA

AK

AZ

CA

CO

HI

ID

MT

NV

NM

OR

UT

WV

WY

4.21

5.65

2.16

3.28

2.58

6.25

3.26

3.49

2.49

5.90

2.22

772.26

417.20

159.27

186.22

285.99

454.12

260.93

340.98

192.55

386.47

196.05

502.50

281.55

468.35

171.47

312.40

296.58

191.73

574.58

137.88

578.39

5.75

3.60

1.69

1.49

2.35

4.40

2.62

2.84

1.98

3.88

2.16

4.34

2.36

4.21

1.45

2.72

2.69

1.97

4.28

1.39

4.12

790.30

790.37

294.71

401.87

648.42

963.31

454.69

732.26

349.61

603.20

436.82

987.73

588.24

852.68

241.36

578.71

532.78

390.58

1,171.32

202.45

1,325.19

4.08

4.02

1.83

1.85

2.97

5.06

2.82

3.87

1.88

3.39

2.58

4.74

2.77

4.43

1.39

2.88

3.01

2.07

4.71

1.24

5.02

1,098.93

1,171.99

499.16

714.33

918.20

702.78

607.52

1,128.86

596.38

879.01

751.57

1,366.63

881.19

884.30

425.05

931.60

837.48

652.20

1,399.72

379.07

1,871.06

3.55

3.90

2.08

2.19

2.78

2.40

2.44

3.91

2.17

3.24

2.96

4.34

2.84

3.06

1.64

3.19

3.17

2.37

3.96

1.56

4.76

1,075.40

1,330.82

538.15

782.94

1,028.53

808.78

689.38

1,253.84

608.42

914.63

879.66

1,627.41

1,004.51

958.93

464.66

977.48

916.89

713.49

1,676.97

413.55

2,098.51

3.14

4.14

2.09

2.23

2.84

2.54

2.59

4.08

2.04

3.03

3.24

4.76

3.02

3.14

1.67

3.14

3.11

2.43

4.38

1.58

5.04

10:44 AM

4.39

2.98

5.16

2.51

3.83

3.84

2.30

5.20

1.88

5.63

4/4/09

source: U.S. Census.

310.99

MS

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Jennifer Gravelle and Sally Wallace

year as a share of personal income). The northeastern states demonstrated the slowest growth in property tax revenue in both periods. How have property taxes done relative to other sources of local government finance? Netzer (2002) points out that in the 1930s property taxes constituted 68 percent of all local government revenue (excluding insurance trust revenues). Increases in intergovernmental grants and other taxes reduced the property tax share of total local government revenue. Since 1980, the tax has constituted between 30.1 and 26.5 percent of total general local revenue, and in 2005, it was 27.9 percent. One of the interesting questions based on this overview of property tax collection trends is whether an overall income elasticity of about 1 is what we would expect for the property tax. Growing income over the period would suggest increased demand for public goods and therefore increased demand for property tax revenues. On the other hand, the capital-to-labor ratio has fallen economywide, which may have reduced the growth in some types of taxable property. Or did discretionary changes to the rate or base reduce such growth?3 Looking to equation (1) for guidance about other factors that affect the growth and elasticity of the tax, we might examine whether discretionary policy, administrative changes, or economic changes have increased or decreased the elasticity of tax collection over time. Unfortunately the data that would be most useful for undertaking this analysis in the United States are not readily available. Until 1992, every five years the U.S. Census Bureau did provide detailed data on gross assessed values by class of property (real property, with subcategories of land, improvements, and personal property) and use (residential with subcategories, vacant land, acreage, and commercial with subcategories),4 and on property tax exemptions. A number of researchers have worked to develop consistent updates to those data, as the Census no longer provides them. Gravelle (2008) provides effective property tax rates, which required the development of market values for 2000. Atkins and Augustine (2007) are developing a database of assessed values for all states for 2005–2006. It will take time to collect these data and verify their consistency with earlier data. However, in this chapter we use these data and other data sources as an indication of the more recent trends associated with the underlying base of the property tax. We take a look at the factors of equation (1) in order from right to left, beginning with property development and moving to the collection ratio. We attempt 3. Giertz (2006) presents the interesting hypothesis that the property tax may be “held back” from its optimal production because it is a potentially large revenue producer. 4. The reporting of gross assessed value by use category ended in 1986.

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to quantify these elements as best we can to provide some insight into which factors seem most likely to effect a change in the growth of property tax, by concentrating on changes in the reported assessed value by class of property using data from the U.S. Census Bureau’s Census of Governments for 1981, 1986, and 1991, and our estimates for 2000. We take a similar look at the use value data for 1981, 1986, and the 2005–2006 update. Both sets of comparisons need to be considered in light of the facts that gathering the data has been a painstaking effort and that there may be a loss of comparability over the years. We supplement other parts of the analysis with data from the Bureau of Economic Analysis (BEA), the Federal Reserve Board, and other sources as noted. MV/Y: Relative Growth in Stock of Property While it is difficult to come up with a single ideal measure of growth in property, we use several indicators that allow us to say something meaningful about the growth in the value of property relative to gross domestic product (GDP) in the United States. First, we use the ratio of residential fixed investment as a share of GDP and the stock of residential property as a share of GDP as rough measures of evidence of capital gains (Wallace 2006). Figures 2.3 and 2.4 demonstrate the growth in these indicators. In Figure 2.3, we see that residential fixed investment has grown quite steadily as a share of GDP since 1991, but with a less steep slope than in the early to mid-1980s. As can be seen, there was a clear decline from 1980 to 1982, in response to the recession. After 1982 the share increased dramatically until 1987, when it began to decline almost to the level of 1982, coinciding with the 1991 recession. As noted earlier, since 1991 residential fixed investment as share of GDP has grown significantly, with particularly strong growth following the 1991 recession and even stronger prolonged growth since the early 2000s. The value of capital stock of all residential property and owner-occupied property as a share of GDP (Figure 2.4) declined during the mid-1980s but has shown more consistent growth since 1992–1993. While there was a sizable decline in the share in the early 1980s, it remained relatively flat between the mid-1980s and 2000, although the value of owner-occupied property seemed to have increased slightly over this period. What is most notable is the clear upward trend for both owner-occupied housing and total residential property since the early 2000s. A further disaggregation can be done for the growth in the value of real estate for households, nonprofit organizations, nonfarm/noncorporate businesses, and nonfarm/nonfinancial corporate businesses, using data from the Federal Reserve Board Flow of Funds. This analysis follows that of Netzer (2002) closely, and the disaggregation will come in useful in further analysis. Figure 2.5 summarizes the

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Jennifer Gravelle and Sally Wallace

FIGURE 2.3

Residential Fixed Investment as a Share of GDP, United States, 1980–2005 0.07 0.065 0.06

Percent of GDP

0.055 0.05 0.045 0.04 0.035 0.03 0.025

1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

0.02

Year source: U.S. Bureau of Economic Analysis, 2006.

growth in the value of real estate owned by households and the sum of holdings by households, nonprofit organizations, nonfarm/noncorporate businesses, and nonfarm/nonfinancial businesses as share of GDP. We see a reiteration of the general pattern of growth in real estate value as a share of GDP—declining to a low in 1993–1994 and then increasing relative to GDP. Both household real estate and total real estate bottom out in 1994 at about 1 percent and 2 percent of GDP, respectively. After 1994, household real estate increases less in value than total real estate. While growth after 1994 was higher for total real estate than household real estate, in household real estate’s share of GDP is about 0.3 percentage points higher in 2006 than the 1986 share and total real estate’s share of GDP is about the same in 2006 as it was in 1986. What do these data suggest? The decline in the 1980s followed by the upsurge in the 1990s is consistent with a rather anemic elasticity of property tax revenues

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FIGURE 2.4

Private Residential Fixed Assets (Current Cost of Net Stock) as a Share of GDP, United States, 1980–2005 1.4

1.3

Percent of GDP

1.2

1.1

1

0.9

0.8

0.7

1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

0.6

Year All Residential

Owner Occupied

source: U.S. Bureau of Economic Analysis, 2006.

with respect to GDP—depending on the years chosen. As importantly, the data suggest that the underlying base of the property tax has not grown consistently with the economy. There may be interactions between the effective property tax rate and the market value of property (see Palmon 1998; Yinger et al. 1988; Rosen 1982). However, at a very macro level, these data suggest that real estate values do not retain a constant relationship with the overall growth in the economy. TMV/MV: Nonexemption Ratio The next step in our decomposition analysis of the growth in property tax revenues focuses on the “nonexemption ratio.” Local governments around the United States allow for numerous types of exemptions, including homestead

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Jennifer Gravelle and Sally Wallace

FIGURE 2.5

Flow of Funds Value of Real Estate Assets as a Share of GDP 3.50 3.00 Percent

2.50 2.00 1.50 1.00 0.50 2006

2004

2002

2000

1998

1996

1994

1992

1990

1988

1986

0.00

Year Total

Household

source: U.S. Federal Reserve Board of Governors, http://www.federalreserve.gov/releases/z1/Current/data.htm.

exemptions, exemptions for certain nonprofits, and specific developmentrelated exemptions (for new or expanding businesses, for example). The exact cost of these exemptions is difficult to quantify, not only because of a lack of consistent data but also due to the difficulty of defining exempt categories. The definition of nonprofits and the legality of the tax-exempt status for specific entities has been particularly problematic (see Brody 2002). We attempt to quantify the change in value of two types of exemptions that drive a wedge between market value and taxable market value: • Exemptions for charities, government, educational and religious institutions, and other nonprofits • The reported tax-exempt portion of gross assessed value We were not able to find consistent data on exemptions afforded for economic development purposes, although there is anecdotal evidence that they are widespread and growing (Wallace 2007). It is also important to realize that while we generally discuss these exemptions here in terms of a wedge between market value and taxable market value, states administer exemptions at very different points in the property assessment pipeline (some taking out exempt property immediately and others waiting until after assessment ratios have been applied). The debate over the tax treatment of charities is well summarized in a series of chapters in Brody (2002). Netzer (2002) brings together various data on the size

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Overview of the Trends in Property Tax Base Erosion

31

of the exempt sector. We have expanded on his series, updating most of the data through 2005–2006. The data are presented in Table 2.2. The reported value of real estate owned by nonprofit organizations has remained relatively constant as a share of total reported value of all entities, as reported in Table 2.2. These data do not suggest major shifts in the concentration of value in the nonprofit sector. Netzer reaches a similar result and concludes that there is little hard evidence that the share of nontaxed property in the nonprofit sector is growing. However, there is no guarantee that the value of exempt properties is revised on an annual basis. With respect to government buildings, we follow Netzer’s lead once again and report the value of the current-cost net stock of assets reported by the BEA for federal and state and local government in Table 2.3. As seen there, the growth in the reported value of government buildings was very robust from 1977 to 1997—about on a par with the reported increase in value of residential buildings. Between 1997 and 2004, the average annual increase in value of government buildings was somewhat smaller than that for residential buildings. This evidence suggests that while the growth of the largely tax-exempt government sector is important, it has not increased relative to some general measures of the tax base (for which the growth in the value of residential property serves as a proxy). There are other significant trends in exemptions, including reduced taxation of personal property, inventories, and intangibles. Matthews (2006) reports that 14 states currently tax inventories, while such taxation was close to universal two decades ago. Wheeler, Matthews, and Sjoquist (2006) report that 26 states tax motor vehicles as personal property, and again, this reflects a decline in the number of states taxing this form of personal property. In Georgia, which does tax personal property, the estimated revenue lost by exempting motor vehicles was about $627 million in 2004 (approximately 7.8 percent of all property tax revenues).5 We turn now to the role of other exemptions, such as homestead exemptions, in determining the growth of property tax collections.6 To estimate the relative magnitude and growth of these exemptions, we compare U.S. census data on total assessed value of property and net assessed value. The ratio (net assessed value/total assessed value) for all state and local governments in the United States changed very little between 1981 and 1991. We do not have full data for 2000, so

5. Census data on assessed value of real versus personal property also demonstrate this decline. From 1981 to 1986, assessed value of real property grew by 63.2 percent and personal property by 65.5 percent. From 1986 to 1991 the growth rates were 47.2 and 26.4 respectively. 6. It is our understanding that the census reported gross assessed value is net of an overall assessment cap. Therefore, we are not able, with these data, to estimate the impact of assessment cap limitations on the growth in property tax. We instead present some state-specific information regarding the magnitude of those types of policies.

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TABLE 2.2

Composition of Value of Real Estate ($ billions) Value of Real Estate Owned by: Households

Nonprofits

Year

Total Households; Nonprofits; Nonfarm, Nonfinancial Corporations; Nonfarm, Noncorporate Business

Nonprofit % of Total

1986

5,719

679

12,250.5

5.54%

1987

6,177

712

13,924.8

5.11%

1988

6,713

758

14,011.8

5.41%

1989

7,296

801

14,969.2

5.35%

1990

7,405

797

15,029.7

5.30%

1991

6,716

761

13,885

5.48%

1992

6,949

715

13,570.9

5.27%

1993

7,105

700

13,580.8

5.15%

1994

7,282

736

14,129.2

5.21%

1995

7,970

782

15,086.4

5.18%

1996

8,344

831

15,906.7

5.23%

1997

8,758

935

17,065.5

5.48%

1998

9,536

1,049

18,664.8

5.62%

1999

10,432

1,125

20,182.9

5.58%

2000

11,410

1,235

22,055.7

5.60%

2001

12,470

1,239

23,185.6

5.35%

2002

13,759

1,309

25,001

5.24%

2003

15,223

1,413

27,242.7

5.19%

2004

17,143

1,568

30,295.5

5.18%

2005

19,313

1,795

34,173.3

5.25%

2006

20,588

2,049

37,308.7

5.49%

source: Federal Reserve Board, Flow of Funds.

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TABLE 2.3

Current-Cost of Fixed Assets ($ billions) Level Year

1977

Residential

1,879

1997

6,816

Average annual growth 2004

1977–1997

1997–2004

11,578.8

26.27%

9.98%

Government Buildings Federal, national defense

86

127.1

161.1

4.78%

3.82%

Federal, other

29

117

177.9

30.34%

7.44%

State and local buildings

377

1,380

2046.6

26.60%

6.90%

Total government buildings

492

1,624.1

2385.6

23.01%

6.70%

sources: Netzer (2002) and Bureau of Economic Analysis, Survey of Current Business, http://www.bea.gov/bea/ ARTICLES/2005/09September/0905fixed_assets.pdf. note: For 2004, federal, state, and local buildings are calculated as the reported values of structures: residential, office, commercial, health care, educational, and public safety.

we cannot provide an overall comparison of the same ratio. However, using census data and data from Gravelle (2008), we analyze the change in the ratio between 1981 and 2000 for 21 states and find that there was little reported reduction in the ratio of net to gross assessed value for those states. On average, the ratio fell less than one percentage point over the period. These estimates are likely to be imprecise due to the aggregate nature of the data and the differences in reporting gross and net assessed value between states. Given the recent debate regarding reduction or elimination of the property tax and the difficulties in estimating the nonexemption ratio, we thought that a few case studies would help shed light on whether or not there have been more recent increases in property tax exemptions that are not captured in our data. A number of states report their tax expenditures annually. A large portion of property tax–related expenditures come from nonprofit or government exemptions. But there are some other big-ticket items. The following is a sample of tax expenditure estimates for Oregon among a long list of tax expenditures (all figures are annual losses in millions of dollars all for 2005–2007):7 • Inventory $528.8 • Farm machinery (2005–2007), $55.1 • Enterprise zones $22.5 7. Oregon Department of Revenue, 2005–2007 Tax Expenditure Report, http://www.oregon.gov/DOR/ STATS/docs/ExpR05-07/Chapter2.pdf.

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Jennifer Gravelle and Sally Wallace

Nursery stock $5.5 Western private standing timber $369.5 Eastern private standing timber $39 Western private forest land $55.3

California reports about $200 million in property tax expenditures (not including special assessed values for farms),8 while New York City reports property tax expenditures, in millions of annual losses in 2006, including9 • homeowner rebate, $257; • industrial and commercial incentives, $371; and • senior citizen assistance, $39.4 Sjoquist and Wallace (2007) estimate that the tax expenditure associated with Georgia’s elderly homestead exemption was $207 million in 2007 (relative to property tax revenues of greater than $7.5 billion). These specific examples suggest that there is a substantial amount of activity related to special treatment, which may or may not be picked up in the aggregate net/gross assessed value figures. Also, since the Census Bureau stopped collecting these data in 1991, it may very well be the case that much of the growth in these exemptions is more recent and thus not captured in the previous analysis. Aggregate census data through 2000 do not show large increases in the ratio of net assessed to gross assessed values. However, we are not convinced of the consistency of these data, and anecdotal evidence suggests that the exemptions are important, although again, it is difficult to quantify their magnitude. AV/TMV: Assessment Ratio The assessment ratio should represent the value of property for tax purposes as a share of the market value of property (assuming we have culled out the exemptions appropriately).10 Assessment ratios vary significantly across states and re8. California Department of Finance, Tax Expenditure Report 2002–2003, www.assembly.ca.gov/acs/ committee/c21/publications/2003_Tax_Expenditures_Summary/Tax_Expenditure_Report.pdf. 9. New York City Department of Finance, Office of Tax Policy, Annual Report on Tax Expenditures Fiscal Year 2006, http://www.nyc.gov/html/dof/html/pub/pub_reports_other_tax.shtml. 10. We should note here that in the actual administration of property taxes, exemptions may be reported to taxpayers after the assessed value. For example, in Georgia, homeowners receive a tax bill that lists “market value” followed by “assessed value—40 percent of market value” followed by “homestead exemption.” Alternatively, in Minnesota gross assessed values are listed at “market value” followed by reductions yielding a “taxable market value” to which a taxable valuation ratio is applied to obtain the final property base “net tax capacity value.” Our decomposition is a general form and does not necessarily reflect the nuances of specific systems of administration in terms of reporting exemptions or credits. Also, some property, such as agriculture, may not be assessed at market value. For example, Oregon estimates that the special assessment of farm land reduces property tax revenue by $181 million. John Anderson (2003) provides a helpful discussion of special assessments.

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flect state and local governments’ preferences for forms of tax relief through low fractional assessment and through variations in assessment ratios across different types of property. As we noted earlier, until 1992, the Census Bureau provided gross assessed values by state by type of property (real, personal, local, and state assessed) and by use (residential, commercial, etc.). The statutory assessed values on residential property in 2005–2006 range from lows of 4 percent on residential property in South Carolina and 10 percent in Alabama, Arizona, and Mississippi to 100 percent in many states (Atkins and Augustine 2007). There are a number of other rates in between, including Illinois and New Mexico at 33.33 percent, Georgia at 40 percent, Tennessee at 25 percent, Kansas at 11.5 percent, Missouri at 19 percent, Nevada and Ohio at 35 percent, Utah at 55 percent, and West Virginia at 60 percent. Actual assessment practices may lead to over- or underassessments, which may (or may not) be systematic over time.11 To remain consistent with our theme, we investigate whether the assessment ratio has changed over time, thus reducing (or increasing) the property tax base, and if so why. The ratio could fall if the statutory ratio were reduced by law or if the effective assessment were less than the statutory assessment. We analyzed the Census Bureau–reported net assessed value at the national level in terms of our estimates of total residential property (set forth in Table 2.2), to get a rough idea of the assessment ratio nationally for 1981, 1986, and 1991.12 We find some evidence of an increase in the assessment ratio over this period from about 36 percent to close to 47 percent (using the base defined in Table 2.2). We also provide updated assessed values allocated to the census categories, to analyze the trend in the growth of assessed values from 1981 to 2000. Due to limitations in the data available, our allocation may not align perfectly with the original census data and comparability between previous years and 2000 may be imperfect. Figure 2.6 provides an index of assessed values to 1981 for all states. In aggregate, the assessed values grew by 35 percent between 1981 and 1986, 64 percent between 1981 and 1991, and by 131 percent between 1981 and 2000. In most states assessed values no more than quadrupled in all periods. However, some states had particularly large increases, most notably Utah, which had assessed values in 1986 and 1991 six times larger than in 1981, and ten times larger than 1981 in 2000. Utah’s growth in the early years stemmed largely from 11. Bird and Slack (2002) provide an interesting summary of practices across a number of countries. 12. It is our understanding that the Census Bureau–reported gross assessed value is net of any adjustment due to statutory limitations on assessed values. The issue of limitations is discussed in the section on tax rates.

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FIGURE 2.6

Gross Assessed Valuations Indexed to 1981 10

6

4

2

la U. b S A am . A las a A riz ka r Ca kanona li s D CoCo fornas is lo tr ic nne ra ia t o D c do f C ela tic ol waut um re F b G lori ia eo da H rgi aw a Id ai Ill ah i In ino o di is an K Io a Ke an wa n Lo tusas ui ck s y M M Mian as a a a sa ry in c la e M hu nd M ichset M inn igats is es n s o M issi ta M issoppi on u N N ew eb tanri H Neras a a N m va ka N ew psh da ew J ir er e N or N Me sey e x N th C w ico or a Yo th ro rk D lin a a O kot k O a Pe lah hio O om n R n r So ho sy ego a u de lva n Soth Is nia ut Car lan h o d Te Da lin nn ko a es ta Tesee x Ve U as r t W Vi moah r a W sh gi nt es in nia t g W Vir ton i g Wsco ini yo ns a m in in g

0 A

Percent

8

1986

1991

2000

source: Author’s calculations.

increases in the statutory assessment ratio. After 1991, however, few changes were made to the statutory assessment ratios, and the increase was concentrated in residential property values. Other states that experienced large increases in assessed values included Nevada with a 2000 index value of 4.1, New York with a 2000 index value of 5.4, and Pennsylvania with a 2000 index value of 4.5. In all of these states the previous indices were less than 2, and these higher values may be due to some incompatibility with the different data sources. However, these states also have large urban areas, and the higher values may reflect increases in residential home values originating from the housing boom. What can be concluded from the trend in assessed values? It appears that any stagnation in the collection of property tax revenue is not the result of depressed growth in assessed values. In fact, aggregated assessed values have grown on average almost two percentage points faster per annum then private or residential fixed assets, and more than one percentage point faster per annum than GDP. Part of the explanation for this result may be the existence of significant underassessment in the early 1980s, necessitating a catch-up in assessed values over the period. In addition, states rarely change statutory assessment ratios, and states that cap growth in assessed values tend to outpace or not fall greatly behind growth rates in the economy. Technological advances such as computer-assisted mass appraisal could also increase the effectiveness of the assessment process.

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FIGURE 2.7

e T A ot D riz al is C tr C o on ic o lo a t o nn ra f C ec do ol tic um ut b Id ia ah Ill o in M L I ois as ou ow sa is a ch ia n M use a M ich tts i i M nne gan is s si ot s M sip a is p M so i N ew N ont uri H eb an N am ras a or p k th sh a D ire ak ot So a ut O Oh h re io C g Te aro on nn lin es a s Te ee x W U as is ta W con h yo si m n in g

90 80 70 60 50 40 30 20 10 0

Sa

m

pl

Percent

Residential Share of Assessed Value

1981

1986

2004

source: Author’s calculations.

State and local governments have also changed the degree to which they rely on property categorized by use to constitute the tax base. Figures 2.7 and 2.8 show the shares of assessed value attributable to residential property and commercial/industrial property between 1981 and 2004. These figures include only states for which 2004 data broken out by use were available. It is important to note that these are shares of assessed values, not the share of residential or commercial/industrial property that exists in the state. Figures 2.7 and 2.8 show states’ preferences, through differential assessment ratios, for relying on residential versus commercial property as the basis for property taxation.13 The data in this sample show that the share of assessed value attributable to residential property increased over the period from about 52 percent to about 64 percent for the sample as a whole. In addition, over half of the states in the sample show residential shares higher in 2004 than in either 1986 or 1981. It is also clear from these figures that states by and large have come to rely more heavily on residential property as the primary source of property tax revenue. 13. The allocation of residential and commercial property depended on the classification description provided by states, and in some cases some property may be imperfectly allocated. For example, Arizona shows almost no commercial property in 2000 because changes in the classification of property made it difficult to identify commercial and industrial property.

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FIGURE 2.8

Commercial and Industrial Share of Assessed Values 60

Percent

50 40 30 20 10

Sa

m

pl

e A Tot D ri a is tr C Col zon l ic o o a t o nn ra f C ec do ol tic um ut b Id ia a Ill ho in M L I ois as ou ow sa is a ch ia n M use a M ich tts i i M nne gan is s si ot s M sip a is p M so i N ew N ont uri H eb an N am ras a or p k th sh a D ire ak ot So O a ut O hi h re o C g Te ar on nn oli es na s Te ee x W U as is t c W on ah yo si m n in g

0

1981

1986

2004

source: Author’s calculations.

For more recent information regarding possible changes to the assessment ratio, we must again look to some specific state cases. A number of states provide an “assessment sales ratio study” that compares assessed to market values. While a number of states provide such analysis on an annual basis, our review of a sample of these studies (Maryland, Georgia, Nevada, and Washington) does not offer clear guidance on trends in assessment ratios, either statutory or effective. For example, Maryland increased its statutory assessment ratio in 2001 (from 40 to 100 percent in most areas of the state), but the state’s 2005 sales ratio study suggests that the effective assessment ratio has fallen over time.14 For comparison in its sales ratio studies, Maryland uses sales price data six months before and six months after the date for which assessments have become effective. The state notes that the downward trend in effective assessment ratios is likely caused by a volatile housing market, as the time proxy method would not work when residential values could have increased by double-digit percentages for each of the past three years. Georgia reports general compliance with assessment ratios of close to 40 percent across most counties.15 The 14. Maryland Department of Assessments and Taxation, 2006 Assessment Ratio Survey Report, http:// www.dat.state.md.us/sdatweb/stats/05rr_t02.html. 15. State of Georgia, Department of Audits and Accounts, 2006 Sales Ratio Study, https://www.audits.state. ga.us/internet/srd/index.html.

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state of Washington reports high levels of compliance with its assessment ratio.16 Nevada reports similar compliance.17 There is also an academic literature that has examined assessment ratios, which may offer guidance regarding the growth or decline in the ratio. For example, Goolsby (1997) finds systematic underassessment of higher-valued properties in Washington for 1993; Kowalski and Colwell (1986) find overassessment of industrial property. However, neither of these studies suggests that the assessment differentials have increased or decreased over time. Sheffrin and Sexton (1998) find that in two counties in California, changes in market values led to increases in the effective assessment ratios for residential property. While this review has demonstrated that there is some movement in the assessment ratio, we are not convinced that there is a generalizable trend. Tl /AV Tax Rate Ratio The statutory tax rate will have a direct and positive effect on the level of property tax revenue once all exemptions, special assessments, and the like are considered. In part because the statutory rate has little relation to the level of collection in practical terms, there are few studies that document statutory tax rates. However, within the general property tax limitation movement, a number of jurisdictions have imposed property tax rate caps. Nathan Anderson (2006) reports that only five states have no property tax limits. Tax rate limitations are not the only type of property tax limitation. Governments have also imposed limitations on tax revenue growth and assessment growth, which fit into the discussions above. These limitations may be operationalized by reducing the tax rate after tax assessments are calculated. Since tax limitations are interconnected in this and other ways, we review the impact of property tax limitations in general in this section. Studies of the effects of tax rate and other limitations provide mixed evidence regarding their impact on property tax growth. In some cases, the tax limitations are not specific to property taxes, complicating the analysis of the impact on property tax revenue. Joyce and Mullins (1991) analyze the impact of tax and expenditure limitations (TELs) in the 1970s and 1980s on state and local budgets. They conclude that overall TELs had little impact on state revenues, but that local TELs reduced the reliance on local taxes and shifted revenue to fees and charges and state aid. Dye and McMillen (2006) investigated Illinois’s assessment 16. Washington State Legislature, Measuring Real Property Appraisal Performance in Washington’s Property Tax System 1998, http://www1.leg.wa.gov/documents/opr/Fin/1998/Ratio.pdf. 17. State of Nevada, Department of Taxation, 2003–04 Report of Assessment Ratio Study, http://tax.state. nv.us/DOAS_FORMS/LA%20Ratio%20Study%202003-2004.pdf.

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limitation and found evidence that the horizontal equity of the property tax system was reduced as tax burdens were shifted among properties. Nathan Anderson (2006) reports that Oregon’s assessment limits can affect both the horizontal and vertical equity of the property tax but that just as importantly, infrequent assessment can have a similar impact. The number of limitations and the vast and growing literature on tax limitations suggests that the limitations issue remains an important one that may challenge the long-term viability of the property tax. While we have not been able to capture the implications of these limitations in this study empirically, based on the literature, we believe that they are an important contributing factor to the overall elasticity of the property tax over the last two to three decades. Others conclude that limitations have had limited impact. For example, Sexton (2008) reports that property tax limits are among the least effective means to provide property tax relief. Tc /Tl Collection Ratio Data on delinquencies and tax administration effort have been hard to find. There is anecdotal evidence of increased delinquencies during recessionary periods, but no obvious overall pattern of decline in the collection ratio over the last twenty years. We leave this as an area for future research. Conclusion Our task has been to look at the general trends in property tax in the United States and, using available literature and data, summarize them, hypothesize about the reasons for them, and discuss their implications and future issues related to the property tax. Overall, the property tax remains an important component of local government finance in the United States, although less so than in the property tax heyday of the 1930s. The growth of tax revenues relative to GDP has been relatively flat over the past two to three decades, with an income elasticity of about 1 over the past three decades. Residential property has become a larger share of the tax base, while there is little evidence that tax-exempt property has increased the speed of base erosion over time. A variety of tax limitations, exemptions, and other forms of special treatment has had some impact on reducing the growth of property tax revenues, although it is difficult to quantify the magnitude of these effects definitively. One way to analyze the overall performance of the tax is to ask the question, should the property tax have grown faster (slower) than it did? Using a straightforward decomposition of the relationship between property tax revenues and GDP, we analyze the factors that contribute to the growth of property tax rev-

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enue in the hopes of isolating economic factors, such as growth in the value of property, from policy choices, specifically the level of exemptions. We use available data and literature to analyze each piece of the decomposition. This decomposition is not perfect; we lack data in many cases, the data may be too aggregate in other cases, and the treatment and reporting from state to state may vary. In cases where there is a substantial literature (such as limitations), we appeal to that literature to supplement our conjectures about the major pressures on the property tax. We provide a summary of our analysis in Table 2.4. We were a bit surprised at some of the findings of our analysis. In particular, the level of property development (MV/Y) has not been very robust over the period.18 The level responds (not surprisingly) to downturns in the economy, but does not show large upturns after a recession. This may be a reflection of the changing nature of the economy, whereby the service sector, whose activity is less property intensive, has replaced manufacturing. The data that we exploit to understand the magnitude of the nonexemption ratio suggest that the value of nonprofit and federal government properties has not been growing particularly fast. We have not been able to quantify the value of other exemptions such as the homestead exemption, circuit breakers, and TELs, so those may have more of an impact than nonprofits. Based on our aggregate data, the assessment ratio has not declined over the last two decades. In fact, we find evidence that it has increased. This could be due to statutory changes in the assessment ratio among states,19 better assessment procedures, or more regular revaluations that led to a “catch-up” of underassessments in the late 1970s and early 1980s. Overall, however, this trend is not consistent with flat revenue growth relative to GDP. A complication in this analysis is that we may not have appropriately identified where tax limitations enter the data. A further decomposition of the assessed values by uses suggests that states may be increasing their reliance on residential property as a major component of the property tax base. Under the tax rate ratio discussion, we include tax rate, assessment, and revenue limitations. Aggregate data have not helped us to understand the magnitude of these components or their implications. Authors have a difficult time isolating property tax–specific limitations. However, there is evidence that the limitations have mattered and have brought about an increase in reliance on 18. We did not include land in this analysis. 19. However, a handful of case studies do not suggest that these statutory changes caused the rise in assessment ratio over this time period.

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TABLE 2.4

Property Tax Revenues: “All They Can Be”? Factor

Summary of Trend

Why?

Implications

Level of property development

Not consistent with GDP over time

Changing economic base

The very base of the property tax may not be as strong in the future, increasing the impact of limitations and other policy adjustments.

Nonexpenditure ratio

Popular press suggests nonprofits and government exemptions are increasingly costly. Our analysis suggests not much of an impact of these and other basic exemptions.

Nonprofits do not seem to be a major factor; state-local government exemption has a larger impact. Homestead exemptions have not been quantified over time.

What many have viewed as big ticket exemptions have largely turned out not to be true.

Assessment ratio

Increases somewhat over time

Better or more frequent assessments, difference in reporting

All else equal, this should increase the tax base and yield a higher revenue share for the property tax.

Tax rate/limitations

Increase in the number of limitations: rates, assessments, and revenue. Literature mixed on net impact.

Not all limitations are binding, some limitations are not tax specific.

There are myriad implications: constraints to using the property tax to support population growth, increased use of fees and charges and (to a lesser extent) other taxes, which may have limits themselves, reduced horizontal equity of the property tax, net changes in the distribution of the tax burden, overall constraints on expenditures.

Collection rate

No current evidence

Increases in computerization could reduce administrative costs, increasing resources for collection. On the other hand, service sector and internet growth could reduce tax handles and make it more difficult to find and assess property.

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other local revenue sources including fees and charges. Over the longer term, this shift may reduce the potential for future increases in these other sources. Horizontal inequities (different treatment of similar types of properties) resulting from the limitations could affect property growth and therefore the property tax base. Many of the components discussed in this paper are susceptible to state and local tax policy decisions, tax administration decisions, or state and local politics. We will not debate the definition of these different roles within government, but simply state that tax limitations, changes in statutory tax rates and assessment ratios, and exemptions are susceptible to policy and politics. The collection and effective assessment rates are a function of the tax administration, which may be affected by policies and politics as well. Other subcomponents of the change in property tax growth over time are not directly affected by these forces. These include the overall level of property value and growth, effects of economic changes such as an increase in the service sector, and demographic changes. What else might be going on and what should we expect in the future regarding property tax revenues as a result of current trends and their implications? First, while we do not find that the nonprofits and government sectors have grown as a share of taxable property, their share is significant. Pressure for increased government spending for education and other public services may increase the call for payments in lieu of taxes (PILOTS) and services in lieu of taxes (SILOTS). The growth of other taxes and charges (especially sales taxes and local options taxes) may have mitigated property tax pressure, but further increases in those taxes could lead to a separate revolt. Sales taxes as a share of general local government revenue increased from 4.6 percent in 1977 to 6.2 percent in 2005; charges and miscellaneous revenues increased from 15.3 percent to 22.5 percent over the same period (U.S. Census, Census of Governments 2006). Second, let’s start back at the beginning; the public does not like taxes, but they really do not like property taxes. Public sentiment continues to work against the property tax. This suggests that pressure will continue to reduce the property tax burden, which means that other taxes, fees, and charges would substitute. Third, while the deductibility of the property tax may mitigate some of the anger toward the tax, it does not often seem to be part of the debate regarding the property tax. For itemizers, the cost of $1 of property tax is about $0.73, while the cost of $1 in fees and charges is $1. As federal income tax rates have fallen over the last 30 years, the value of the deduction has also fallen, which may explain the lack of focus on this offset issue in part.

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A fourth point relates to demographic shifts, which may be one of the reasons for the pressure on the property tax. In many states, there has been a movement to increase homestead exemptions for the elderly or to reduce or eliminate portions of the property tax. The magnitude of the movement may not have made its way into the data that we present above, but the aging of the population will serve to increase the pressure for an intergenerational shift in the property tax. Increased age by itself may translate into a lower demand for housing (Goodman 1990; Mankiw and Weil 1989). This decreased demand for housing occurs due to changes in income as individuals age, changes in the family structure of elderly households, and the movement of the elderly from their owner-occupied homes to other types of institutions. As more and more elderly move to smaller houses or retirement homes, the housing stock available to those looking to buy homes increases without increases in the amount of property subject to local property taxes. A policy response may be to adjust millage rates. The housing stock made available by the elderly moving to smaller homes is more likely to accommodate the relatively slow-growing home-ownership age group, those between 30 and 55. Absent property tax rate increases or repeal of exemptions, without additional building the property tax base simply does not grow as fast as it would if the demand for housing were not dampened by this demographic impact. The continued aging of the population therefore has significant potential to affect state and local government budgets through potentially reduced growth in property, income, and sales tax bases. While all regions of the country can expect these pressures, the census projections suggest that the South will see the largest increase in its elderly population. Future research on property tax revenue growth will have to pay close attention to this demographic change.

REFERENCES

Advisory Commission on Intergovernmental Fiscal Relations. 1987. Significant features of fiscal federalism, Washington, DC: Advisory Commission on Intergovernmental Fiscal Relations. Anderson, John. 2003. Preferential assessment: Impacts and alternatives. In The property tax, land use, and land use regulation, ed. Dick Netzer. Northhampton, MA: Edward Elgar. Anderson, Nathan. 2006. Property tax limitations: An interpretive review. National Tax Journal 59(3):685–694. Atkins, Patricia, and Nancy Augustine. 2007. Property tax data 2005–06. Unpublished data set, George Washington University Institute of Public Policy, Washington, DC.

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Bahl, Roy. 2007. Property taxation: Challenges and opportunities. Paper prepared for the National Tax Assessors Conference, Atlanta (September 10). Bahl, Roy, and Johannes F. Linn. 1992. Urban public finance in developing countries. New York: Oxford University Press. Bird, Richard, and Enid Slack. 2002. Land and property tax: A review. Journal of Property Tax Assessment and Administration 7(3):31–89. Brody, Evelyn. 2002. Property-tax exemptions for charities, ed. Evelyn Brody. Washington, DC: Urban Institute Press. Dye, Richard, and Daniel McMillen. 2006. Illinois’ response to rising residential property tax values: An assessment growth cap in Cook County. National Tax Journal 59(3):707–716. Federal Reserve Board of Governors. 2007. Flow of Funds. http://www.federalreserve. gov/releases/z1/Current/data.htm. September 10, 2007. Giertz, J. Fred. 2006. The property tax bound. National Tax Journal 59:695–706. Goodman, Allen C. 1990. Modeling and computing transactions costs for purchasers of housing services. Real Estate Economics 18(1):1–21. Goolsby, William C. 1997. Assessment error in the valuation of owner-occupied housing. Journal of Real Estate Research 13(1):33–46. Government of the District of Columbia. 2006. Tax rates and tax burdens in the District of Columbia—A nationwide comparison. Washington, DC: Government of the District of Columbia. Gravelle, Jennifer. 2008. Empirical essays on the causes and consequences of tax policy: A look at families, labor, and property. PhD diss., George Washington University. Joyce, Philip, and Daniel Mullins. 1991. The changing fiscal structure of the state and local public sector: The impact of tax and expenditure limitations. Public Administration Review 51(3):240–253. Kowalski, Joseph G., and Peter. F. Colwell. 1986. Market versus assessed values of industrial land. AREUEA Journal 14(2):361–373. Mankiw, N. Gregory, and David N. Weil. 1989. The baby boom, the baby bust, and the housing market. Regional Science and Urban Economics 19:235–358. Matthews, John. 2006. Inventory taxes. Fiscal Research Center Working Paper No. 136. Atlanta: Andrew Young School of Policy Studies, Georgia State University. McFadden, Daniel. 1994. Demographics, the housing market, and the welfare of the elderly. In Studies of the Economics of Aging, ed. David Wise. Chicago: University of Chicago Press. Mieszkowski, Peter. 1972. The property tax: An excise tax or a profit tax? Journal of Public Economics 1:73–96. Netzer, Dick. 2002. Local government finance and the economics of property-tax exemptions. In Property-tax exemptions for charities, ed. Evelyn Brody. Washington, DC: Urban Institute Press. Palmon, Oded. 1998. Confirmations and contradictions. Journal of Political Economy 106(5):1099–1111.

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Rosen, Kenneth. 1982. The impact of Proposition 13 on house price in northern California: A test of the interjurisdictional capitalization hypothesis. Journal of Political Economy 90(11):191–200. Sexton, Terri. 2008. The increasing importance of assessment limitations as a means of limiting property taxes on homeowners. The Property Tax in Fifty States: Property Tax Roundtable Proceedings. Sheffrin, Steven, and Terri Sexton. 1998. Proposition 13 in recession and recovery. San Francisco: Public Policy Institute. Sjoquist, David, and Sally Wallace. 2007. Selected fiscal and economic implications of aging. Paper presented at the conference “Georgia’s Aging Population: What to Expect and How to Cope,” Andrew Young School of Policy Studies, Atlanta, September 26. Sokolow, Alvin. 1998. The changing property tax and state-local relations. Publius 28(1):165–187. U.S. Bureau of Economic Analysis (various years). National Income Accounts. U.S. Census Bureau, State and Local Government Finances. http://www.census.gov/ govs/www/estimate.html. September 4, 2007. Wallace, Sally. 2006. Property taxation in a global economy: Is a capital gains tax on real property a good idea? Paper prepared for the Lincoln Institute of Land PolicyLand Policy Institute of Taiwan, Conference, “Toward A 2015 Vision of Land,” October 24–25, Taipei, Taiwan. ———. 2007. Interjurisdictional competition under U.S. fiscal federalism. Paper prepared for the Lincoln Institute of Land Policy Conference, “Land Policies and Fiscal Decentralization,” June 3–5, Boston. Wheeler, Laura, John Matthews, and David Sjoquist. 2006. Personal property tax on motor vehicles. Fiscal Research Center Brief No. 130. Atlanta: Andrew Young School of Policy Studies, Georgia State University. Yinger, John, Howard Bloom, Axel Borsch-Supan, and Helen Ladd. 1988. Property taxes and house values: The theory and estimation of intrajurisdicational property tax capitalization. San Diego: Academic Press.

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COMMENTARY

RICHARD M. BIRD

J

ennifer Gravelle and Sally Wallace provide a useful and comprehensive overview of the property tax in the United States in recent years. Of course, my main task as a commentator is less to talk about all the good things that are in their work than to note a few things that might have been treated differently or added to the discussion. For example, while I like the decomposition approach and find it illuminating in many respects, these ratios focus not on the erosion of the property tax base but rather on the failure of property taxes to increase despite what appears to be generally accepted to have been an increase in the potential base. The real question is not why the base has eroded—it has not—but why it has proved so difficult for local governments to maintain, let alone increase, the revenues they collect from this base. Why, in other words, have local governments employed various methods (as usefully summarized in the decomposition approach) to decouple tax base and tax collection, thus avoiding collecting the revenues they might have reaped if they had refrained from decoupling? One possible explanation of the apparent paradox—an increase in the tax base that results not in greater revenues but rather in political pressures ensuring that little or no additional revenue flows to local government coffers—is simply that there is insufficient political support for increasing local taxation especially, as the authors note, local property taxes. In the (approximate) words of Shakespeare, the fault, if there is one, lies not in the stars but in ourselves. One way to probe more deeply than this chapter does into the behavior of property taxes is to begin by taking a more general view of the local government budget constraint. Why might budgetary pressure on residential property taxes increase? Is it because expenditure levels have increased, because transfers or other tax and nontax revenues have not increased adequately, or because taxes on nonresidential property have decreased in relative terms? If the income elasticity of local public expenditure is greater than 1, then as income levels rise the need to finance local expenditures rises more than proportionally. If no other revenue source responds to this demand or if some 47

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other source weakens (for example, in a one-industry town when the plant closes and the nonresidential base erodes) then the only way out for local governments would seem to be to raise the effective tax rate on residential property. However, attempts to tax residences more heavily usually require a fairly fundamental shift in the local political balance. As the survey data cited in this chapter suggest, because the local residential tax rate is in many ways the most exposed fiscal aspect of the (at least temporary) equilibrium balance of interests achieved in any community, significant change in this rate usually requires prior change in the underlying local political situation. The authors note the differing rates of growth in property tax in different regions of the country and in different time periods. However, their analysis does not attempt to relate the observed trends in property tax collections directly to changes in property values, as would seem to be essential to the analysis of changes in the property tax base. A number of ways in which one might look more closely at what has happened to the relation between market values and gross domestic product or income are suggested but not explored in depth in the chapter. At one point, for instance, the authors note that the capital-labor ratio has declined. To the extent it is capital in the form of real property that has declined this would imply a decrease in the potential tax base. This idea could be explored further if data permitted, for example by relating it to the relative changes in the presumably more real-property-intensive manufacturing sector and the less property-intensive service sector. Alternatively, one might examine changes in the assessed value per dollar of output in different sectors in different states. Property taxes are often compared to personal income in the chapter, for example with respect to volatility. However, the base of the property tax is not personal income. Arguably, it is likely closer to gross state product. Certainly one would expect changes in the base of the property tax in any time period to be more closely related to changes in the composition of gross state product than to changes in personal income. Analysis of the volatility of the property tax base requires close attention to the decomposition not only of property tax collections but also of the property tax base itself: for example, the role of growth of residential and nonresidential portions of the base in different regions and localities. Perhaps the experience of the Depression should be looked at more closely for evidence of the extent to which local governments can (or cannot) absorb substantial reductions in property tax collections. At least in Canada during that period, although property tax increased as a percentage of GDP real property tax revenues declined substantially. It might be revealing to take a somewhat longer look at the evolution of the property tax base and property tax collections relative to other economic trends.

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As an example, in a recent study of my own province, Ontario, when the developments of the last decade or so are placed in the context not just of the last 30 years but of the last century one gets quite a different perspective on recent developments (Slack et al. 2007). One aspect found to be particularly important was the differing relative importance of the nonresidential and residential tax bases in different regions and cities. In Canada, on average almost half of property tax revenues come from nonresidential property. Not only does the value of this important component of the property tax base often change over time in a different way than residential values, but much of it is also assessed in a quite different way than most residential property, and it is often taxed at considerably different effective rates. Moreover, although in Canadian provinces as in U.S. states there has been a variety of property tax freezes, caps, and limitations in recent years, these measures have sometimes been applied differently with respect to different classes of property. Similarly, our experience suggests that appeals of assessments are both more common and more often successful with respect to nonresidential property. Whether or not any of these potentially important differences between the two major components of the property tax base are equally valid in the United States, it is a bit surprising to see so little discussion of the extent to which the composition of the local property tax base has or has not changed over time and between regions, particularly since the data provided appear to suggest that there are wide variations in the relative importance of nonresidential and residential tax bases in different states. Finally, two minor points may be worth noting. The first relates to the brief discussion of the incidence of property tax. The authors note that the tax is probably somewhat progressive, a proposition with which most economists would likely agree. However, I suspect that most people would not agree, and that the property tax is generally still considered to be regressive. This perception probably underlies to some extent the persistently poor survey scores of the tax noted in the chapter. Higher property taxes are resisted both by those who would pay higher taxes because they have more property and by those who would not pay more but think that they would. If there is anything to my earlier mention of the apparent key role of the residential property tax in local political equilibrium, those who wish to influence policy outcomes should perhaps spend more time trying to spread the good word about the incidence of property taxes. The second minor comment is that the authors make a plausible argument that there have not been marked changes in the share of exempt properties. In my experience, however, usually little effort is made to keep the recorded values of exempt properties up to date, so I doubt one can say this with much certainty.

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To conclude, much of what I have said may perhaps not seem very relevant to those more immersed than I am in U.S. realities. A trap facing anyone who ventures to comment on such highly institutionalized policy issues in another country is that some comments may miss the point completely. They may end up saying less about the work at hand than about the paper the commentator might have written about the subject in his or her own country—provided such a paper could be written, and the commentator were brave enough to undertake the task. Since I am neither able nor willing to write such a paper for Canada, I can only conclude by again expressing my gratitude that Jennifer Gravelle and Sally Wallace have tackled the question of property tax base erosion in the much more complicated environment of the United States. I think they have done an excellent job in summarizing a complex and difficult situation. As with all good research, their paper answers some questions and raises others that need further examination. What more can one ask? REFERENCE

Slack, Enid, Almos Tassonyi, and Richard M. Bird. 2007. “Reforming Ontario’s property tax system: A never-ending story?” Toronto: ITP Paper 0706, Rotman School of Management, University of Toronto (September).

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3 Property Tax Exemptions, Revenues, and Equity Some Lessons from Wisconsin RICHARD K. GREEN ELAINE WEISS

Why Property Tax Exemptions Matter for State Policy Makers The property tax has many merits, not least of which is that it is a benefit tax1—it allows people in a municipality or school district to choose the mix of taxes and services they desire. Because, at least theoretically, people can vote both at the ballot box and with their feet, government officials have a powerful incentive to provide an efficient mix of taxes and services.2 The ability of property taxes to target issues so cleanly, or of the people who pay them and benefit from their services to “vote with their feet,” however, is often theoretical indeed. Thus, policy makers are legitimately concerned about the economic, political, and social issues that property taxes raise. Some worry about their distributional implications. This concern stems from a straightforward calculation. Low-income people tend to spend a higher fraction of their current income on housing than do high-income people; if property taxes were applied in an ad valorem fashion, then low-income people would pay a greater share of their incomes on property taxes than do their wealthier counterparts. Under this scenario, the property tax is regressive, a feature that elected officials do not favor.3 Opinions are those of the authors, and are not necessarily those of any institution to which they belong. 1. See Tiebout (1956). 2. See Hamilton (1975). 3. For discussions of the regressivity of the property tax, see Suits (1977), Aaron (1974), and Musgrave (1974). These works suggest that the property tax is less regressive than, say, the sales tax, and that when

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Policy makers also worry about whether property taxes cause rural homeowners to be “taxed off their farms,” or, in the case of the elderly, taxed out of their houses. In the same vein, lawmakers express concern that corporate property taxes that are too high will drive business elsewhere. All of these problems feed legislators’ sensitivity to the possibility of a tax revolt, such as the one that took place in California in 1978.4 State legislatures have developed a variety of policies intended to solve the problems discussed above; most states have enacted laws that give property tax relief to low-income people, to the elderly, to farmers, and to business, and in some cases, such as Minnesota and Kansas, to all homeowners.5 Ironically, many of these solutions have led to a narrowing of the tax base, and therefore to higher tax rates and payments for certain groups of property tax payers. This chapter assesses some of the implications of these policies; in particular, it will take a prima facie view of how property tax exemptions, as well as related policies such as different tax rates for commercial and residential owners or differential land valuation, narrow the tax rate and increase rates on nonexempt property. The Theory and Reality of Property Tax: The Issue of Equity Economists generally like the property tax because, to the extent that it is a tax on land (rather than improvements), it is a Ramsey Tax—a tax on something with low elasticity and therefore minimal impact on allocative efficiency. However, debates have long existed and continue about the property tax’s true impact on allocative efficiency with respect to improvements and its impact on equity. Because lawmakers justify many property tax relief programs on the basis of equity, that will be our focus here. With respect to equity, even the leading scholars in the field have trouble agreeing on the bottom line—who pays more in property taxes—and there are good reasons for this. If we look at the property tax in a more straightforward way, assuming that incidence is closely related to statutory obligation, the distributional impact of the tax is still not entirely clear. This lack of clarity can be attributed in part to the exemptions and tax credit programs that are the focus of this chapter. For example, many jurisdictions have policies in place that provide property tax relief through the income tax code, such as circuit breakers

incidence is accounted for properly, property taxes may not be regressive at all. But as Aaron noted, this did not prevent officials from thinking that property taxes are regressive. 4. See Preston and Ichniowski (1991) and Lowery and Sigelman (1981) for discussions on the origins of the California property tax revolt. 5. See George Washington Institute of Public Policy and Lincoln Institute of Land Policy (2008).

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and tax credits. Circuit breakers prevent households in certain income classes from paying more than a certain level of income in property taxes. Tax credits map property tax payments into income tax relief; such credits are sometimes means tested, and sometimes not. These policies effectively reduce property tax burdens for households with incomes that fall below some critical point to mitigate the perceived regressive nature of the tax. Most jurisdictions also have policies that create departures from an ad valorem structure. These might include use valuation (where property is valued based on how it is currently used, rather than its highest and best use), limits on changes from year to year in assessed value (Proposition 13 in California is the most dramatic example of this), and differences in effective tax rates across property classes. While enacted with the intent of increasing equity, some of these may actually make property taxes less progressive than they otherwise would be. We should pause to note that in an Ando-Modigliani life framework (Ando and Modigliani 1957), it is not at all clear that that the property tax is regressive. If households make housing decisions based on lifetime income, and the lifetime income-elasticity of demand for housing is 1, then the property tax will be proportional to lifetime income. Green and Malpezzi (2003), in reviewing housing literature, show that while income elasticities of demand for housing within cross-sectional analyses are generally less than 1, income elasticities of demand for housing across time series are about 1. In summary, while the property tax appears regressive in a contemporaneous income framework,6 the reality is that in a life-cycle framework a pure ad valorem property tax is more or less proportionate. We would argue that the problems with equity thus stem mainly from the exemptions to the property tax, and not from the tax itself. Property Tax Exemptions: Implications for Tax Base, Revenue, and Distribution Public finance theory has some basic tenets, among which two are relevant as we think about property tax exemptions. First, there is a widely held belief that low rates on a broad tax base are superior to higher rates on a narrow base, since lower and uniform rates are less likely to create distortions than higher and nonuniform rates.7 Second, public finance theory asserts that direct expenditures

6. Although we must again note that if the incidence of the tax falls on owners of capital, the property tax may be progressive even in a contemporaneous income framework. 7. Buchanan (1987) makes the classic case for this proposition.

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are more efficient than tax expenditures (e.g., tax breaks for certain behaviors relative to others). For example, if policy makers seek to even the income distribution, they would do better to give direct subsidies to low-income people than to give them homestead tax credits (Edal and Sclar 1974). As this chapter sets out, exemptions tend to violate one or both of those tenets, leading to inefficient use of public resources and decreased overall revenues. Property tax exemptions could be divided into two types: broad and specific. Among the broadest are those favoring homeowners and residential property; on average, property owners pay lower property taxes than do renters, and commercial property owners are charged higher taxes than are owners of residential property. Among the more common specific exemptions are farm preservation tax credits and tax benefits for the elderly.8 While different in scope, each brings with it its own economic consequences and distortions. Home ownership is among the most sacred of cows in American politics. Writers have championed the glories of home ownership at least since the days of Tocqueville, and numerous American presidents have praised its virtues. They are not without reason; there do, indeed, seem to be some social benefits that result from owner occupation. DiPasquale and Glaeser (1998) have shown that homeowners are more likely than renters to be civic minded, and Green and White (1997), as well as Haurin, Parcel and Haurin (2002), find that child outcomes for owners seem to be better, after controlling for a variety of household characteristics, than for children of renters. Let us assume, then, that home ownership carries sufficient social benefits to make it worth subsidizing. This does not mean that the best method for encouraging home ownership is property tax relief for owners. First, many owners would be owners regardless of tax treatment. A universal property tax relief program for owners amounts to a tax expenditure that enriches people who would already engage in the desired behavior. As such, it very much parallels the mortgage interest deduction, which many have shown does little to increase homeownership. Second, much of the benefit of the property tax is related to the Tiebout hypothesis. When ad valorem property taxes are the principal source of revenue for local spending, taxpayers have a strong incentive to make sure their money is well spent: they will demand that the capitalized benefit of the spending exceeds the capitalized cost of the housing. Nechyba (2003) maintains that decoupling school funding from local revenue sources reduces public school quality and increases flight to private schools. Thus policies that relieve property taxes for owners with a substitute source of revenue undermine the 8. See George Washington Institute of Public Policy and Lincoln Institute of Land Policy (2008) for a list of states and their exemptions.

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beneficial connection between local revenue generation and local government spending. Property tax limits for owner-occupied housing can also have the simple impact of limiting local spending. But the impact of tax mix on total spending is not the focus of this chapter. This chapter is rather about the implications on exemptions and differential treatment on the property tax base and property tax rates given some level of spending. Commercial property owners are like renters in that they tend to pay higher property taxes than residential owners. Taxing commercial properties at higher rates is understandably tempting to government officials: it allows them to provide the level of services that voters want without taxing them to the extent required to pay for those services. But businesses, like voters, may vote with their feet, and many will eventually, if not immediately, leave a jurisdiction with relatively high expenses, including property taxes. Perhaps more critically, effective differential tax rates on residential and commercial properties distort the mix of land uses in a community. Henry George famously advocated for a single tax based on land value, whose rate would be independent of how the land was used.9 In addition to the two general preferences discussed above, many states also engage in differential valuation of certain types of land. States are increasingly taxing agricultural land based on use value rather than market value. This likely reflects both the ingenious nature of farm lobbying (which explains the large tax preferences for agricultural land in a state like Kansas) and a preference on the part of suburban dwellers to preserve green space (which explains the preference for agricultural land in places such as suburban Maryland). But it also represents a shift of the tax burden away from farm property to other types, and a shift of the tax burden from farmers who have valuable land to those whose land cannot be converted to urban use. As such, taxing farm property based on use value is both distortionary and inequitable. Finally, policy makers worry about taxing the elderly out of their houses. It is surely reasonable public policy to try to help retirees to remain in their houses. We must remember, however, that the elderly who own expensive houses are, in fact, wealthier than the elderly who own less expensive houses or rent. As such, the policy is regressive.10 Changing state laws to allow property taxes owed by the elderly to accrue until time of death or sale of the house would accomplish the goal of not putting an undue cash flow burden on the elderly, without providing 9. It is worth noting that although George agued that public finance using anything other than land taxed created economic distortions, zoning likely creates more distortions than differential taxes. 10. Much modern economic literature discusses why wealth, which serves as a proxy for lifetime income, may be a better basis for determining tax equity than income.

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tax benefits to the relatively affluent, as current policies do. We recognize, however, that this may not be a politically popular proposal.11 It is a well-known fact that property taxes are politically unpopular. This may explain why various interest groups have been able to convince legislatures to undermine property taxes through a series of exemptions and preferences. The irony is that some taxpayers, who pay the full property tax rate for their state or municipality, wind up disliking property taxes even more. Perhaps these taxpayers do not entirely understand how much higher their rate is because of basenarrowing exemptions and assessments based on something other than full market value. They may be interested to know how much, given current spending, property tax rates could be cut if exemptions, preferences, and special assessments were eliminated. At least as important, if states do not know what their various exemptions and deviations from full taxes are costing them (as well as the distribution of gains and losses among its residents), they cannot understand the impact of their policies. This chapter seeks to set this issue out in accessible terms, so that states and their residents can understand the trade-offs being made and make informed decisions as to whether to keep them. Because it keeps better data on its property tax system than other states, we will use Wisconsin as a case study. Institutional Structure: What do States Exempt and Value Differently? We now describe policies in Wisconsin, which has a “model” system of accounting for and measuring the impact of its property tax exemptions and differentiations. Wisconsin alone seems to have sufficient data to draw some inferences about the impact of its exemptions on its property tax bases. In Massachusetts, for example, exemptions tend to be determined at the local level, and there is no systematic survey of how much they affect the overall tax base in that state. Real Property Exemptions Wisconsin’s property tax exemptions are not unusual; the state has removed the same types of property from its property tax base that other states commonly remove. A 2005 report compiled by Secretary of Revenue Roger Ervin for Governor Jim Doyle calculates the percentage of total state exemptions that each type constitutes and the property value of the exemptions.12 Religious establishments account for 32.9 percent, or $7.4 billion; nonprofit hospitals for 11. At the 2006 spring meeting of the National Tax Association in Washington, DC, Richard G. Woodbury, a member of the Maine legislature as well as a Research Associate with the National Bureau of Economic Research, related that he was labeled “immoral” by his fellow legislators for proposing just such a policy. 12. Doyle (2007), 75–76.

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11.9 percent, or $2.7 billion; residential property owned by benevolent associations (YMCAs, Scouts, and the like) for 10.3 percent, or $2.3 billion; K–12 public schools represent 7.5 percent, or $1.7 billion; private colleges are close at 6.7 percent, or $1.5 billion; and “others” (educational, religious nursing and retirement homes, and so on) make up the remainder. In addition to these visible and commonly known exemptions, there are a number of types of real property that are taxed at less than full market value. These include the sorts of differential valuations discussed above. While not technically exemptions, they work as such; the owners of the properties benefit from lower taxes, and the state obtains less revenue, owing to policy decisions about their merits that change the state’s tax base. These are discussed below. Personal Property Exemptions Wisconsin, along with many other states, exempts “most personal property, [including] household furniture and furnishings, machinery and equipment used in manufacturing, computer equipment, pollution abatement equipment and inventories . . . from the property tax.”13 In his report on the impact of tax exemption devices, Ervin calculates the costs of these exemptions, which constitute another sizeable chunk of potential revenue:14 • Machinery and equipment used in manufacturing: $1.34 billion worth of such equipment was taxable, so assuming 10 percent is taxable, about $13 billion is exempt. • Waste treatment facilities: The department estimates that approximately $2.5 billion of [nonutility] waste treatment property is exempted.15 • Computer Equipment: In 2005, roughly $3.2 billion in such equipment was exempted, and the state’s compensating aid payments in fiscal year 2006 totaled only $67.7 million.16 While not necessarily major contributors to the overall cost of tax exemptions and deviations in this state, or any other, we felt it useful to include these exemptions for two reasons. First, they represent, in many cases, a small percentage of what used to be much larger chunks of state revenue; second, most of them were enacted in ways very similar real property exemptions—the state’s 13. Ibid. 14. Ibid. 15. “Qualifying facilities must remove, alter or store waste materials. The exemption is available to utilities, manufacturers and commercial businesses.” Oakleaf, et al. (2007), 14. 16. Exempt are: mainframes, minicomputers, personal computers, networked personal computers, servers, terminals, monitors, disk drives, electronic peripheral equipment, tape drives, printers, basic operational programs, systems software, prewritten software, faxes and cash registers. Oakleaf, et al. (2007), 14.

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desire to help or placate a particular population or industry, inevitably placing more of a burden on others. We now move on to the deviations and valuations that are the focus of this report. Nonexemptions that Affect Property Tax Revenue and Distribution Wisconsin’s real tax laws deviate from full market value (FMV) in three important ways. As a state with an agricultural tradition, Wisconsin’s farmers have been successful in lobbying to decrease the share of property taxes they pay.17 A set of laws ordering the assessment of farming and other types of property at less than FMV causes the loss of a third chunk of property tax revenues for municipalities and school districts, beyond the “standard” real and personal property exemptions, and further narrows the tax base. In response to farmers’ complaints that property taxes would force them to sell their land to developers,18 the state passed a law in 1995 valuing agricultural property at its agricultural use value, rather than its market value.19 A second law, which was initially enacted in 1927 and later revised and combined with another, gives special property tax treatment to owners of qualifying forest land.20 The intention is to reduce the burden on owners of such land, who reap a harvest only once every several years, and are thus burdened in a different way, with respect to tax payments, from other people who earn their living off the land. The state amended the tax code so that landowners of forest land pay a flat annual per-acre fee, plus a severance tax when timber is harvested.21 Finally, since the 1970s “swamp and waste” land has been counted as “undeveloped” and assessed at 50 percent of market value. In addition to deviations from FMV in agricultural contexts, Wisconsin has adopted a number of other exceptions that act like exemptions. First, like many other states, Wisconsin has a TIF (tax incremental financing) program. Started in 1975, the program was substantially expanded in 2003 and 2005.22 17. While the state has an agricultural tradition, agriculture’s share of employment in Wisconsin is now less than 1 percent. 18. It is perhaps worth mentioning that the exemption does nothing to prevent farmers from selling to developers. 19. The law was originally scheduled to be phased in through 2007, but based on an October 1999 recommendation by the Farmland Advisory Council, the state “promulgated an emergency rule providing for the full implementation of use value beginning in 2000.” Boldt (2002). 20. In 1985, the state combined the 1927 Forest Crop Law and the 1954 Woodland Tax Law (for smaller plots) in the Managed Forest Laws. Doyle (2007), 79. 21. The state Department of Revenue (DOR) estimates a net tax reduction of $61.4 million for FY 2005– 2006 for the Forest Tax Laws. See Doyle (2007), 79–82 and Table 1 for details. 22. “2003 Wisconsin Act 231 and 2005 Wisconsin Act 13 provided towns with the limited authority to create TIF districts. Similarly, 2005 Wisconsin Act 357 allowed certain counties with no cities or villages (Florence and Menominee counties) to create TIF districts.” Runde (2007), 1.

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Under Wisconsin’s program, city and village governments are permitted to create a TIF district if 50 percent or more of the area is “blighted,” in need of rehabilitation or conservation work, or suitable for industrial sites or mixeduse development. Once an area is designated as a TIF, a base incremental tax value, which is equal to the equalized property value, is established.23 The tax increment is equal to the difference between the value of the TIF-zone property tax levy and the zone’s base value. All taxing jurisdictions within the district divide the increment and pay it, thus paying off the cost of the redevelopment. Data from 1975 to the present indicate that • 1,428 TIF districts have been established, 516 have been terminated or dissolved, and 912 are still in existence;24 • overall, the average annual change in incremental value in TIF districts has been 12.5 percent, and the change in equalized value 8.3 percent;25 • Overall, tax increment levies have increased nearly 10 percent annually, total levies for villages and cities have increased nearly 5 percent, and the percent of total levies attributable to tax increment is about 3.5 percent.26 One could make a case that TIFs do not reduce the property tax base, since the benefits to property owners arising from the TIF are based entirely on the “incremental” value created by the property, and the property does pay taxes on the enhanced value. That said, the taxes go to infrastructure improvements connected specifically to the property. Also, TIFs may have two other negative impacts on the property tax base. First, as lawmakers and residents of non-TIF districts complain, many TIF-assisted developments would likely have taken place without the TIF, and hence could potentially add to the property tax base for schools and other municipal services. Second, some TIFs assist developments that are not economically feasible, and as such may cost communities more than their ultimate contributions to the tax base. Property Tax Relief to Individuals Also like most other states, Wisconsin has programs in place to grant property tax relief to individuals. In 1963, the homestead credit helped low-income senior citizens, providing a refundable maximum of $300 against income taxes for 23. Equalized value is the market value as certified by the state. Wisconsin estimates equalized value so that municipalities cannot provide low estimates of taxable property for the purpose of benefiting from the state aids to municipalities formula. 24. See Runde (2007), Table 1. 25. See ibid., Table 2. 26. See ibid., Table 3.

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50 percent (or 75 percent at lower incomes) of property taxes (or rent that was property taxes) exceeding 5 percent of income. It has since broadened substantially, costing the state much more as a result.27 In order to help farmers in an era in which farming increasingly does not produce revenue equivalent to other uses, and to preserve some land as open space, a tax credit was given in 1977, with a range.28 And the state established a property tax deferral loan program to help low-income elderly homeowners hold onto their homes in the face of rising property tax rates. Finally, in 1981 state property tax credits were revised in response to discontent in disadvantaged rural areas: “Between 1982 and 1983, both GPTR (general property tax relief) and PPTR (personal property tax relief) were replaced by the Wisconsin state property tax relief program (WSPTR).”29 Aid to Municipalities to Equalize Revenue-Raising Capacity Wisconsin does have several programs in place that grant property tax relief to municipalities, purportedly in order to compensate them for losses due to property tax exemptions and the like. The largest of these is the shared revenue program (county and municipal aid and utility aid). These two aid programs, part of the state’s property tax relief program, are general, unrestricted aid and “rank as the fifth largest state general fund program.” Nevertheless, the program is insufficient to put all municipalities on a level playing field with respect to property tax capacity.30 The shared revenue program dates back to 1911, when state taxes were used to compensate local governments for exemptions to the property tax. When the individual and corporate income taxes were enacted in 1972 to replace the property tax on intangible personal property, shared revenue became the way to make up for lost revenue for municipalities and counties. Other revenues also shifted from locality to state. In 1971, however, the “return-to-origin” system was replaced with one based on local need, with four components: per capita, utilities, percentage of excess

27. Stark (1992), 35. 28. Ibid., 51. 29. “In 1982, $54,417,900 was distributed according to the old PPTR formula and $118,729,900 was paid according to the old GPTR formula. According to a new WSPTR formula based on the share of school property taxes collected, municipalities were to be paid the following amounts: $59.4 million in 1982, $105 million in 1983, and $195 million in 1984 and thereafter. The rest of the WSPTR payment, which was to increase annually, was to be paid to municipalities according to the school aid formula, thereby adding an element of equalization to shared revenue. Current credits are paid on 2 bases: property taxes levied for school districts and property taxes levied for municipalities.” Ibid., 53. 30. Shared revenue falls “behind general elementary and secondary school aids, medical assistance, the University of Wisconsin system, and corrections.” In 2004, the state transitioned from shared revenue to county and municipal aid, at which point “total payments declined by 7.9 percent.” Olin (2007a), 1.

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levies, and minimum guarantee.31 Payments are fairly consistent from 1997– 2001, with municipalities receiving $761 million and counties $189 million. There is a small spike in 2002–2003, after which a decline brings these amounts down to about $720 and $175 million, respectively.32 A second area of targeted municipal aid includes the expenditure restraint, computer aid, and small municipalities shared revenue programs.33 Since 2003, the annual distribution has been set at $58.1 million, with distribution based on the share of the municipality’s excess levy within all excess levies of qualifying municipalities.34 As discussed above in the section on more specific and recent exemptions, since 1999, when the property tax levy exempted computers, software, and related equipment from property taxes (the exemption was expanded in 2003–2004 to include cash registers, faxes, and similar devices), the state instituted a hold harmless measure to compensate those localities that lost revenue as a result. “Payments equal the value of the exempt property multiplied by the local government’s current tax rate.” Annual payments are around $65 million; recently they have declined slightly. A shared revenue program for small municipalities existed from 1994 to 2004 but has since been suspended and folded into other programs. Other programs include the payments for municipal services program, which pays about $20 million annually to municipalities for services they provide to state government offices,35 and state property tax credits, which are made up of school levy and lottery and gaming credits. The former could be viewed as a payment in lieu of taxes, whereby the state is simply compensating municipalities for the direct service burden it places on them, while the latter is a tax credit program where credits are paid to municipalities and shown on property tax bills.36 School levy tax credits are distributed to municipalities, which then give them directly back to individual property owners, based on each municipality’s share of statewide levies for school purposes. The lottery 31. See ibid., 7–11, for further history and details about the current aid system. 32. Ibid., Table 1. Table 2, “Distribution of Estimated 2007 County and Municipal Aid and Utility Aid (Shared Revenue) Payments,” sets out county and municipal aid totaling $860 million and utility aid totaling $38 million. 33. “The expenditure restraint program provides targeted, general aid to towns, villages, and cities.” There are two criteria to receive aid: the municipality must have a full-value property tax rate over five mills, and it must restrict the rate of year-to-year growth in its budget according to a formula. “For the year prior to the aid payment, the rate of budget growth cannot exceed the inflation rate plus an adjustment based on growth in municipal property values. . . . To be eligible for a 2007 payment, municipalities were required to limit their 2006 budget increases to 3.3 percent to 5.3 percent, depending on individual municipal adjustments due to property value increases. . . . For 2007 payments, 413 municipalities met the tax rate test, but only 318 municipalities also met the budget test.” Olin (2007c), 1–2. 34. Ibid., Table 1. Showing that from 1998 through 2007, cities received by far the largest share of the distribution, generally 90 percent or more, with villages getting around 9 percent and towns just a little. 35. Runde (2007), 1. 36. Olin (2007b), 1.

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was established in 1987 with the specific goal of property tax relief, and, since 1991, it goes to owners of taxable property, with owners of less valuable property getting a higher percentage of tax relief.37 The school levy tax credit system had annual funding of $469 million from 1996 to 2005, and has been increased to $593 million starting in 2006–2007.38 For 2005–2006, lottery and gaming credits were $120 million, increasing to $145 million in 2006–2007.39 Redistributing state revenue (whether from a lottery or other source) to place school districts and municipalities on a level playing field is an understandable yet controversial policy. On the one hand, it does seem manifestly unfair that cities that have relatively little taxable property value per student should have to compete with cities that have considerable value. The phenomenon is particularly problematic when affluent municipalities use fiscal zoning (see Fischel 1995, 266) to exclude low-income households and their children. Under such circumstances, some sort of redistribution plan seems the only mechanism by which children in property-poor school districts will have adequate resources for their education (and a number of state supreme court decisions have made just this point). On the other hand, one attribute of some property-poor municipalities and districts is poor government management. Indeed, they are property poor in part because they have high tax rates and low levels of service. One could question whether redistributing revenue to poorly performing governments will produce desirable policy outcomes. Wisconsin is not alone in its property tax exemptions of and preferences for “standard” classes of real, and to a much lesser extent personal, property. It is also not alone in enacting laws granting tax relief to certain classes of residents viewed as particularly vulnerable. We discuss the fiscal implications of these policies below. We reiterate that unlike the vast majority of other states, Wisconsin has taken on the difficult but important task of trying to calculate how much these various exemptions and deviations cost it. While far from complete, this extensive data collection and analysis regime distinguishes Wisconsin from any other state we studied, or that we know of, and serves as a model that we believe other 37. In some years, the credit was targeted to “property used as the owner’s primary residence,” which meant that fewer received it. In other years, all property owners received it. Ibid., 5. 38. “Statewide, the credit reduced the school portion of 2006(07) property tax bills by an average of 15.2 percent. On a home with a full market value of $150,000 subject to the average statewide levy rate for school purposes, school taxes of $1,247 would have been reduced by a credit estimated at $190. Higher-valued homes would receive a proportionately higher credit. For example, a $250,000 home taxed at the same rate would have a school tax bill of $2,078 and would receive a credit estimated at $316. The actual percentage reduction in school taxes will vary by municipality.” Ibid., 2. 39. Ibid., Table 2 shows amounts allocated for all types of Wisconsin state property tax relief credits from 1980 (total $344 million) through 2007 (total $738 million, estimated), and how they have changed in amount and shifted in type over time.

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states would do well to emulate. As discussed in more detail in the conclusion, one of the most important steps for states to take in reforming their property tax laws is to be able to understand the impact the current laws have on tax base, revenues, and distribution. Impact: How Much Do These Exemptions Cost the State? Ervin (2005) investigates the impact that exemptions have on the property tax base. We use this to calculate how much the state loses annually as a result of its various property tax exemptions and differential valuations and classifications. Real property that is exempt from taxation includes property owned by religious establishments, educational and medical facilities, and residential property that is owned by benevolent associations. In total it is estimated that the value of this exempt property is $22.5 billion. There are also a number of exemptions to personal property taxation, most notably the exemption for machinery and equipment for manufacturing, which comprises an estimated value of $12.0 billion. If the exempt property examined in this report were taxable, property tax rates would be reduced by an estimated 8.6 percent statewide, ranging from a 12.6 percent reduction in cities to a 3.2 percent reduction in towns.40

While it offers a well-calculated estimate of the cost to the state of its various property tax exemptions and differential valuations, the report begins with a caveat on how the cost of exemptions is measured, noting several potential problems.41 First, when fiscal impacts are measured (which is difficult), it is assumed that only that provision, and no other, is changed, which may not be realistic. Thus, two or more changes should not be combined to produce a total estimate of the fiscal impact. It is assumed that changes do not alter behavior, which is also unrealistic. For example, a change in income tax deductions may prompt people to spend and save differently. As with many such data collection efforts, this one is not complete; not all districts may report. Indeed, in 2006, as of the time the report was compiled, 248 of 1,907 taxation districts, about one of eight, had not reported. The author notes, too, that “the value of exempt federal, state, and local government property is not included in this report.” Finally, and perhaps most difficult to correct for, exempt property may be systematically undervalued for two reasons: (1) the inability to value highly specialized property, which has not been on the market and is unlikely to be in the near future, properly; and (2) a desire to minimize the perceived benefit of the tax exemption for political reasons. 40. Ervin (2005), 2. 41. Calculations throughout the following discussion are derived from Ervin (2005).

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These caveats aside, however, the report goes into substantial detail about how the values of the property and exemptions were calculated, suggesting that at the very least, Wisconsin has made a good faith effort to inform the public and policy makers, on this important issue. The report focuses on exempt real property, using the estimated fair market value submitted by owners of such property.42 Each type of property is categorized (as a place of worship, a hospital, and so on) and then placed within a value range ($1–$10,000, $10,000–$100,000, and so on). The calculation involves using the midpoint of each range and then multiplying the number of parcels within that category and value range by the midpoint dollar value. Based on this aggregation, the value of the 19,483 exempt parcels in the summary report is $21.5 billion.”43 For those exemptions that were not reported—as noted above, 248 municipalities did not report for the most recent set of calculations—estimates were made based on the percentage of taxable property reported to be exempt among districts that did not report. “The value of exempt real property in the nonfiling municipalities was added to the $21.5 billion for the municipalities that filed, producing a total of nearly $22.5 billion.”44 Bottom Line: How Much More Are State Residents Paying, and Who Is Burdened? We take the information above to develop a first-order estimate of how much the average property tax payer’s tax burden would be reduced if no property were exempt from the tax and all property were treated equally under the tax system. Wisconsin’s system is arguably the closest to a uniform property tax system among the states we have reviewed. Overall, the state has a potential property tax base of $469 billion, of which $40 billion is exempt from taxation (Doyle 2007). The effect of this is straightforward. More difficult is the issue of use value assessment for agricultural land. We approach it by looking at assessed value of agricultural land in Wisconsin during both the last year it was taxed on a highest and best use basis (2001) and the first year it was taxed on a use value basis (2002). In 2001, the taxable value of agricultural land in Wisconsin was $5 bil42. “Owners of several types of exempt real property must report, in even-numbered years, the estimated fair market value of the property. Municipalities submit these numbers to the DOR, which tabs the data and estimates total property value by owner category. NOTE: Owners of exempt personal property do not have to report it, and new 1996 legislation repealed the reporting requirements for many types of districts, so this report ‘focuses on exempt private real property.’ ” Doyle (2007), p. 75. 43. “In order to estimate total values for each category of property, the number of parcels in each value cell for a category is multiplied by the midpoint of the range of values for that cell, and the results summed. Thus, for the ‘place of worship’ classification, the 142 parcels in the $1–$10,000 range multiplied by $5,000 is added to the 974 parcels in the $10,000–$100,000 range multiplied by $55,000, and so on for each value category and classification.” Ibid., 75. 44. Ibid.

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lion, falling to $2.8 billion in 2002. We can estimate, based on these figures, that 44 percent of agricultural value was removed from the tax base in that single year.45 In 2006, the assessed value of agricultural land in Wisconsin slipped even further, to $2 billion. Assuming that 44 percent of agricultural value continues to be exempt, this means that the tax base lost to the exemption was $1.6 billion.46 When we add the direct exemptions to the exemption implied by the use valuation of farm land, we find that the Wisconsin property tax base has been eroded by at least 9 percent by exemptions and special assessments. If property taxes were levied on a uniform basis, those paying full rates on full values would pay about 8.6 percent less in property taxes than they do now. In our view, 8.6 percent is a large number: most property owners would be happy receiving a tax cut of 8.6 percent. It is entirely possible, however, that the number would be even larger in other states. George Washington Institute for Public Policy, et al.’s (2008) work suggests that Wisconsin is sparing in its use of exemptions and differential tax rates relative to other states. To give one example where favorable treatment of a particular type of property has an enormous impact on tax payment to others, we may look to Kansas, where Fisher and Gile (2006) estimate that about 15 percent of property is exempt, but also note that its property tax system is not remotely uniform. More specifically, Fisher and Gile show that the market value of agricultural land in Kansas is nearly five times its taxable value, and that the share of the taxable value of residential property is less than its share of market value. On the other hand, commercial properties’ share of the tax base is 80 percent higher than their share of property values. If Kansas were to move to a uniform system of taxation and hold spending constant, the impact would be a large property tax increase for residential homeowners and an extraordinary increase for farmers, while owners of commercial/industrial property would see a sizeable tax cut. In other words, the political issues involved in moving the state toward a more uniform system of property taxation would be quite complicated, pitting some groups of residents against others. Conclusion The federal tax code contains many exemptions (for example, imputed rent on owner-occupied housing is not taxed), deductions (charitable giving, mortgage interest, accelerated depreciation, and certain health expenses being the best 45. See Town, Village and City Taxes (2001) and (2002), http://www.revenue.wi.gov/pubs/slf/tvc01.pdf and http://www.revenue.wi.gov/pubs/slf/tvc02.pdf. 46. It is possible that the amount is larger than this, because residential property (the likely alternative use) value rose quite rapidly in Wisconsin between 2002 and 2006.

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known), and preferences (for example, capital gains and dividends are taxed at a lower rate than ordinary income). Many of these exemptions, deductions, and preferences, are controversial, but as a matter of policy, taxpayers are informed about the costs of these departures from the basic tax structure. The Office of Management and Budget makes an attempt every year to quantify the costs of these characteristics of the tax code by presenting a document known as the Tax Expenditure Budget.47 In fact: The Congressional Budget Act of 1974 (Public Law 93–344) requires that a list of “tax expenditures” be included in the budget. Tax expenditures are defined in the law as “revenue losses attributable to provisions of the Federal tax laws which allow a special exclusion, exemption, or deduction from gross income or which provide a special credit, a preferential rate of tax, or a deferral of liability.” These exceptions may be viewed as alternatives to other policy instruments, such as spending or regulatory programs. Identification and measurement of tax expenditures depends importantly on the baseline tax system against which the actual tax system is compared.48

The OMB estimates of tax expenditures show they are large: for example, the mortgage interest deduction is about $80 billion, and accelerated depreciation for plant and equipment is about $277 billion. OMB does not give a total: “Each tax expenditure estimate in this chapter was calculated assuming other parts of the tax code remained unchanged. The estimates would be different if all tax expenditures or major groups of tax expenditures were changed simultaneously because of potential interactions among provisions. For that reason, this chapter does not present a grand total for the estimated tax expenditures.”49 Nevertheless, the individual items give policy makers and taxpayers a sense of how much lost revenue must be recaptured by other parts of the code to generate a certain level of tax receipts. State and local governments generally have no such requirement for estimating the impact of tax expenditures. Indeed, our research has shown that Wisconsin is among the few states, if not the only one, that collect data in such a manner that calculating such an expenditure budget is feasible. The inability or unwillingness of most states to detail the revenue costs of their exemptions and preferences creates a serious problem from the standpoint of transparency and policy development. The transparency issue may be the more important of the two: for instance, while many economists think the 47. Anaytical Perspectives, Budget of the United States 2007, p. 285. Accessed at http://www.law.wayne .edu/mcintyre/text/Taxation_Class/US_Budget_tax_expenditures.pdf. 48. Ibid., 285. 49. Ibid.

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mortgage interest deduction is an inefficient and inequitable tax expenditure, taxpayers and members of Congress know what it costs the treasury, and have decided for various reasons to retain it. In the case of, say, an agricultural preference in a state’s property tax code, it is not entirely clear to taxpayers in many states what they are actually paying to support a policy of “preserving farms.” It may be that armed with such knowledge, taxpayers will still be willing to support the preference, but as things currently stand, they may be supporting something they view as iconic without knowing what they are paying to do so. In his comments, Schwab suggests that states and local government should develop their own tax expenditure budgets. This is almost certainly a good idea. But doing so will require states, counties, and cities to develop capacity that they currently lack. Wisconsin is not a particularly large or rich state; the fact that it can come close to providing the tools necessary to measure tax expenditures means that other places can do it too. REFERENCES

Aaron, Henry. 1974. A new view of property tax incidence. American Economic Review 64(2): 212–221. Ando, A., and F. Modigliani. 1957. Tests of the life cycle hypothesis of saving: Comments and suggestions. Oxford Institute of Statistics Bulletin (May):99–124. Boldt, Rebecca. 2002. Impact of use valuation on agricultural land values and property taxes. Madison: Wisconsin Department of Revenue. Buchanan, James. 1987. Public finance in the democratic process: Fiscal institutions and individual choice. Chapel Hill: University of North Carolina Press. DeNucci, A. Joseph. 2005. The state auditor’s report on the local financial impact of property tax exemptions for senior citizens, pursuant to Massachusetts General Laws Chapter 11, Section 6B. (September). DiPasquale, Denise, and Edward L. Glaeser. 1998. Incentives and social capital: Are homeowners better citizens? Journal of Urban Economics 45(2): 354–384. Doyle, Jim. 2007. State of Wisconsin summary of tax exemptions devices. State of Wisconsin Department of Administration, Division of Executive Budget and Finance and Department of Revenue, Division of Research and Policy (February). Edel, Matthew, and Elliott Sclar. 1974. Taxes, spending and property values: Supply adjustment in a Tiebout-Oates model. Journal of Political Economy 82(5):941–954. Einess, Ward. 2007. Limited market value report, 2006 assessment year, taxes payable 2007. Minnesota Department of Revenue, Tax Research Division (March 1). Fischel, William. 1995. Regulatory takings: Law economics and politics. Cambridge, MA: Harvard University Press. Fisher, Glenn W., and Crystal Gile. 2006. Erosion of the Kansas property tax base. Wichita: Kansas Public Finance Center, Hugo Wall School of Urban and Public Affairs, Wichita State University (December).

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George Washington Institute of Public Policy and Lincoln Institute of Land Policy. 2008. Significant features of the property tax. Green, Richard K. 1996. Should the stagnant homeownership rate be a source of concern? Regional Science and Urban Economics 26(3–4):337–368. Green, Richard K., and Stephen Malpezzi. 2003. A primer on US housing markets and housing policy. Washington, DC: Urban Institute Press. Green, Richard K., and Michelle J. White. 1997. Measuring the benefits of homeowning: Effects on children. Journal of Urban Economics 41:441–461. Haurin, Donald R., Toby Parcel, and R. Jean Haurin. 2002. Does home ownership affect child outcomes? Real Estate Economics 30:635–666. Hamilton, Bruce. 1975. Zoning and property taxation in a system of local governments. Urban Studies 12:205–211. Lowery and Sigelman. 1981. Understanding the tax revolt: Eight explanations. American Political Science Review 75(4):963–974. Minnesota Department of Revenue. Minnesota’s property tax system: An overview. http:// www.taxes.state.mn.us/taxes/legal_policy/other_supporting_content/property_tax _primer.pdf. Musgrave, Richard. 1974. Is a property tax on housing regressive? American Economic Review 64(2):222–229. Nechyba, Thomas J. 2003. Centralization, fiscal federalism and private school attendance. International Economic Review 44(1):179–204. Oakleaf, Michael, Brad Caruth, Blair Kruger, and Pamela Walgren. 2007. State tax incentives for economic development in Wisconsin. Wisconsin Department of Revenue, Division of Research and Policy. Olin, Rick. 2007a. Shared revenue program (county and municipal aid and utility aid). Informational Paper 18, Wisconsin Legislative Fiscal Bureau. ———. 2007b. State property tax credits (school levy and lottery and gaming credits). Informational Paper 22, Wisconsin Legislative Fiscal Bureau. ———. 2007c. Targeted municipal aid programs (expenditure restraint, computer aid, and small municipalities shared revenue). Informational Paper 19, Wisconsin Legislative Fiscal Bureau. Preston, Anne E., and Casey Ichniowski. 1991. A national perspective on the nature and effects of the local property tax revolt. National Tax Journal 44(2):123–145. Runde, Al. 2007. Tax Incremental Financing. Madison: Wisconsin Legislative Fiscal Bureau. Stark, Jack. 1992. A history of property tax and property tax relief in Wisconsin. Legislative Reference Bureau. Suits, D. B. 1977. Measures of tax progressivity. American Economic Review 67(4):747– 752. Tiebout, Charles M. 1956. A pure theory of local public expenditures. Journal of Political Economy 64(5):416–424. Zodrow, George. 1991. On the traditional and new views of dividend taxation. National Tax Journal 44(4):497–509.

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COMMENTARY

ROBERT M. SCHWAB

A

s Richard Green and Elaine Weiss explain, the effective property tax rate can vary dramatically from property to property within a jurisdiction as a result of a broad range of exemptions and exclusions. So, for example, taxes on farmland may be based on current use rather than highest and best use, homeowners may enjoy a homestead exemption, the elderly may benefit from circuit breaker provisions, and nonprofit organizations may be exempt from the property tax. Green and Weiss then ask an interesting question. What is the cost of these exemptions? Based on a careful review of the Wisconsin property tax, they conclude that if property taxes were levied on a uniform basis, those paying full rates would pay 8.6 percent less in property taxes than they do now. Green and Weiss make a very useful contribution to the property tax literature. These exemptions are widespread, yet we have little systematic evidence about their cost. This chapter is a significant step toward filling that gap. In my comments, I focus on three issues. First, I try to put the Green and Weiss estimate for Wisconsin in a broader context. I then look at the role of payments in lieu of taxes (PILOTS) in determining the cost of property tax exemptions. Finally, I argue that property tax exemptions are a special case of a broader problem. These exemptions are tax expenditures. The federal government estimates the cost of federal tax expenditures every year. Perhaps state and local government should be required to estimate the cost of their tax expenditures as well. The Wisconsin Estimates in a Broader Context Let me first place the Wisconsin estimate in a broader context. How should we think of the Green and Weiss estimate of 8.6 percent of revenues? Is this estimate reasonable? Is it large compared to what we would find in other states? Has the cost of the exemptions changed much over time? These are difficult questions to answer. A full answer would require careful, detailed calculations for a number of states for several different years. I cannot offer those calculations, but I can offer a simple calculation that may prove to be useful. The 69

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TABLE 3.1C

Exclusions and Exemptions as Percentage of Assessed Value Subject to Local Property Taxes 1986 States

California

Percentage

States

Percentage

4.3

Maine

5.6

Georgia

10.4

Maryland

3.7

Hawaii

11.9

Oregon

2.9

Idaho

19.1

Rhode Island

6.6

Average

8.1

source: Census of Governments (1987).

1987 Census of Governments includes data for eight states on (1) educational, charitable, and religious exclusions; (2) exemptions; and (3) gross assessed values subject to the local property tax. I use those data to calculate exclusions and exemptions as a percentage of assessed value subject to the tax. Table 3.1C presents these simple back-of-the-envelope calculations. The average for the eight states included in the census sample is 8.1 percent, very similar to Green and Weiss’s much more careful estimate for Wisconsin. But there is a caveat here. There is a great deal of variation among the eight states. The estimates range from 2.9 percent in Oregon to 19.1 percent in Idaho. This suggests that it may be dangerous to draw broad conclusions from the Wisconsin case study. If states have very different costs, then there may be no typical case in any meaningful sense. This issue can only be resolved by replicating Green and Weiss’s work for a number of other states. Payment in Lieu of Taxes As Green and Weiss explain, educational, religious, and charitable organizations are typically exempt from property taxes. Some of these institutions, however, make a payment in lieu of taxes, or PILOT. A PILOT is a voluntary payment made by a tax-exempt organization to a local government. Some PILOTS are large. Harvard makes a payment of $1.7 million each year to the city of Cambridge; the MIT annual PILOT is $1.1 million. I would argue that if we want to develop a reasonable estimate of the lost property tax revenue from exclusions and exemptions, we need to net out the income local governments collect through PILOTS. Consider, for example, a

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town that foregoes $3 million by exempting a university from the property tax but then collects a $1 million PILOT from the university each year. The net foregone tax revenue is just $2 million. I would argue that this discussion of PILOTS leads to a number of interesting questions. • How common are PILOTS? • How much revenue do local governments collect through PILOTS? • Would PILOTS significantly change our view of the revenues lost from exclusions and exemptions? I cannot claim to know the answers to these questions. I suspect that PILOTS may not be sufficiently common or sufficiently large to offset much of the foregone revenue from property tax exemptions. Harvard’s PILOT is one of the best-known examples: $1.7 million may seem like a substantial annual payment, but it is important to remember that Harvard owns 4,938 acres of land (not all of which, admittedly, is in Cambridge). But this is a question that can only be resolved through a systematic review of the available evidence. Tax Expenditures The property tax revenue lost through exemptions and exclusions is an example of a tax expenditure. Tax expenditures are defined as revenue losses from elements of a tax system that grant special tax relief for certain kinds of behavior by taxpayers or for taxpayers in special circumstances. The federal government has published a list of tax expenditures in the federal budget each year starting in 1967. These tax expenditures are calculated by starting with a rough approximation of Haig-Simons income and then calculating the tax revenue that is lost from various provisions of the tax code. The largest tax expenditures are employer contributions for medical care and medical insurance ($120 billion), the mortgage interest deduction ($68 billion), property taxes on owner-occupied homes ($22 billion), and charitable contributions ($34 billion). The logic behind the analysis of federal tax expenditures is compelling. The purpose of the tax expenditure estimates in the federal budget is to subject spending programs administered through the tax code to the same scrutiny and control as direct expenditures. We would certainly expect a lengthy debate over a $90 billion spending program to subsidize housing. Shouldn’t we have a similar debate over the $90 billion in tax revenue the federal government foregoes by allowing homeowners to claim deductions for property taxes and mortgage interest?

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But the same logic should apply to state and local governments as well. I would expect a local government proposal for a $1 million subsidy to a firm that is thinking of relocating to be analyzed carefully and to be the subject of a long debate. Shouldn’t we have a similar debate over a proposed $1 million property tax credit for that firm? This chapter has convinced me that the answer to this question should be yes. I would argue that state and local governments should be required to include an analysis of tax expenditures in their annual budgets that parallels the federal analysis. I would quickly concede that developing these estimates is a far from straightforward task. Some difficult problems would need to be solved. What is the baseline property tax system (the analogue to Haig-Simons income in the federal tax)? How should we deal with classification? Current use versus highest and best use? Tax incentives to promote development? While these are difficult questions, Green and Weiss make a convincing case that there are clear benefits from extending the tax expenditures concept to state and local governments. Summary and Conclusion The Green and Weiss chapter is a valuable contribution to the literature on the property tax. We should think of it as a call to arms (or what passes for a call to arms among people who think about the property tax). Property tax systems often include a wide array of exemptions and exclusions. We have little idea of the cost of these provisions. If the costs were made explicit, we could then have a sensible discussion of the wisdom of these exemptions and exclusions. Without these cost estimates these implicit subsidies will remain hidden and out of the eye of the voters.

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4 Residential Property Tax Relief Measures A Review and Assessment JOHN H. BOWMAN

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y purpose in this chapter is to examine the spread of residential property tax relief, the ways in which such relief is given, and the effects of that relief on the property tax. Given the breadth of the topic, some selectivity is required. Because a better understanding of the various residential property tax relief approaches in use is an important first step, this chapter emphasizes review of existing structures over assessment. The first section defines the scope of the chapter, including the types of residential property tax relief covered. This is followed by a section tracing the history of these relief mechanisms, concluding with an account of the extent to which they are currently in use throughout the country. I then turn to the effects these residential property tax relief mechanisms can have on the property tax; traditional criteria for evaluating taxes provide the framework for this consideration. Finally, I sum up by relating the residential property tax relief movement to the broader development of the property tax and concluding with my own recommendations. Property tax relief has been accomplished in various ways, but the focus of this chapter is direct property tax relief.1 By “direct” I mean relief that either works within the property

The author wishes to acknowledge the thoughtful comments by John E. Anderson, the discussant at the October 2007 Property Tax Roundtable, and by the four editors of this volume. Responsibility for shortcomings of the final version rests with the author. 1. Indirect property tax relief, the substitution of other revenue sources for property tax revenue, has also been of tremendous significance over time. Three snapshots over the space of a century—1902, 1957, and

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tax framework (e.g., a homestead exemption or credit) or incorporates information on the property tax into the calculation of tax relief benefits (e.g., a state-funded circuit breaker).2 I shall not discuss forms of direct relief that are covered in other chapters of this book, such as caps on the increase in either assessed value or the tax amount itself,3 or limits on rate of levy growth or on the nominal tax rate. That leaves for this chapter a not-insubstantial collection of relief programs: homestead exemptions and credits, circuit breakers, deferrals, and classification. Residential Direct Property Tax Relief Types The property tax bill is the product of the nominal statutory tax rate times the legal tax base (assessed value) less any applicable credits, so equivalent relief can be provided by altering any of these terms or by a separate refund process. For example, a 20 percent homestead exemption excludes that fraction of value from the tax base before the rate is applied and thus reduces the tax bill by 20 percent. The same result can be gotten with a homestead credit equal to 20 percent of the gross property tax bill for each homestead property, or by applying a tax rate to homestead properties that is just 80 percent of the rate applicable to other properties when all property is assessed at the same percentage of value.4 All residential property tax relief creates differences in effective tax rates within a single taxing unit across classes of real property. Given the noted equivalence, some of the distinctions often drawn between categories of tax relief are largely semantic. Suppose state A has a twoclass real property classification system; class 1 homestead property is

2005—show that the property tax role in state and local government finance has dropped sharply. For example, considering state and local general revenue (as defined by the Census Bureau) from own sources, the property tax share was 77.7 percent in 1902, 37.5 percent in 1957, and 21.2 percent in 2005. Only for local taxes considered alone is the story much different, and even here there has been a decline in the role of the property tax. From 88.6 percent in 1902, it dropped slightly to 86.7 percent in 1957, and then to 72.4 percent in fiscal 2005; it has fluctuated in a narrow range near the 2005 figure for about two decades. Most of the drop in the property tax share of local taxes has come in the last half century, the same period in which direct residential property tax relief has proliferated. 2. Some circuit breakers, though, lack a very clear link to the claimant’s property tax bill, as discussed later. 3. When the tax amount itself is limited, assessed values can be left unaltered; the tax bill is then credited by the amount of tax attributable to the increase in excess of the allowed percentage. Maryland and the District of Columbia, for example, limit tax increases in this way. Bowman (2006), 725, 727, 728. 4. Homestead property is a subset of residential property. A homestead is the principal residence of the occupant; often, only owner-occupied properties are considered homestead properties, although renteroccupied properties are sometimes included.

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assessed at 80 percent of market value and all other real property (class 2) is assessed at 100 percent. Suppose further that state B says it does not classify real property and assesses all such property at 100 percent of market value; however, it applies a 20 percent homestead credit to the gross tax bill for each homestead property. There is no substantive difference between the real property tax systems of the two states; both intend the same effectiverate differentials between homestead property and other real property use classes. Homestead Exemptions and Credits In its most common form, the homestead exemption reduces assessed value by a specified number of dollars, thus reducing the property tax base to which the statutory tax rates are applied; alternatively, a given percentage of value may be exempt. The two approaches have very different implications for the cost of a homestead exemption program and for the distribution of that cost across properties. Deducting a constant amount from the assessed value of each homestead property gives percentage reductions that vary inversely with value. If assessed value is to equal market value, a $20,000 exemption reduces the tax bill by 20 percent for a $100,000 home, by 10 percent for a $200,000 home, and by 2 percent for a $1 million home. An exemption equal to a constant 20 percent of value, on the other hand, allocates more of the property tax relief budget to owners of highvalue homes. The owner of a $1 million home gets a $200,000 reduction in assessed value, while the owner of a $200,000 home gets a $40,000 reduction in the tax base. The constant-percentage exemption will cost the state or localities much more than exemption of a uniform amount. Suppose a typical entry-level home costs $150,000, the property tax is 1 percent of market value, and a typical low-income owner of such a home is thought to be able to pay only $600 in property taxes. The property tax bill can be reduced from $1,500 to $600 through a 60 percent homestead exemption or a $90,000 homestead exemption.5 Suppose further, however, that whatever property tax relief is given will go to all homeowner-occupants, including those with higher incomes and more valuable homes. Reducing all homeowners’ property tax bills through a uniform 60 percent homestead exemption clearly would cost much more than a uniform

5. A $900 homestead credit also would achieve the desired result. These examples ignore variations in home values within the target population, as well as differences in assessment levels and tax rates.

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$90,000 homestead exemption.6 Conversely, if the government budget allocates the same total amount for property tax relief under either approach, the constant-percentage approach will not provide relief that is as meaningful, or significant, for those with lower-value homes, who generally will be those most in need. Note, too, that although either approach will lower the average effective property tax rate for owner-occupied residential properties, the constantpercentage approach will not (by definition) create different effective rates within the homestead class, but exempting a constant amount for each homestead property will produce effective rates that vary directly with home value. Circuit Breakers What circuit breakers are—and are not. The principal criterion for a circuit breaker is an inverse relationship, over a significant range of income, between income and tax relief amounts for a given property tax amount. Programs with a variety of provisions meet this definition (Bowman 2008). An example of the threshold approach is a West Virginia program adopted in 2007 for homeowners of all ages and income levels that relieves property taxes in excess of 4 percent of income, to a maximum of $1,000 relief. This approach most clearly shows the logic of the circuit breaker label, which suggests that circuit breaker property tax relief can prevent a property tax overload, just as an electrical circuit breaker prevents an electrical overload. The West Virginia example in essence defines tax in excess of 4 percent of income as a tax overload. A New Hampshire program for homeowners of all ages for property taxes imposed by the statewide school tax exemplifies the sliding-scale approach. For married claimants with income of $40,000 or less, relief declines as income rises, from 100 percent to 20 percent through four income brackets.7 Both types of circuit breaker are discussed more fully below. Not all programs that some consider to be circuit breakers satisfy the definition used here. Of the following examples, the first three do not meet the definition; the last is a program I accept as a circuit breaker, but with some hesitation.

6. An exemption of a uniform amount of assessed value would create (or reinforce) an incentive for underassessment if the state picks up the cost of the exemption, to make the exempt amount cover a larger fraction of value for local homeowners. A state would need to monitor assessment levels and perhaps adjust local reimbursements in line with aggregate residential assessment levels of the localities. Note, however, that exemption of a given amount of market value, used in a few states, cannot calculate market value accurately parcel by parcel; assessment ratios for a local jurisdiction or other defined geographic area must be applied to all homes within the area. 7. The income ceiling is half as high and brackets are half as wide for single homeowners; regardless of marital status, the tax on only the first $100,000 of market value is considered.

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A 2006 Indiana law creating a “2 percent circuit breaker” is “aimed at helping Hoosiers by ensuring that they don’t pay more than 2 percent of their property value in taxes” (Indiana Department of Local Government Finance 2006). Credits are applied to tax bills for any amount of tax in excess of 2 percent of estimated market value. This tax cap amount may prevent a property tax “overload” as circuit breakers are said to do, but it defines overload in relation to property value rather than income. Over the course of about 40 years, when used in connection with property taxation, the term circuit breaker has come to be associated with income-conditioned property tax relief. Indiana’s use of the term for this property value–based program muddies the waters and makes easy communication in this field more difficult. I do not consider this program to be a circuit breaker. Tennessee provides another example of a tax relief measure that is not a circuit breaker, although it was categorized as such by the Advisory Commission on Intergovernmental Relations (Advisory Commission on Intergovernmental Relations 1994, table 39). It reimburses elderly or disabled homeowners for property taxes on “the first twenty-five thousand dollars ($25,000), or such other amount as set forth in the general appropriations act, of full market value.”8 Relief does not phase out as income rises; those below the income ceiling qualify for reimbursement and those above it do not. The last example of a non–circuit breaker comes from Lake County, Indiana. It is a refundable income tax credit for owner-occupants of homestead properties. If earned income is under $18,000, the credit is equal to the lesser of $300 or property taxes paid. The maximum credit of $300 is reduced by $0.50 for each dollar of earned income above $18,000, reducing the credit to zero at $18,600 of earned income.9 Over that $600 range, relief is inversely related to income, but this does not qualify the provision as a circuit breaker. It is a homestead credit that is phased out over a comparatively small range of income to avoid a notch problem.10 An inverse relationship between income and property tax relief is not exhibited over a large enough range of income to qualify as a circuit breaker; the distinction is important, but the criterion is admittedly imprecise. 8. Tennessee Code Annotated §§67-5-702 and 703. A $20,000 income limit was legislated for tax year 2006. The limit applies in 2007, after which it will be indexed. 9. Indiana Code §6-3.1-20. 10. A notch effect, or problem, exists if a small difference in income results in a much larger difference in property tax relief; where the loss of relief is particularly large, it is sometimes likened to “falling off a cliff” and some authors have used the term cliff effect in the same way notch effect has more traditionally been used. In the Indiana example, without the phase-out, a $1 difference in income would result in a $300 difference in tax relief: a person with $18,000 income would qualify for the $300 credit and a person with $18,001 would not.

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A final example to help clarify the circuit breaker concept as used here is a Wyoming program that I count as a property tax circuit breaker, but with some discomfort. The program is a tax refund (sometimes called a rebate) for elderly and disabled homeowners and renters structured as a circuit breaker; a maximum benefit is reduced by the percentage by which actual income exceeds $12,500 for married claimants or $8,000 for single ones. However, in determining tax relief Wyoming does not consider the actual amount of property tax or rent paid. Because it lacks a clear link to the property tax, my first inclination is to consider this a general relief program for the low-income elderly population. However, the Wyoming circuit breaker does establish at least some connection to property taxes. First, there is some provision for coordinating it with other programs clearly linked to property taxes and providing property tax relief; second, the statute includes the requirement that the refund checks for this particular program be accompanied by a letter stating, in part, “that each payment represents an allowance for sales and use tax refund, property tax refund and a refund for utility or energy costs.”11 Something in the legislative history of this program may show that it replaced an earlier property tax relief program. For me, categorizing this program as a circuit breaker was a close call, but I find there are sufficient links to property tax to justify the classification. In fact, several other states’ circuit breakers do not use actual property tax or rent payments in calculating relief; tax or rent payments serve only to establish maximum relief, as in Arizona and California (Bowman 2008). This link to the property tax is rather slight, but it is a bit stronger than in the Wyoming program. In addition, programs such as Arizona’s and California’s generally require that the claimant be the head of a household and the owner or renter of the homestead property. Types of circuit breakers. As noted earlier, two basic approaches to circuitbreaker property tax relief, threshold and sliding scale, have long been recognized (Advisory Commission on Intergovernmental Relations 1975, 3–4; Gold 1979, 55); hybrid or special programs include elements of the two basic approaches.12 The threshold approach, often considered the classic circuit breaker, is quite simple in its basic form (as illustrated by the West Virginia example above). The portion of a claimant’s property tax that exceeds some percentage of income, 11. Wyoming Statutes Annotated §39-11-109(c)(iv). 12. Considerably more detailed treatment of this varied and complex set of programs is provided in Bowman (2008). This section is drawn from a draft of that paper, which is the source for facts not otherwise attributed.

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broadly defined, is eligible for relief. The percentage threshold amount can be thought of as a reasonable or acceptable amount of property tax in relation to income. If the threshold is set at 4 percent, a household with $20,000 income is eligible for relief on property tax in excess of $800. Relief may be equal to all or only part of the tax in excess of the threshold amount, and other limits may also be imposed on benefits. If there are no income or benefit limits, claimants’ effective property tax rates with respect to income are lowered to the threshold percentage. A multiple-threshold variant used by several states defines several bands of income; the threshold percentage for each income band, or bracket, is higher than for the one below it, and the thresholds are applied incrementally.13 For example, Maryland has a zero threshold for the first $8,000 of income, 4 percent for the next $4,000 of income, 6.5 percent for the next $4,000, and 9 percent for the portion of income above $16,000. Thus, for a claimant with $17,000 income, the threshold is (0 ⫻ $8,000) + (0.04 ⫻ $4,000) + (0.065 ⫻ $4,000) + (0.09 ⫻ $1,000) = $0 + $160 + $260 + $90 = $510. Under such a multiple-threshold system, claimants’ effective net property tax rates with respect to income rise with income, rather than being leveled to a constant threshold percentage for all claimants, as under a single-threshold formula. Application of benefit limits can reduce or even cancel out this effect, depending on the level of the limits. A number of states use the sliding-scale approach, which does not relate property tax relief to income in the same manner as the threshold approach. A threshold circuit breaker provides no tax relief until the property tax rises above some amount given by the application of the threshold percentage. By contrast, a sliding-scale circuit breaker sets up multiple brackets of income and assigns a relief percentage to each bracket, falling from bracket to bracket as one moves up the income scale.14 The sliding-scale approach in essence assumes everyone within a bracket needs property tax relief to the same degree, and that the need declines as income rises; because there is an income above which relief falls to zero, an income limit is inherent in the sliding-scale approach (although the highest bracket could be open-ended). If the relief percentage for an income bracket is 60 percent, that percentage reduction is provided for each claimant in that bracket, whether gross property tax was 13. Two states with multiple thresholds, New York and Rhode Island, do not apply the thresholds incrementally; instead, each claimant’s threshold amount of property tax before relief begins is his or her income times the threshold percentage for the bracket in which the total income falls. In effect, there are multiple income ceilings, and a notch problem is presented by each. 14. Some variants of the sliding-scale approach do not use relief percentages, but define maximum relief amounts that decline in moving from bracket to bracket as income rises.

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equal to 1 percent, 25 percent, or some other portion of income.15 Thus, this approach may not eliminate property tax overload for some claimants. Limits on the amount of relief a claimant can receive can reduce the actual percentage reduction in any bracket. Tax Deferral Another sort of property tax relief, quite different from other forms, is deferral. It creates a lien against the property, and interest is charged on the deferred amount. If interest is at market rate, claimants receive no subsidy; the deferral is simply a loan. By contrast, other relief forms provide outright tax reductions, or grants (gifts); consequently, deferral is less popular with homeowners than other relief forms. For the same reason, however, many students of property taxation consider deferral the best way to ease the cashflow crunch that homeowners can experience from a tax on asset value that is paid on a current basis if the value of the asset (or the rate at which it is taxed) increases more rapidly than income.16 It has been suggested that public sector property tax relief is “obsolete” because financial market innovations, especially reverse mortgages, enable the private sector to take care of the problem (Kondaks 2007). Deferral is listed here among forms of relief because it addresses the oft-noted cash-flow crunch. The amount of tax eligible for deferral may be the full amount, a specified percentage, or the amount above some percentage of the claimant’s income.17 Classification The essence of classification is taxing various defined property classes (or uses) at different effective rates relative to value. This can be achieved by altering one or more of the three variables that determine the final tax bill—the statutory tax base (assessed value), the nominal, or statutory, tax rate, and the tax amount (subtract a credit from the product of tax base times tax rate). Why classification is a form of residential property tax relief is clear from Glenn Fisher’s description, 15. The sliding-scale approach also implicitly assumes that differences in the share of income taken by property taxes within an income bracket should not be eliminated, as they are in the threshold approach. The policy reason may be, for example, because higher taxes represent more housing services or public services. See Bowman (1980), 367–369. 16. Some worry that deferral reduces the flow of revenue to taxing governments, creating a cash crunch in the public sector. The reality, of course, is that all tax relief imposes a cost on some set of people or entities. Outright reduction and forgiveness of a portion of the property tax bill also reduces government income available for public uses; if property tax relief is funded by the state, this result is seen at the state level. 17. A lien is placed on the property to assure repayment of the deferred amount plus interest. For the same reason, the cumulative amount that can be deferred is limited to some fraction of the taxpayer’s equity in the property.

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which touches on the political reality of all property tax relief: “In those states with a legal classification system, business property is assessed or taxed higher in proportion to value than residential or farm property. Within the business class, utility property is usually assessed or taxed higher than other business property. Clearly this reflects the reality of electoral and legislative politics. Every home and every farm is represented by one or more voters. Utility companies are far less represented in the electorate” (Fisher 1996, 205). Relief Approaches Versus Payment Mechanisms Aside from tax deferral, any of the property tax relief approaches discussed above can be structured to extend benefits to claimants in any of a variety of ways. Most basically, tax relief may directly reduce the property tax bill and thus the amount collected from the property owner18 in the first place, either by an exemption, which reduces the property tax base before application of rates, or by a property tax credit, which reduces the tax bill after the initial rate-times-base calculation. Alternatively, the property tax bill may be left unaltered, with tax relief provided through another mechanism. If property tax relief is funded by the state, it must reimburse localities for the amount of tax relief provided. If the property tax bill is not directly reduced, property owners must receive property tax relief benefits another way, generally by a refundable state income tax credit or a separate refund. All these payment mechanisms exist among the states. Although there is no inherent difference in the different practices, state funding of circuit breaker relief is the norm (approaching universality, in terms of numbers of states, though not numbers of programs), but state funding is considerably less common for homestead exemptions and credits. In 2007, statefunded circuit breakers were found in 34 states and the District of Columbia; however, the number of circuit breakers in Virginia—where all property tax relief is at local option and is locally funded—exceeded the number in the other circuit breaker states (Bowman 2008). Recapitulation: The Uniqueness of Circuit Breakers As noted, many types of property tax relief are equivalent despite obvious differences in such details as payment mechanisms. Circuit breakers, however, are unique among the relief approaches because they establish an inverse relationship between property tax relief and income. This inverse relationship is 18. When renters are included in a property tax relief program, as they are in many circuit breakers, direct reduction of the property tax bill is not an option.

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exhibited by all forms of circuit breakers, but it is qualitatively different in each of the two main formula types. The inverse relationship holds for all claimants under the threshold approach because all claimants face the same threshold requirement; as income rises, so does the amount of tax the claimant must bear before relief is available. This form of circuit breaker is also unique in determining property tax relief by considering the tax amount in relation to income; this is the reason for the universality of the inverse tax relief-income relationship among its claimants. It is what makes a threshold circuit breaker unique and provides its superior targeting ability. By contrast, sliding-scale circuit breakers separate claimants into several income brackets with different tax relief levels for each bracket.19 Because each claimant within a bracket receives the same percentage tax reduction, regardless of how high the tax is before relief, effective property tax rates in relation to income still vary across claimants within each relief bracket. However, because the relief percentage declines in moving from lower to higher income brackets, there is an inverse relationship between income and relief across the brackets for any given tax bill. Thus, a homeowner with a $2,000 property tax bill in two consecutive years whose income puts him in a 60 percent relief bracket one year and a 10 percent relief bracket the next experiences this inverse relationship. A Brief History of Residential Property Tax Relief Residential property tax relief in the United States has a long history, and no doubt a long future, because taxes in general are unpopular; the property tax is the largest tax at the combined state and local level; the home generally is the largest family asset; the property tax imposes a tax on unrealized capital gains when real estate values are growing; and past successes in securing property tax concessions encourage further efforts. Rapid Spread of Residential Property Tax Relief The first U.S. residential property tax relief movement started in the early 1930s. By 1973, each state had adopted at least one program to provide for residential property tax relief.20 From the start, the programs have differed in 19. A sliding-scale program approximates a series of income-limited homestead exemptions or credits; each bracket has its own income boundaries (limits), its own relief percentage, and its own notch effect. 20. See Table 4.1. As of 2006, according to a spreadsheet produced by the George Washington Institute of Public Policy and distributed by the Lincoln Institute of Land Policy (2008), there were over 230 residential property tax relief programs for the 50 states (not including the District of Columbia).

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many respects, including relief structure or type, eligible population groups, benefit levels, payment mechanisms, statewide provision versus local option, and state versus local funding. The broad outline of the development of residential property tax relief is sketched in the balance of this section. Although this section is organized by relief type, it is essentially chronological. The first approach to gain wide acceptance among the states was the homestead exemption, in the 1930s; although classification of real property got its start somewhat earlier, in the 1910s, it was practiced in just two states for the first two decades, and in just three for more than another 30 years. Meanwhile, the circuit breaker was developed in the 1960s and soon adopted by many states, and deferral, never as popular as the other approaches, also made its appearance. General homestead exemptions. By most accounts, residential property tax relief in the United States emerged in the 1930s in the form of partial “homestead” exemptions. For example, Groves (1964, 98) observed, “Much of the legislation creating these exemptions took root during the foreclosure period of the depressed 1930s.” Mabel Walker (1964, 5) stated, “Homestead exemptions made their appearance during the depression of the thirties. They were adopted at that time by 14 states and . . . 11 states now provide exemptions.” Texas is credited with the first homestead exemption, in 1932; by the end of the decade a fourth of the states had homestead exemptions. After the Great Depression the movement lost momentum (Sliger 1967, 213). Early homestead exemptions were for homeowners of all ages and income levels, and although they removed only a specified number of dollars from taxation, no upper limit was placed on the total value of eligible homestead property. Failure to target the tax relief to those most in need attracted criticism (Fisher 1996, 193), and this no doubt helped to slow the homestead exemption movement. Classification of real property. Another early form of residential property tax relief is the general classified property tax, which typically favors residential property. Classified real property taxes first were adopted in Minnesota and Montana, in 1913 and 1917, respectively, followed by West Virginia in 1934. The classification movement then paused for over 30 years, until Arizona classified its tax in 1968. In the 1970s, however, adoption of classified real property taxes took off, with 11 more adoptions, and by the end of 1986 a total of 21 states and the District of Columbia had classified real property taxes (Bowman 1987, 289). Although classification can be accomplished in various ways, most states classifying real property accomplish differential taxation through different

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assessed value levels for different classes of property. Several apply differential rates to valuations that are intended to be a uniform percentage of market value, and a few use tax credits. Classification systems also differ in the number of classes defined and the degree of differentiation in effective tax rates across classes. In 1986 the number of classes ranged from two in each of three states to nine in one and thirty-four in another. The degree of effective-rate differentiation can be indicated by expressing the rate for the highest-taxed class as a percentage of that for the lowest-taxed class. This figure for the four states with the least differentiation was 111 percent (North Dakota), 138 percent (Colorado), and 167 percent (District of Columbia and Utah); for the three states with the highest degree of differentiation it was 1,000 percent, 2,000 percent, and 2,750 percent—Montana, Arizona, and Minnesota, respectively (Bowman 1987, 289). In truth, all states classify property. Each state has property tax relief programs for some residential property and agricultural property, producing different effective tax rates for different classes of property. When the relief applies broadly, as with a general homestead exemption (as opposed to one that applies to only a comparatively small group, such as all homeowners with incomes under $20,000), a case can be made that a classified property tax is in place, even if it does not go by that name. The case for calling a general homestead exemption (or other variety of relief) a form of classification is strongest if the exemption provides the same percentage reduction to all owner-occupants because all claimants’ effective tax rates are changed to the same degree; by contrast, a constant-dollar exemption drops the average effective property tax rate for homestead property relative to other property uses, but it also produces differential rates within the homestead class. Many states’ classification systems did not arise as a way of creating residential property tax relief, but rather as a way of preserving de facto relief. In a number of states that required uniform assessment and taxation of all real property, a pattern of differential taxation (classification without legal sanction) emerged in which different use classes of real property were assessed at different average percentages of value, typically favoring residential and agricultural properties. De facto classification in violation of uniformity requirements ultimately was challenged successfully in the courts (Shannon 1967). Conflict between assessment law and practice can be resolved by changing practice to fit legal requirements or by changing legal requirements to reflect prevailing practice. Several states changed the legal requirements, adopting classification regimes in an attempt to avoid a reallocation that would increase the tax burden for homeowners, who generally had been favored by de facto classification (Advisory Commission on Intergovernmental Relations 1974b, 2–12; Shannon 1967, 51). However, these

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attempts were often futile when they merely codified de facto classification. The poor assessment practices that resulted in differing average assessment levels across property classes also produced considerable variation across parcels within classes. Because even in a classified tax system uniformity within a class is typically required, reassessment was necessary to bring about compliance with the law, producing higher tax bills for many homeowners. Relief for low-income elderly homeowners. Whether the lineage of the property tax relief movement is traced from the first classified real property taxes in the 1910s or the first homestead exemptions in the 1930s, the movement changed direction and regained strength in the 1950s and 1960s, with emphasis on relief for elderly homeowners and for farmers (Chen 1967; Stocker 1967). In the second wave of the residential property tax relief movement,21 reliance on owners’ (and renters’) ages and incomes to determine eligibility began to personalize the property tax, and this time, relief grew rapidly. In 1965, some form of relief for the elderly, mostly in the form of exemptions, was found in seven states (Chen 1967, 234–235) but a paper presented in late 1966 counted eleven (Stocker 1967, 289), and by 1973 all fifty states provided for residential property tax relief for at least the elderly. Table 4.1 traces the development from 1970 through mid-1973.22 The renewed push for residential tax relief took into account some of the criticisms of the general homestead exemptions of the 1930s. Specifically, the movement of the 1950s and 1960s targeted need in terms of income and old age (a proxy for need), generally limiting property tax relief to elderly homeowners with incomes below a given level. Another reason (or another facet of the same reason) for restricting new homestead tax relief to the elderly was the increasing importance of Social Security, which made retirement a feasible option for more of the elderly population. “In the 1950s, a sharp drop occurred in labor force participation for men 65 and older, as Social Security retirement affected labor force participation rates” (Fullerton 21. Sliger (1967) covers a development that might be considered a second wave of property tax relief: veterans’ exemptions, starting at the end of World War II. “Since 1945, 32 states have granted some form of exemption to the property of veterans” (213). Exemptions and other relief for veterans, survivors of service personnel, widows in general, and select other groups are to be found in several states; see, for example, Advisory Commission on Intergovernmental Relations (1994, table 40); for an up-to-date list, see George Washington Institute of Public Policy and Lincoln Institute of Land Policy (2008). However, narrow tax relief programs such as these are excluded from close consideration in this chapter. 22. Both Chen and Stocker include the Wisconsin circuit breaker, which provided relief to elderly renters, not just homeowners. Stocker’s list also includes homestead exemptions in seven states, a homestead property tax credit in one state, deferral in one state, and a tax freeze in yet another. The Advisory Commission on Intergovernmental Relations list of states with property tax relief for the elderly likewise includes various relief forms.

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TABLE 4.1

1974 ACIR Table: State Action on Property Tax Relief Plans for the Elderly Kind of Relief

Number of States by Type of Plan

Jan. 1, 1970

Jan. 1, 1973

July 1, 1973

State-Financed Circuit Breaker

4

13

21

State-Financed Other Plans

8

11

10

State-Mandated Locally Financed

12

15

13

State-Authorized Locally Financed

4

6

6

28

45

50

Total

source: ACIR staff compilation based on Commerce Clearing House State Tax Reporter. Reproduced from ACIR 1974a (Table 106, p. 177).

1999, 5).23 Income targeting used a broad definition of income (Chen 1967, 234–235) and was seen as enhancing equity: “most proposals for tax concessions to the aged are limited to those whose incomes do not exceed a specified sum, usually between $2,000 and $5,000 in family income from all sources. The merit of such an income test, of course, is that it limits the tax relief to those who genuinely need it, and holds down the total cost of the program” (Stocker 1967, 289). It is somewhat surprising that income was defined more broadly for property tax relief eligibility than for income taxes. Of the seven states that had adopted property tax relief for the elderly by 1965 (Chen 1967, 234–235), five already had state income taxes and a sixth adopted an income tax in 1967 (Advisory Commission on Intergovernmental Relations 1994, Table 43). However, Wisconsin set up its new property tax relief program, which came to be known as the circuit breaker, as a credit against the state income tax using a broader income definition to determine credit eligibility than that used to determine income tax liability.24 The first income-targeted property tax relief for the elderly was enacted in New Jersey in 1957 (Gold 1979, 82); adopted nearly 20 years before that state imposed an income tax, it logically employed a broad definition of money income to direct the relief to those most in need 23. Between 1950 and 1970, the time when homestead property tax relief for the elderly became a frontburner issue for state legislatures, the labor force participation rate for men 65 and over declined from 45.8 percent to 26.8 percent, and most of that drop occurred in the 1950s (Fullerton 1999, 4). See also Gruber and Wise (1998). 24. The Wisconsin circuit breaker, as discussed later, differed from the other six early elderly property tax relief programs in other ways than being administratively part of the income tax.

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(Chen 1967, 235). Use of such a definition of income elsewhere may be attributable, in part, to states’ tendency to copy other states’ tax policy innovations. Although income-targeted homestead property tax relief for the elderly proved popular with state legislators, it drew some criticism. One student of property taxation commented, “In the current wave of sentiment for doing things for the aged—many of whom are more able to pay taxes than many younger persons— resort is again being had to the exemption device” (Walker 1964, 8). After careful analysis of the new proliferating programs for the elderly and of the comparative economic status of the elderly and nonelderly, another analyst concluded that “the case for tax favors seems tenuous, because the economic circumstances of the aged as a group appear to be better than those of most other age groups” (Chen 1967, 232). It is noteworthy that these assessments predated the maturing of Social Security and the indexing of its retirement benefits, developments that further improved the relative situation of the elderly; the evidence at the time consisted mostly of such things as the better net worth of those 65 and over, including a higher rate of home ownership unencumbered by mortgages. More recently, the poverty rate for people 65 and over dropped from 35 percent in 1960 to 10 percent in 1995, slightly below that for working-age adults and well below that for children (National Bureau of Economic Research 2004).25 In fact, the poverty rate for people 65 and over has been below that for the total population since the early 1980s (U.S. Social Security Administration 2006, 11). Despite evidence to the contrary, the notion that the elderly have a greater relative need for public financial assistance still finds ready acceptance in many quarters, including in legislative chambers when property tax relief is being considered. It is an outdated notion. Other aspects of the new wave of property tax relief for the elderly also drew some criticism (Stocker 1967, 289). Low income was criticized as a condition for property tax relief on two rather different bases: that income criteria constituted a means test, which was distasteful for some of those intended to be helped, and that such criteria created a notch problem, so that a small increase in income could cost a family much more in lost tax relief. Additionally, it was noted that renters as well as owners were burdened by property taxes, but homestead exemptions gave no relief to renters. Property tax circuit breakers. The next significant development in residential property tax relief, the circuit breaker, emerged less than a decade after the first elderly-only homestead exemption. Pioneered by Wisconsin in 1964 (Advisory Commission on Intergovernmental Relations 1975, 1), the circuit 25. The 2005 poverty rates for people under 18, those 18 to 64, and those 65 and over, respectively, are 17.6 percent, 11.1 percent, and 10.1 percent. U.S. Census Bureau (2006), 14–15.

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breaker addressed some of the criticisms leveled against homestead exemptions. Although the initial Wisconsin program was for only the elderly (Stark 1992, 34–36; Chen 1967, 235), it differed from the other recent residential property tax relief programs in several respects: • It provided property tax relief to renters as well as owners, defining a renter’s property tax as 25 percent of rent for right of occupancy. • Relief was determined in a manner that caused a gradual decline in the benefit amount as income rose, rather than abruptly dropping to zero upon reaching an income ceiling. • Relief was granted in the form of a refundable income tax credit. As in the other states that recently had adopted income-targeted property tax relief for elderly homeowners, the Wisconsin income tax credit for homeowners and renters defined income very broadly. The state bore the cost of the program, but some other states also bore the cost of their property tax relief programs, either by reimbursing local governments for property tax revenues foregone or by making payments to taxpayers who qualified for tax relief. A rather common misperception is that state funding is unique to, and a defining characteristic of, circuit breakers. There is no inherent difference among relief forms that precludes state government funding of some programs; it just happens that state funding has been more common for circuit breakers. The feature that makes the Wisconsin program a circuit breaker is the gradual decline in relief amount as income increases. As stated above, generally speaking a property tax relief measure that incorporates this feature and applies it over a substantial range of income is a circuit breaker. States have designed programs that establish this inverse relationship between income and property tax relief in various ways and to varying degrees. The Advisory Commission on Intergovernmental Relations (ACIR) tracked the spread of property tax relief in its annual statistical report. A table in the 1974 volume showing the rapidity of that spread is reproduced above as Table 4.1. Between January 1, 1970, and July 1, 1973, the number of states with relief programs of all sorts for at least the elderly rose from 28 to 50 and the number with circuit breakers rose from 4 to 21. By the end of 1974 there were circuit breakers in 24 states and the District of Columbia (Advisory Commission on Intergovernmental Relations 1975, 3).26 26. The pace of circuit breaker adoption by additional states clearly had to slow; by 1980 30 states and the District of Columbia had such programs (Bowman 1980, 355). Only four more had joined the list by 2007, with Ohio ready to leave it as of 2008; on the other hand, circuit breaker programs have proliferated in some states (Bowman 2008).

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Not all states with circuit breakers in 1974 were new to the list of states with property tax relief for the elderly. Four of the circuit breakers were in states (Indiana, Maryland, Michigan, and Oregon) identified by Chen as having another form of relief for the elderly in 1965. As already noted, several programs that provide property tax relief for the elderly are for the nonelderly, as well. In 1974, of the twenty-five state-level circuit breakers (including the District of Columbia), six were for elderly homeowners only, thirteen for elderly homeowners and renters, one for elderly renters only (a companion to a homestead exemption), and five for owners and renters of all ages (Advisory Commission on Intergovernmental Relations 1975, 4). In the mid-1960s, only Wisconsin’s circuit breaker provided property tax relief for renters. Tax deferral. Deferral, like the circuit breaker, was an invention of the 1950s and 1960s, part of the second wave of the residential property tax relief movement; at that time, a number of states provided tax deferral as part of their property tax relief for farmers, and Oregon allowed deferral as one of two forms of residential relief for elderly homeowners (Chen 1967, 235; Stocker 1967, 285–86, 289). As already noted, the deferred amount, including interest, creates a lien on the property that must be settled at a future date, usually upon the death of the owner or other transfer of the property. As deferral of residential property taxes has evolved, it is most often available to elderly homeowners. Eligibility may be based solely on age, or income may also be a factor. Partial deferral often applies to the amount of tax increase over some base year, such as the year the claimant turned 65 or the year prior to reassessment. Although, as mentioned above, many public finance specialists consider deferral the best relief form to address the cash-flow problem that the property tax can cause because it is simply a loan, deferral programs often attract few takers.27 Current Status of Residential Property Tax Relief Property tax relief programs adopted after the renewed interest in residential property tax relief 50 years ago were much more likely to provide relief to the elderly, whether owners or renters, than to the nonelderly. That remains true in the twenty-first century, and often when both elderly and nonelderly are 27. A recent Norfolk, Virginia, program is a case in point. Homeowners wanted tax relief; the city responded with a deferral for which an estimated 84 percent of all homeowners were eligible, but on the eve of the deadline only 18 applications had been received despite widespread publicity for the program (Messina 2006). Consider also the following recent report from Washington State: “Even though the eligibility requirements are broader for the deferral program than for the exemptions, only 1,041 people took advantage of the available tax deferral for 2005, compared to 115,801 receiving exemptions” (Washington Senate 2007, 7).

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covered, benefits for the elderly are better. The notion that age is a reasonable proxy for need seems quite ingrained and difficult to dispel. More cynically, not to say unrealistically, the data show the relative effectiveness of lobbying by senior citizens. Fisher’s 1996 observation on why homes and farms are favored in classification programs is in this vein: “The universal truth about taxation is that people want government without paying for it. The history of taxation is the story of a struggle among individuals and groups intent upon achieving that goal for themselves or for their groups” (Fisher 1996, 187). Similarly, 30 years earlier a paper considering property tax breaks for farmers and elderly homeowners observed, “The fact that both are well organized, with articulate spokesmen, is another point of similarity that helps account for the extent to which public attention has been focused on the plight of these two groups” (Stocker 1967, 290–291). What has changed over the years, of course, is the number of states with residential property tax relief programs and the number of programs found in individual states. To summarize the status of the various forms of property tax relief, I draw on several recent studies. My own research on income-targeted residential property tax relief, undertaken for the Lincoln Institute of Land Policy, provides information on circuit breakers and also some information on homestead exemptions and credits and deferrals (Bowman 2008). In addition, several studies or surveys so far this century have produced lists of residential property tax relief programs in varying degrees of detail, but because the American Association of Retired Persons (AARP) (Baer 2003) and National Conference of State Legislatures (NCSL) (National Conference of State Legislatures 2002) studies provide coverage that is more comprehensive and a more helpful breakdown of program types, particular attention is given to their enumerations of homestead exemptions and credits and deferrals. Sexton (2003) provides information on classification.28 Homestead exemptions or credits. Nearly 30 years ago, the most common form of residential property tax relief was the homestead exemption or an equivalent credit (Gold 1979, 81); that still is the case. Recently, NCSL counted 44 states with at least one homestead exemption or credit program in 2002 and AARP counted 41 states (Baer 2003, 20–27; National Conference of State Legislatures 2002, 10–15); because of multiple programs in many states, the number of homestead exemption or credit programs is greater than the num28. An additional source of information on property tax provisions throughout the United States is becoming available from the George Washington Institute of Public Policy and Lincoln Institute of Land Policy (2008). The residential tax relief spreadsheet mentioned in note 19 above was not used in constructing this summary because the programs had not yet been categorized by type.

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ber of states with such programs.29 Local-option programs exist in several states, sometimes as the only relief, sometimes in addition to statewide relief. The states and the District of Columbia can be divided into three groups in terms of coverage of their homestead exemption and credit programs: (1) all programs are for all ages (13 by AARP’s count, 17 by NCSL’s); (2) all programs are for the elderly only (AARP 14, NCSL 12); and (3) some programs are for all ages, some for the elderly only (AARP 14, NCSL 13). Thus, some programs are for all ages in most states (AARP 27, NCSL 30) and most states also have some programs for the elderly only (AARP 28, NCSL 25). The elderly often are given more generous benefits through an additional or enhanced program. AARP information shows no income limits for homestead exemption or credit claimants in 22 states (of the 41 it counts as having homestead programs), compared to 27 (of 44) from NCSL information. In a minority of states (AARP 8, NCSL 6), all such relief is income targeted; in addition, for some such programs more than twice as many states limit participation to those below some income ceiling (AARP 19, NCSL 15). These income limits are found almost exclusively in programs restricted to the elderly.30 They may be due, in part, simply to a continuation of policies adopted up to 50 years ago, when the second wave of residential relief began. One motivation then was to avoid the criticism that benefits were being squandered on people who didn’t need help with their property taxes; the same justification may apply today, whether the elderly program is stand-alone or exists alongside a more general homestead exemption or credit program. Income ceilings vary considerably, from $12,000 to $100,000 (the same range was reported in both studies), with lower figures in some of the local-option programs. For example, the AARP report accurately reported that the income ceiling “varies” across localities in Virginia, while NCSL reported a $62,000 ceiling, seriously overstating the ceilings generally in place at the time.31 Circuit breakers. The NCSL study reports circuit breakers in 34 states and AARP shows them in 36 (Baer 2003, 12–19; National Conference of State

29. States often have multiple homestead exemption or credit programs, such as a general program for homeowners of all ages plus more generous programs for the elderly, veterans, people with certain types or degrees of disability, and the like. The counts here are restricted to programs of more general coverage. Rhode Island and Pennsylvania programs could not be categorized from the information provided in the NCSL report. 30. Both studies show an income ceiling for an Oklahoma program for all ages, and AARP also shows such a program in Pennsylvania. 31. In 2002, the income ceilings in Virginia cities, counties, and towns ranged from $5,000 (a town) to $75,000 (also a town); for both cities and counties, the high was $62,000; the low was $15,000 for cities and $7,500 for counties; and city and county medians were $25,000 and $22,000, respectively (Knapp and Kulp 2002, 23).

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Legislatures 2002, 17–20);32 both show circuit breakers are most often available to elderly homeowners, but owners and renters of all ages are eligible for several programs.33 My own research shows circuit breakers in 35 states in 2007, based on the definition given earlier. In 23 states, only the elderly are covered (owners in 22, renters in 18—Oregon’s circuit breaker is for renters only). In 12 states, circuit breakers are for all ages (owners in 12, renters in 10). Thus, elderly homeowners are covered in 34 of 35 states with circuit breakers; elderly renters are covered in 28 states. Where all age groups are included, benefits often are better for the elderly; where both renters and owners are included, renters often do not receive benefits as generous as those for owners. Such differences frequently show up as multiple circuit breaker programs; of the thirty-five circuit breaker states in 2007, fourteen (and the District of Columbia) had two programs; four had three circuit breakers each; two had four programs each; and one had five.34 A state’s circuit breaker provisions are considered to constitute two or more programs if provisions applicable to different claimant groups differ in more than income ceiling, causing benefits to differ across groups at a given income level. Besides restricting eligibility according to age and occupancy status (owner or renter), many states place upper limits on the income or wealth (that is, the value of certain types of assets) that claimants can have. Income limits are by far the more common of these restrictions (in fact, they are nearly universal), but they vary dramatically.35 There are also vast differences in the way benefits are calculated; 17 states use threshold formulas (this number is about evenly split between single and multiple thresholds), 11 use the sliding-scale approach (most of these define four to six income brackets), and 14 have hybrid

32. AARP counts five states as both homestead exemption/credit and circuit breaker states because Nebraska, New York, North Dakota, Ohio, and Washington homestead exemptions are structured as circuit breakers (Baer 2003, 3). By comparison, NCSL incorrectly reports no circuit breaker for Nebraska or Ohio; it includes the other three states in its circuit breaker count but not its homestead exemption count (National Conference of State Legislatures 2002, 17–20). 33. Many states include some categories of disabled persons, regardless of age, in programs for the elderly; separate programs for the disabled are not summarized here. Who is considered disabled and therefore eligible for circuit breaker benefits differs rather widely from program to program, making satisfactory coverage of this group very difficult. 34. The following states have multiple programs: Arizona, California, Colorado, Iowa, Michigan, Minnesota, New Hampshire, New York, North Dakota, South Dakota, Utah, Vermont, Washington, and Wyoming have two, as does the District of Columbia; Maine, Maryland, New Jersey, and Pennsylvania have three; Connecticut and Nebraska have four; and Montana has five. In 2008, the total dropped to 34, with Ohio replacing its slidingscale circuit breaker with a constant-amount exemption; at the same time, West Virginia’s new threshold circuit breaker gave that state two circuit breakers—although the older one, counted because it is on the books, is inactive (see Bowman 2008). 35. In addition to differences in the amount of income participants can have, income definitions also differ; they are discussed in some detail in Bowman (2008).

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formulas.36 Several states use different formula types in different programs. Benefit limits are common, and they often reduce benefits below the level determined by the formula. Limits can reduce or even eliminate differences in the patterns of effective net property tax rates in relation to income that normally obtain between sliding-scale and threshold circuit breakers (Bowman 2008). Tax deferral. Property tax deferral programs were found in 25 states in 2002, according to both the AARP and the NCSL studies (Baer 2003, 29–31; National Conference of State Legislatures 2002, 21–23). The studies also agree that deferral is available only to those below a given income level in 21 of the 25 states. As with other programs, the income ceilings vary a good bit, from a low of $10,000 to a high of $60,000. Beyond the income restrictions, there are some differences in the two studies’ findings, but they agree that most deferral programs are for elderly homeowners. Classification. Lists of classification states differ, in part because some consider classification to occur only through unequal assessment levels. This view was held by some people who worked on the Census of Governments, conducted every five years.37 The census listed 14 classification states in 198638 but the discussion of classification added another three—two in which classification applied in only a small part of the state, plus California, where Proposition 13’s modified acquisition-cost valuation approach introduced a different sort of classification (U.S. Census Bureau 1989, xv); California was on my 1986 list, noted above. More recently, Sexton (2003, Tables 1–3) counted 25 states with classified systems; of these, 19 are shown to classify on the assessed value side and six on the rate side. Her list, however, omits states that use what Gold described as dynamic classification (1979, 150–151). Dynamic classification attempts to hold constant some historic relationship between the tax shares of residential (and possibly agricultural) property and other property, rather than taking the more traditional approach of setting fixed rate or valuation differentials.39 For example, the objective may be to keep the residential share of the property tax 36. The most recent published study of circuit breakers is from the Center on Budget and Policy Priorities (Lyons, Farkas, and Johnson 2007); it counts only 18 circuit breaker states because it defines circuit breakers to include only threshold formulas. Anderson (2005) can be read as embracing this definition as well, but his total clearly includes other forms. 37. I talked with some people involved in the Census of Governments about the time I prepared my 1986 paper (Bowman 1987) and before, but did not win them over to a more inclusive view. 38. The census formerly included a great deal of information on property taxation but has not done so since 1987. 39. At the time of my 1986 study, Iowa, New York, Ohio, and Oregon employed such dynamic classification, and California’s Proposition 13 produced another form, based on acquisition cost (Bowman 1987, 288–290). These states are not on Sexton’s list.

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levy from rising above some historic or arbitrary level; to do this, if property values rise due to “inflation” (for example, through excluding new construction) more rapidly for residential property than for other classes, adjustments (such as rate reductions, valuation reductions, or tax credits) are made to hold down the residential share of the tax levy. In addition to dynamicclassification states, Sexton’s list also omits Indiana, which has a universal 20 percent homestead credit, and Massachusetts, where classification is at local option.40 Thus, real property appears to be classified in 30 states or so, although in some it is at local option and covers less than the whole state. Evaluation Part of my task in this chapter is to consider how residential property tax relief programs affect the property tax. I use standard criteria for evaluating taxes. These include equity (both horizontal and vertical), efficiency (which covers both neutrality and the costs of administration and compliance), revenue adequacy, and tax stability or certainty.41 Equity A common notion of equity in property taxation is uniformity of effective property tax rates with respect to market value. The coefficient of dispersion (COD) is generally used as an indicator of horizontal equity while the pricerelated differential (PRD) measures vertical equity (Eckert 1990, 534–541). If, in a given assessment jurisdiction, each parcel sold in an arm’s-length market transaction and included in a study of the relationship between assessed value and market value (bona fide market sale price) were assessed at the same percentage of market value, there would be perfect uniformity; the COD would equal zero, indicating perfect horizontal equity, and the PRD would be 1.0, indicating no progressive or regressive bias in assessments. Those who insist on always measuring property tax equity against market value fault property tax relief programs for causing effective-rate differences; in

40. In addition to dynamic classification, Ohio also applies credits (termed “rollbacks”) of 10 percent to nonbusiness real property and another 2.5 percent for homestead properties (Ohio Department of Taxation 2007c, 137–138). 41. This section discusses the types of effects that may result from property tax relief of various sorts, but it does not attempt new empirical measurement of the effects or a review of the substantial literature that might yield some examples of estimates of certain effects (e.g., location) for some sorts of tax relief. Part of the reason is that data and space to explore these matters adequately are not available. Studies of the effects of taxes on economic decisions generally do not get into residential property tax relief, let alone into distinguishing different sorts of relief. Also, the effects might well vary in different settings due to interactions with other circumstances not adequately controlled for. This area of inquiry is another for which further research will be needed.

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this view, all property tax relief is inequitable. While this view seems too doctrinaire, more narrowly focused relief programs that create less widespread departures from uniform effective rates within a taxing unit seem preferable to broad residential tax relief programs. The logic of the property tax is that it taxes asset value. The idea that differences in tax liability should reflect property value differences is a guiding principle; if it is abandoned and anything that can gain political support is acceptable, the tax can become a tax on lack of political clout instead of a tax on property value. Although a common argument of property tax relief advocates is equity, relief programs can create effectiverate differentials that seem indefensible.42 For example, under classification in the 1980s, the highest prescribed effective rates relative to value were 27.5 times the lowest in Minnesota and 20 times the lowest in Arizona (Bowman 1987, 289). When relief is appropriate, the number of departures from a standard of uniform effective property tax rates should be minimal.43 As always, there are tradeoffs. A uniform-percentage homestead exemption or credit for all homeowners does not cause differences in effective net property tax rates within the homestead class. However, for such a relief program to provide meaningful relief to those most in need, the relief percentage has to be high, which increases program costs and gives substantial relief to many homeowners who do not need it. Based solely on the fact that it does not change effective rates within the homestead class, a uniform-percentage exemption or credit might be considered better than a circuit breaker. Circuit breaker relief is based on the personal circumstances of claimants, so relief amounts, and thus effective net property tax rates relative to value, vary among claimants, as well as between claimants and nonclaimants. An offsetting advantage for the circuit breaker is that it targets relief narrowly and thus affects a comparatively small number of properties; also, because relief is based on the personal circumstances of a claimant rather than on attributes of the property, capitalization of circuit breaker benefits seems unlikely. A common complaint is that residential property tax levels strain certain homeowners’ budgets; they cause what sometimes is called a cash-flow crunch. In essence, the property tax bill is too large relative to income. Such mismatches can arise because income is a current flow, while the property tax is

42. It is worth noting that although it is not part of the subject of this chapter, one of the worst offenders in this regard is a cap on tax or value increases, which lowers the tax bill (and thus the effective rate) most for properties whose values have been increasing the fastest, adding a property tax subsidy to market-driven windfall gains for the owners of rapidly appreciating properties (Bowman 2006). 43. Effects of targeted relief on effective-rate uniformity for an entire county or other area, as measured by a COD or PRD, will depend on such things as how many households receive relief and at what level, causing variation in overall uniformity effects across local areas at a given time and no doubt for a single area over time.

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imposed on accumulated asset value; there is no necessary link between the two. To rectify this perceived problem, it is reasonable to introduce income as a major consideration in providing property tax relief; that is, to employ income targeting. Typically, property tax relief is advocated because of a perceived need; sometimes proxies for that need are used, such as age or disability, but often there is explicit reference to income. Why use proxies when more direct information exists? Much relief is income-targeted, but targeting takes various forms. Incometargeted homestead exemptions or credits, and many deferrals, set an income ceiling above which no relief is given and below which full benefits are available. For example, a 20 percent homestead exemption for homeowners with incomes of $50,000 or less provides the same 20 percent tax savings for claimants with $50,000 income and for those with $1,000 of income, but zero if a claimant’s income is $50,001 or higher. Such targeting of relief is imprecise; furthermore, this approach creates the so-called notch problem, previously noted. More precise income targeting can eliminate the notch; this is the case for a threshold-type circuit breaker except at the income ceiling, if any.44 As noted earlier, sliding-scale circuit breakers inherently have an income ceiling. In fact, there is a notch at the upper limit of each income bracket defined, because when income rises above that limit, the relief percentage falls, causing the drop in property tax relief to be greater than the additional income. These notch effects are reduced as the number of brackets increases and the change in relief percentages in moving from one bracket to another diminishes. Although all circuit breakers provide property tax relief that varies inversely with income, different circuit breaker types result in different patterns of effective net tax rates relative to income. If no benefit or income limits are imposed, threshold formulas with a single threshold reduce effective property tax rates for claimants to a constant percentage of income equal to the threshold percentage, while multithreshold circuit breakers can create a pattern of effective rates that rise with income; those ineligible for circuit breaker relief because their property taxes are below the qualifying threshold amounts obviously have lower effective property tax rates with respect to income. Sliding-scale circuit breakers lower effective property tax rates measured against income, but they do not change the pattern of effective-rate differences among claimants within a single bracket (that is, claimants with the same relief percentage).

44. An income limit creates a notch problem when the limit is exceeded. Benefit limits cause their own problems, keeping the net effective property tax rate from dropping to the threshold level. Michigan provides an example of phasing out circuit breaker benefits to avoid any notch effect associated with an income ceiling. See Bowman (2008).

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Efficiency Efficiency can be thought of as the absence of waste, or the use of the fewest resources possible to accomplish a given task. However, it is useful to distinguish two aspects of efficiency concerning taxation and tax relief: neutrality with respect to decisions and ease of compliance and administration. Neutrality. Residential property tax relief favors residential properties by reinforcing income tax incentives arising from the deductibility of mortgage interest and property taxes; it gives residential properties lower effective tax rates that may cause some bias in favor of investment in them. Broader relief, such as a general homestead exemption, will cause a greater bias than relief targeted narrowly on claimants’ need, such as a circuit breaker. The incentive favoring residential investment will be higher the more generous the relief; a 75 percent homestead exemption can be expected to have a greater effect than a 10 percent exemption. If residential property tax relief is available only to owners, the decision between owning and renting may be affected. When the uniformity principle is abandoned, attempts to create additional or more favorable treatments are invited, and this process is another form of inefficiency. In 1966, when other states were considering classification, Minnesota Tax Commissioner Rolland Hatfield related the experience of his state, where real property classification had begun a half-century earlier: “We started with four classes and we now have some twenty different classes. I think the fact that we have only twenty classes of property is a tribute to the legislature, because had they yielded to all the pressures involved we could easily have had over two hundred” (Hatfield 1967, 242). Proposals for changes to the classification system and to other forms of property tax preference are a regular feature of state legislative sessions, often accounting for significant expenditure of resources by those seeking new or expanded preferences, legislators and their staff, and administrators testifying on the proposals. Ease of administration and compliance. From the perspective of society at large, it is wasteful if raising a given amount of tax revenue imposes more costs (over and above the tax amounts) on the taxpayers (compliance costs) and the administrative agencies (administrative costs) than necessary.45 In general, the real property tax is taxpayer-passive, meaning that there are few if any compliance costs other than paying the tax. This is in marked contrast to individual income taxation, which imposes relatively heavy compliance burdens on taxpayers, and 45. It may still be desirable, overall, to impose taxes that entail higher administrative or compliance costs if those taxes score higher against other criteria; in short, tradeoffs among the criteria must be considered.

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thus is considered taxpayer-active. Also, while individual consumers bear few direct compliance costs in paying sales taxes, compliance costs for vendors (the legal taxpayers) can be important. When property tax treatment differs with property use, qualifying properties have to be identified; thus, residential property tax relief increases administrative and compliance costs. The costs are greater for some forms of relief than for others, however, and the division of added costs between administrators and taxpayers differs. The simplest treatment would be one based on information already in the property records, such as a uniform exemption for all residential properties without regard to whether they are owner- or renter-occupied. With a residential property tax relief program of this sort, the property tax would remain taxpayerpassive; the added costs would be on the administrative side for assuring that all and only eligible properties receive the tax break, calculating the effect on the budget-balancing tax rate in each taxing unit, and like activities. More effort is added when relief is restricted to owner-occupied housing, as this requires information that often is not already collected. Administering agencies must prepare the forms to collect required information, claimants must file them, and the agencies must process them. Because income and other personal information changes, periodic reapplication is needed to assure that the tax relief is targeted as intended. If relief is restricted to homestead properties that are the principal residences of their owners, more information is needed than if all residential properties, or even all owner-occupied residential properties, qualify for relief. If tax relief depends upon claimants’ income levels, income information must be assembled, reported, processed, and (ideally) verified on a random audit basis to assure the targeting is implemented as intended. For equity, income should be (and generally is) defined quite broadly, requiring agencies to collect information on income from sources not part of income tax bases. The added administration and compliance costs imposed by such income targeting allow improved equity and lower total costs for a given level of relief for those most in need of it. Revenue Adequacy Property tax relief costs money, but it is too narrow to ask, as is sometimes done, how much it reduces the tax base. Residential property tax relief has a direct effect upon the property tax base only if structured as a tax exemption. Circuit breakers in most states are state funded, but in some states there are local-option (and locally funded) programs that either stand alone or are addons to a state program. Homestead exemptions and credits often are state funded as well. While property tax relief that is fully state funded has no direct

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revenue consequences for local governments, more money spent for property tax relief may mean less state money for other programs, including grants to local governments. In addition, there may be indirect effects on taxpayers, such as capitalization of the lower taxes resulting from relief into higher home values (this is more likely for broad, general relief programs), partly mitigating the costs of relief, or discouragement of business investment and economic growth if residential relief suggests a poor business tax climate, adding to the costs of relief. Accurate measurement of the extent to which these efffects result from various forms of property tax relief is a challenge for future research. Because residential relief programs vary quite widely in terms of eligibility and scope of available relief, total and per-claimant costs vary widely among programs. Circuit breaker programs differ widely in program design; slidingscale programs are different from threshold programs; and within each general type, there are many variations. Threshold circuit breakers may have a single threshold or multiple thresholds, and the threshold levels vary significantly across programs. The same formula may apply to all claimants, or there may be separate formulas for different groups (for example, one formula for single individuals and another for married couples, or one for the elderly and another for the nonelderly). There also are differences in such provisions as income definition, income limits, and benefit limits. Sliding-scale circuit breakers vary in many of the same ways, but instead of differences in threshold percentages, the differences arise in the number of defined relief brackets, the level of relief percentages, the level of benefit limits, the income level at which relief drops to zero, and so on. Income-targeted homestead exemptions and credits employ still other income definitions, have different income ceilings, and provide for different levels of exemption. Moreover, housing values, property tax levels, home ownership rates, income levels, and other variables that affect program costs differ from state to state. For these reasons, there is no attempt here to estimate what a particular sort of relief program might cost in a particular setting; especially for circuit breakers, cost estimation has been a difficult endeavor in many states. Some general (and perhaps obvious) comments can be made about relative program costs. For example, a 20 percent homestead exemption available to all owner-occupants regardless of age or income level is more costly than the same level of exemption available only to owner-occupants at least 65 years old with income less than $30,000. To provide a given level of relief to those with the greatest need (understood as lowest income), it is obviously more costly to include all homeowners than to restrict the relief to those below a specified income level. Suppose the greatest need is thought to be among those with incomes, broadly defined, below $25,000; if homeowners with income

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up to $50,000 are included, total program costs can be held down to some extent if relief diminishes as income rises. Finally, for any sort of residential property tax relief program, including both renters and owners will increase costs substantially. To go a bit beyond these general observations, I offer some numbers for a few selected property tax relief programs of different sorts. Not all states make such numbers readily available. Wisconsin, the originator of the circuit breaker approach over 40 years ago, reports program participation and cost data for the entire period (Wisconsin Department of Revenue 2006, Table 1). In fiscal 1965, the first year of operation, the program provided average benefits of $60 to 30,715 claimants for a total program cost of $1.8 million. In fiscal 2006, there were 239,546 claimants with average benefits of $509 and a total program cost of $121.9 million. The increased numbers reflect program expansion and benefit liberalization, as well as rising levels of taxes and incomes over the years. In the latest year, benefits were available to homeowners and renters at least 18 years old with income not exceeding $24,500. Relief was calculated using a threshold formula with threshold percentages of zero for the first $8,000 of income and 8.788 percent on income above $8,000; the level of relief was 80 percent of property tax (or rent equivalent) above the threshold amount, but no more than $1,450 of property tax was considered. Thus, the maximum relief was $1,160 (80 percent of $1,450), available to claimants with income no greater than $8,000 and thus subject to a zero threshold. By comparison, Ohio’s circuit breaker cost $70.1 million for tax year 2004, when 220,525 claimants received benefits averaging $318 (Ohio Department of Taxation 2006). Compared to Wisconsin, Ohio had 92 percent as many claimants but both total program costs and cost per claimant were much lower (57.5 percent and 62.5 percent, respectively). The Ohio income ceiling was slightly higher ($25,000 versus $24,500) but a narrower definition of income was used, which would result in more claimants, all else equal, because the Ohio law allowed understatement of claimants’ incomes compared to Wisconsin’s definition. In many other ways, the situations are not comparable. Ohio’s population was more than twice that of Wisconsin, but the Wisconsin program included homeowners and renters of all ages while Ohio’s covered only homeowners 65 and older or who were disabled. Moreover, benefits were calculated very differently in the two states. The Wisconsin formula is given above. Ohio used a sliding-scale structure with three brackets and extended relief through a partial homestead exemption. The exempt portion was 75 percent of assessed value (but not more than $5,200) if income was $12,900 or less; 60 percent of assessed value (but not more than $3,200) if income was between $12,901 and $18,900; and 25 percent of assessed value (but not more

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than $1,000) if income was between $18,901 and $25,000. Note that Ohio calls for assessed value to be equal to 35 percent of market value, so the maximum assessed values subject to reduction were about $14,860, $9,140, and $2,860. According to the Census Bureau, the median value of owner-occupied homes in Ohio in 2000 was $103,700.46 As proposed by its new governor in 2007, Ohio stripped circuit breaker provisions from the homestead exemption and eliminated any income restriction, converting the program into a flat exemption of $25,000 of market value for all homeowners 65 and over or who are disabled (Ohio Department of Taxation 2007a and 2007b). The state estimates that the number of tax relief recipients will more than treble to 775,000 and that program costs will jump from $70 million to $330 million; these numbers imply an average benefit of about $425 under the new program. The new Ohio program increases benefits for people participating in the circuit breaker in its last years because changes to dollar amounts in the old circuit breaker did not keep up with inflation. Adjusting for inflation, the total program cost for the new general exemption will be more than twice that for the initial circuit breaker adopted in 1971, even though the new flat exemption is only 35 percent as high as the maximum available under the initial circuit breaker structure (Bowman 2007, 391). As noted earlier, for a given level of benefit for those most in need, program costs are lower if the relief is targeted; given a total program cost, a general program providing a uniform level of relief will supply less meaningful relief to those most in need. For another perspective on the possible cost of a residential property tax relief program, consider some basic statistics bearing on the residential share of the property tax. Recent estimates put single-family residential property value at about 71 percent of all real property assessed value for Virginia, but the percentage varies considerably across localities (Knapp 2005). For example, the share is 84 percent in Prince William County, a large county with a population of over 350,000 in the second tier of counties outside Washington, DC, but only 22 percent in Buchanan County, a county of about 25,000 in the mountains of southwest Virginia. The Census Bureau places the 2000 homeownership rate for Virginia at 68 percent, but this also varies across localities (for example, it was 83 percent in Buchanan County, 72 percent in Prince William County, and 46 percent in Richmond, the state capital). Using state-level data, a 20 percent general homestead exemption for all single-family residential properties would reduce the tax base by about 14 percent (71 percent ⫻ 0.20). 46. Census Bureau data here and elsewhere, if not specifically attributed, are from State and County QuickFacts.

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If only owner-occupied housing qualified for relief, the figure would drop by about one-third. Such crude reckoning provides only a ballpark figure—a starting point. To refine it, some assumptions could be made about how the cost would be reduced by specifics of the contemplated property tax relief program, such as restricting coverage to the elderly, to homeowners, to elderly homeowners below a given income level, and so on. Up to now, our discussion of program costs has at least implied that property tax relief diminishes resources available to governments for other purposes. However, lowering the tax price of local benefits for homeowners may cause them to support higher levels of taxes. There is some empirical support for this notion (Bowman 1974; Bell and Bowman 1987),47 and it seems consistent with Glenn Fisher’s view of the desirability of changes to the property tax that have made it less uniform (Fisher 1996, 206–208). Fisher’s basic underlying premises are that meaningful local self-government is good, that a revenue source with significant local control (such as rate setting) is essential to strong local government, and that the property tax is better suited to this role than the other major taxes. Thus, changes to the property tax that make it palatable enough to homeowners and voters for it to continue as the major source of local tax revenue are, in this sense at least, good or worthwhile. For example, Fisher says that “extralegal local adaptations to the [property] tax may have contributed to its survival by making it more acceptable politically” (206). After considering changes such as relief measures and tax limits, he says, “The modification in the tax base and the various limits imposed on property tax levels permitted a much-modified property tax to survive and to remain the major revenue source of local governments” (208). In this view, a property tax with residential relief may produce more revenue than one without, and focusing on the cost of relief is misplaced. Tax Stability The final criterion considered is stability of revenue; this is at least close to tax predictability, which may be more important than absolute stability. Incometargeted residential property tax relief seems likely to exacerbate the fiscal problems of state and local governments during recessions or slow periods, because more people will qualify for relief. The problem tends to be mitigated to some extent by the fact that there is a lag involved; property tax relief pro-

47. The 1974 paper found a very significant positive relationship between local property tax level and the share of the tax not borne (or perceived not to be borne) by local residents, based on the composition of the property tax base. The 1987 study found that a Minnesota homestead credit, under which the state paid 54 percent of the homestead tax up to a $650 maximum credit per homeowner, stimulated additional taxes and spending until the maximum credit was received; again, the results were highly significant statistically.

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grams that consider claimants’ incomes generally use income information for the previous year. The other important perspective, of course, is that of taxpayers; in general, it is the mirror image of that of governments. Lower tax bills when income falls are desirable, and the lag in income data considered diminishes the timeliness of the relief. Summing Up To use Fisher’s phrase, the property tax has been “much modified.” There is less uniformity, in part because of the proliferation of residential property tax relief programs considered here. I have attempted to give some feel for the number and variety of such relief programs, but the topic is too broad and the space too limited to do this completely. I confess to some surprise upon finding—after some time away from close consideration of property tax relief programs across the United States—how many different programs exist in each of a number of states. It is one thing to say that two-thirds of the states have state-funded circuit breakers; it is something else again to realize that most of them have two or more circuit breaker programs. In a number of states, residential property tax relief programs of all sorts number more than 10, and in some more than 15. Often, the same people can take advantage of more than one program. In addition, caps or freezes on assessment levels or taxes, a subject not discussed in this chapter, can vary among homeowners, bringing about more nonuniformity. The property tax has changed so much in the last 50 years that at times I question whether we still have a property tax. Tax differences can depend more on political influence than on differences in property value. My level of comfort with some of the legally sanctioned changes increasing effective-rate differences seems lower than that of Glenn Fisher and many others. The Path to the Present When considering changes to the tax brought about by various relief measures, it can be helpful to adopt a historical perspective. About 40 years ago, Arthur Lynn (1967) provided the following summary of a property tax cycle: “The property-tax cycle (observed by Bastable, Seligman, and others) appears repeatedly in history—i.e., as a particular society and economy develops, property taxation moves from a specific to an ad valorem rate; from taxation of land to tax coverage of all or most property. Thereafter, as property becomes more heterogeneous in character and ownership distributed less equally, other taxes are substituted in relation to some categories of property, and the tax reverts to a levy essentially on realty. A study of the past illustrates the continual recurrence of

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such a pattern” (16). Lynn traced the cycle over several centuries, continents, and countries, including the United States. Coverage “of all or most property” was achieved in this country around the middle of the nineteenth century. Earlier, property taxes tended to be specific taxes of varying amounts on different types of property, and some property types were not taxed at all. Ad valorem taxation in the sense that we tend to think of it started early in some colonies, but really caught hold in the period after the American Revolution, particularly in the early nineteenth century.48 Soon after the general ad valorem tax was in place, however, it began to erode. Taxation of intangibles and some other forms of personal property came to be viewed as troublesome, both practically and philosophically, and such items started to be taxed more lightly or not at all. Real property classification, adopted by two states early in the twentieth century, began differential taxation of real estate. Roughly a fourth of the states adopted homestead exemptions in the 1930s. After a pause of nearly two decades, the residential property tax relief movement changed course, got a second wind (coincident with agricultural property tax relief), and 50 years later is still going. The sort of differentiation brought about by the residential relief movement recalls some colonial-era tax provisions. For example, buildings in general, but houses in particular, often were not taxed. “Some colonies supplemented their land taxes with taxes on buildings. But such taxes were usually unimportant. Connecticut taxed stores, warehouses, and manufacturing buildings lightly since the owners already paid faculty (occupation) taxes. And the colony exempted most dwelling-houses since they were considered non-productive property. Thus in 1776 house valuation [in Connecticut] represented only 1.41% of the Grand List (compared with 36.17% in 1924)” (Benson et al. 1965, 25). The same pattern was found in other states as well in the early period. For example, in 1778, after becoming independent from New York, Vermont adopted an act establishing a property tax system said to be copied from Connecticut’s system: “The improved land alone was included in the list, for that alone had much value. Ordinary buildings, such as dwelling-houses and farm-buildings, and tools, etc., were not included. . . . Business buildings, from which an income could be expected, were particularly mentioned, and horses and cattle were carefully entered. Intangible personal property . . . was also included” (Wood 1894, 36). A study of state taxes in 1796 by U.S. Secretary of the Treasury Oliver Wolcott found houses subject to tax in only five of the fifteen states, while land was taxed in fourteen states (Ely 1888, 118).49 48. Some early ad valorem taxes used legislated values for various types of buildings and other property. 49. The Wolcott study is summarized by Ely (1888), 117–130.

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Emphasis on income production in establishing different tax treatments, originating two centuries ago and more, is still with us. Proponents of homestead exemptions, classification, and other forms of residential property tax relief have used the distinction between income-producing and non–incomeproducing properties to justify taxing owner-occupied residences more lightly than other property uses. So in this sense, too, recent property tax developments have very old precedents. Everything old is new again. Whether the property tax cycle, like the business cycle, repeats itself or whether it is more a description of stages of development that an economy and its property tax pass through is not entirely clear. If it is the former, we (or our descendents) may look forward to an eventual reversal as the pendulum swings back and takes us through another period of more uniformity. I’m inclined to think we are still moving toward a collection of differential taxes on different sorts of property, as was typical of the American colonial period. As in that period, the tax burden on housing may decrease. As Fisher observed, political forces tend to move us in that direction. And the property tax is a political creation. Thoughts on the Path Forward for Property Tax Relief If only because of its size and the consequent difficulty of replacing it, the property tax is likely to remain the major tax for local government, so there will continue to be pressure for residential property tax relief. Although local control of a significant revenue source is important to meaningful local government, states must provide the framework for property taxation, which should include state provision and funding of property tax relief. My preferred approach to residential property tax relief is a state-funded circuit breaker with these features: • a threshold formula, preferably of the multiple-threshold variety found in Maryland and several other states, to provide narrower targeting of benefits; • a very broad definition of income; • coverage of owners and renters of all ages; • state-reimbursed homeowners’ property tax credits and state-issued checks for renters; • no income or benefit limits; and • tax relief limited to the property tax on the first $X of a home’s market value (X might be set at some multiple of median home value, such as 1.5 or 2.0 times the median).

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State funding is important because a major problem with locally provided property tax relief is revenue adequacy. Local jurisdictions differ in both their need for residential property tax relief (for example, they have different poverty rates) and their ability to fund such relief (differences in fiscal capacity per capita). If large concentrations of households need relief in a jurisdiction with comparatively low per capita fiscal capacity, meaningful property tax relief may be impossible. This basic problem is also present at the state level, but should be less acute than in some local areas because all property use classes are more likely to be heard from at the state level. A threshold circuit breaker is able to deal with property taxes that are high, for whatever reason and over whatever period of time, relative to income. Thus, it is a better tool than caps on assessments or tax liabilities for dealing with any hardships due to escalating home values. A threshold circuit breaker targets relief to those most in need of it, as measured by income, better than any other relief mechanism; use of multiple thresholds, incrementally applied, enhances this feature. For targeting to be carried out appropriately, it is essential that income be defined very broadly. Historically in circuit breaker programs income has been and generally still is so defined, but there has been some retreat; for example, some states now exempt all or some Social Security benefits from the definition of income. Households rely to varying degrees on the excluded sources. As a result, funds available for property tax relief are redirected to some extent from those who truly have very little income to others who are able, solely because of a narrower definition, to appear as if they have very little income. If the practice of narrowing the definition of income spreads, it will be most unfortunate; serious inequities result from pretending that some sources of income really do not constitute income.50 Coverage of all owners and renters is a matter of simple equity. Age is not a good proxy for need, so all ages should be included. Furthermore, although some market conditions, such as a glut of rental housing, make it difficult for landlords to pass all property taxes forward to tenants, in general renters surely bear property taxes, so they should be included. Property tax credits for owners provide property tax relief in a visible and timely manner; renters do not receive property tax bills, so their circuit breaker benefits must be paid differently. Structuring a circuit breaker as a refundable income tax credit does not have the advantages it may seem to at first blush. Many who qualify for circuit breaker property tax relief have too little income 50. For a fuller discussion of circuit breaker definitions of income, the composition of income (particularly among the elderly), and inequities arising from narrower definitions of income, see Bowman (2008).

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to be required to file income tax returns. Also, because income should be, and generally is, defined more broadly for circuit breakers than in income tax law, information not required for the income tax return must be collected for the circuit breaker credit. In addition, property tax relief that leaves the property tax bill unchanged while income tax liability decreases or an income tax refund increases may leave people unsure of whether, and to what extent, they are getting property tax relief. If this is the case, property tax relief may not ease demands for property tax relief. Limits on income and benefits serve to control program costs, but they are not necessary in a threshold circuit breaker. Because housing consumption (that is, home value) generally does not increase proportionately with income, benefits decline as income rises, eventually falling to zero for essentially all households. In addition, limits can undercut such objectives as assuring that property taxes do not force people from their homes. If limits prove politically necessary (to assure that only “deserving” households receive property tax relief), they should be set at realistic levels and adjusted annually through automatic indexation.51 One limit that makes some sense restricts taxes considered for relief to those on only the first $X of market value, to keep from making large benefit payments to people with very expensive homes. If X is set at, say, 1.5 to 2.0 times median home value (which effectively indexes this limit), benefits available to occupants of especially valuable homes are limited, which may increase political acceptance and also improve targeting. Moreover, it generally will not cause hardship, as very high home values generally are indicative of wealth, or at least of equity that may be borrowed against to pay taxes. REFERENCES

Advisory Commission on Intergovernmental Relations. 1974a. Federal-state-local finances: Significant features of fiscal federalism. Report M-79. Washington, DC: Government Printing Office (February). ———. 1974b. The property tax in a changing environment: Selected state studies. Report M-83. Washington, DC: Government Printing Office (March). ———. 1975. Property tax circuit-breakers: Current status and policy issues. Report M-87. Washington, DC: Government Printing Office (February). ———. 1994. Budget processes and tax systems. Vol. 1 of Significant features of fiscal federalism. Report M-190. Washington, DC: Government Printing Office (June). 51. A number of states index dollar amounts in their circuit-breaker programs, but many others do not; if appropriate adjustments are not made over time, the relief provided becomes less and less significant and the program becomes outdated, perhaps irrelevant; see Bowman (2007) for two examples.

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Anderson, John E. 2005. Circuit breaker. In Encyclopedia of taxation and tax policy, ed. Joseph J. Cordes, Robert D. Ebel, and Jane G. Gravelle, 56–57. Washington, DC: Urban Institute Press. Baer, David. 2003. State programs and practices for reducing residential property taxes. Washington, DC: AARP Public Policy Institute (May). http://assets.aarp.org/rgcenter/ econ/2003_04_taxes.pdf. Bell, Michael E., and John H. Bowman. 1987. The effect of various intergovernmental aid types on local own-source revenues: The case of property taxes in Minnesota cities. Public Finance Quarterly 15 (July):282–297. Benson, George C. S., Sumner Benson, Harold McClelland, and Proctor Thomson. 1965. The American property tax: Its history, administration, and economic impact. Claremont, CA: Claremont College Printing Service. Bowman, John H. 1974. Tax exportability, intergovernmental aid, and school finance reform. National Tax Journal 27 (June):163–173. ———. 1980. Property tax circuit breakers reconsidered: Continuing issues surrounding a popular program. American Journal of Economics and Sociology 39 (October):355–372. ———. 1987. Real property classification: The states march to different drummers. Proceedings of the seventy-ninth annual conference on taxation, 288–296. Columbus, OH: National Tax Association-Tax Institute of America. ———. 2006. Property tax policy responses to rapidly rising home values: District of Columbia, Maryland, and Virginia. National Tax Journal 59 (September):717–733. ———. 2007. Circuit breaker property tax relief in Ohio and West Virginia. State Tax Notes 45 (August 6):389–391. ———. 2008. Property tax circuit breakers: Features, use, and policy issues. Working Paper WP08JB01. Cambridge, MA: Lincoln Institute of Land Policy. Chen, Yung-Ping. 1967. Property-tax concessions to the aged. In Property Taxation, USA, ed. Richard W. Lindholm, 225–235. Madison: University of Wisconsin Press. Eckert, Joseph K., ed. 1990. Property appraisal and assessment administration. Chicago: International Association of Assessing Officers. Ely, Richard T. Assisted by John H. Finley. 1888. Taxation in American states and cities. New York: Thomas Y. Crowell. Fisher, Glenn W. 1996. The worst tax? A history of the property tax in America. Lawrence: University of Kansas Press. Fullerton, Howard N., Jr. 1999. Labor force participation: 75 years of change, 1950– 1998 and 1998–2025. Monthly Labor Review (December):3–12. http://www.bls.gov/ opub/mlr/1999/12/art1full.pdf. George Washington Institute of Public Policy and Lincoln Institute of Land Policy. 2008. Property tax usage in the U.S., statutory year 2006 [computer file]. Washington, DC: George Washington Institute of Public Policy [producer]; Cambridge, MA: Lincoln Institute of Land Policy [distributor]. Gold, Steven David. 1979. Property tax relief. Lexington, MA: Lexington Books.

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Groves, Harold M. 1964. Financing government, 6th ed. New York: Holt, Rinehart and Winston. Gruber, Jonathan, and David Wise. 1998. Social Security and retirement: An international comparison. American Economic Review 88 (May):158–163. Hatfield, Rolland F. 1967. Minnesota’s experience with classification. In The property tax: Problems and potentials, 239–244. Proceedings of a symposium of the Tax Institute of America. Princeton, NJ: Tax Institute of America. Indiana Department of Local Government Finance. 2006. 2 percent circuit breaker fact sheet. Indianapolis: Department of Local Government Finance (June). http://www. in.gov/dlgf/news/circuitFS.html. Knapp, John L., 2005. Classification of the assessed value of locally assessed real property in Virginia, 2004–2005. Charlottesville, VA: Weldon Cooper Center for Public Service, University of Virginia. http://www.coopercenter.org/econ/sitefiles/documents/ pdf/classcoderesult.pdf. Knapp, John L., and Stephen C. Kulp. 2002. 2002 tax rates: Virginia’s cities, counties, and selected towns. Charlottesville, VA: Weldon Cooper Center for Public Service, University of Virginia. Kondaks, Tony. 2007. Property tax protection programs for seniors: An obsolete entitlement. State Tax Notes 44(May 14):521–524. Lynn, Arthur D., Jr. 1967. Property-tax development: Selected historical perspectives. In Property taxation, USA, ed. Richard W. Lindholm, 7–19. Madison: University of Wisconsin Press. Lyons, Karen, Sarah Farkas, and Nicholas Johnson. 2007. The property tax circuit breaker: An introduction and survey of current programs. Washington, DC: Center on Budget and Policy Priorities, March 21. http://www.cbpp.org/3-21-07sfp.pdf. Messina, Debbie. 2006. Most qualify, few apply for home tax deferral. The VirginianPilot, July 29. http://www.highbeam.com/doc/1G1-148874231.html. Englehardt, Gary V., and Jonathan Gruber. 2004. Social Security and the evolution of elderly poverty. Working paper W10466. Cambridge, MA: National Bureau of Economic Research, May. Social Science Research Network: http://ssrn.com/abstract=541683. National Conference of State Legislatures. 2002. A guide to property taxes: Property tax relief. Denver: National Conference of State Legislatures. Ohio Department of Taxation. 2006. Property tax relief: Number of real property homestead exemptions granted, average reduction in taxable value and total reduction in taxes, by county, tax year 2004. Table HE-1, No. 71. Columbus (September 28). http://tax.ohio.gov/divisions/tax_analysis/tax_data_series/real_property/he1/ documents/he1cy04.pdf. ———. 2007a. Governor Strickland’s proposed senior citizen property tax relief. http://www.tax.ohio.gov/divisions/communications/news_releases/homestead_ exemption_expansion_Q_and_A.stm. ———. 2007b. New expanded homestead exemption. Columbus. http://www.tax.ohio. gov/divisions/communications/Expanded_Homestead_Exemption_FAQs.stm.

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———. 2007c. 2006 annual report. Columbus, May 18. http://tax.ohio.gov/divisions/ communications/publications/documents/real_property_tax.pdf. Sexton, Terri A. 2003. Property tax systems in the United States: The tax base, exemptions, incentives, and relief. Provisional, unpublished report, Center for State and Local Taxation, Institute for Governmental Affairs, University of California-Davis (June 20), Davis, CA. http://www.iga.ucdavis.edu/property_tax_report.html. Shannon, John. 1967. Conflict between state assessment law and local assessment practice. In Property taxation, USA, ed. Richard W. Lindholm, 39–63. Madison: University of Wisconsin Press. Sliger, Bernard F. 1967. Exemption of veterans’ homesteads. In Property taxation, USA, ed. Richard W. Lindholm, 213–223. Madison: University of Wisconsin Press. Stark, Jack. 1992. A history of property tax and property tax relief in Wisconsin. Madison, WI: Legislative Reference Bureau. Stocker, Frederick D. 1967. Property tax exemptions for farmers and the aged. In The property tax: Problems and potentials, 283–294. Proceedings of a symposium of the Tax Institute of America. Princeton, NJ: Tax Institute of America. U.S. Census Bureau. 1989. 1987 census of governments. Vol. 2, taxable property values. Washington, DC: Government Printing Office. ———. 2006. Income, poverty, and health insurance coverage in the United States: 2005. Washington, DC: Government Printing Office (August). http://www.census.gov/ prod/2006pubs/p60-231.pdf. ———. [n.d.] State and County QuickFacts. http://quickfacts.census.gov/qfd/index .html. U.S. Social Security Administration. 2006. Fiscal year 2006 performance and accountability report. Baltimore, MD: Social Security Administration (November). http:// www.ssa.gov/finance/2006/FY06_PAR.pdf. Walker, Mabel. 1964. Increasing clamor for property tax exemptions. Tax Policy 31 (October):3–14. Washington State Legislature. Senate. 2007. A legislative guide to Washington state property taxes 2007. http://www1.leg.wa.gov/documents/Senate/SCS/WM/SwmWebsite/ Publications/2007/PropTaxGuide2007.pdf. Wisconsin Department of Revenue. 2006. The homestead tax credit program: Summary for FY 2006. Madison: Wisconsin Department of Revenue, Division of Research and Policy (December 14). http://www.revenue.wi.gov/ra/06hmsted.pdf. Wood, Frederick A. 1894. History of taxation in Vermont. Reprint of the 1894 Columbia College publication. New York: AMS Press, 1968.

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T

his chapter provides a very good overview of the property tax relief measures that have been implemented in the United States over the past century. Bowman combines historical perspective with contemporary economic and policy concerns, producing a very accurate, readable, and evenhanded review of this important topic. His broad experience is evident as he provides a panoramic overview. Given the potential breadth of the topic, Bowman limits the scope of his review to the following forms of property tax relief: • • • •

Homestead exemptions and credits Circuit breakers Tax deferral Classification

This list covers most of the important major forms of property tax relief, but omits some notable policies that deserve attention. First, the Californiastyle regime change (moving from property taxation to acquisition value taxation) deserves some consideration as other states are looking to emulate that example. Second, limits on the rate of growth of assessed value have become widespread in recent years. Finally, so-called truth in taxation provisions (e.g., Michigan’s Headlee Amendment) adopted by some states require tax rates to be rolled back proportionately when assessed values rise in order to keep tax liability from rising, unless voters override. The discussion of circuit breakers is well done, drawing out very useful distinctions for informing policy discussion among circuit breaker variants. Bowman provides comprehensive coverage of the many variants, with evaluative comments on the distinctions between true circuit breakers and imitators. This material is useful but would be improved with a focus on how each form of circuit breaker affects the marginal price of local public services. Circuit breakers cause income and substitution effects for property owners, both of which can affect their voting behavior in local elections related to the choice of public 111

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goods. Also, while it is implicit in the description of state circuit breakers, discussion of any perceptible trends in state adoption of circuit breakers or in changes in circuit breaker parameters over time would be helpful. Anderson (2005) provides a basic introduction to circuit breakers and their design. Tax deferral is mentioned and briefly discussed, but this topic would benefit from more complete coverage. Developments in financial markets make deferral increasingly feasible as a means of providing property tax relief, if not more politically palatable. Of course, there are also implicit forms of deferral that should be recognized. For example, consider common agricultural property tax relief programs that require land owners to sign a nondevelopment contract in order to receive relief. If the terms of the contract do not require payment of back taxes with interest when the contract is violated, there is an implicit deferral that can be significant. Any use of below-market rates of interest charged on such contracts represents a form of implicit deferral. One could discuss a number of ways that residential property tax provisions, as well, can provide implicit deferral. The classification section should also mention that agricultural property is nearly always subject to a lower effective tax rate than other classes of property, either through formal classification or implicit classification due to differences in assessment practices. While the focus of the paper is on residential property tax relief, somewhat more attention to agricultural tax relief is justified, inasmuch as it may also provide relief for rural homeowners. In the evaluation section, Bowman explicitly states the four criteria he uses for evaluating tax relief programs: • • • •

Equity Efficiency Revenue Adequacy Stability

He considers both horizontal and vertical equity and uses the concepts of the coefficient of dispersion and the price-related differential as measures of each type of equity. This is a useful framework that provides a more specific set of benchmarks than is typical of such discussions. Further into the discussion of equity, however, Bowman recommends that where relief is appropriate, departures from a standard of uniform effective property tax rates should be minimal. Most readers will find this recommendation rather vague and nonoperational. A somewhat more concrete recommendation would be helpful. Perhaps standards suggested by the International Association of Assessing Officers or other professional assessment organizations could be cited and discussed.

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The efficiency section discusses neutrality and ease of administration or compliance. Bowman includes a very brief discussion of the efficiency effects of tax relief in that it lowers the effective tax rate and alters the allocation of resources in the economy. I would try to put this in context by citing studies of the effective rate of taxation (federal, state, and local) across asset classes. For example, the Congressional Budget Office has published measures of the effective rate of taxation. Housing receives very significant tax preference at the federal level, affecting the allocation of resources dramatically. Some perspective on the degree to which state and local property tax relief can alter the overall effective rate of taxation of residential property would be helpful. In Bowman’s section on ease of administration and compliance, I suggest some discussion of the cost of administration be added. Critics of the property tax claim that it is a very expensive system of taxation. Data on the cost of administration per $1,000 of revenue generated, or some such measure, would be helpful to put the cost of administering the property tax system in context compared to other forms of financing the provision of local public goods. The section on revenue adequacy would benefit from a basic introduction to the notion of the optimal quantity of public goods to provide (i.e., the Samuelson rule). In that way, the discussion could give some substance to the concept of what is adequate. It could then progress to a discussion of the implications of narrowing the tax base and raising the tax rate in order to accommodate tax relief for at least some taxpayers. Perhaps reference to Brueckner (1979) would be a useful starting point to establish a benchmark for thinking about testing for optimality/efficiency. Additionally, some discussion of the ways economists measure fiscal condition would be useful. The fiscal condition of a local government is typically measured by the gap between its expenditure need and its revenueraising capacity. Both need and capacity are, in turn, measured in several alternative ways. Ladd (1994) provides a good overview of the measurement issues and Bahl, Martinez-Vasquez, and Sjoquist (1992) is also a useful reference. Bowman addresses the direct effects of residential property tax relief programs on the tax base at the beginning of his section on revenue adequacy. I would like to see the discussion include indirect effects as well. There are several important ways that tax relief programs have indirect effects on the tax base. First, there is the issue of capitalization. Tax relief that lowers the asset owner’s liability is capitalized into a higher asset price. The higher asset price, if properly recognized by the tax assessor, will undo some of the tax relief. Measurement of the capitalization effect is difficult, requiring sophisticated statistical approaches (see Yinger et al. 1988), but capitalization is real and important. Second, tax relief may be provided in a form that reduces the tax price of public goods. For example, a circuit breaker may alter the marginal price of local

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public education or police services because it lowers the after-tax price of those services for qualifying households. If so, the lower price may induce the household to demand a larger quantity of the public good. Voters in such a situation may be more likely to vote yes on the next millage proposal or bond vote. If the tax relief mechanism induces the decisive voter in an election to demand more of the public service, then the provision of a larger quantity of the public good will affect the entire tax base. Bowman addresses this concern, but I would like to see a fuller discussion. Bowman devotes one brief paragraph to tax stability; this issue deserves greater attention. I suggest using a portfolio context to discuss various tax sources and their growth responsiveness and stability characteristics, placing the property tax in context. Then, a discussion of the income elasticity of the property tax base and its implications would be helpful. In his summation, Bowman provides a very intriguing description of a stylized pattern observed over time—a property tax cycle. According to this concept, as an economy develops, its use of property taxation moves from a specific tax to an ad valorem tax; for example, from taxation of land to taxation of all or most property. As property becomes more varied in its character and ownership patterns become increasingly concentrated, other forms of taxation are substituted for some types of property and the property tax reverts to a tax on realty. While it is always tempting to look for patterns in history in the hopes of finding regularities that can provide powerful tools for interpretation and anticipation of future events, in this case we need more research to establish the existence of such a pattern. The refutable hypothesis of a property tax cycle needs rigorous empirical testing. Recent experience in transition countries would seem to provide a natural experiment by which such testing could be conducted. If the hypothesis is correct, the land tax in those countries should be replaced with a general ad valorem property tax, which should be followed by the introduction of new taxes that replace parts of the property tax, leading eventually to a reversion state where the property tax is a tax on realty. Given the varying start dates and paces of reform among transition countries, they would seem to provide a good laboratory in which to test the property tax cycle hypothesis. Researchers in the property tax field would do well to investigate this hypothesis. Bowman’s title implies that two major topics are to be covered: the increasing use and variety of property tax relief measures and their impact on property taxes. Bowman has succeeded admirably in covering the first topic, but the paper does not really provide evidence about the second. That is, what evidence do we have of the impact of property tax relief measures? Have they caused overall property tax rates to rise? Have they put upward pressure on the

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demand for local public services? Have they changed measures of the distribution of the property tax burden? Future research will benefit from more attention paid to the impacts on property taxes. REFERENCES

Anderson, John E. 2005. Circuit breaker. In Encyclopedia of taxation and tax policy. 2nd ed. Washington, DC: Urban Institute Press. Bahl, Roy J., Jorge Martinez-Vasquez, and David Sjoquist. 1992. Central city-suburban fiscal disparities. Public Finance Quarterly 22(4):420–432. Brueckner, Jan. 1979. Property values, local public expenditure and local economic efficiency. Journal of Public Economics 11:223–245. Ladd, Helen F. 1994. “Measuring disparities in the fiscal condition of local governments.” In Fiscal equalization for state and local government finance, ed. John E. Anderson. Westport, CT: Praeger. Yinger, John, Howard S. Bloom, Axel Börsch-Supan, and Helen F. Ladd. 1988. Property taxes and house values: The theory and estimation of intrajurisdictional property tax capitalization. San Diego: Academic Press.

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5 Assessment Limits as a Means of Limiting Homeowner Property Taxes TERRI A. SEXTON

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n the late 1970s, the combination of rapidly rising property values and stable property tax rates in California increased property taxes as a fraction of income and shifted the tax burden from commercial property owners to homeowners. The share of property taxes directly levied on homeowners in California increased from 34 percent in 1970 to 44 percent in 1978. Taxes on owner-occupied residential properties increased an average 12.8 percent per year between 1973 and 1977, while commercial property taxes increased only 7.6 percent per year (Citrin and Levy 1981). State and local governments did not respond to rising property values and tax revenue by cutting tax rates, so voters took matters into their own hands by overwhelmingly approving Proposition 13 in June of 1978. The recent U.S. housing boom is over but homeowners are still reeling from increased property tax bills and angry that they are shouldering an increasing burden relative to commercial property owners. Some taxpayers in Indiana saw their property taxes increase by more than 250 percent between 2003 and 2007 (Schneider 2007). Similar cases can be found in almost any state across the country (Lyman 2006). Housing prices increased over 55 percent nationwide between 2000 and 2005 and local property tax collections grew by 36 percent.1 Over the same period, the ability to pay higher taxes as measured by

1. The statistic on housing price increase is derived from the Housing Price Index published by the Office of Federal Housing Enterprise Oversight and available at http://www.ofheo.gov/hpi.aspx. The data on property tax collections derive from U.S. Census Bureau, Federal, State, and Local Governments, State and Local Government Finances, available at http://www.census.gov/govs/www/estimate.html.

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personal income increased only 22 percent and median household income increased less than 11 percent.2 State and local lawmakers have been facing a barrage of criticism from unhappy taxpayers calling for property tax relief. Fearing the kind of backlash that led to the passage of Proposition 13, many state and local governments have taken action. Major property tax relief measures were proposed in 27 states in 2006 and 2007 (Hamilton 2007). Recent property tax relief measures targeted to homeowners have included increased exemptions, circuit breaker tax credits, tax deferral programs, and assessment caps or limits. Assessment limits are among the most popular because they are perceived as predictable and stable for homeowners. They are currently in use in 19 states and the District of Columbia. Under the most common form of assessment limit, the annual increase in assessed value of each individual property cannot exceed a specified percentage of the prior year’s value. These programs vary from state to state along several dimensions such as the type of property that is eligible and the specific limit. This chapter examines the various types, prevalence, and impacts of assessment limit programs in the United States. While the intention is to stabilize property tax burdens, this research shows that assessment limits, by themselves, do not guarantee lower tax bills or prevent redistribution of the tax burden. Instead, they undermine the fairness of the property tax and lead to inefficient mobility effects. This chapter begins with a description of the various types of assessment limits. The prevalence of assessment limits and their most common features are then examined and the impacts are analyzed. Alternative strategies for providing homeowner property tax relief are discussed, and the chapter concludes with a look to the future of assessment limits. Types of Assessment Limits Assessment limits restrict the annual increase in assessed value to a specified percentage of the previous year’s assessed value. Assessment limits currently in use vary according to the following characteristics: • The limit is a fixed percentage, or is tied to an index for inflation such as the Consumer Price Index. Current statewide limits range from 2 to 15 percent.

2. The statistic on ability to pay derives from Bureau of Economic Analysis, National Income and Product Accounts, Table 2.1, available at http://www.bea.gov/national/nipaweb/TableView.asp?SelectedTable= 58&ViewSeries=NO&Java=no&Request3Place=N&3Place=N&FromView=YES&Freq=Year&FirstYear= 2000&LastYear=2005&3Place=N&Update=Update&JavaBox=no#Mid. The median income statistic derives from U.S. Census Bureau, Historical Income Tables-Households, Table H-6, available at http://www .census.gov/hhes/www/income/histinc/h06AR.html.

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• In most states the limits apply to individual parcels, but they can be applied instead to aggregate assessments across jurisdictions or the entire state, as in Iowa. • They apply to all types of property, as in California, or only to certain classes, such as owner-occupied residential (homestead) properties in Florida. Some states, such as Arkansas, have established different limits for different classes of property. • They can apply to eligible property owned by anyone, as with the limits considered in this report, or be targeted, as in many states, at elderly or lowincome households. Apart from these variations, certain features are common to most assessment limits: • Assessment limits usually include an “acquisition value” rule that resets the assessed value of properties based on their market value when they are sold. • New construction and improvements are usually excluded from the assessment limit. • An extreme version, or assessment freeze, prevents any increase in assessed values from year to year. Delayed or infrequent reassessment has the same effect as a freeze between assessment years. Prevalence of Assessment Limits Nineteen states and the District of Columbia currently have some form of assessment limitation that applies to all owner-occupied residential property. Table 5.1 identifies these states and the characteristics of their programs. Sixteen of these programs involve uniform statewide limits (district-wide in the case of the District of Columbia). Limits in Connecticut, Georgia, and Illinois are available as a local option, and New York mandates limits in New York City and Nassau County. Some states, such as Florida, Maryland, South Carolina, and Texas target this form of relief to homeowners by applying limits only to owner-occupied residential (homestead) properties while others, like New Mexico, include the entire broader class of residential property and still others, including California, Oregon, and Oklahoma, limit assessment increases for all property types. Most states that apply the assessment limit to individual parcels, except Arizona, Minnesota, and Oregon, have adopted an acquisition value–based assessment system in which assessment limits apply until the property is sold, at which time its assessed value is redefined in terms of market value.

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TABLE 5.1

Property Tax Assessment Limits in the United States, 2008 Individual parcel values or aggregate assessments?

State

Coverage

Eligible Property

Caps removed upon sale?

Arizona*

statewide

all

no

individual

greater of 10% or 25% of difference between last year’s limited value and current market value

Arkansas

statewide all (constitutional)

yes

individual

homestead 5%, other 10%

California

statewide all (constitutional)

yes

individual

lesser of 2% or inflation

Colorado

statewide residential (constitutional)

N/A

statewide aggregate

implicit limit to hold residential burden at 45%

Limit

Connecticut local option

all

N/A

individual

phase-in, at least 25% per year

District of Columbia

districtwide

homestead

yes

individual

10%, 5% for qualifying low income

Florida

statewide homestead (constitutional)

yes

individual

lesser of 3% or inflation

Georgia

local option (local constitutional)

homestead

yes

individual

freeze (0%)

Illinois

local option

homestead

yes

individual

7% with maximum exemption value of $33,000

Iowa

statewide

residential and agricultural

no

statewide aggregate

4%

Maryland

statewide

homestead

yes

individual

10% statewide for state taxes; local option for local taxes, ranging from 0% to 10%

Michigan

statewide all (constitutional)

yes

individual

lesser of 5% or inflation

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TABLE 5.1 (continued)

Eligible Property

Caps removed upon sale?

Individual parcel values or aggregate assessments?

State

Coverage

Limit

Minnesota

statewide

farm, residential, seasonal residential

no

individual

greater of 15% or 33% of difference between last year’s limited value and current market value

Montana

statewide

all

yes

individual

16.66%/yr phase-in of reassessment over 6 yrs.

New Mexico statewide

residential

yes

individual

3%

New York

New York City & Nassau County

residential with 10 or fewer units

yes

individual

6% (residential up to three units) or 8% (other residential) per year; 20% or 30% over 5 years respectively

Oklahoma

statewide all (constitutional)

yes

individual

5%

Oregon

statewide all (constitutional)

no

individual

3%

South Carolina

statewide homestead (constitutional)

yes

individual

15% over 5 years

Texas

statewide homestead (constitutional)

yes

individual

10%

sources: Anderson (2006), Sexton (2003), and various state Web sites. *Arizona assessment limits apply for taxes owed to counties, cities, towns, and community college districts only.

The legal basis of these limits is also significant. In 10 states constitutional amendments limit assessment increases (indicated in Table 5.1, column 2); voters in these states must ratify amendments to change or eliminate the limits. The other 9 states and the District of Columbia have legislatively imposed limits; the legislature can revise these limits without voter approval. Of the 19 states with assessment limits, 8 also have both revenue limits and tax rate limits, 7 have only rate limits, 1 has only a revenue limit, while Connecticut, Maryland, and South Carolina have no explicit rate or revenue limits (Anderson 2006, 688). Not included in the table are the 27 states that do not require annual reassessment and thereby impose an implicit assessment limit of 0 percent if no

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adjustments are made to assessed valuations in nonassessment years. New Hampshire is the only state in the continental United States that has no explicit assessment, revenue, or rate limit and an annual statewide reassessment system. California was among the first states to impose statewide assessment limits and its 2 percent cap remains the lowest. Proposition 13, approved by voters in 1978, lowered the assessed values of all properties from their 1978 levels to those that prevailed in 1975–1976 and limits increases to a maximum of 2 percent per year, as long as there is no change in ownership. In addition, it placed a cap on the total property tax rate at 1 percent at a time when the average statewide rate was 2.5 percent. Florida, Oregon, and New Mexico allow a maximum of 3 percent annual growth in assessed values and South Carolina limits increases to a maximum of 15 percent over five years, or an average of 3 percent per year. Oregon’s Measure 50, passed in 1997, is similar to California’s Proposition 13 in that it rolled back assessments to 90 percent of 1995–1996 values and limits their annual growth to at most 3 percent. Oregon did not, however, adopt the acquisition value rule that resets assessed value to market value when a property is sold, nor does it assess new construction or improvements at market value. Instead, new construction or improvements are assessed at the same ratio of assessed value to market value as existing property, thus giving the new property the same relative tax break. In 1994 Michigan limited increases in the assessed value of individual properties to 5 percent or the inflation rate, whichever is less. Total property taxes in each jurisdiction are also allowed to grow no faster than inflation without voter approval. Oklahoma also limits increases in assessed values for all types of property to 5 percent per year, while Arkansas applies a 5 percent limit to homestead properties and a 10 percent limit to other types of property. Georgia and Illinois allow assessment limits as a county option. Georgia gives counties the option of freezing property values, and 19 counties have chosen to freeze residential values. In 2007 Georgia lawmakers debated but did not approve a constitutional amendment to restrict the rate of increase in assessments of all individual properties statewide to 3 percent per year or 9 percent over three years. Illinois enacted a state law in 2003 allowing counties to impose a 7 percent cap on annual increases in residential property assessments. Cook County immediately implemented the new law for taxes payable in 2004. The Illinois limit is unique in that there is a maximum of $20,000 that can be excluded from taxation. The limit is in the form of an expanded homestead exemption. If a home increases more than 7 percent in value then the excess up to a maximum of $20,000 can be used as an increased exemption. The Illinois law was

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first enacted for a three-year period, and then extended for three more years with an increase in the maximum exclusion from $20,000 to $33,000. Assessment limits in New York City vary according to property type. The assessed values of one- to three-unit residential properties cannot increase by more than 6 percent in one year and 20 percent over five years. For four- to ten-unit properties, assessments may not increase by more than 8 percent in one year and 30 percent over five years. For all other residential and commercial properties, assessment changes are phased in over five years. Two years after California passed Proposition 13, Arizona introduced a program designed to protect property owners from skyrocketing property tax bills. Each parcel of property has two separate values, a fair market value (FMV) and a Limited Property Value (LPV). The FMV is used to determine taxes for special districts, fire districts, school districts, bond issues, and bond overrides, while LPV is the basis for taxes owed to counties, cities, towns, and community college districts. The annual increase in a property’s LPV is limited to the greater of 10 percent or 25 percent of the difference between last year’s LPV and this year’s FMV. Minnesota enacted a similar program in 1993. Under its “Limited Market Value” law, increases in assessments of farms, residential property, seasonal recreational residential property (cabins), and timberland are limited to the greater of 15 percent of the prior year’s taxable value or 50 percent of the difference between the current estimated market value and the prior year’s value (the “difference factor”). The limit applies to owner-occupied and rental housing with three or fewer units. A change in ownership does not affect the assessment limitations. Increases in value due to new construction and improvements are not subject to the limit. The difference factor is up from 25 percent in 2006; the current 50 percent limit is for taxes payable in 2009, after which the program is scheduled to end.3 The District of Columbia, Maryland, and Texas limit annual increases in assessed valuations to 10 percent. In the District of Columbia, the Assessment Cap Credit program was established in 2002 when the three-year assessment cycle with phase-in of value increases was abandoned. Reassessment is now done annually and any increase in the assessed value of an owner-occupied principal residence greater than 10 percent results in an automatic credit for the amount of tax on the excess value. The cap was originally set at 25 percent in 2002 and reduced to 12 percent in 2003 and 10 percent in 2004 (Bowman 2006).4 3. The law originally capped the increase in the assessed value of homes at 10 percent per year or one-third of market value increases, whichever is greater. The limit has been as low as 8.5 percent (1999–2001) and the difference factor as low as 15 percent (2002). 4. The assessment cap credit limit is 5 percent for qualifying low-income households who have lived in their homes at least seven years.

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Maryland has a three-year staggered reassessment cycle in which one-third of any value increase determined in a reassessment is added to assessed value in each of the three years of the cycle. An assessment cap credit of 10 percent, similar to that in the District of Columbia, applies for state property taxes; local governments have the authority to lower the cap for local taxes. For fiscal 2007, 15 of the 24 local jurisdictions set limits below 10 percent. Talbot County allows no increase in homeowner reassessments and Anne Arundel County has set a 2 percent limit. Seven counties have established 5 percent caps and nine counties maintain the maximum allowable 10 percent cap. Also at the upper end of assessment limits, Texas voters approved a constitutional amendment in 1997 that limits the increases in the assessed value of homesteads to 10 percent annually. A recent task force recommended that local voters be allowed to swap a 0.5 percentage point sales tax increase for a reduction in the assessment limit from 10 to 5 percent or a larger homestead exemption (Shafroth 2007). The least restrictive assessment limit is Iowa’s, which was established in 1978. Even though assessments are limited to a relatively low 4 percent annual increase, the limit is applied statewide on entire classes of properties (residential, agricultural, and commercial) rather than on individual properties.5 If the increase in the total assessed value of a class of property exceeds the 4 percent limit, then all assessments in that class are reduced by the ratio of the allowable assessed value of the class (the previous year’s assessed value plus 4 percent) to the actual assessed value. This type of limit will not prevent large increases in assessments of individual properties because of significant variations in appreciation rates. The same is true of Colorado’s implicit limit that applies to the aggregate statewide residential tax base. In 1982 Colorado voters approved the Gallagher Amendment, a constitutional amendment that requires commercial property owners to pay 55 percent of all property taxes, with residential property owners bearing the remaining 45 percent of the burden. Commercial properties in Colorado are assessed at 29 percent of market value while the assessment ratio for residential property is allowed to fluctuate in order to maintain the 55/45 burden ratio. So increases in residential assessments are essentially limited to the rate of increase in commercial property values. Montana reassesses property every five years. To protect against huge jumps in tax liabilities, it effectively limits assessment increases on all properties by phasing in increased assessments due to reappraisals at the rate of 16.66 percent per year. Local governments in Connecticut, which also has a five-year reap5. Utility property is limited to 8 percent annual growth.

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.

praisal cycle, have a similar option to increase assessed values gradually over the cycle, though they must phase in at least 25 percent per year. Other states authorize some form of assessment limit, often a freeze, for elderly and disabled homeowners. According to Rappa (2003), at least 12 states have some form of property tax freeze in effect for elderly homeowners and 5 of them extend the freeze benefits to disabled taxpayers. While this limits the extent to which homeowners’ annual taxes can increase by excluding the increase in assessed value from taxation, it does not freeze the amount they pay unless tax rates or tax payments are also frozen. Most states that use this method to target property tax relief to seniors require elderly taxpayers to meet age and income criteria. Canadian provinces have also turned to assessment limits to provide property tax relief to homeowners. Nova Scotia’s CAP program, which became effective in 2005, established a 2001 base year for residential properties and has limited the increases in assessed values to 15 percent in 2002 and 2003, and 10 percent each year from 2004 through 2007. Beginning in 2008–2009, the cap will be set at the Consumer Price Index. Assessments in Ontario were frozen at their 2005 values but this freeze expired in 2008 and increased assessements will be phased in over a four year period. Impacts of Assessment Limits In order to evaluate the effectiveness of assessment limits in providing property tax relief to homeowners, the impacts of this strategy are examined below. The primary impact on government is a reduction in the property tax base and subsequent loss in property tax revenue. The impact on property owners is broken down into the equity effects which describe the winners and losers, and the efficiency effects brought about by changes in the behavior of property owners. Erosion of the Tax Base When property values increase at a rate greater than the assessment limit, the property tax base will be smaller than it otherwise would have been in the absence of the limit. The lower the assessment cap and the greater the rate of increase in property values, the greater the erosion of the tax base will be. If property values are not changing or are declining, the assessment cap has no affect on the tax base. It is only in situations where property appreciates at a rate higher than the established assessment limit that the limit has a constraining impact on the tax base. If an acquisition value rule is in effect so that assessed values are reset at market value at the time of sale, then the turnover of property will reduce the

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impact on the tax base. In the extreme, if every property that is eligible for the limit were sold each year the limit would never come into play and the tax base would be unaffected. Also, since new construction is usually exempt from the limit, jurisdictions that are growing more rapidly will experience smaller percentage reductions in their tax base. It is often difficult to get precise measures of the loss in taxable value after limits are in place. Such is the case in California since Proposition 13 because county assessors no longer have any reason or incentive to maintain a record of the market value of property. This information is only relevant in the year that a property is sold. Between sales, assessed values are determined simply by increasing the previous year’s value by 2 percent (or the rate of inflation if lower). In a comprehensive study of the effects of Proposition 13, O’Sullivan, Sexton, and Sheffrin (1995a) compared the assessed value and market value of a sample of properties that sold in 1992 to estimate the market value of all property in 1992. We found that the assessed value was approximately 56 percent of market value, or that the 2 percent assessment cap resulted in a 44 percent reduction in the tax base for 1992. A study prepared for the Texas Association of Property Tax Professionals in 2004 (Moak, Casey & Associates 2004) reported that Texas’s 1997 constitutional amendment limiting residential homestead assessed-value increases to 10 percent annually resulted in an estimated loss in tax base of $1.9 billion in 1998. The value lost increased to $14.2 billion in 2002 and was an estimated $10.9 billion in 2003. According to the study, this 2003 loss would have translated into $301 million in local revenue, assuming the same tax rates as were actually in effect that year. Beginning in 1983, the assessed values of homesteaded property in Muscogee County, Georgia, were frozen for local property tax purposes by a local constitutional amendment. Local assessments of individual homestead properties can change only if there is an improvement to the property (and then only by the value of the improvement) or a change in ownership. Since the state levies a tax based on fair market value, the county is required to maintain two values for tax purposes for all homesteaded property. These data allowed Sjoquist and Pandey (2001) to measure the loss in revenue due to the assessment freeze. For the period 1985–1989 the difference between the state and local property tax bases was less than 3.5 percent. Because of mandated revaluation in 1989, the state property tax base increased substantially and the difference grew to nearly 10 percent. From 1989 to 1997, the percentage continuously declined to less than 6 percent and in 1997 the ratio of the local residential tax base to the state residential tax base was 0.87. During this period, the homeowner share of the property tax burden declined.

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Recent property tax reform efforts in Florida have resulted in several studies examining the effects of that state’s “Save Our Homes” 3 percent assessment cap. In one such study, Hawkins (2006) reports that over the 10-year period from 1995 to 2004 the differential between the market value and assessed value of Florida homesteaded properties increased 4700 percent due to the assessment cap. Significant tax base erosion has also occurred in Minnesota since passage of its Limited Market Value law. Even though the assessment limit is considerably higher than California’s 2 percent or Florida’s 3 percent, the Minnesota Revenue Department reported a $32.5 billion (8 percent) reduction in the tax base statewide for taxes payable in 2006 (Minesota Department of Revenue 2006). Impact on Government Revenues By themselves, assessment limits need not reduce overall property tax revenue if government jurisdictions can increase the tax rate to make up for the lost value. If, however, tax rate limits are also in effect, as is the case in 15 of the 19 states with assessment limits, then revenues will likely be affected.6 Proposition 13 in California rolled back assessed values and lowered the total property tax rate from an average of 2.5 percent in 1977–1978 to 1 percent the following year. As a consequence, total property tax revenue in California fell from $10.3 billion in fiscal 1977–1978 to $5.6 billion in 1978–1979, a decline of more than 45 percent. Counties were hit hardest, experiencing a 57 percent reduction in property tax revenues. Property tax revenues of school districts fell from $4.2 billion in 1977–1978 to $2.0 billion in 1978–1979, and to $1.6 billion in 1979–1980. This represented a 61 percent decrease over the two-year period. Enterprise special districts provide services that are generally supported by user fees. Examples of such districts include utilities, transportation, sewers, and waste removal. These districts experienced a 27 percent reduction in property tax revenues from 1977–1978 to 1978–1979. Nonenterprise special districts such as parks, libraries, and police- and fire-protection districts were harder hit, experiencing a 52 percent reduction in property tax revenues from 1977–1978 to 1978–1979.7 Revenue losses are often difficult to measure in cases when tax rates are adjusted in response to reductions in the tax base. In most cases it is impossible to know what the tax rate would have been in the absence of the assessment 6. The fifteen states are Arizona, Arkansas, California, Colorado, Florida, Georgia, Illinois, Iowa, Michigan, Montana, New Mexico, New York, Oklahoma, Oregon, and Texas. See Anderson (2006). 7. These statistics are derived from the annual reports of financial transactions issued by the California State Controller for the relevant years.

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limit. Hawkins estimates that countywide property tax revenues in Florida were $1.82 billion (10.6 percent) lower in 2004 than they would have been without the assessment limit, based on average tax rates. If tax rates can be adjusted enough to make up for the decrease in the tax base, revenues need not be affected at all by an assessment limit. For example, Illinois has a statewide limit on increases in local levies, so most local governments were forced to reduce their tax rates in response to rising assessed values prior to implementation of the 7 percent assessment cap in Cook County. The assessment limit has translated into smaller reductions in tax rates in Cook County than otherwise would be the case, not lower property tax revenues. When local property tax revenues are reduced, budgets and services must be cut or alternative revenue sources must be found. Shortages experienced by local governments often result in increased reliance on state funding with a consequent increase in state control and loss of local autonomy. Equity Effects The primary motivation or defense of assessment limits is that they correct inequities that arise when housing prices rise rapidly and government does not respond by reducing tax rates. The fear is that the elderly, living on fixed incomes, will be forced to sell their homes to pay their taxes and homeowners in general will be forced to shoulder an unfair share of the tax burden. In reality, assessment limits do alter the distribution of the tax burden between different categories of property, but not always as intended, and can result in horizontal inequities whereby owners of identical properties bear very different tax burdens. Both types of equity effects are discussed below.

Redistribution of Burden One of the reasons assessment limits on residential property have been so popular is the perception that they will prevent the tax burden from shifting to homeowners. Property value appreciation, unless uniform, shifts relative tax burdens to more rapidly appreciating properties, and housing prices have risen faster than other property values. Assessment limits may or may not prevent this shift, depending on whether tax rates are adjusted to maintain or grow revenue or whether they are constrained. Other factors include whether the assessment limit applies to all property and whether an acquisition-value rule applies. In an acquisitionvalue system with rate limits, an assessment limit applied to all property will shift the property tax burden toward the class of properties with the highest turnover or the most new construction.

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When residential property assessments are capped but tax rates and government spending are not, someone will end up paying more tax. Properties that appreciate at rates above the cap will not generate as much revenue as they would in the absence of the cap. Government will likely make up this shortfall by raising the tax rate on all property, so that nonresidential property, lowappreciation residential properties, and even some residential properties with appreciation above but near the cap will end up paying higher taxes than they would have paid without the cap. So the tax burden is shifted to types of property not protected by the limit and within the protected class, from high- to low-appreciating properties. Such has been the case in Minnesota. In 2006, the state’s Limited Market Value law increased property taxes for 78 percent of homeowners by $106 million, an average of $96 per parcel. Property taxes decreased for the other 22 percent of homeowners by $86 million, an average of $273 per parcel. Some of the properties (16 percent) that experienced tax increases actually had their assessments reduced by the limit but ended up paying higher taxes because the increased tax rate more than offset their comparatively small assessed value reduction.8 Seasonal recreational residential property in Minnesota received the largest value reductions under the limit law (22.7 percent statewide), while residential homestead property was reduced the least, only 4.5 percent. In terms of tax dollars, the owners of farm homestead property were the chief beneficiaries of the limit law, enjoying a reduction in tax burden of $25.6 million while the commercial/industrial property tax burden increased by $51.5 million. Similar results have been reported for Cook County, Illinois (Dye, McMillen, and Merriman 2006a, 2006b). Prior to imposition of the 7 percent assessment limit in Cook County, the property tax burden was shifting from commercial and industrial property to residential property. This was due not only to more rapid appreciation of residential property but also to an increase in the relative number of residential parcels. The Chicagoland Chamber of Commerce reports that between 1995 and 2004 the number of residential parcels increased by 168,000 units, more than 13 percent, while the number of commercial and industrial properties decreased by 7,800 units, about 8 percent.9 Since the total revenue collected in Cook County has not changed, lower tax liabilities for some homeowners have meant higher tax liabilities for others. On the losing end are owners of commercial, industrial, and rented residential properties and homeowners with less than 7 percent appreciation. Even homeowners 8. Minnesota Revenue Department (2006). 9. See Chicagoland Chamber of Commerce. 7% Assessment Cap—Myths vs Facts. http://www.chicago landchamber.org/upload/libDoc_83.pdf.

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whose properties appreciated more than 7 percent and hence saw their assessed values reduced by the limit ended up paying higher taxes than they would have owed without the cap, because the tax rate was higher than it otherwise would have been. Those not eligible for the increased exemption paid roughly 4 to 6 percent more in taxes, while the eligible received tax cuts ranging from 0 to 50 percent and averaging 14 percent. Dye, McMillen, and Merriman found that both the benefits and burdens of the Cook County assessment limit varied across property types, location, and property values. Commercial properties absorbed the largest share of the burden of the tax reductions on eligible residential properties. Their tax increase as a percentage of the tax savings of eligible homeowners ranged from 36 percent in the south suburbs to 40 percent in the north suburbs and 47 percent in the city of Chicago. The geographic differences across the county are not surprising. Commercial or other ineligible properties in jurisdictions where rapidly appreciating homestead properties make up a large portion of the tax base will experience the largest tax increases, while rapidly appreciating homestead properties in jurisdictions where ineligible properties constitute a large portion of the tax base will enjoy the greatest tax savings. In terms of value, the authors found that in Chicago, the gains from the assessment limit decreased as property value increased. The largest percentage tax savings went to properties at the bottom or middle of the value distribution. Proponents of assessment limits argue that they are needed to protect seniors from being taxed out of their homes, but the irony is that seniors may end up paying higher taxes with the limit. Senior citizens in Illinois are eligible for the “senior freeze,” which freezes their assessed valuation. The Cook County 7 percent assessment limit does not reduce their assessed value but has resulted in higher tax rates and thus higher taxes. The Cook County government tax rate increased 4.5 percent to compensate for the fall in tax base. In Chicago and its suburban jurisdictions tax rates rose anywhere from 4.1 to 6.6 percent. School districts, on average, had to increase their tax rates 5 percent to maintain spending but tax rate limits prevented six districts from increasing their rates enough to compensate for the loss in tax base. Idaho has been considering Proposition 13–type property tax reforms for years and the 2008 debate focused on implementing an assessment limit once again in light of 2007 increases in assessed value, as high as 50 percent in some areas. Dornfest (2005) explored the impact of hypothetical assessment limits ranging from 2 percent to 8 percent on residential property in two of the largest counties in Idaho. He assumed that tax rates would adjust to achieve a

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7.5 percent budget increase, and as a consequence many properties that have their taxable values reduced due to the various assessment caps end up paying higher taxes than would have been the case without the cap. In Kootenai County, 86 to 88 percent of the parcels analyzed would have lower taxable values as a result of any of the caps considered, but over 50 percent of these parcels would pay higher taxes; overall, 60 percent of the parcels tested would pay more tax with the assessment limit, while 40 percent would get a tax break. In Ada County, where property values have not increased as rapidly, a smaller proportion of properties either gain or lose from an assessment cap. However, a sizeable proportion (38 percent) of properties whose values are constrained by a 3 percent cap would pay higher taxes. Dye and McMillen (2007a, 2007b) develop a stylized model that demonstrates the distributional effects of assessment limits. Their model confirms that the taxes owed on properties whose assessments are reduced by the limit may increase, and that the likelihood and magnitude of this effect increases with the appreciation rate of eligible properties and the proportion of eligible properties with high appreciation rates. Assessment limits shift the tax burden from eligible to ineligible properties and among eligible properties from those with high rates of appreciation to those appreciating slowly. Owners whose properties are increasing in value more rapidly than the permitted rate of increase benefit from lower effective property tax rates, at the expense of those whose properties are decreasing in value or are increasing at a lower rate. It is often argued that the burden is therefore shifted from high- to low-income households. While it is true that high-income households are more likely to be homeowners and generally own larger and more valuable homes, it is not necessarily true that these properties appreciate more rapidly. In California, a relative shortage of entry-level homes has resulted in higher rates of inflation for smaller, less expensive homes. This is also the case in Maryland, where properties valued at less than $200,000 increased in price an average of 75 percent while all property increased an average 18.7 percent in 2006 (Carson 2006). In a February 28, 2007, Washington Post article, Thomas Branham, Washington, DC’s, chief property assessor, is quoted as saying “In general, some of the more affordable and lower-priced neighborhoods are the areas that have appreciated the highest percentage. We actually saw that last year as well” (Woodlee 2007). Therefore it may not be accurate to conclude that assessment limits benefit higher-income households by shifting the burden to lower-income households. Dingemans and Munn (1989) found that from 1978 to 1985, property owners in the more expensive neighborhoods in Davis, California, received the greatest benefits from Proposition 13 because their properties are more stable with lower

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turnover rates. By 1985–1988, those same neighborhoods experienced the largest increases in taxes because of increased home sales. Moak, Casey & Associates (2004) argue that the property tax burden will be shifted from business property owners to homeowners if assessment limits on all property types are imposed during a recession, because increases in the market value of business properties (which change ownership infrequently) will not be reflected in assessed values as quickly as increases in the market value of residential properties (which turn over more rapidly). While the intention is to stabilize property tax burdens, assessment limits may undermine the fairness of the property tax. Assessment limits provide the most benefit to those whose property values are increasing the most rapidly, since effective tax rates decline more rapidly the faster the property appreciates at rates above the limit. The acquisition-value rule puts residential properties at a tax disadvantage, because homes typically change ownership more frequently than do businesses. Thus, if the assessment limit applies to all types of property, the burden will shift toward residential property as its aggregate assessed value increases more rapidly due to turnover.

Horizontal Inequities All of the states that impose assessment limits on individual properties except Arizona, Minnesota, and Oregon have converted to an acquisition-value-based property tax, meaning that the assessed value of a property is reset at market value at the time of sale. This feature, coupled with an assessment limit, creates significant disparities in property tax bills and effective property tax rates among owners of comparable properties, violating the principle of horizontal equity which calls for the equal treatment of equals. Under an acquisition-value tax system, horizontal inequities among property owners are inevitable. When a property is sold, it is assessed at market value, but if the reassessment cap is less than the rate of property inflation, the assessed value will be less than the market value, and the gap between the two values will grow over time. The sale of a property triggers reassessment at its full market value, so households in identical dwellings will face different tax liabilities, with a recent mover paying higher taxes than an owner who has remained in the same dwelling for some time. In a November 3, 2003, letter to the editor of the Wall Street Journal, Warren Buffett used his own property tax obligations to describe the inequities resulting from California’s acquisition-value system. He paid $2,264 in 2003 property taxes for a home he purchased in the 1970s. In 2003 that property was worth $4 million. He purchased a second house in the same neighborhood in the mid1990s. The second house was worth roughly half the value of the first but his

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2003 property tax bill on the second house was $12,002. The effective tax rate on the second house (0.6 percent) was 10 times higher than that on the first (0.056 percent). O’Sullivan, Sexton, and Sheffrin (1995a) document the disparities created by California’s system. In 1991, California homeowners who had resided in their current homes in Los Angeles County since 1975 (a group that constituted 43 percent of all homeowners in the county) were, on average, underassessed relative to market value by a factor of five. This means that actual market value had increased to a level five times that of assessed value and that the property taxes due on two identical homes would differ by a factor of five if one of the homes were to sell. This inequity in tax bills increases over time as long as the rate of property inflation exceeds the 2 percent cap. One way to demonstrate the horizontal inequities generated by an acquisitionvalue system is to compute the effects of a revenue-neutral switch to marketvalue taxation. O’Sullivan, Sexton, and Sheffrin conducted such an analysis in California. To predict the effects of a switch to market-value taxation on different types of homeowners, we matched property tax records with income tax returns (made available by the California Franchise Tax Board) for homeowners in four counties (Alameda, Los Angeles, San Bernardino, and San Mateo). We used estimates of disparity ratios (the ratio of market value to assessed value) to estimate a market value for each homeowner, and then calculated the total market value for homeowner property and the resulting revenue-neutral property tax rate. For a fixed tax rate, a switch to market-value taxation would increase total tax revenue because market values exceed assessed values. For revenue neutrality, the market-value tax rate must be less than the 1 percent rate in force under the acquisition-value system. In 1992, our computations indicated that the appropriate tax rate would be about 0.55 percent of current market value. The acquisition-value system benefits low-income homeowners at the expense of other households. With a switch from the current system to a marketvalue system, the typical homeowner in Los Angeles County with an annual income of $30,000 would pay $138 more in property taxes. In contrast, the typical homeowner with an income of $70,000 would pay $69 less. In Alameda County the figures are $213 more for the low-income homeowner and $162 less for the high-income homeowner; in San Mateo County, the figures are $294 more (low income) and $105 less (high income). Poor homeowners benefit from the acquisition-value system because they tend to move less frequently, and thus have relatively large disparity ratios and low effective tax rates. The lower mobility rates for the poor are reflected in the relatively large fraction of poor households that own homes with 1975 base

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years.10 The 1975 base year means that the homeowner purchased the property in or before 1975. In Alameda County, 25 percent of all nonsenior homeowners had a 1975 base year. Among the poorest nonsenior households (income less than $20,000), the percentage with a 1975 base year was 43 percent; among nonseniors with moderate income ($20,000 to $40,000), the percentage was 31 percent. In contrast, only 20 percent of nonsenior homeowners with income between $60,000 and $80,000 had a 1975 base year. Senior homeowners would pay higher taxes under a market-value system because they are less mobile, as reflected in the relatively large fraction of senior households with a 1975 base year—82 percent in Alameda County (compared to 25 percent of nonsenior households; 82 percent in Los Angeles County (compared to 30 percent of nonseniors). On average, in the four counties, senior households are about three times more likely to have 1975 base years. In the long run, differential patterns of turnover (coupled with inflation in excess of 2 percent) are the primary sources of inequity with regard to Proposition 13. Disparity ratios and the distribution of base years change over time. In Los Angeles County, the percentage of properties with 1975 base years decreased from 43 percent in 1992 to 30 percent in 1996, a result of natural turnover of property. The recession of the early 1990s led to a nearly 30 percent drop in property values in southern California, and the median disparity ratio for properties with a 1975 base year decreased from 5.19 to less than 4.0. Thus both natural turnover and the recession diminished property tax disparities between 1992 and 1996 (Sheffrin and Sexton 1998). The impact of the recent housing boom on these disparities is unknown. While rapidly rising property values would tend to increase the disparities, the increased turnover of properties would have the opposite effect. Since the increase in value and turnover rate has been greater for residential property, the property tax burden has shifted toward homeowners. The assessed value of homeowner property in California as a percentage of total assessed value has increased from 32 percent in 1979–1980, immediately after the implementation of Proposition 13, to 39.5 percent in 2005–2006.11 Sjoquist and Pandey (2001) document similar disparities in Georgia. They found that the assessment freeze in Muscogee County created significant assessment disparities among homeowners that increase absolutely but decrease on a percentage basis with the value of the property. The average dollar reduction in assessed value is found to increase with household income, age, and percentage

10. The base year of a property is 1975 or the year of its last sale, whichever is more recent. 11. Research and Statistics Section, California State Board of Equalization, June 2006.

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of the population that is white, although the percentage reduction is negatively correlated with income. Hawkins (2006) observes similar horizontal inequities among Florida homeowners, noting two Siesta Key condominium neighbors who own virtually identical properties but pay widely different property tax, $2,300 and $5,700, because the second property was purchased more recently. He points out that seasonal homeowners are at a particular disadvantage because they do not qualify for the “Save Our Homes” assessment limit and therefore pay higher property taxes than residents while consuming fewer local services. In fact, a group of Alabama residents with second homes in Florida filed a class action suit in 2007 asking the state to throw out the assessment cap because it has shifted an unfair share of the property tax burden onto “snowbirds” and second-home owners. In 2006 homestead property accounted for 45 percent of the market value of all taxable property in Florida but generated only 32 percent of property tax revenue (Florida Legislative Office of Economic and Demographic Research 2007a, 2007b). Although a Florida judge dismissed the 2007 case, owners of second homes in Florida were awarded a 10 percent assessment cap as part of a 2008 voter-approved constitutional amendment. Horizontal inequities like those documented here are not limited to residential properties. Disparities are also prevalent within the commercial property class in California. Morain (2003) reported some of the inequities that exist between new and old businesses. At that time the owners of the new Wells Fargo Center in Los Angeles paid $1.77 per square foot in property taxes and the owners of the Sun America Center paid $5.00 per square foot. In contrast, businesses that were well established before the passage of Proposition 13 in 1978 paid far less. In 2003, the owners of Disneyland paid an average of five cents per square foot on its original property and the owners of Capitol Records paid ten cents per square foot on its famous building near the Wells Fargo Center. O’Sullivan, Sexton, and Sheffrin (1995a) found that disparities of this magnitude are not uncommon. We computed a mean disparity ratio of 5.66 for commercial/industrial properties with 1975 base years in 1991. This ratio declined to 3.23 in 1996 due to the recession, but had increased to 4.0 by 2002 (Sexton and Sheffrin, 2003; Sheffrin and Sexton, 1998). Efficiency (Mobility) Effects An acquisition-value-based property tax assessment system discourages people from moving because their taxes go up dramatically if they do, even if their new home has a market value that is the same as or less than the old one. This penalty results in inefficient resource allocation because it discourages mobility. It

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discourages moving to bigger homes when families grow; it also discourages moving to smaller homes when children leave, thus limiting the supply of affordable starter homes for young families. Also, homeowners are less likely to move to avoid longer commutes if their job location changes. An acquisition-value-based property tax not only decreases household mobility but increases the likelihood of home ownership among infrequent movers at the expense of frequent movers, and attracts infrequent movers while repelling frequent movers. O’Sullivan, Sexton, and Sheffrin (1995b) use a simulation model to compute the optimum time per dwelling and the excess burden resulting from an acquisition-value tax. Our results suggest that the distortions are relatively large: a revenue-neutral switch from a conventional property tax to an acquisition-value tax, assuming a 3 percent tax rate and property value appreciation of 6 percent, increases the median time per dwelling by about 18 percent and results in a differential excess burden of about 4.5 percent of total tax revenue. In California’s system, assuming a 6 percent inflation rate for housing, the change in tax policy causes much smaller increases in time per dwelling (about 4 percent for the median household) because of the lower tax rate of 1 percent. In terms of jurisdictional choice, the tax causes households to sort themselves with respect to mobility. The acquisition-value system distorts the household’s location decision: If a city switches from a market-value to an acquisition-value tax, it will attract infrequent movers and repel frequent movers. In addition, the effect of the acquisition-value system on property values (capitalization) is ambiguous. Given the choice between two cities, identical except that one has a market-value tax and the other has an acquisition-value tax, infrequent movers have the most to gain from living in the acquisition-value city, and they bid up the price of housing in this city to a level at which frequent movers are better off in the market-value city. The analysis of jurisdictional choice would change if the level of public services were endogenous. A switch to acquisition value decreases tax revenue from the property tax, requiring either an increase in the property tax rate, a cut in public services, or an increase in other taxes to balance the public budget. Any response would decrease the relative attractiveness of the acquisition-value city, muting or reversing the capitalization effect. We compute the excess burden of a revenue-neutral switch from a marketvalue to an acquisition-value tax. Assuming the quantity of housing is fixed, the market-value tax does not distort behavior, so its excess burden is zero. The excess burden incurred by a particular household is the compensating variation associated with the switch, that is, the lump-sum payment required to restore the utility level or satisfaction achieved under a market-value system. The total excess burden is the sum of the compensating variations (some of which are negative)

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across households. The annual compensating variation for the median household is estimated to be $440 per year which equals 0.88 percent of their income or 4.58 percent of their market-value tax liability (O’Sullivan, Sexton, Sheffrin 1995b, 123). The excess burden increases with both the inflation rate and the tax rate. The estimated excess burden of California’s acquisition-value tax system is much lower ($22 to $66 per household per year), because the state’s tax rate is lower and the gap between assessed and market value is assumed to grow by only 4 percent per year (the inflation rate of 6 percent less the assessment rate of 2 percent) rather than the full 6 percent. Wasi and White (2005) also examine the mobility effects of an acquisitionvalue property tax. They find that from 1970 to 2000, the average tenure length of homeowners in California increased by 0.66 years, or 6 percent, relative to that of owners in the comparison states of Florida and Texas. The increase in tenure length was found to be higher in areas where housing values are higher, increase more rapidly, or both, so that the mobility effect of Proposition 13 was greatest in the coastal areas of California. Further evidence of this lock-in effect was found by Ferreira (2004). California Propositions 60 and 90 allow homeowners age 55 and older to sell their homes and take their assessed value with them. So once the homeowner reaches age 55, the moving penalty is removed. Ferreira found that 55-year-olds in California in 1990 had a 1.2 percent higher rate of moving when compared to 54year-olds. He also reports that homeownership rates in California, which are barely half the national average for young families, actually converge to the national level as homeowner age increases. This convergence is not observed in other states or in 1970 census data in California. In contrast to the above studies, Sjoquist and Pandey (2001) found that the assessed value freeze in Muscogee County, Georgia, had no significant effect on mobility and hence no impact on housing turnover or community stability. The moving penalty also affects business property decisions. Like households, businesses will be less responsive to changes in business and property-market conditions, tolerating a bigger mismatch between desired and actual property characteristics. Businesses will also be biased toward modifying property rather than moving to another property and will be willing to absorb higher transportation costs before moving closer to their market. An added distortion is that existing businesses have a tax advantage over new ones. If a new firm purchases a property that is identical to the property owned by its competitors, the new business will pay higher property taxes because its property will be assessed at full market value, while its competitors’ assessed values will be based on their acquisition values.

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Alternative Relief Measures Assessment limits are believed to protect homeowners from increases in their property tax bills and increases in their share of the tax burden when governments fail to adjust tax rates in response to rapid increases in housing prices. Although some taxpayers benefit from the limits, many others, often among those most in need of property tax relief, receive no protection. Assessment limits generally result in a significant redistribution of the tax burden both between and within property types, and they violate the principles of fair and uniform taxation. Better targeted and less expensive options for providing relief from sudden increases in property taxes include the following: • Circuit breaker tax credits provide targeted tax relief to low-income and elderly taxpayers for whom property taxes are deemed too burdensome because they exceed some percentage of income. Statewide circuit breaker programs are offered in 18 states (Lyons, Farkas, and Johnson, 2007). • Levy limits cap the amount of revenues that can be collected by a taxing jurisdiction, forcing local governments to reduce tax rates when assessments increase. If appreciation in property values is not uniform, then the tax burden will shift toward those properties appreciating the most rapidly. Missouri has this type of limitation, allowing revenues to increase at the same rate as the Consumer Price Index. • A limit or cap on individual tax payments would ensure that tax bills did not rise by more than a certain percentage and would maintain the existing distribution of burden, if the limit or cap were applied to all properties. In 2005 Nevada instituted such a cap at 3 percent. While this prevents a redistribution of tax burden, it violates equity principles because different properties end up facing different effective tax rates based on their rate of appreciation, with above-average value increases leading to above-average reductions in effective tax rates. • Tax deferral programs are popular for providing property tax relief to seniors or low-income households. Norfolk, Virginia, offers homeowners with combined annual incomes of $100,000 or less the option to defer the annual increase in their property taxes in excess of 5 percent. Any taxes deferred must be repaid with interest when the property is sold. Relatively few homeowners have chosen this option because of the repayment requirements. • “Truth in taxation” programs attempt to hold local governments accountable. Significant increases in assessed value, if fairly uniform across the jurisdiction, need not result in increased taxes for most property owners if the tax rate is reduced proportionately. Local governments certainly have the power to reduce

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tax rates to offset assessment increases, but are too often reluctant to forego the increased revenues that result so easily from growth in the tax base. “Truth in taxation” legislation requires at least public disclosure, if not voter approval, of any increases in tax collections, whether due to growth in the tax base or a rate increase. Virginia’s only statewide program that addresses rising assessed values is its truth-in-taxation law. Tennessee also relies on statutory “Truth in taxation” requirements to keep tax liabilities in check, making it politically difficult to maintain, let alone raise, tax rates following reappraisals. Utah’s full disclosure law (adopted in 1985, effective in 1986) has limited the growth in property taxes despite rapidly rising property values. Each local taxing jurisdiction (city, town, school district, and special district) determines a constant-yield tax rate each year. This is the rate that, when applied to the current year tax base, yields the same revenue as the previous year. If local governments want to generate more revenue, they must vote on and adopt a rate increase after the public has been informed and rate hearings announced. Cornia and Walters (2006) report that local officials in 10 counties have reduced property tax rates in response to rising home prices. If our goal is to help those truly overburdened by property taxes, to whom do we want to target relief? Many programs have been targeted to the elderly because they are likely living on fixed incomes and we do not want to see them forced to sell their homes. The assumption that retired seniors on fixed incomes are the group most in need of property tax relief has been called into question recently, for example by Kenyon (2006). As of 2003, the poverty rate for seniors was lower than that for all age groups up to 34 years old, and seniors have the highest average net worth of families in any age group. In addition, the increase in availability of reverse mortgages has allowed them to tap their home equity to pay property tax increases. Conclusion Assessment limits are believed to be the answer both to skyrocketing property taxes, caused by rapidly appreciating property values, and to the redistribution of tax burden that occurs when appreciation is nonuniform. This examination of their impacts, however, suggests that they are among the least effective, equitable, and efficient strategies available for providing property tax relief. Assessment limits give tax breaks to anyone whose property value increases rapidly, with the biggest breaks going to those whose properties appreciate fastest, and provide no relief to those whose assessed values are stagnant. These limits result

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in substantial shifts in tax burden and differences in effective property tax rates within and across property classes. Housing prices are dropping nationwide, but it will take some time for the slowdown to show up in property tax assessments. Meantime, property tax reform efforts continue. Fortunately, policy makers and voters are turning to assessment limits less frequently, and many of the recent attempts to implement them have failed. Anti-tax activists in Idaho have long sought a system patterned on Proposition 13 but lawmakers continue to reject such tax reform because of concerns over the redistribution of tax burden and the loss of revenue to local governments. Assessment limit laws recently failed in Maine and Georgia and Washington has been unable to pass an initiative to limit assessments or tax levies. Recognition of the inequitable and inefficient impacts of Florida’s “Save Our Homes” assessment limit led to several property tax reform proposals in 2007. They included raising the assessment limit from 3 percent to 6 percent, and gradually phasing out the limit and substituting a larger homestead exemption. Ultimately, however, Florida voters approved a constitutional amendment in January 2008 in which they decided not to eliminate the assessment limit, but rather to extend it. Although our conclusion is that assessment limits are ineffective, inequitable, and inefficient, particularly when paired with acquisition-value-based assessment, we must recognize the consequences of abandoning such programs and returning to market-value-based assessment. One of the key results or our analysis of Proposition 13 is that relative to a market-value property tax system that raises the same revenue, the acquisition-value system in California tends to favor lower-income and elderly homeowners. Within any income or age class, however, there are households that gain and households that lose depending on their mobility patterns. From this vantage point, Proposition 13 created a tension between horizontal and vertical equity. Households that are similar in all respects except mobility rates will be treated differently. On average, however, lower-income homeowners and the elderly exhibit less mobility and are relative beneficiaries of Proposition 13. This makes the prospect of abandoning Proposition 13 or similar measures and returning to a traditional market-value based property tax system unlikely. REFERENCES

Anderson, Nathan B. 2006. Property tax limitations: An interpretative review. National Tax Journal 59(3):685–694. Bowman, John H. 2006. Property tax policy responses to rapidly rising home values: District of Columbia, Maryland, and Virginia. National Tax Journal 59(3):717–733.

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Carson, Larry. 2006. House values in Maryland up 18.7%. Baltimore Sun, December 29:1A. Chicagoland Chamber of Commerce. 7% Assessment Cap—Myths vs Facts. http:// www.chicagolandchamber.org/upload/libDoc_83.pdf. Citrin, Jack, and F. Levy. 1981. From Proposition 13 to Proposition 4 and beyond: The political meaning of the ongoing tax revolt in California. In The property tax revolt: The case of Proposition 13, ed. G. Kaufman and K. Rosen. Cambridge, MA: Ballinger. Cornia, Gary C., and Lawrence C. Walters. 2006. Full disclosure: Controlling property tax increases during periods of increasing housing values. National Tax Journal 59(3):735–748. Dingemans, Dennis, and Andrew Munn. 1989. Acquisition-based assessment and property tax inequalities after California’s 1978 Proposition Thirteen. Growth and Change (Winter):55–66. Dornfest, Alan S. 2005. Effects of taxable value increase limits: Fables and fallacies. Journal of Property Tax Assessment and Administration 2(4):5–15. Duncombe, William, and John Yinger. 2001. Alternative Paths to Property Tax Relief. In Property taxation and local government finance, ed. Wallace Oates, 243–294. Cambridge, MA: Lincoln Institute of Land Policy. Dye, Richard F., and Daniel P. McMillen. 2007a. Surprise! An unintended consequence of assessment limitations. Land Lines 19(3):8–13. ———. 2007b. The algebra of tax burden shifts from assessment limitations. Working paper, Lincoln Institute of Land Policy, Cambridge, MA. Dye, Richard F., Daniel P. McMillen, and David F. Merriman. 2006a. The economic effects of the 7% assessment cap in Cook County. Chicago: Institute of Government and Public Affairs, University of Illinois. ———. 2006b. Illinois’ response to rising residential property values: An assessment cap in Cook County. National Tax Journal 59(3):707–716. Ferreira, Fernando. 2004. You can take it with you: Transferability of Proposition 13 tax benefits, residential mobility, and willingness to pay for housing amenities. Working Paper 72. Center for Labor Economics, University of California, Berkeley. Florida Legislative Office of Economic and Demographic Research. 2007a. Florida’s property tax study interim report. Tallahassee (February 15). http://edr.state.fl.us/ property%20tax%20study/Ad%20Valorem%20iterim%20report.pdf. ———. 2007b. Final report: Analytical services relating to property taxation, Part I: Assessment component. Tallahassee (July 31). http://edr.state.fl.us/property%20tax %20study/Report-Assessment.pdf. Hamilton, Billy. 2007. Proposition 13’s long shadow. State Tax Notes (June 11):831– 834. Hawkins, Richard. 2006. Four easy steps to a fiscal train wreck: The Florida how-to guide. Fiscal Research Center Report No. 132. Andrew Young School of Policy Studies, Georgia State University, Atlanta. Kenyon, Daphne A. 2006. Talking sense on property tax relief. State Tax Notes (March 20):897–901.

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Lyman, Rick. 2006. As property values rise, homeowners feel pinch. New York Times, February 19:14. Lyons, Karen, Sarah Farkas, and Nicholas Johnson. 2007. The property tax circuit breaker: A survey of current programs. State Tax Notes (April 23):261–273. Minnesota Department of Revenue. 2006. Limited market value report: 2005 assessment year taxes payable 2006. St. Paul: Tax Research Division. http://www.taxes.state.mn .us/taxes/legal_policy/index.shtml. Moak, Casey & Associates 2004. Appraisal limits: A wrong turn on the road to property tax relief? A report to the Texas Association of Property Tax Professionals. Austin, TX. Morain, Dan. 2003. Firms’ Proposition 13 savings are coveted. Los Angeles Times, June 30: A1. O’Sullivan, Arthur, Terri A. Sexton, and Steven M. Sheffrin. 1995a. Property taxes & tax revolts. New York: Cambridge University Press. ———. 1995b. Property taxes, mobility, and home ownership. Journal of Urban Economics 37:107–129. Rappa, John. 2003. Cap on property tax payments for elderly homeowners. OLR Research Report 2003-R-0873. Connecticut General Assembly Office of Legislative Research, Hartford. http://www.cga.ct.gov/2003/olrdata/pd/rpt/2003-R-0873.htm. Schneider, Mary Beth. 2007. Property tax pain is felt across state. Indianapolis Star, July 14. Sexton, Terri A. 2003. Property tax systems in the United States: The tax base, exemptions, incentives, and relief. Working paper. Center for State and Local Taxation, University of California, Davis. Sexton, Terri A., and Steven M. Sheffrin. 2003. The market value of commercial real property in Los Angeles County in 2002. A Technical Assistance Report commissioned by the California Policy Research Center for the Senate Office of Research. Center for State and Local Taxation, University of California, Davis. Shafroth, Frank. 2007. Proper property taxes? State Tax Notes (February 19):497–500. Sheffrin, Steven M., and Terri Sexton. 1998. Proposition 13 in recession and recovery. San Francisco: Public Policy Institute of California. Sjoquist, David L., and Lakshmi Pandey. 2001. An analysis of acquisition value property tax assessment for homesteaded property. Public Budgeting and Finance (Winter):1–17. Wasi, Nada, and Michelle J. White. 2005. Property tax limitations and mobility: Lockin effect of California’s Proposition 13. Brookings-Wharton Papers on Urban Affairs: 59–88. Woodlee, Yolanda. 2007. 2008 Brentwood values to rise 46 percent. Washington Post, February 28: B4.

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COMMENTARY

JON SONSTELIE

I

n her chapter, Terri Sexton provides a thorough review of assessment limits and an unequivocal conclusion: “assessment limits, by themselves, do not guarantee lower tax bills or prevent redistribution of the tax burden. Instead, they undermine the fairness of the property tax and lead to inefficient mobility effects.” Few of us would argue with this conclusion, leading to this uncomfortable predicament: though public finance economists are nearly unanimous in their condemnation of assessment limits, nearly half of the states have enacted them. Are the experts missing something? If assessment limits are so undesirable, why do states enact them? Sexton provides a good starting place for this inquiry with her characterization of the conditions leading to the assessment limits in California. In her account, those conditions were “the combination of rapidly rising property values and stable property tax rates.” She adds: “State and local governments did not respond to rising property values and tax revenue by cutting tax rates, so voters took matters into their own hands.” While this may be a reasonable account of why assessment limits were introduced in California, we can ask whether it applies to other states. Is a rapid increase in property values a cause of assessment limits? Casual empiricism seems to support that idea. Table 5.1C shows the percentage increase in house prices from 1980 to 2007 in the 21 states (including the District of Columbia) that enacted assessment limits. The average increase among those states is 222 percent. Table 5.2C shows the same data for states that have yet to enact assessment limits. The average increase for these states is only 168 percent. Not a large difference, perhaps, but certainly consistent with the idea that a rapid increase in housing prices leads to assessment limits. However, that explanation invites the question of why state and local governments did not respond to rising assessments by cutting tax rates. In fact, in the early 1970s Governor Reagan had introduced the concept of revenue limits through which the property tax revenue of local governments would be held constant and rates automatically adjusted when assessments rose. Under that system, revenues could be increased or decreased through affirmative action by 143

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TABLE 5.1C

States with Assessment Limits House Price Increase 1980 to 2007

Property Tax Revenue Per Capita in 1977

Population Increase 1980 to 2005

Arkansas

62%

$312

22%

Arizona

230%

$924

118%

California

436%

$1,336

53%

Colorado

169%

$901

61%

Connecticut

279%

$1,233

13%

District of Columbia

465%

$727

−14%

Florida

285%

$601

83%

Georgia

138%

$552

66%

54%

$862

2%

Illinois

184%

$924

12%

Massachusetts

517%

$1,468

12%

Maryland

347%

$767

33%

Michigan

115%

$969

9%

Minnesota

173%

$804

26%

Montana

187%

$1,059

19%

New Mexico

140%

$329

48%

New York

464%

$1,344

10%

5%

$397

17%

Oregon

268%

$1,038

38%

South Carolina

122%

$366

36%

26%

$672

61%

222%

$837

34%

Iowa

Oklahoma

Texas

Average

sources: Housing price increases are measured by the Housing Price Index published by the Office of Federal Housing Enterprise Oversight; state population is from the Census of Population; property tax revenue is from the Census of Governments. Property tax revenue is measured in 2002 dollars.

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TABLE 5.2C

States without Assessment Limits House Price Increase 1980 to 2007

Property Tax Revenue Per Capita in 1977

Alaska

83%

$3,951

65%

Alabama

93%

$177

17%

Delaware

320%

$392

42%

Hawaii

354%

$483

32%

Idaho

149%

$585

51%

Indiana

60%

$695

14%

Kansas

48%

$886

16%

Kentucky

92%

$324

14%

Louisiana

49%

$279

8%

Maine

321%

$701

18%

Missouri

107%

$570

18%

60%

$341

16%

North Carolina

139%

$403

48%

North Dakota

56%

$668

−2%

Nebraska

60%

$1,087

12%

New Hampshire

308%

$1,114

42%

New Jersey

382%

$1,411

18%

Nevada

203%

$796

202%

71%

$704

6%

Pennsylvania

212%

$591

5%

Rhode Island

396%

$939

14%

South Dakota

90%

$909

12%

Tennessee

113%

$408

30%

Utah

183%

$546

69%

Virginia

278%

$570

42%

Vermont

265%

$950

22%

Washington

309%

$737

Mississippi

Ohio

Population Increase 1980 to 2005

52% (continued)

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TABLE 5.2C (continued) House Price Increase 1980 to 2007

Wisconsin

Property Tax Revenue Per Capita in 1977

Population Increase 1980 to 2005

135%

$897

18%

West Virginia

32%

$323

−7%

Wyoming

80%

$1,196

8%

168%

$788

30%

Average

sources: Housing price increases are measured by the Housing Price Index published by the Office of Federal Housing Enterprise Oversight; state population is from the Census of Population; property tax revenue is from the Census of Governments. Property tax revenue is measured in 2002 dollars.

local governments. In that sense, revenue limits would not really restrict local revenue; they would have merely made it impossible for local governments to sit idly by and watch their revenues increase when assessments rose. These revenue limits did eventually become an element in the state’s school finance system, though in an entirely different role. The revenue limits that Governor Reagan envisioned were never enacted in California, leaving us to wonder whether the failure to adjust property tax rates when assessments rise is really the issue. What are other plausible explanations? The qualification in the conclusion above—“assessment limits, by themselves”—suggests another possibility. In California, assessment limits were accompanied by tax rate limits. Eight other states with assessment limits also have tax rate limits. The combination of assessment and rate limits is, of course, a limit on property tax revenue. Thus, another explanation of assessment limits is that they are a necessary part of a larger campaign to limit property tax revenue. Figure 5.1C suggests that this larger campaign may have been successful. In the United States, property tax revenue is still the most important component of state and local revenue. In per capita terms, however, it has grown very little since 1972. In 1972, property tax revenue was $882 per capita in 2002 dollars. Thirty years later, it was $998 per capita, a 13 percent increase. In contrast, during that period, per capita sales tax revenue increased by 84 percent, and state and local income tax revenue per capita increased by 114 percent. If the desire to limit property tax revenue is the underlying reason for assessment limits, states with high property tax burdens should be more likely to pass those limits. Again, the data in Tables 5.1C and 5.2C are consistent with this hypothesis. Among states that enacted assessment limits, property tax revenue per capita averaged $837 per capita in 1977 (measured in 2002 dol-

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Commentary

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FIGURE 5.1C

U.S. State and Local Tax Revenue by Source 1,200

2002 Dollars Per Capita

1,000 800 600 400 200 0 1972

1977

1982

Property

1987 Sales

1992

1997

2002

Income

source: Census of Governments.

lars). For states without limits, the average was $788 per capita, a small difference but one that is consistent with assessment limits as part of a broader campaign to limit property tax revenue. The desire to limit property tax revenue cannot be the entire explanation, however, because about half the states with assessment limits do not have tax rate limits. Perhaps a more fundamental reason for assessment limits lies with a feature that almost always accompanies them, the “acquisition value rule,” the rule that sets the assessed value of a property equal to its market value when it is sold. In growing areas, the practical effect of this rule is to increase the property tax burden of new members of a community relative to the burden of those who are already there. To Sexton, this feature of assessment limits causes an inefficiency, the mobility effect. To residents of a community, however, the acquisition value rule is a way to transfer the tax burden to others, to those who by their own actions have demonstrated a high willingness to pay to live in the community. If this transfer of the property tax burden to new residents is part of the explanation of assessment limits, those limits ought to be more likely to be found in states that are growing rapidly. In a growing state, the potential gains from such a transfer are larger, and thus existing homeowners ought to be more likely

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to enact them. The data in Tables 5.1C and 5.2C are weakly consistent with this explanation. Among states with assessment limits, the growth in population from 1980 to 2005 averaged 34 percent. In other states, the growth rate averaged 30 percent. This empiricism is too casual in a number of ways. It does suggest, however, a way in which the research on assessment limits might be extended. It is important to document the inequities and inefficiencies of assessment limits, and Terri Sexton has been a leader in that research. It is also important to understand why these limits are enacted. More research on this topic would be useful.

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6 Tax and Expenditure Limitations and Local Public Finances BING YUAN JOSEPH CORDES DAVID BRUNORI MICHAEL E. BELL

T

he modern political landscape is dominated by the belief that localities are critical to the governance of America. An influential report issued by the National Conference of State Legislatures (1997) asserted that public service responsibilities should be assigned to the lowest feasible level of government, to foster accountability and best meet local citizens’ needs. Such views of localism are broadly accepted by political leaders, academics, and the general public (Brunori 2003). There is little debate that local governments are the most efficient providers of certain public services. Scholars have long recognized that each level of government—federal, state, and local—is capable of providing some services more effectively than the others. Public services should be provided by the jurisdiction covering the smallest area over which benefits are distributed (Gramlich 1993; Oates 1972). As Bird (1993, 211) asserted, “so long as there are variations in tastes and costs, there are clearly efficiency gains from carrying out public sector activities in as decentralized fashion as possible.” Another rationale for localism is that it promotes democratic values and practices (Frug 1980). That is, government closer to the people will not only better reflect citizen desires, but it will encourage citizens to participate in public affairs and in the democratic process. As one prominent political scientist Some material in this chapter is drawn from Brunori, Bell, Cordes, and Yuan (2008). Tax and expenditure limitations and their effects on local finances and urban areas, in Urban and Regional Policy and Its Effects, Turner, Wial, and Wolman eds., 109–154. Washington, DC: Brookings Institution Press.

149

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observed: “The bedrock of American local democratic theory is that the role of the local government is to reflect the will of the people and that direct individual participation in local government is the best means of achieving this end” (Wolman 1997, 136). And there is scholarly evidence that the public desires local government because of the democratic ideals that such government fosters (Haselhoff 2002). The theory of localism outlined above is dependent upon local governments having an independent source of revenue within their political control that is adequate to meet local needs for goods and services (Peterson 1995). An implication is that local governments, through their elected officials, must have the ability to impose taxes on their citizens without undue interference from state or federal law. Without that ability, local governments cannot effectively or efficiently provide public services or respond to the needs of their citizens. As Bird (1993, 211) stated, “Local governments should not only have access to those revenue sources that they are best equipped to exploit—such as residential property taxes and user charges for public services—but they should also be both encouraged and permitted to exploit these sources without undue central supervision.” It has now become part of public finance lore, however, that the local property tax is often thought to be the “worst tax.” During the latter half of the twentieth century, the Advisory Commission on Intergovernmental Relations (ACIR) conducted an annual public opinion poll to gauge the public’s views on the federal, state, and local tax systems. One of the most cited aspects of the poll was the request for people to identify the tax that they dislike the most. Over the course of the ACIR polling, the property tax was annually listed as the worst tax, or second worst following the federal income tax. So it is not surprising that virtually all states have some limitations on local government power to impose property taxes. States have placed limits, either through constitutional amendment or statutory enactment, on rates, assessment increases, or revenue and expenditure increases. Some states are subject to more than one type of limitation, and a few states such as California are subject to all three. The proliferation of such property tax limitations has curtailed local taxing authority, hindering local political autonomy. There is some evidence that local elected officials are concerned about this loss of autonomy. For example, in a recent survey by the National League of Cities, 54 percent of elected city officials said they would not trade local tax revenue authority for a larger share of state revenues (Hoene 2005). In addition to such property tax limitations, many states have also instituted broader tax and expenditure limitations (TELs) on state and local governments. TELs are controversial. Some see TELs as a necessary means of

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protecting the public from politicians who set taxing and spending levels higher than it actually prefers. Others see TELs as an unwarranted attack on local autonomy. According to a recent survey of elected city officials, respondents were pretty evenly split on the desirability of TELs. Just over half of the city officials responding to the survey felt TELs were either sometimes a good idea (47 percent of respondents) or always a good idea (6 percent of respondents). Alternatively, 24 percent of respondents felt TELs were sometimes a bad idea and 16 percent felt they were always a bad idea (Hoene 2005). The objective of this chapter is to summarize the state of knowledge about TELs, with special emphasis on their effects on local public finance.1 We begin by discussing the history of TELs, and present a typology of the variants of TELs that are presently in existence. This discussion is followed by a survey of the empirical evidence on the various effects of TELs on local public finances. We conclude with a summary of the main findings of the empirical research on TELs and a discussion of research remaining to be done. A Brief History of Tax and Expenditure Limitations TELs arose from the public’s well-documented unhappiness with the property tax. But contrary to what many believe, the tax limitation movement did not start with California’s Proposition 13. Rather, the initial push to limit property tax increases began during the Great Depression. Despite the harsh economic realities of the Depression, the under- and unemployed were still faced with paying their property taxes. While property values (and hence property tax burdens) were falling, the dramatic loss of income forced many homeowners into or near bankruptcy. By 1932 real estate values fell by 92 percent (Beito 1989), but tax assessments did not fall nearly as far or as fast. Moreover, the share of income absorbed by the property tax doubled between 1929 and 1932, reaching 11.3 percent (O’Sullivan 2000). Local governments remained heavily dependent on the property tax. In 1932, for example, property taxes accounted for 85.2 percent of local government own-source revenue. The Depression produced an upsurge in tax delinquencies, bankruptcies, and foreclosures. Nationwide, localities had property tax delinquency rates of over 26 percent (O’Sullivan 2000). The sheer volume of delinquencies and the threat of losing homes gave rise to the most serious tax revolts in America since the Whiskey Rebellion. As early as 1930, unhappiness with property tax burdens caused a storm of protest across the country. Thousands of taxpayer organizations, all created 1. For a recent analysis of state-level TELs see Bae and Gais (2007).

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specifically to fight for property tax relief, were formed. These protests had significant repercussions. In 1932 and 1933 alone sixteen states and numerous localities adopted some form of limitation on property taxation (O’Sullivan 2000). Throughout the Great Depression, states began to limit local property taxation. Michigan (1933), Nevada (1936), Ohio (1929), and Oklahoma (1933) all placed statutory or constitutional limits on property tax rates during the early years of the Great Depression. West Virginia (1939) and Washington (1944) would later place limits on rates. The property tax unrest during the Great Depression also spurred states to adopt property tax relief measures such as homestead exemptions. But the early limitation movement and the proliferation of homeowner relief did not quell the public’s dislike of the property tax. That dislike, combined with a growing cynicism and distrust of government, led to the most significant development in American property tax history—the tax revolts of the late 1970s and early 1980s. Proposition 13 and its progeny not only dramatically changed property taxation, but also were a defining moment in the public’s attitudes toward taxation in general in the United States. The tax revolts changed the way many local governments raised revenue. But they also signaled the beginning of a new and decidedly antitax political philosophy that continues to this day. The causes of Proposition 13 were varied. The public was frustrated by continuously rising property tax burdens. California real estate values were increasing 25 percent a year in the decade before the passage of Proposition 13. The public was equally frustrated with local government leaders who refused to lower tax rates and state government leaders who refused to offer relief. Political leaders around the state were aware of the property tax problem for at least a decade before 1978. Governor Ronald Reagan proposed limiting property taxes in 1973. Los Angeles County assessor Phil Watson led two property tax limitation drives in 1968 and 1972. These efforts were unsuccessful, and as Lo (1995) noted, the California legislature refused to provide property tax relief for four straight years before the proposition passed. Another cause of Proposition 13, and indeed other property tax protests, was school finance litigation. In 1972, the California Supreme Court declared that the system of financing education through local property taxes was unconstitutional. The court ordered that the state assume the primary role in financing the schools. That decision had the effect of diminishing public support for property taxes and is arguably one of the reasons for the public’s willingness to approve Proposition 13 (Fischel 1989). On June 2, 1978, two-thirds of California voters chose to reduce and limit property taxes in the state radically. Proposition 13 rolled back assessment values to 1976 levels. It limited increases in assessed value to 2 percent a year as

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long as the property was not sold. It imposed a 1 percent limit on the property tax rate. The measure also required that all state tax increases be approved by a two-thirds vote of the legislature and that all local tax increases be approved by a vote of the electorate. The effect was dramatic. Property tax revenue immediately fell by 57 percent across the state. Local governments in California collected over $6.6 billion less in property tax revenue in 1979 than they did in 1978 (Citrin 1984). California property taxes went from 51 percent above the national average in 1978 to 22 percent below the average in 1981. California local governments became much more dependent on state aid as a result of Proposition 13. They also began significantly increasing user fees and charges, which were not subject to limitation. Between 1978 and 1981, local government user fee revenue increased by 48 percent; Los Angeles increased user fee revenue by 67 percent (Richter 1984). The immediate impact of Proposition 13 beyond California was significant. Within six months after the passage of Proposition 13, tax limitation measures were on the ballots in 17 states and all but 5 were approved. There were 58 ballot measures during the 1979–1984 period concerning property tax classification, exemptions, assessment reform, and rollbacks. Among the most successful were tax and expenditure control measures. Forty-three states adopted new property tax limitations or relief plans between 1978 and 1980. Idaho and Massachusetts followed California’s lead and adopted measures that both cut and limited property taxes. New state spending limits were set in New Jersey and Colorado. Several states (Arizona, Michigan, Louisiana, Oregon, Utah, and Washington) tied growth in local government spending or revenue to growth in personal income or population. Michigan restricted growth in local property tax revenues to the rate of inflation, and state revenues were limited to the share of personal income they represented in 1978–1979. Although the tax revolt movement lost momentum in the latter half of the 1980s, continued dislike of the property tax, together with the fiscal pressures resulting from the subsequent recessions, has served to maintain interest in changing the taxing and spending activities of state and local governments. In 1992, voters in Florida approved a 3 percent limit on assessed value increases until sale for homeowner property. In a historic move, the Michigan legislature voted in 1993 to eliminate all property taxes for school operations. Tax and Expenditure Limitations Today California’s Proposition 13, which many would regard as the paradigmatic example of a tax and expenditure limitation, is in fact one specific form of tax

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and expenditure limitation among several different variants. Important distinctions among TELs are whether limitations are imposed at the state or at the local level, how the limitation is administratively imposed, and whether the constraint implied by the limitation is considered to be binding or nonbinding. A listing of the various forms of TELs currently in existence (assessment limitations, rate limits, and revenue/expenditure limitations) is provided in Appendix Tables 6.1A, 6.2A, and 6.3A. State Versus Local Limits One important distinction is between state TELs and local TELs (Shadbegian 2003; Shadbegian 1996; Mullins and Joyce 1996; Joyce and Mullins 1991). State TELs refer to limitations imposed on the state government whereas local TELs refer to those imposed on local governments by the state. Both types of limitations were simultaneously adopted in a number of states. As discussed in more detail below, constraints on state revenue or expenditure are a new invention of the most recent tax revolt (Joyce and Mullins 1991), but they are less effective than local TELs in controlling the size and growth of government because states have greater capacity than local governments to circumvent such limitations (Shadbegian 2003; Shadbegian 1996; Mullins and Joyce 1996; Joyce and Mullins 1991). Unlike local government, whose fiscal authority is strictly defined in state legislation, state government may have easier access to alternative revenue sources not affected by the limitation, such as fees, charges, tolls, and lotteries. Most state TELs limit state revenue or expenditure growth to personal income growth, a less restrictive factor than population growth plus inflation (Bae and Gais 2007), which explains why state TELs have stronger constraining effects on states with low income growth than state governments in general (Shadbegian 1996). Administrative Implementation of Limitations In the case of local tax and expenditure limitations, three options present themselves: (1) limiting the base of the property tax through assessment limitation; (2) limiting the rate at which the property tax base may be taxed; and (3) limiting revenues and/or expenditures.

Assessment Limitations Eighteen states have some form of limitation on the amount assessed values can increase each year. The assessment limits usually apply only to residential property, rarely to other uses. For example, there are few commercial property assessment limitations in the United States. The states with assessment limits

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along with a brief description and legal authority are listed in Appendix Table 6.1A. Assessment limitations vary widely. For example, some states such as California, Florida, Oklahoma, and New Mexico have flat percentage limitations on yearly increases in assessed value. California’s Proposition 13 limits the increase in assessed value for residential property to 2 percent per year unless the property is sold. When the property is sold, it acquires a market value for assessment purposes. But not all assessment limits are so straightforward. Colorado mandates that residential property comprise no more than 45 percent of total assessed value. This requirement serves to limit the growth of residential assessment, but property owners have a difficult time determining how much. Georgia only limits conservation use assessments. New York only limits assessments in taxing units with a population over one million (effectively only New York City and Nassau County).

Rate Limitations Thirty-seven states have some form of limitation on the property tax rate that can be levied by a local government. Like assessment limitations, rate limitations are set by statute or the state constitution. The states with rate limitations are set forth in Appendix Table 6.2A. Rate limitations also vary from state to state. Some states (such as California and Wyoming) have rate limit laws that do not allow for any increases. But many states have rate limit laws that can be overridden in particular circumstances. Alabama, Ohio, and Michigan, for example, allow their rate limits to be increased after a majority vote of the electorate. Oregon and Nebraska require a supermajority vote of the electorate to override a rate limit. In some states (including Maryland, Minnesota, and Illinois) the property tax rate limitation is a local option. Revenue and Expenditure Limits Thirty-six states have some form of limitation on revenue or expenditure increases by local governments. This type of TEL may place a cap on property tax revenue alone, or more broadly on general revenue or general expenditure. The states with revenue and expenditure limits are listed in Appendix Table 6.3A. In every state except Alaska, Arkansas, Iowa, and New Mexico, the limits can be overridden by the electorate or the legislative body in the taxing jurisdiction. In Alaska, local governments cannot collect property taxes over $1,500 per capita. In Arkansas, property tax revenue cannot increase more than 10 percent from the previous year.

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As with other limitations, there are wide variations among the states limiting revenue and expenditure growth. In many cases, property tax revenues are limited to a flat percentage increase. Some states limit revenue or spending by some combination of population growth and inflation. A few states tie revenue or expenditure growth to personal income growth. Binding Versus Nonbinding Limits Scholars also distinguish between different types of local TELs based on their stringency, that is, the degree to which the constraint is binding.2 A binding TEL is expected to constrain its stated revenue or expenditure target effectively, while a nonbinding TEL may be easily circumvented through various means. Joyce and Mullins (1991) identify six categories of TELs: overall property tax rate limit,3 specific property tax rate limit,4 assessment increase limit,5 property tax levy limit,6 general revenue or general expenditure limit,7 and full disclosure or truthin-taxation.8 Rate limits and assessment limits are expected to be potentially binding if combined with each other. Limits on the overall property tax levy or on general revenues or expenditures are also considered potentially binding due to the fixed nature of the ceiling, whereas full disclosure is considered nonbinding because the local legislative body can easily raise the tax through a formal vote (Joyce and Mullins 1991). Some states have adopted a combination of the potentially binding limitations while some have implemented only the least binding type. Because states with potentially binding TELs have caps on the growth rate of property tax revenue that vary in size, Shadbegian (2003) suggests 5 percent as the threshold to distinguish between stringent and nonstringent limitations. Poterba and Rueben (1995), on the other hand, consider limits on property tax rates, property tax revenues, or general revenues or expenditures as

2. See Anderson (2006); Shadbegian (2003); Brown (2000); Sokolow (2000); Sokolow (1998); Mullins and Joyce (1996); Poterba and Rueben (1995); Joyce and Mullins (1991); Preston and Ichniowski (1991). 3. An overall property tax rate limit sets a ceiling on the aggregate property tax rate of all local governments. 4. A specific property tax rate limit applies to specific types of local government, such as school districts, or to narrowly defined service areas. 5. An assessment increase limit caps the growth rate of assessed values; it is intended to control the ability of local governments to raise revenue by reassessment of property or through natural or administrative escalation of property values. 6. A property tax levy limit constrains the growth rate of total revenue that can be raised from the property tax, independent of the rate. 7. A general revenue or general expenditure limit sets the maximum growth rate of total revenue or spending. 8. Full disclosure, or truth-in-taxation, requires public discussion and a specific legislative vote before enactment of tax rate or levy increases.

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effective limitations, and assessment limits along with full disclosure as ineffective. In Anderson’s review (2006), assessment limits offer better insurance against large property tax increases for homeowners than limits on rates and revenues. As indicated above, TELs may also be divided into those with an override mechanism and those without (Figlio and O’Sullivan 2001; Cutler, Elmendorf, and Zeckhauser 1999). Override provisions offer a method for overcoming tax and expenditure limitations, thus rendering TELs less binding than they otherwise would be. Override provisions can be as simple as allowing a majority vote of the governing body to effect an override. But most are much more difficult to implement, often requiring a majority or even supermajority vote of the electorate in a special election. Effects of TELs on Local Public Finances Because local governments have traditionally been so dependent on the property tax, property tax limitations have had several effects on local public finances. Some local governments have responded to TELs by increasing reliance on user charges and fees. In other cases, reduced locally and independently generated revenues have been replaced by revenues from the state, leading to greater centralization in the finance of local public services. In 2000, for example, the state share of state-local tax revenue in the United States was 61 percent, compared with 55 percent in 1970, and Sokolow (2000) has argued that local property tax restrictions are a cause of diminished local government autonomy and increased fiscal centralization. In fact, Sokolow (1998) found that state control over local government finances has been increasing for more than two decades and that the rising state share of state-local revenue best illustrates the increased level of state control. The various limitations have forced local governments to rely increasingly on state aid to fund services once paid for exclusively by the localities. This is especially true in the case of primary and secondary education. Local tax and expenditure limitations that target property taxes, traditionally the major source of funding for public education, have led to spending cuts in public schools, higher student-teacher ratios, limited starting teacher salaries, and declined teacher quality, all of which are likely to compromise the quality of educational services (Figlio and Rueben 2001; Downes and Figlio 1999). TELs are also suspected to be partly responsible for lower student scores on standardized tests (Downes, Dye, and McGuire 1998; Figlio 1997). Given the potential link between property tax burdens and house prices, the imposition of property tax–focused TELs are likely to trigger some fluctuations in property values in

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constrained jurisdictions. Besides all the aforementioned general trends, TELs may affect different segments of the society quite differently, depending on the design features of a specific limitation. There is a substantial empirical literature on the various effects of TELs on the public finances of the local communities that are subject to these limitations. Broadly speaking, these empirical studies fall into four groups: (1) studies that examine whether TELs have indeed had their intended effect of restraining government revenue and spending; (2) studies that examine the effect of TELs on education expenditures; (3) studies of the impact of TELs on property values; and (4) studies that have analyzed the distributional effect of TELs. Effects of TELs on Taxes and Spending Because most TELs have the explicit purpose of constraining property tax revenues and containing the growth of government, there is an extensive empirical literature focusing on their effects on the fiscal structure of state and local governments.9 These studies can be grouped, in turn, into those that focus on the extent to which different types of TELs impose binding or nonbinding constraints, and those that focus on the effect of TELs on revenue from property taxes, the level of government spending, and the mix of local financing sources.

Are TELs Binding or Not? The degree of interstate variation in the design of TELs implies similar variation in their effects on government finance. Not surprisingly, the more binding the limitation, the more likely it is to have an influence (Joyce and Mullins 1991). One indirect way of showing this is to compare the effects of TELs imposed on state spending and taxes with those that constrain local spending and taxes. One might expect that the former would be less constraining than the latter because of the greater breadth and diversity of state revenue and spending. Shadbegian (2003) examines the impact of state and local tax and expenditure limitations on school finance. His analyses of the state-level data support the view that state-level limits on local education spending per student have a negligible effect, in contrast to local-level limitations, which have a substantial impact. 9. See Brooks and Phillips (2006); Cornia and Walters (2006); Cornia and Walters (2005); Dye, McGuire, and McMillen (2005); Glickman and Painter (2004); Mullins (2004); Shadbegian (2003); Figlio and O’Sullivan (2001); Sokolow (2000); Cutler, Elmendorf, and Zeckhauer (1999); Figlio (1998); Galles and Sexton (1998); Sokolow (1998); Bland and Laosirirat (1997); Cutler, Elmendorf, and Zeckhauer (1997); Dye and McGuire (1997); Waters, Holland, and Weber (1997); Mullins and Joyce (1996); Shadbegian (1996); O’Sullivan, Sexton, and Sheffrin (1995); O’Sullivan, Sexton, and Sheffrin (1994); Elder (1992); Joyce and Mullins (1991); Preston and Ichniowski (1991); De Tray and Fernandez (1986); Merriman (1986).

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Shadbegian (1999) found that the effects of tax caps appear to increase with their stringency. For example, he found that less stringent TELs reduced property taxes by about $32 per capita and that “other” taxes did so by roughly $12 per capita; however, local governments facing less stringent TELs raised about $23 per capita in additional miscellaneous revenues, for a net reduction of ownsource revenues of $22 per capita (about 4 percent). On the other hand, he found that more stringent TELs reduced property taxes by $44 per capita, raised “other” taxes by $3 per capita and raised $6 per capita less in miscellaneous revenues than expected, leading to an overall net reduction in own-source revenues of $47 per capita (about 9 percent). The cross-state analysis by Preston and Ichniowski (1991) empirically corroborated Joyce and Mullins’s (1991) findings about the degree to which various types of limitations impose binding or nonbinding constraints. Property tax rate limits, when coupled with assessment limits, result in the largest reduction in the growth of per capita property tax revenue. Property tax levy limits and general revenue limits have significant yet smaller impacts. Similarly, Brown (2000) argues that the comprehensive revenue and expenditure limit in Colorado is more effective than the earlier assessment limit in controlling the growth of government.

Effects of TELs on Property Tax Revenue Studies of TELs based on data from individual states10 and on cross-state comparisons11 both marshal compelling evidence that state-imposed limitations on local property tax rates, levies, and assessments have a significant impact on property tax revenues—reducing them either absolutely or as a share of local own-source or general revenue. Dye, McGuire and McMillen (2005) also find evidence that in Illinois, these effects become more pronounced over time. Illinois school districts with the cap in effect for four to nine years saw a more dramatic decline in the growth rate of property tax revenue than those in which the cap was in place for one to three years. Findings regarding the effects of full disclosure laws are more mixed than those about explicit restrictions. Consistent with the expectation that full disclosure is nonbinding, Bland and Laosirirat (1997) conclude from their analysis of city-level panel data in Texas that truth-in-taxation requirements have little or no effect on real property tax burdens per household. Cornia and Walters

10. See Cornia and Walters (2006); Dye, McGuire, and McMillen (2005); Cutler, Elmendorf, and Zeckhauer (1999); Galles and Sexton (1998); Dye and McGuire (1997); Elder (1992). 11. See Mullins (2004); Sokolow (2000); Sokolow (1998); Mullins and Joyce (1996); Joyce and Mullins (1991); Preston and Ichniowski (1991).

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(2006), on the other hand, contend that the full disclosure law in Utah strikes a balance between restraint and local discretion by allowing property tax revenues to grow, though less rapidly than would have been expected based on growth in property values. A 2005 paper by the same authors also suggests that full disclosure in Utah may have provided a benefit initially unforeseen by legislators: uniformity in the administration of the property tax (Cornia and Walters 2005).

Effects of TELs on Government Revenue Raising Despite evidence that at least some variants of TELs have had a significant constraining effect on property tax revenue, there is little empirical evidence that TELs have had much effect on the overall size of government, as measured by indicators such as the level and growth of general revenue and general expenditure.12 (An exception is Poterba and Ruben [1995], which found that effective property tax limits are associated with slower wage and employment growth for local government employees.) However, there is evidence that TELs have had a significant effect on the composition and structure of government revenues as well as on the mix of state and local financing of local public services. A number of studies have found that adoption of TELs has fostered increased local reliance on narrowly based nontax revenues and state-level centralization of school finance.13 Local governments have sought to replace revenue foregone due to TELs with alternative revenue sources such as user fees, charges, and intergovernmental aid from the states, thus eliminating the need to cut down spending. Using multistate cross-sectional data, Joyce and Mullins (1991) showed that, in response to the recent tax revolt in the late 1970s and early 1980s, nontax revenue had grown as a share of state and local revenue. Shadbegain (1993, 233) concluded that “evidence indicates that local governments located in TEL states substitute miscellaneous revenue for tax revenue, but that this substitution is less than dollar-for-dollar. In particular, the point estimates indicate that for each $1 reduction in taxes per capita, there is a corresponding $0.27 increase in miscellaneous revenue per capita.” In addition, Joyce and Mullins (1991) found that states with TELs increased their aid to local governments, which led to the shifting of responsibility for certain expenditure functions from local government to state government. Joyce and Mullins confirmed these findings in a 1996 study with updated data.

12. See Galles and Sexton (1998); Cutler, Elmendorf, and Zeckhauer (1997); Mullins and Joyce (1996); Joyce and Mullins (1991). 13. See Sokolow (2000); Shadbegian (1999); Sokolow (1998); Galles and Sexton (1998); Dye and McGuire (1997); Mullins and Joyce (1996); Joyce and Mullins (1991).

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Galles and Sexton’s comparative analysis of California and Massachusetts (1998) reported that local revenues and expenditures were initially reduced by the limitations, but that state and local governments soon made up lost revenues through increased use of fees and charges and were able to exceed their pre-limit real per capita revenues and expenditures in 1990. Glickman and Painter (2004) have also found that there is a positive relationship between the presence of TELs and a state’s adoption of a lottery. The authors’ explanation is that the median voter may strategically use the combination of limitation and state lottery to lower the tax burden without affecting the desired level of public services. Another fiscal response to the presence of TELs has been the replacement of lost property tax revenues with grants from higher levels of government, associated with increases in state aid to local governments and in the share of state taxes in total state-local revenue (Sokolow 1998, 2000). The trend is most pronounced in the financing of K–12 education, which has traditionally depended heavily on the local property tax as a revenue source. Public finance experts have expressed their concern over the viability of nontax revenue and state aid as a long-term substitute for the property tax revenues foregone under TELs. Unlike broader-based property taxes, user fees and charges have very limited revenue-generating capacity (Joyce and Mullins 1991). Moreover, the shift to nontax revenue may fundamentally change the way in which public services are financed. While property tax revenues go into a general fund for general services, user fees and charges are collected to cover the costs of specified services and are imposed on those who consume those services. Thus, even when TELs do not change the amount of taxes collected, they do change how specific goods and services are financed. Over time, such a shift toward more dedicated sources of revenue tied to the provision of specific local public goods and services has the potential to alter the mix of goods and services provided by local government. A shift from localities to states as a revenue source creates the risk of substantial cuts in an economic downturn. In addition, state centralization of expenditure functions that are traditionally local, such as elementary and secondary education, undermines local fiscal control and increases the distance between the locus of responsibility for delivering public services and the population to be served.14 Since state government is less responsive to diverse local preferences, the shift to state finance of local services reduces the potential gains in efficiency to be had from providing local public goods in a decentralized manner.

14. See Sokolow (2000); Sokolow (1998); Mullins and Joyce (1996); Joyce and Mullins (1991).

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Effects of TELs on Education Expenditures Although the weight of the evidence suggests that local governments have had some success in replacing revenues foregone due to TELs with other funding sources, TELs nonetheless have affected revenues available for specific public goods and services. Given that property taxes have traditionally been a main, often earmarked, source of revenue for education, it is natural that empirical studies of the effects of TELs on provision of local public services have focused on the provision of public education.15 It remains unclear how voters came to believe they could cut taxes without cutting public services or compromising the quality of services. Undisputedly, the property tax is a cornerstone of the U.S. education system, consistently generating money for public schools. It is therefore important to answer the general question: Does the enactment of TELs sufficiently constrain revenue (and in some cases expenditure) for local public schools to materially affect the “amount” of public education provided? Answering this question empirically requires an operational measure of educational “output” or “outcomes.” Although measures are hard to come by in practice, several empirical studies have made use of quantitative measures of “outcomes” as measured by indicators such as test scores. Figlio’s cross-sectional analysis (1997) suggests that tax limitations worsen student performance on standardized tests in mathematics and various other subjects. Downes, Dye, and McGuire (1998) find that the tax cap in Illinois has a modest negative effect on mean math scores of third graders but not on reading scores of eighth graders. Conventional wisdom has it that per-pupil spending, student-teacher ratios, starting teacher salaries, and teacher quality should be related to student educational outcomes. Although these indicators are ultimately measures of inputs rather than outputs or outcomes, other empirical studies have substituted such measures of educational inputs for measures of actual output or outcomes to assess the effects of TELs. One way to gauge the amount of input in public education is to see how much money local governments have invested in public schools and how funds have been spent on different parts of local education budgets. In their 1997 study of the property tax revenue limits in Illinois, Dye and McGuire found that the state-imposed cap had a constraining effect on school district operating expenditures, but no effect on school district instructional spending. Regarding 15. See Dye, McGuire, and McMillen (2005); Shadbegian (2003); Figlio and O’Sullivan (2001); Figlio and Rueben (2001); Downes and Figlio (1999); Bradbury, Case, and Mayer (1998); Downes, Dye, and McGuire (1998); Figlio (1998); Dye and McGuire (1997); Figlio (1997).

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operating expenditures as the administrative overhead of operating a school system and instructional expenditures as the provision of actual educational output, the authors concluded that TELs improved efficiency by reducing “less essential” public spending while preserving “essential” spending. In a later study, however, Dye, McGuire, and McMillen (2005) find that the cap reduced both operating and instructional spending, especially in the long run, and thus had no differential effect. The authors concluded that while the short-run effect of TELs may have enhanced efficiency by reducing only the fat but not the muscle of public spending on education in Illinois, the longer-run effect may have been to cut both less essential and more essential spending. The notion of using the effects of TELs on different components of educational spending to infer whether TELs achieve their stated purpose of trimming only “wasteful” spending is intriguing. However, Downes and Figlio (1999) caution against taking for granted the assumed linkage between inputs and outcomes in education. In particular, they note that instructional spending might actually be more susceptible to cuts where administrative costs are already at a minimum, or in districts that are populated by budget-maximizing bureaucrats who see cutting essential educational spending as a strategy to inflict enough pain to encourage voters to subsequently support overrides of TELs. The differential effect of TELs on different kinds of services is further highlighted by Figlio and O’Sullivan (2001), who suggest that local politicians—those “budget-maximizing bureaucrats”—may strategically manipulate the teacheradministration ratio (that is, the ratio of instructional spending to administrative spending) in order to enlist citizen support for overrides of tax caps. The larger the demonstrated loss of public goods (here, teachers), the more likely citizens are to approve an override.16 Such strategic manipulation of spending reductions in response to TELs makes interpretation of prior studies more difficult. Student-teacher ratios, teacher salaries, and teacher quality are other input measures that have been used to assess the effects of TELs. Using countrywide school district data from 1988 through 1991, Figlio (1997) demonstrated that local property tax limitations led to higher student-teacher ratios and lower starting salaries for teachers. In a comparative study of Oregon and Washington, Figlio (1998) also found that state-imposed limitations significantly increased student-teacher ratios, while the ratio of administrative to educational spending remained unchanged or increased. Using test scores and college selectivity as measures of ability, Figlio and Rueben (2001) also found evidence that tax limitations significantly reduce the 16. In the same vein, local politicians may reduce the ratio between uniformed police and police administration in exchange for voter support for limitation overrides.

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average quality of new public school teachers, who may face longer queues for an opening as a result of limitations. Shadbegian (2003) found that stringent local limits increase student-teacher ratios only slightly but exert no significant impact on teacher salaries. The author cited this as evidence that local governments that are subject to caps improve in efficiency. Some researchers have tracked the experience of a single state or several states (Dye, McGuire, and McMillen 2005; Bradbury, Mayer, and Case 2001; Downes, Dye, and McGuire 1998; Figlio 1998; Dye and McGuire 1997; O’Sullivan, Sexton, and Sheffrin 1995), while except for Figlio (1997) cross-sectional analyses have almost exclusively relied on aggregate data at the state level (Shadbegian 2003; Mullins and Joyce 1996). With about 96 percent of their tax revenue coming from the property tax, school districts would feel the effect of tax caps on their finance system most acutely. Yuan (2006) seeks to extend the current literature with an analysis of the impact of TELs on education spending using school districts, not states, as the unit of analysis. Specifically, she uses district-level panel data for fiscal years 1990–2000 provided by the National Center for Education Statistics (NCES). While there is no conclusive empirical evidence for a positive relation between monetary input in education and student performance, spending is often used as an indicator of the level of education service provided by local government. Following that practice, Yuan uses per-pupil expenditure on elementary and secondary education to account for the effect of enrollment on spending, and per-pupil instructional expenditure to approximate the quality of service being provided. Yuan also distinguishes between different types of property tax limitations,17 estimating their effects on school expenditures in both ordinary least squares (OLS) and fixed-effects models. The following Table 6.1 summarizes state-by-state adoption of different types of tax and expenditure limitations applicable to school districts,18 including the year in which the limits were first enacted. The data in the table show that by the year 2006, 12 states had overall rate limits, 21 had specific tax rate limits, 15 set a ceiling on property tax revenue, and 8 cap the growth of assessed values. Yuan finds partial yet compelling empirical evidence for the negative impact of property tax limitations on the provision of public education. The analysis distinguishes between property tax limitations that place a ceiling on tax rates, on

17. Strictly speaking, property tax limitations are a subset of tax and expenditure limitation that clearly target property taxes. But since limits on general revenue are likely to constrain property taxes as well, and limits on general revenue or general expenditure are likely to affect school expenditures, these TELs are also included in the regression analyses. 18. Limits that apply to local governments other than school districts (e.g., counties or municipalities) have not been included in the table.

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TABLE 6.1

Summary of Tax and Expenditure Limitations on School Districts*

State

Overall Property Tax Rate Limit

Alabama

1972

Alaska

None

Arizona

1980

Specific Property Tax Rate Limit

Arkansas California

Property Tax Assessment Revenue Increase Limit Limit

General Revenue Limit

General Expenditure Limit

1980

1974

1978

1979

Full Disclosure

1981 1978

Colorado

1992

Connecticut

None

Delaware

None

1992

1992

1973

Florida

1855

Georgia

1945

1991

1963

1991

Hawaii

None

Idaho

1978

Illinois

1995

1992

1974

1991

Indiana

1975

Iowa

1989

1981

1973 1978

1971

Kansas

1999

Kentucky

1946

1979

Louisiana

1974

1978

Maine

None

Maryland

None

Massachusetts

None

Michigan

1933

1979

1978

Minnesota

1982 1971

Mississippi

1988

1983

Missouri

1875

Montana

1971

Nebraska

1921

1980

1991 (continued)

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TABLE 6.1 (continued) Overall Property Tax Rate Limit

Specific Property Tax Rate Limit

Nevada

1936

1956

New Hampshire

None

State

Property Tax Assessment Revenue Increase Limit Limit

General Revenue Limit

Full Disclosure

1985

New Jersey New Mexico

General Expenditure Limit

1976 1914

New York

1973

1979

1979

1894

North Carolina

None

North Dakota

None

Ohio

1929

Oklahoma

1933

Oregon

1991

Pennsylvania

1976 1996 1991 1959

Rhode Island

1997 2006 2006

South Carolina

1975

South Dakota Tennessee

1915 None

Texas

1883

Utah

1929

Vermont

None

Virginia

None

Washington

1944

West Virginia

1939

1999

1986

1979 1939

1990

1990

Wisconsin

1994

Wyoming Total

1982

1911 12

21

15

8

2

7

source: Authors’ compilation of state constitutions and statutes. Please refer to Tables 6.1A–6.3A for further details. *See notes 3–8 for definitions of the terms in this table.

14

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assessed value, and on property tax revenue or general revenue and expenditures. While existing literature suggests that caps on revenue and expenditures are potentially more binding than the other two types, Yuan’s fixed-effects estimates provide no support for this proposition. The district-level data seem to support a finding that property tax rate limits and assessment limits have significant effects. The findings should be interpreted with caution, however, inasmuch as the results are driven by information about districts in states that switched limit status between 1990 and 2000. They would be more convincing if longer time series were available for all the districts. The regression results also provide indirect evidence for the revenue substitution effects of intergovernmental aid. Both federal and state funds are shown to boost local spending on education; federal aid seems to be more readily translated into expenditure than state assistance. Although the “median household income” variable fails to perform as expected, the other two indicators of district wealth (or rather district poverty) hint at the connection between revenue-raising capacity and education expenditures. A higher percentage of students eligible for school lunch programs indicates that the districts are relatively poor and have fewer resources at their disposal. On the other hand, a higher percentage of minority students may suggest either greater diversity of the student body or a greater degree of segregation. In either case, minority students are likely to be disadvantaged in public education, receiving a lower level or lower quality of services. While the connection between property tax limitations and property tax revenue growth has been well established in the literature, the effects of limitations on the provision of public education remain understudied. Future research may focus more on the link between education input and education outcome as well as the impact of property tax limits on student performance. Effects of TELs on Property Values In principle, TELs should affect property values, with the direction of the effect indicative of the underlying “political economy” of TELs. If the effect of TELs is to disrupt an underlying Tiebout equilibrium (in which voters are efficiently sorted among different communities based on their preferences for public goods and services, which in turn are supplied by politicians and bureaucrats acting in citizens’ self-interest), TELs would have the undesirable effect of constraining tax rates below levels truly desired by citizens. If instead the net fiscal surplus derived from local supply of public goods is capitalized into housing prices, the effect of TELs would be to lower property values in constrained communities by making them less attractive to current and potential residents because of the perceived reduction in public goods. If, however, consistent with

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the Leviathan hypothesis (which interprets the passage of TEL laws as citizens’ attempt to rein in a wasteful and inefficient government, Leviathan), TELs act to bring taxes and spending more in line with residents’ preferences, as opposed to preferences of politicians and bureaucrats, they would have the opposite effect of raising property values in constrained jurisdictions by making them more attractive to their residents. By contrast, in the nonresident taxpayer self-interest model, TELs are predicted to increase the value of property other than owner-occupied housing since, as Vigdor (2004) notes, lower tax rates would shift some of the rents garnered from properties owned by nonresidents away from the fisc and back to nonresident owners. By contrast, the impact of restrictions on resident owneroccupiers is theoretically ambiguous. Resident owners would gain from a reduction in tax rates, but would lose from any associated reductions in public services. In view of the potentially important effects of TELs on the value of taxable property, and hence on the tax base of local jurisdictions, as well as the relevance of directions and patterns of change in property values for assessing the effect of TELs on voter well-being, surprisingly little empirical research exists on the effect of TELs on changes in local property values. Vigdor’s 2004 paper is a notable exception in attempting to provide such estimates. In principle, to estimate the effects of TELs on property values, one should observe the time path of property values in communities affected by a TEL with and without the TEL. In practice, such observations are impossible. Vigdor constructed a “synthetic” counterfactual by comparing the time path of property values in Massachusetts communities affected by Proposition 21/2 with those in similar communities in Connecticut. He found that the net impact of Proposition 21/2 on values of owner-occupied housing was positive. Vigdor also found that the estimated increase in property values was greater in communities that initially opposed the ballot measure, a finding consistent with the view that it is nonresidents rather than residents who favor statewide TELs (because residents can export local property taxes to nonresident landowners and employees). Distributional Effects of TELs A number of researchers also address the incidence of TELs among communities with differing characteristics and in different income classes. For example, David Merriman (1986) concluded that high-tax-capacity and low-density communities in New Jersey experienced the most severe spending cuts as a result of the statewide expenditure limit. Although population density is expected to be positively related to expenditure, New Jersey’s data suggest that spending growth would have been greater in less dense communities without TELs. Merriman

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further speculated that the distributional effects of a TEL are dependent on its design. In their examination of the fiscal effects of the Illinois property tax limit, Dye and McGuire (1997) found, in addition to their other results, that the magnitude of the cap’s impact varied across different types of jurisdictions, including park, fire, library, school districts, and municipalities. Brown (2000) found that smaller municipalities were more constrained by the TABOR amendment in Colorado than larger ones, even though the measure applied uniformly to all jurisdictions. Using county areas as the unit of analysis, Mullins (2004) showed that TELs have increased variation in revenues and expenditures, which may imply service differentials across general-purpose and school-district governments. More specifically, the constraining effects of TELs were stronger in county areas comprising the urban core and those serving relatively more disadvantaged populations (that is, areas with relatively lower fiscal capacity). A few studies have attempted to estimate the effect of TELs on the distribution of tax burdens and public services among different income groups. The findings of these studies are mixed. De Tray and Fernandez (1986) draw on the “new view” of property tax incidence, which holds that the burden of the component of local property taxes that corresponds to the national average effective property tax rate falls on owners of capital, while the incidence of the component that deviates from that national average falls on local immobile land, labor, and consumers.19 Using incidence assumptions that are consistent with the new view, De Tray and Fernandez allocate local property taxes collected in four California and four New Jersey cities to individual taxpayers before and after the passage of TELs in each state. A key assumption of the authors’ analysis is that what matters for the distribution of relative local tax burdens is mainly the effect of TELs on the deviation of local property taxes from the national average. The authors found that when the local tax burden is assumed to be borne entirely by owners of land, the

19. Decomposing the effects of local property taxes in this manner has become standard practice in the economic analysis of local property tax burdens. As noted by Rosen (2005), the new view of property tax incidence starts from the premise that because property taxes are levied nationwide (though at different rates), the local property tax is best viewed as a national tax on capital, with property in individual jurisdictions taxed at, above, or below the average tax rate. The general portion of the tax thus should be viewed as a general tax on capital, the burden of which is borne by owners of capital. Because property tax rates across jurisdictions are not uniform, however, the existence of property tax rate differentials creates additional economic incentives for capital to migrate from jurisdictions with higher-than-average tax rates to jurisdictions with lower-than-average tax rates until after-tax returns to property are equalized. These effects are referred to in the public finance literature as the excise tax effects of property taxes. As Rosen notes, determining the precise incidence of these changes is complicated, although it can be shown that the portion of the property tax that falls on land (which is immobile) will be borne by property owners. The portion of the tax that falls on structures may be borne by owners, by renters, or be shared depending, inter alia, on local conditions in the housing market.

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initial effect of adopting TELs in both California and New Jersey was to shift state and local tax burdens from lower- to higher-income households, in part by shifting state and local tax burdens toward state income taxes, which were relatively more progressive. (The effect was smaller in New Jersey because its state income tax was less progressive). These findings are robust for alternative shifting assumptions (e.g., that local property taxes are also borne by local consumers and labor) for California cities, but not for New Jersey cities, where TELs have a regressive impact under some alternative local shifting assumptions. Subsequent research on the distributional effects of California Proposition 13 by O’Sullivan, Sexton, and Sheffrin (1994) reached conclusions broadly consistent with those of De Tray and Fernandez with regard to vertical equity among residential homeowners. One important feature of Proposition 13 is that it severely limits annual assessment growth to 2 percent unless the property is sold, at which time its taxable value is reassessed based on actual market conditions. While not quite freezing the assessed value, this provision bases assessments more on acquisition value than on actual market value. In a real estate market such as California’s the effect of such a system is to benefit less mobile homeowners, who, the authors argue, are more likely to be low-income and older households. Of course a direct corollary of this increase in the taxable value of property upon sale, as Sexton, Sheffrin, and O’Sullivan (1999) note, is a substantial horizontal inequity among households in the same income class depending on when a property is purchased. For example, Sheffrin (2005) notes that in Los Angeles county in 1992, 43 percent of homeowners had been in their homes since 1975 and faced an effective property tax rate of 0.2%, compared with an effective rate of 1.0% for newly purchased homes. (Downes and Figlio [1999] caution, however, that the advantage of remaining locked in to one’s home under Proposition 13 is a unique feature of this particular form of TEL.) Other research finds that TELs can have less progressive effects. Downes and Figlio (1999) found that economically disadvantaged communities suffered larger reductions in student performance when subject to TELs. Using a Computable General Equilibrium model to simulate the economic and fiscal effects of Oregon Measure 5, Waters, Holland, and Weber (1997) estimated that higherincome Oregon households garnered disproportionate benefits in the form of higher-factor incomes resulting from reductions in production costs caused by lower property taxes. The simulated effect of Measure 5 on the overall progressivity of the Oregon tax system was mixed, reducing progressivity at the top of the income distribution and increasing it at the bottom.

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Conclusions and Directions for Further Research The emergence of the tax revolt in the 1970s and the subsequent support for measures intended to limit local taxes and spending have caused much to be written about such measures. From the standpoint of local public finance, what should one make of widespread if not uniform support for TELs in many communities? TELs restrict local government autonomy when they are legally and administratively structured to be binding. Since local fiscal autonomy is widely recognized to be critically important to the American federal system, and local governments are seen to be the most efficient and effective providers of local services, what offsetting advantages, if any, can be identified with enacting such measures? The answer to this question lies in the recognition that even democratic systems of government are human and hence imperfect institutions. When citizens believe, for good or ill, that elected leaders and bureaucrats are apt to use the taxing and spending powers of the government to pursue self-interested objectives, or when one group of taxpayers seeks to insulate itself from paying what it believes to be unjustified taxes imposed by other groups of taxpayers, voters have incentives to impose fiscal restraints on elected officials and bureaucrats. From the standpoint of both positive and normative local public finance, the embrace of such democratically imposed limitations by state and local governments raises a number of questions. How have such restrictions operated in practice? How have they affected local public finances? On balance, have such measures had desirable or undesirable effects? The empirical literature on TELs summarized above provides answers to some of these questions. • TELs that are legally and administratively structured to be binding are more likely to have measurable effects on local public finances than are TELs whose constraints can be circumvented. • When TELs are binding they have constrained growth in property tax revenue, which has long been the main broad-based source of revenue for local governments. Property tax rate limits coupled with assessment limits are particularly binding, resulting in the greatest reduction in the growth of per capita property tax revenue. • Local governments have reacted to such constraints by substituting other, narrower local revenue sources such as fees and charges, and by increased reliance on grants from state government.

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• TELs have constrained local spending on public schools, as measured by a variety of indicators such as student-teacher ratios, teacher salaries, and teacher quality. • TELs are not only associated with reduced spending on education inputs, but also with lower educational outcomes, as measured by test scores. • Evidence from Proposition 21/2 in Massachusetts suggests that TELs may have actually raised property and home values in constrained jurisdictions. • Enacting TELs creates both winners and losers among taxpayers. The potential winners include nonresident taxpayers (both nonresident workers and absentee property owners), while residents of communities with the ability to export tax burdens to nonresidents are potential losers. • Evidence on whether TELs favor lower-income versus higher income taxpayers is mixed. California’s Proposition 13 may have benefited lower-income homeowners. There is somewhat weaker evidence that the TEL enacted in New Jersey had a similar effect. In contrast, there is also evidence that lowerincome communities experienced larger reductions in educational outcome from TELs. In Oregon, Measure 5 was estimated to have benefited higherincome taxpayers, and to a lesser extent the lowest-income taxpayers. Future Research These broad findings provide important insights for gauging the effects of TELs on local public finances. However, further research is needed to provide more definitive quantitative answers.

Empirical Evidence on Effects of TELs Attempts to quantify the effects of TELs on local public finances confront the usual challenges associated with establishing that statistical relationships estimated from nonexperimental data are in fact causal. It is difficult to isolate the effects of TELs from other factors that affect local public finances, and to rule out the possibility that some unobserved characteristics of local jurisdictions are responsible for both the adoption of TELs and changes in local fiscal systems and public services. The research summarized above employs the usual statistical approaches for addressing the problem, including the use of “difference-indifference” designs, fixed effects estimators to account for unobservable factors, and of quasi-experimental control groups (such as the use of Connecticut as a comparison group for Massachusetts by Vigdor). However, much of this literature has drawn upon a relatively small number of state- or jurisdiction-specific “natural experiments” with TELs. Further replication of these findings using more natural experiments drawn from a larger number of states and types of

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TELs would be of value, especially if such natural experiments can be shown to deal decisively with the problem of inferring causation.

Distributional Effects of TELs There has also been relatively little conceptual and empirical modeling of how TELs affect the distribution of tax burdens. Such distributional effects are apt to vary considerably with the type of TEL and the specific offsetting fiscal response to the TEL by local and state governments. Hence, more analysis of different types of TELs, drawing both on microsimulation modeling of tax burdens along the lines of De Tray and Fernandez, or general equilibrium modeling along the lines of Waters, Holland, and Weber is warranted. In addition to exploring the distributional effects of TELs across income groups, more analysis needs to be done on the differential consequences of TELs across local governments. For example, the overall fiscal conditions of jurisdictions differ as a result of different revenue structures and expenditure needs. According to a recent survey of city fiscal conditions, 46 percent of central cities indicated they were in excellent or good fiscal condition. This is a smaller percentage than rural areas (63 percent), and substantially smaller than suburban areas (67 percent). In central cities the fiscal situation is probably more difficult because they have limited, or declining, revenue bases, but high expenditure needs (Hoene 2005). Rural areas have a limited ability to generate revenues from own sources, but probably smaller expenditure. Suburbs are probably better off because they have a stronger economic base and more limited expenditure needs. These differences are even more pronounced when the size of the jurisdiction is considered. For example, 63 percent of cities with populations under 50,000 indicate they are in excellent or good fiscal condition, while only 48 percent of cities over 100,000 population characterize their fiscal condition as good or excellent. A primary factor in determining the effect of TELs on individual local governments is the composition of local revenues. A recent study of the fiscal capacity of local governments within metropolitan areas documented substantial variation of the relative importance of property taxes to municipal own-source revenues. For example, in the Miami metropolitan area the city of Miami relied on property taxes for 54.8 percent of its own-source revenues, while property taxes in suburban jurisdictions ranged from 95.9 percent in Golden Beach and 71.2 percent in Key Biscayne to 14.7 percent in Homestead and 16.4 percent in Aventura. Similarly, in the San Francisco metropolitan area local property taxes accounted for 34.1 percent of San Francisco’s own-source revenues, but ranged from 79.8 and 83.3 percent of own-source revenues in San Mateo and Marin counties respectively to 10.6, 17.0, and 19.5 percent of own-source revenues in

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Half Moon Bay, Burlingame, and San Anselmo respectively (Atkins, Curran, and Bell 2005). TELs will have substantially different effects across individual jurisdictions, based in part on the difference in the revenue structure of those jurisdictions.

Benefit-Cost Evaluation of TELs Last, as noted by Downes and Figlio (1999), it would be useful to derive quantitative estimates of the net benefits and costs of TELs. The framework for such an assessment should be the standard public finance paradigm of estimating the size of tax reductions due to TELs and the reduction in the economic costs (excess burden) of taxation attributable to them, and then comparing these magnitudes to the economic value of public services foregone due to lower tax revenues. APPENDIX TABLE 6.1A

Assessment Limitations

State

Limit

Citation

Alabama

None

Alaska

None

Arizona

Assessed value cannot increase by more than the lesser of 10% or 25% of the difference between the last year’s assessed value and the current year’s fair market value.

Ariz. Rev. Stat. § 42-13301

Arkansas

Homestead value limited to 5%; all other real property capped at 10%.

Ark. Const. amend. LXXIX

California

Assessment increase cannot exceed 2% per year.

Proposition 13, California Constitution Article 13A

Colorado

Constitution requires residential property to comprise no more than 45% of total assessed value.

Colorado Const. Art. IX

Connecticut

Local option.

Connecticut General Statutes Chapter 203

Delaware

None

Florida

Residential assessments limited to 3% or CPI.

Fla. Const. Art. VII, § 4

Georgia

Conservation use property assessment cannot exceed 3% per year.

Ga. Code. Ann. §§ 48-5-7.4 & 48-5-269

Hawaii

None

Idaho

None

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TABLE 6.1A (c ontinue d ) State

Limit

Citation

Illinois

None

Indiana

None

Iowa

Increase of total statewide assessments cannot exceed 4% annually.

Kansas

None

Kentucky

None

Louisiana

None

Maine

None

Maryland

State cap at 10% annually; county and municipal governments can set limits from 0–10 %; no limits for school districts.

Massachusetts

None

Michigan

Total assessed tax base cannot exceed the lesser of 5% or the rate of inflation without a rate rollback.

Mich. Const. Art. IX, § 3

Minnesota

Value limited to the greater of 15% increase over last year’s limited value or 25% of the difference between this year’s estimated value and last year’s limited value. This only applies to agricultural, residential, timberland, or noncommercial seasonal recreational residential (cabins) property.

Minn. Stat. §273.11

Mississippi

None

Missouri

None

Montana

None

Nebraska

None

Nevada

None

New Hampshire

None

New Jersey

None

New Mexico

3% cap on residential property unless title changes.

N.M. Stat. Ann. § 7-36-21.2

New York

Nassau County and New York City: 6% per year or 20% over 5 years (Class I property); 8% per year or 30% over 5 years (Class II).

NYReal Prop. Tax Law § 1805

North Carolina

None

North Dakota

None

Iowa Code § 44121 (4)-(5)

Md. Code. Ann. Tax-Property, Title 9 §9.105

(continued)

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Limit

Ohio

None

Oklahoma

Assessment cannot increase more than 5% per year unless title to property is sold.

Okla. Const. Art. X, § 8B

Oregon

Taxable assessed value cannot increase more than 3% each year.

Or. Const. Art. XI

Pennsylvania

None

Rhode Island

None

South Carolina

None

South Dakota

None

Tennessee

6% cap on assessments of greenbelt properties.

Tenn. Code Ann. § 67-5-1008

Texas

Residential assessed value limited to 10%. Number of years since last reappraisal.

Tex. Tax Code Ann. Chapter 26, § 26.01 et. seq.

Utah

None

Vermont

None

Virginia

None

Washington

Total assessments for the district cannot increase more than 25% over previous total assessments (special assessment districts only).

West Virginia

None

Wisconsin

None

Wyoming

None

TABLE 6.2A

Citation

Wash. Rev. Code § 35.85.030

Property Tax Rate Limits

State

Limit

Override

Citation

Alabama

Residential tax rates cannot exceed 1% FMV

majority vote in a special election

Ala. Const. Amend. CCCLXXIII

Alaska

Municipalities: 3% of assessed value Second Class Cities: 2% of assessed value

none

Alaska Stat. § 29.45.090 Alaska Stat. § 29.45.590

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Limit

Override

Citation

Arizona

Cannot exceed 1% of full cash value

majority vote of electorate

Ariz. Const. Art. IX, § 18 (1)

Arkansas

Counties and municipalities 5 mills

none

Ark. Const. Art. XI § 4 Ark. Code Ann. § 26-25-101

California

Cannot exceed 1%

none

Cal. Const. Art. 13A

Colorado

All governments limited to rate of previous year

majority vote of electorate

Colo. Const. Art. X, § 20(4)

Connecticut

None

Delaware

Kent County (only) limited to 50 cents per $100 of assessed value

none

Del. Stat. Title 9, § 8002

Florida

All governments 10 mills

referendum

Fla. Const. Art. VII, § 9

Georgia

Rate for school districts: 20 mills No limits for independent cities/counties

Hawaii

None

Idaho

Counties: the greater of 2.6 mills or a rate sufficient to raise $250,000; Municipalities: 9 mills

majority vote of electorate

Ga. Code Ann. § 48-5-8 Ga. Const. Art VIII, §6

majority vote of electorate

Idaho Code §§ 50-235, 63-805

Idaho has numerous rate limitations for its county governments’ functions. Function

Limit

Cite

Airport

.0004

21-404

Ambulance

.0002

31-3901

Armory Construction

.0002

46-722

Building Funds

.0006

31-1008

Charities & Indigent

.0010

31-863

Medical Bldg. & Equip.

.0006

31-3503

Current Exp. Fund

.0026

63-805 (continued)

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TABLE 6.2A (continued) Function

Limit

Cite

County Justice Fund

.0020

63-805

Dist. Court Fund

.0004

31-867

Fair Exhibits

.0002

31-823

Fair Buildings

.0001

31-822

Fair Operation

.0001

22-206

Fish Hatchery

.00005

36-1702

Health Prevention

.0004

31-862

Herd

.0002

25-2401

Historical Societies

.00012

31-864

Hospital Operation

.0006

31-3613

Revaluation Program

.0004

63-314

Sinking Fund

.0002

39-1334

Jr. College Tuition

.0006

33-2110a

Museums

.0003

31-4706

Noxious Weeds

.0006

22-2406

Parks & Recreation

.0001

63-805

Pest Fund

.0002

25-2602

Road & Bridge

.002

40-801 (1)(a)

Special Tax

.00084

40-801 (1)(b)

Jt. County Bridges

.000024

40-807

Seeding Burned Areas

.0002

38-509

Solid Waste Disposal

.0004

31-4404

Veteran’s Memorial

.00001

65-103

Veteran’s Memorial Const

.00005

65-104

Warrant Redemption

.002

63-806

LID Guarantee

.0002

50-1762

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TABLE 6.2A (continued) State

Limit

Override

Citation

Illinois

Local option

referendum

35 Ill. Comp. Stat. Ann. 100/18-125

Indiana

$0.6667/$100 municipal $0.4167/$100 all other local governments

none

Ind. Code § 6-1.1-18-3

Iowa

Counties 3.5 mills Municipalities 8.1 mills

majority vote of electorate in special election

Iowa Code § 331.423

voter approval

Ky. Const. § 157

majority vote of electorate

La. Const. Part III, § 26

Kansas

None

Kentucky

$.75–$1.50/$100 municipalities (sliding scale) $.50/$100 county $1.50/100 school district

Louisiana

4 mills 7 mills Orleans Parish 5 mills Jackson

Maine

None

Maryland

No state limit, but Prince George’s county limit at 96 cents per $100

Massachusetts

None

Michigan

15 mills for all governments except 18 mills for counties

can be increased to 50 mills with voter approval

Mich. Const. Art. IX, § 6

Minnesota

Local option

referendum

Minn. Stat. § 275.011

Mississippi

None

Missouri

Municipalities: $1 on $100 assessed valuation Counties: 35 cents on $100 assessed valuation School district formed of cities & towns: $2.75 on $100 All other school districts: 65 cents on $100

2/3 vote of electorate majority of electorate for schools

Mo. Const. Art. X, § 11b

(continued)

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TABLE 6.2A (continued) State

Limit

Override

Citation

Montana

The maximum number of mills that a governmental entity may impose is established by calculating the number of mills required to generate the amount of property tax actually assessed in the governmental unit in the prior year based on the current year taxable value, less the current year’s value of newly taxable property, plus one-half of the average rate of inflation for the prior 3 years.

majority vote of electorate

Mont. Code § 15-10-420

Nebraska

Rate limit for county government is 50 cents per $100 Schools: $1.05 per $100 Counties: 50 cents per $100 Cities: 45 cents per $100 Natural resource districts: 4.5 cents per $100 Community Colleges: 8 cents per $100

School boards can vote in an additional 1% over limit with a supermajority.

Neb. Rev. Stat. § 77.3442

Nevada

Rate capped at 5 cents per $100 assessed value

majority vote of electorate

Nev. Const. Art. X § 2 Nev. Rev. Stat. § 361.453

New Hampshire

None

New Jersey

None

New Mexico

$11.85/$1,000 county $.50/$1,000 school district $7.65/$1,000 municipality

majority vote of electorate

N.M. Stat. Ann. § 7-37-7

New York

Counties: 1.5% of the full market value of taxable

none

N.Y. Const. Art. VIII, § 10

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TABLE 6.2A (continued) State

Limit

Override

Citation

real estate, averaged over the last 5 years. Municipalities: 2%. New York City: 2.5% North Carolina

Counties and municipalities may levy taxes for several specified purposes up to a combined rate of $1.50 per $100 assessed value

majority vote in referendum

N.C. Gen. Stat. § 153A-149

North Dakota

23 mills (county limit), Various other special levy limits 38 mills (city limit)

varies by jurisdiction

N.D. Cent. Code §§ 57-15-06, -08, -14, -20 N.D. Cent. Code § 57-16-01 N.D. Cent. Code § 57-17-01

50%–60% voter approval

18 mills (township limit) Ohio

Rate limit at 1% of taxable value

majority vote of electorate

Ohio Rev. Code 5705.02 Ohio Rev.Code 5705.19 Ohio Const. Art. 12.02

Oklahoma

Mill levy limits for: common schools 5–15 vo-tech schools 5 county government 2.5–10 municipal government 5 special districts 3–4 assessment districts 3–10

majority vote of electorate (school districts only)

Okla. Const. Art. X, § 9

Oregon

School prop tax rates capped at 0.5% of FMV Nonschool tax rates capped at 1% of FMV

increases must be voted on by double majority

Or. Const. Art. XI

Pennsylvania

Tax rates cannot exceed 12 mills of market value

none

Pa. Cons. Stat. § 53.6917 (continued)

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TABLE 6.2A (continued) State

Limit

Override

Citation

Rhode Island

None

South Carolina

None

South Dakota

General county limit $12/thousand Snow removal fund $1.20/thousand Highway reserve $1.20/thousand Courthouse .90/thousand Ag building .30/thousand Fire fighting .60/thousand Railroad authority $2.40/thousand Airport authority $2.40/thousand Ambulance district .60/thousand Water project district $1/thousand Sanitary district .27/thousand Hospital fund .60/thousand

3/4 majority of electorate (school district majority)

S.D. Codified Laws § 10-12-21 et seq.

Tennessee

None

Texas

County/Municipality 8 mills School districts 13.3 mills

majority vote of electorate

Tex. Const. Art. VII–VIII

Utah

County .0032 Library .001 Health .0004 Tort liability .0001 State A&C .0003 Local A&C .0002 School district set by legislature School capital outlay .0024 School reading program .000121

under limited circumstances

Utah Code Ann. § 59-2-908

Utah Code 53A-17a-135

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TABLE 6.2A (continued) State

Limit

Override

City/town .007 Water/light/power .0008 City library .001 City Tort liability .0001 Special cemetery .0004 Special Mosquito .0004 Special fire .0008 County water .0008 Flood control .0008 Special County service .0014

Citation

Utah Code 10-6-133

Utah Code 17A-2-222

Vermont

None

Virginia

None

Washington

Tax rates limited to 1%

3/5 majority of electorate

Wash. Const. Art. VII, § 2

West Virginia

Class one property .50/100 Class two property $1/100 Class three property $1.50/100 Class four property $2.00/100

majority vote of electorate

W. Va. Code § 11-8-6

Wisconsin

Counties: 1 mill or rate in effect in 1992, whichever is greater

majority vote of electorate

Wis. Stat. § 59.605.

Wyoming

Counties: 1.2% of assessed value Cities and towns: 0.8% of assessed value School districts: 2.5% of assessed value

none

Wyo. Statutes § 39-13-104

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Revenue/Expenditure Limits

State

Limit

Override

Citation

Alabama

None

Alaska

No municipality may collect more than $1,500 per resident

none

Alaska Stat. § 29.49.090

Arizona

Property taxes levied by any local government cannot increase more than 2%

popular vote

Ariz. Const. Art. 9, § 19

Arkansas

Property tax revenue cannot increase more than than 10% from previous year

none

Ark. Const. Art. 16, § 14

California

Annual appropriations growth linked to population growth and per capita personal income growth

majority vote of electorate

Cal. Const. Art. 13A

Colorado

Increases cannot exceed the lesser of local growth/ inflation or 5.5% or the previous year’s revenue (suspended through 2010)

majority vote of electorate

Colo. Const. Art. IX, § 20

Connecticut

None

Delaware

County property tax revenue cannot increase more than 15% annually

none

Del. Code Ann. Title 9, § 8002

Florida

None

Georgia

None

Hawaii

None

Idaho

Revenue growth factor capped at 3%

additional amounts to be approved by 60% of voters in cities. In other taxing districts, must be approved by 66 2/3%

Idaho Code, § 63.802

Illinois

Tax cap limits levy increases of taxing bodies to lower of 5% or rate of inflation

majority vote of governing body

35 Ill. Comp. Stat. 200/18-55

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TABLE 6.3A (continued) State

Limit

Override

Citation

Indiana

Property tax revenue increases are limited to not more than the 6-year annual growth of nonfarm personal income

local government can appeal through state admin. agency

Ind. Code § 6-1.1-18.5-3

Iowa

School district expenditure cannot exceed annual allowable growth

none

Iowa Code § 257.7

Kansas

Property tax revenue is limited to amounts from previous year

majority vote of governing body

Kan. Stat. Ann. § 79.292

Kentucky

4% annual increase limit for school districts

vote by school board after public notice

Ky. Rev. Stat. Ann. § 160.470

Louisiana

Property tax revenue cannot exceed previous year

2/3 vote of governing body

La. Const. Art. VII, § 23

Maine

Municipal property tax levy increases limited to formula based on inflation, assessment growth, and income

can be overridden by local government majority vote, but 10 percent of electorate can call referendum

Me. Rev. Stat. Ann. Title. 30A, § 5721

Maryland

No state limit, but Anne Arundel, revenue limit of 4.5% or CPI growth; Montgomery County, rev. limit of CPI; Talbot & Wicomico Counties, rev. increase limit of 2% or CPI

Massachusetts

Municipal property tax levies cannot increase by more than 2.5 percent annually

majority vote of electorate

Mass. Const. Ch. 59, § 21C (Prop 2 1/2)

Michigan

No net tax increases without voter approval

majority vote of electorate

Mich. Const. Art. IX, § 31 (Headlee Amendment)

MD Code. Ann. Tax- Property, § 2-2005

(continued)

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TABLE 6.3A (continued) State

Limit

Override

Citation

Minnesota

Local option/property tax revenue cannot exceed previous year

referendum

Minn. Stat. § 275.70

Mississippi

10% cap on increase in all tax collections

majority vote of electorate

Miss. Code Ann. § 27-39-320

Missouri

No net revenue increases

majority of voters within jurisdiction

Mo. Const. Art. X § 22

Montana

Nonschool property tax revenue cannot increase more than 1/2 average rate of inflation for prior 3 years

majority vote of electorate

Mont. Code Ann. § 15-10-420

Nebraska

School district expenditure increase limits vary by size of district from 2.5–5.5% annually

School boards can vote in an additional 1%. Requires a 3/4 majority vote

Neb. Rev. Stat. § 77.3402

Nevada

Property taxes, except for school districts, cannot be raised more than 6% annually

majority of popular vote

Nev. Rev. Stat. § 354.59811 Nev. Rev. Stat. § 354.5982

New Hampshire

None

New Jersey

County property tax revenue cannot increase more than 2.5 percent over previous year plus cost of living adjustment

referendum

N.J. Stat. Ann. 40A § 4.45.4

New Mexico

Property tax revenue cannot increase more than 5% annually

none

N.M. Stat. Ann. § 7-37-7.1

New York

None

North Carolina

None

North Dakota

School district property tax revenue limited to previous year plus 18%

majority of electorate

N.D. Cent. Code § 57-14-14

Ohio

Statute freezes amount of revenue from real property until the property is reappraised

Ohio Rev. Code Ann. § 319.301

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TABLE 6.3A (continued) State

Limit

Override

Oklahoma

None

Oregon

None

Pennsylvania

HB 39 New law limits property tax revenue increases to inflation rate

by vote of electorate

Rhode Island

S 3050, New law lowers the cap on local property tax increases from the current 5.5 percent to 4 percent in fiscal 2013 and reduces the amount school budgets can rise over the previous year from 5.25 percent in fiscal 2008 to 4 percent in fiscal 2012. The percentage limit by which school budgets can increase will drop by 0.25 percentage point per year until reaching 4 percent.

4/5 majority of local legislature

South Carolina

None

South Dakota

Nonschool property tax revenue may not increase more than the lesser of 3 percent or rate of inflation

Tennessee

None

Texas

Citation

majority of electorate after 2/3 governing body vote

S.D. Codified Laws § 10-35

Property tax revenue limited to previous year

vote of governing body after notice and hearing

Tex. Const. Art. VIII §2

Utah

Property tax revenue limited to previous year

vote of governing body after notice and hearing

Utah Code Ann. § 59-2

Vermont

None

Virginia

County and municipality property tax revenue capped at 101% of previous year’s revenue

by local gov. vote after holding a public hearing

Va. Code Ann. § 58.1-3321

(continued)

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TABLE 6.3A (continued) State

Limit

Override

Citation

Washington

Property tax revenue majority vote limited by formula based of electorate on population and inflation

Wash. Rev. Code § 84.55

West Virginia

Property tax revenue limited to previous year

by local government vote after notice and hearing

W. Va. Code § 11-8-6

Wisconsin

Levy increase limited to either 2% or percentage change in municipality’s equalized value due to net new construction, whichever is greater

referendum

Wis. Stat. Ann. § 66.0602 (Act 25, 2005-2007)

Wyoming

None

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Poterba, James M., and Kim S. Rueben. 1995. The effect of property-tax limits on wages and employment in the local public sector. American Economic Review 85 (May):384–389. Preston, Anne E., and Casey Ichniowski. 1991. A national perspective on the nature and effects of the local property tax revolt, 1976–1986. National Tax Journal 44(2): 123–145. Richter, Paul. 1984. A look at the revolt. In California and the American tax revolt, ed. Terry Schwardon. Berkeley: University of California Press. Rosen, Harvey S. 2005. Public finance, 7th ed. Boston: McGraw-Hill. Sexton, Terri A., Steven M. Sheffrin, and Arthur O’Sullivan. 1999. Proposition 13: Unintended effects and feasible reforms. National Tax Journal 52(1):129–138. Shadbegian, Ronald J. 1996. Do tax and expenditure limitations affect the size and growth of state government? Contemporary Economic Policy 14 (January):22–35. ———. 1999. The effect of tax and expenditure limitations on the revenue structure of local government, 1962–87. National Tax Journal 52(2):221–237. ———. 2003. Did the property tax revolt affect local public education? Evidence from panel data. Public Finance Review 31 (January):91–121. Sheffrin, Steven M. 2005. Property tax, real property, residential. In The encyclopedia of taxation and tax policy, ed. Joseph Cordes, Robert Ebel, and Jane Gravelle. 2nd ed. Washington, DC: Urban Institute Press. Sokolow, Alvin D. 1998. The changing property tax and state-local relations. Publius 28 (Winter):165–187. ———. 2000. The changing property tax in the west: State centralization of local finances. Public Budgeting and Finance 20 (Spring):85–104. Vigdor, Jacob L. 2004. Other people’s taxes: Nonresident voters and statewide limitation of local government. Journal of Law & Economics 47 (October):453–476. Waters, Edward C., David W. Holland, and Bruce A. Weber. 1997. Economic impacts of a property tax limitation: A computable general equilibrium analysis of Oregon’s Measure 5. Land Economics 73 (February):72–89. Wolman, Harold. 1997. Local government institutions and democratic governance. In Theories of Urban Politics, ed. David Judge, Gerry Stoker, and Harold Wolman, 135–159. Thousand Oaks, CA: Sage Publications. Yuan, Bing, 2006. Property tax limitations and public school expenditures: A district-level analysis. Mimeograph. George Washington University, Washington, DC.

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TRACY M. GORDON

T

he chapter by Yuan, Cordes, Brunori, and Bell highlights a central theme of the conference for which it was originally written. Economists have long admired the property tax for its approximation of a nondistortionary land tax, its ability to generate revenue, and its fairness to the extent that it is progressively borne by owners of capital or beneficiaries of local government expenditures. The property tax is also the lynchpin to the idea that a local government system can be self-regulating, as homeowners attuned to capitalization shop among competing jurisdictions for the best combination of taxes and services (Fischel 2001). Yet citizens revile the property tax as an unfairly administered, regressive tax on housing consumption or unrealized capital gains. They are often unwilling to support higher property taxes even to realize their most cherished policy goals, such as improving K–12 education. Moreover, the public has frequently subverted the property tax by approving state limits on local property rates, assessment practices, and levies. Antipathy toward this mainstay of local governments has also carried over to result in the passage of limits on overall revenues and expenditures. A key question for researchers and policy makers is the net cost or benefit of these rules. Do property tax limits improve government efficiency or cut vital public services? This chapter works toward an answer by reviewing the state of knowledge on local tax and expenditure limits (TELs) across a range of fiscal and policy outcomes. It calls particular attention to studies that have moved beyond aggregate measures to assess exactly where TELs bind (e.g., total revenues or property taxes, education or health spending, K–12 instructional or administrative expenses). In so doing, it also sheds light on what may be the underlying local political environment, a key question for any final cost-benefit analysis. I have three main reflections on this chapter. First, it is unclear how state limits on local governments arise in the first place. The chapter describes the case of California, where Proposition 13 may have been precipitated by the

192

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Serrano school finance equalization decision, as well as by local property tax assessment scandals, a large state budget surplus, and state and local intransigence in the face of rising household property tax burdens.1 More generally, however, why did voters resort to state action to correct local mistakes? This end run is particularly surprising because voters did it in such a way as to diminish local fiscal autonomy. By giving the state the power to allocate property tax revenues among local governments, they laid the groundwork for making local governments dependent on state aid despite the advantages of decentralization, which include not only allocative efficiency but also enhanced government accountability and citizen engagement as the authors point out. It seems that we need a more nuanced view of local government, one that allows for bad policy despite the threat of mobile households’ exit from the jurisdiction or failure to enter. In a recent survey, Helsley (2004) describes several such models. For example, Epple and Zelenitz (1981) show that although competition can curb government rent seeking, it cannot eliminate this activity entirely because of the fixity of jurisdictional boundaries and the immobility of land. A related issue is that jurisdictions constituting a large proportion of a metropolitan area, as “utility setters” in the region, may be able to export the adverse price effects of higher taxes and lower levels of service provision (Hoyt 1999). Thus, voters should be more likely to support state limits on local government finances where there is incomplete capitalization of community quality variables into property values. Alternatively, there may be institutional sources of government failure, such as districting or the form of government (Baqir 2002). Still, the key question is: why should the state do any better? One answer may be that state TELs are a response to a few isolated cases of government failure in large jurisdictions. If so, the weak relationships often detected between state limits and local outcomes may arise because voters in the preponderance of smaller jurisdictions are content with their local governments and continue to set taxes and expenditures according to their preferences, notwithstanding the TEL. Another possibility is that anti–property tax interest groups are simply more successful at the state level and local governments ultimately bear the cost of these actions. My second reaction is that I would have liked to read more about the mechanics of the studies reviewed in the chapter. Many first generation studies take variation in state fiscal institutions to be exogenous, or at least historically 1. Serrano v. Priest, 5 Cal.3d 584 (1971).

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determined and therefore independent of fiscal outcomes, whereas more recent studies include state- and year-fixed effects to isolate the effects of state history or political culture as well as economic conditions or events affecting all states in a given year. An alternative strategy is to focus on a time-varying relationship or exogenous shock that theory suggests should be mediated by the presence of a restrictive fiscal institution (Poterba 1994). Other researchers have used instrumental variables such as the ease of passing voter-initiated legislation or constitutional amendments (Knight 2000; Rueben 1996). I did not see much attention to the techniques used in the studies reviewed or much discussion of which results the authors find most plausible. Similarly, I would have liked to see more detail on the new school district results presented in this chapter. What kinds of regressions are these and what else is included in the model? What are basic descriptive statistics for schools in states with and without TELs? What do we gain by using school districts as the unit of analysis when policies vary at the state level? Finally, selfishly, I would like to see much more information in the appendix tables. The George Washington Institute of Public Policy has done a real public service by amassing vast quantities of data and making them available to other researchers. Although the tables are already quite long, they could convey more information (for example on the years in which limits were enacted and their origins as legislative or voter-proposed measures). In any event, I commend the herculean data collection efforts of the George Washington Institute of Public Policy with the support of the Lincoln Institute of Land Policy, and look forward to learning more about the fruits of their efforts. REFERENCES

Baqir, Reza. 2002. Districting and government overspending. Journal of Political Economy 110(6) (December):1318–1354. Epple, Dennis, and Allan Zelenitz. 1981. The implications of competition among jurisdictions: Does Tiebout need politics?” Journal of Political Economy 89(6):1197– 1217. Fischel, William A. 2001. The homevoter hypothesis: How home values influence local government taxation, school finance, and land-use policies. Cambridge, MA: Harvard University Press. Helsley, Robert W. 2004. Urban political economics, in Handbook of Regional and Urban Economics, J. V. Henderson and J. F. Thisse, eds., volume 4, 2381–2421. Elsevier. Hoyt, William H. 1999. Leviathan, local government expenditures, and capitalization.” Regional Science and Urban Economics 29:155–171.

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Knight, Brian J. 2000. Supermajority voting requirements for tax increases: Evidence from the states, Journal of Public Economics 76(1):41–67. Poterba, James M. 1994. State responses to fiscal crises: The effects of budgetary institutions and politics, Journal of Political Economy 102(4):799–821. Rueben, Kim S. 1996. Tax limitations and government growth: The effect of state tax and expenditure limits on state and local government, PPIC Working Paper.

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7 Efforts to Override School District Property Tax Limitations GARRY YOUNG MARGARET SALAS KELLY BROWN JESSICA MENTER

I

n general, local governments, from school districts to municipalities to counties to a variety of special districts, rely quite heavily on the property tax to fund their services. Yet the property tax is rivaled only by the federal income tax as the most loathed tax in the United States (Jacobe 2005). This helps explain the popularity of state restrictions on local property taxation through the use of tax and expenditure limitations (TELs). California’s Proposition 13 remains the best known and, in many ways, the most restrictive of TELs, but forty-six states now impose some sort of TEL on some or all of their local governments (Brunori et al. 2007). Furthermore, despite persistent concerns at all levels of government regarding school quality and funding, 35 states impose some type of TEL on their school districts. However, most (26) of these states provide their local governments with some capacity to override the limitation, typically through a referendum held among voters in the school district. We know very little about the frequency and outcomes of TEL override attempts through these referenda. Nor do we know much about the factors that contribute to the success or failure of these attempts. In this chapter we take a first cut at analyzing the use of referenda for TEL overrides by focusing on override attempts by school districts in Wisconsin between 1995 and 2007. We address three issues of interest to a range of scholars and practitioners in the United States. First, our chapter provides the first systematic empirical analysis of TEL overrides. For schools and other forms of local government, TEL override provisions are common across the United States, but 197

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remain virtually unstudied. Yet without understanding override provisions it is impossible to fully evaluate the actual impact of TELs on local governance and on the use and erosion of the property tax. Second, along with initiatives, referenda constitute a key form of direct democracy in the United States. While state-level referenda attract intense scholarly attention, the place where the referendum is most common, the local government level, receives very little attention. This is true even though local governments across the nation rely on referenda to gain approval of a wide range of statutes, tax increases, and bond issues. Finally, TELs directly affect education policy, since they potentially impose limitations on the ability of school districts to raise revenue. Indeed, since school districts rely heavily on referenda to augment school finance, especially through bond measures, we can contrast voter actions on TEL overrides with voter actions on other school finance referenda. In the sections that follow we first provide an overview of TELs as they apply to schools across the fifty states. We then go on to discuss local referenda, with a stress on their relation to school finance. We proceed with an overview and analysis of Wisconsin school districts for the period from 1995 to 2007. Types of TELs and Override Provisions TEL provisions are exceptionally variable and complex state by state. Thus any attempt at generalizing and categorizing TELs is bound to oversimplify in some cases. Relying heavily on the information and categories developed by the Significant Features of the Property Tax project, and ignoring various public disclosure provisions, we identified four main categories that apply to school districts. These are: (1) property tax rate limits, where a limit is imposed on the property millage rate; (2) property tax levy limits, where a cap is imposed on the amount of property taxes that can be collected; (3) limits on general revenues or expenditures; and (4) limits on property assessments. Table 7.1 provides a very general description of the 50 states and the TELs on schools that they have in place. Table 7.2 summarizes the descriptions from Table 7.1. Thirty-five states have a school TEL in at least one of the four categories. Table 7.2 shows that twenty-five states impose a rate limit, fourteen states impose a levy limit, seven states impose a revenue/expenditure limit, and fourteen states impose an assessment limit. In regard to override provisions, eighteen of the twenty-five rate limit states, eight of the fourteen levy limit states, five of the seven revenue/expenditure limit states, and none of the assessment states allow a simple-majority referendum to override the respective TEL. In three cases referenda require supermajorities for override approvals. In two cases school boards can override and in Minnesota revenue/expenditure

No

No

Yes

No

Yes

Yes

No

No

Yes

Yes

No

Yes

No

Yes

No

Alabama

Alaska

Arizona

Arkansas

California

Colorado

Connecticut

Delaware

Florida

Georgia

Hawaii

Idaho

Illinois

Indiana

Iowa

Applies?

n/a

None

n/a

Referendum

n/a

Referendum

Referendum

n/a

n/a

Referendum

No

No

Yes

Yes

No

No

No

No

No

Yes

No

No

No

n/a

n/a

Referendum

Referendum

n/a

n/a

n/a

n/a

n/a

Referendum

n/a

n/a

n/a

n/a

n/a

Override?

Yes

No

No

No

No

No

No

No

No

Yes

Yes

No

Yes

No

No

Applies?

None

n/a

n/a

n/a

n/a

n/a

n/a

n/a

n/a

Referendum

Referendum

n/a

Referendum

n/a

n/a

Override?

Revenue/Expenditure Limit

Yes

Yes

No

No

No

No

Yes

No

No

Yes

Yes

Yes

No

No

No

Applies?

(continued)

None

None

n/a

n/a

n/a

n/a

None

n/a

n/a

None

None

None

n/a

n/a

n/a

Override?

Assessment Limitations

10:45 AM

None

n/a

Referendum

No

No

Applies?

PT Levy Limits

4/4/09

n/a

n/a

Override?

PT Rate Limit

Tax and Expenditure Limitations on School Districts

TABLE 7.1

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No

Yes

Yes

No

No

No

Yes

No

No

Yes

Yes

Yes

Yes

No

No

Yes

Kansas

Kentucky

Louisiana

Maine

Maryland

Massachusetts

Michigan

Minnesota

Mississippi

Missouri

Montana

Nebraska

Nevada

New Hampshire

New Jersey

New Mexico

Referendum

n/a

n/a

Referendum

Referendum

Referendum

Referendum

n/a

n/a

Referendum

No

No

No

No

No

No

Yes

Yes

Yes

Yes

No

No

No

n/a

n/a

n/a

n/a

n/a

n/a

Referendum

Referendum

Referendum

Referendum

n/a

n/a

n/a

n/a

n/a

n/a

Override?

No

No

No

No

Yes

No

No

No

Yes

No

No

No

No

No

No

No

Applies?

n/a

n/a

n/a

n/a

Referendum

n/a

n/a

n/a

Tax Court Appeal

n/a

n/a

n/a

n/a

n/a

n/a

n/a

Override?

Revenue/Expenditure Limit

Yes

No

No

No

None

No

No

No

Yes

Yes

Yes

No

No

No

No

No

Applies?

None

n/a

n/a

n/a

n/a

n/a

n/a

n/a

None

None

None

n/a

n/a

n/a

n/a

n/a

Override?

Assessment Limitations

10:45 AM

n/a

n/a

n/a

No

No

No

Applies?

PT Levy Limits

4/4/09

Referendum

None

n/a

Override?

PT Rate Limit

Applies?

TABLE 7.1 (continued)

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No

Yes

Yes

Yes

Yes

Yes

No

No

Yes

No

Yes

Yes

No

No

No

Yes

No

Yes

North Carolina

North Dakota

Ohio

Oklahoma

Oregon

Pennsylvania

Rhode Island

South Carolina

South Dakota

Tennessee

Texas

Utah

Vermont

Virginia

Washington

West Virginia

Wisconsin

Wyoming

None

n/a

Referendum

n/a

n/a

n/a

School Board

Referendum

n/a

No

No

Yes

Yes

No

No

No

Yes

No

No

Yes

No

Yes

No

No

Yes

Yes

No

No

n/a

n/a

School Board

Referendum

n/a

n/a

n/a

None

n/a

n/a

None

n/a

Referendum

n/a

n/a

None

Referendum

n/a

n/a

No

Yes

No

No

No

No

No

No

No

No

No

No

No

No

No

No

No

No

No

n/a

Referendum

n/a

n/a

n/a

n/a

n/a

n/a

n/a

n/a

n/a

n/a

n/a

n/a

n/a

n/a

n/a

n/a

n/a

No

No

No

No

No

No

Yes

No

No

Yes

No

No

No

Yes

No

No

No

Yes

n/a

n/a

n/a

n/a

n/a

n/a

None

n/a

n/a

None

n/a

n/a

n/a

None

n/a

n/a

n/a

None

Through the Property Tax).

note: Italicized referenda require supermajority for override passage.

10:45 AM

Referendum

n/a

n/a

None

Referendum

Referendum

Referendum

Referendum

n/a

n/a

4/4/09

source: Significant Features of the Property Tax. Lincoln Institute of Land Policy and George Washington Institute of Public Policy (Limitations on Local Authority to Raise Revenue

No

New York

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TABLE 7.2

Number of States with School District TEL and Override TEL States with Override States with TEL

SimpleMajority Referendum

SuperMajority Referendum

School Board

Administrative Appeal

PT Rate Limit

25

18

1

1

0

PT Levy Limits

14

8

2

1

0

7

5

0

0

1

14

0

0

0

0

Type of TEL

Revenue/Expenditure Limit Assessment Limitations

note: Some states have more than one category of TEL. Thirty-five states have a TEL in at least one category.

limits applied by the state Department of Revenue are appealable to the Tax Court. We stress that the general information provided in Tables 7.1 and 7.2 masks variation and complexity. The specifics of the TELs vary by state. For example, the property tax rate limit for school districts in Kentucky is 15 mills, while in Oregon it is 5 mills. Some states exempt specific aspects of school expenditures, such as debt relief, from the TEL, while others do not provide exemptions. Aside from interstate variance, some states allow intrastate differences as well. For example, under the Louisiana constitution Orleans Parish schools can set a higher mill rate than other school districts in the state. Likewise, the specifics of referenda override requirements differ in substantive ways. As noted earlier, three states require supermajorities to override. It appears that school boards have the power to place override provisions on the ballot in all the relevant states, but in some cases a supermajority vote of the school board is necessary. For example, in North Dakota a two-thirds vote of the school board is required to place an override on the ballot. Furthermore, some states limit the extent of the override. For example, an override referendum in Missouri can raise the rate limit to 60 mills from 27.5 mills. In West Virginia a simple-majority vote suffices for a 100 percent increase in the rate limit but a supermajority vote (60 percent) can raise the limit even higher. In some states, the override has a time limit. Finally, TELs can affect school districts in indirect ways. In some states dependent school districts will be affected by TELs on other local governments.

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Likewise, in many cases school districts rely on other local governments, such as counties, for administration of property tax collections. Indeed, we have included the assessments category in Tables 7.1 and 7.2 because assessment limits on local governments can affect school districts, since school districts tend to rely on other local governments to carry out assessments. However, there may be circumstances where other types of TELs, such as levy limits that are placed on other local governments, also affect school districts due to administrative entanglements. These caveats aside, Tables 7.1 and 7.2 illustrate the tremendous variation that exists in the TEL landscape across the states. Indeed, this variation is even starker when TELs on local governments in addition to school districts are considered (Brunori et al. 2007). States differ on the scope of TELs across government types, the timing of adoption, TEL stringency, and, of course, override provisions. While examinations of TEL adoption in individual states exist, the literature lacks any systematic investigation of why some states adopt TELs while others do not, and of what explains variation in design across those states with TELs. One obvious line of investigation in this regard is to see whether states that provide their citizens with the initiative are more likely to impose strong TELs on local governments. (Initiative states are more likely to have TELs on their state government [Smith and Tolbert 2007].) The literature does have much to say regarding the impact of TELs on local governance and fiscal policy. Numerous studies find that TELs restrict local government revenue collection to some degree (Cornia and Walters 2006; Dye, McGuire and McMillen 2005; Galles and Sexton 2000; Sokolow 2000; Cutler, Elmendorf and Zeckhauer 1999; Sokolow 1998; Dye and McGuire 1997; Mullins and Joyce 1996; O’Sullivan, Sexton, and Sheffrin 1995; Elder 1992; Joyce and Mullins 1991; Preston and Ichniowski 1991). The specific implications for schools are notable. For example, Dye, McGuire, and McMillen (2005) find that the longer a TEL is in effect the more it restricts school property tax revenue. Sokolow (1998, 2000) finds that TELs diminish the capacity of school districts to raise revenue and have thus undermined local school autonomy. For better or worse, TELs thus have potentially profound implications not just for school finance, but also for school governance. Yet, as we have noted, not all TELs are equally stringent, and many allow overrides through the referendum process. We thus turn our attention to the question of referenda as they fit into democratic theory and then look specifically at override referenda and whether local school districts use the override option to their advantage.

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Direct Democracy and Local Referenda The last several decades have seen a dramatic increase in the practice and study of direct democracy (Smith and Tolbert 2007). In this context, direct democracy refers to the ability of voters in a jurisdiction to create law (statutes, constitutional amendments, ordinances, and so on) through a vote, rather than indirectly through the actions of elected lawmakers. Direct democracy occurs through two general procedures: the initiative and the referendum. In an initiative citizens place a proposition directly on the ballot (usually through a petition process) while in a referendum citizens vote to accept or reject some particular proposal made by the jurisdiction’s legislature. Crucially, in the context of TEL overrides the referendum measure is normally placed on the ballot by the local government, typically the school board. With very few exceptions the literature on the initiative and the referendum focuses on state governments and electorates despite the far higher number of local governments that use one or both. This is probably for the rather mundane reason that state initiatives and referenda are more visible and the data about them easier to collect than local measures. A key issue with referenda is control of the agenda. That is, who places the measure on the ballot and who controls the conditions (wording, timing, and so on) of that placement? With the standard initiative, the agenda is controlled, or at least heavily influenced, by the citizens who place the proposal on the ballot. Their power is by no means absolute, since gaining ballot access is costly and the ballot is open to competing proposals. With most local referenda, including most TEL overrides, ballot access is controlled by the local government. In the case of the TEL overrides we examine in Wisconsin, the school boards write the measure and choose the timing. This gives the local school boards significant agenda-setting power (Romer and Rosenthal 1978, 1979). We can demonstrate this with a simple setter model based on Romer and Rosenthal (1978). Here we show a unidimensional continuum indicating preferences for higher or lower school taxes, with taxes increasing leftward. Actor preferences are indicated by a school board median (S), an electorate median (V), and the current tax rate or status quo ante (Q).1 An override passage requires a simple majority. In this type of spatial model the actors (i.e., the school board median and electorate median) prefer policy outcomes as close to their preferences as possible. Thus the electorate’s (V) most preferred policy outcome is a tax rate at its own position (or ideal point), that is, V. When given the choice between

1. We assume perfect information and single-peaked symmetric utility functions. See also Gerber and McCubbins (2007) for this type of theoretical argument.

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two possible policies V will prefer the closer policy. In the above scenario S prefers a much higher property tax rate relative to V, but both prefer a rate higher than the status quo, Q. As the agenda setter, S can offer V the take-it-orleave-it offer of the new tax rate (A). Since V prefers A to Q, a majority of the electorate votes in favor of the override and the school districts gets its increased revenues. This simple model has several implications. As the agenda setter the school board enjoys significant leverage and effectively obtains an override yielding a higher rate than ideally preferred by the electorate. At the same time, the referendum requirement still constrains the school board’s actions; S cannot simply move the tax rate to its ideal point. The TEL constraint is stronger when the preferences are arrayed with Q between S and V, as with Figure 7.2. Here there is no way for the school board to propose an override that can garner a majority of the vote; that is, there is no way to move Q toward S and still obtain the vote of V. All of this suggests a further practical implication. Assuming that holding a referendum is not costless to the school board, a sophisticated body will avoid making proposals that fail. Thus in a case like Figure 7.1 the school board will not propose S, but rather something more moderate such as A, and in a case like Figure 7.2 the school board will propose nothing at all and no referendum will be held. Indeed, it is important to remember that, at least in the short run, local governments may have options other than pursuing overrides. For example, Gerber (2007) notes that local governments facing TELs can reduce spending and modify their revenue sources to address revenue shortfall caused by the TEL. It is here that such a model reveals itself as more heuristic or illustrative than empirically accurate. As we show below, override referenda do indeed frequently fail, while the model predicts that referenda will always pass. Nonetheless, predictions about the likely observable effects of phenomena such as the so-called Gray Peril—where increased numbers of senior-citizen voters potentially decrease electorate support for school finance measures—on school finance referenda need to consider this strategic element. FIGURE 7.1

Agenda Setting for a TEL Override Referendum

|-----S---------A------V-------Q-------| FIGURE 7.2

Preferences with No Chance of a TEL Override

|-----S----------------Q-------V-------|

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While referendum measures sometimes fail, it seems likely that school boards attempt to avoid placing measures on the ballot that they think are unlikely to win, thus inflating the success rate. Suppose it is true that the “Gray Peril” is increasing or that voters in general are offering less support for higher taxes. In that case, success rates for TEL overrides or other school finance referenda might not fall over time if school boards either strategically withheld measures that they really prefer to hold2 or figured out ways to bundle issues to make them succeed.3 Other factors may make TEL overrides more or less likely to succeed. Turnout for TEL initiatives tends to be low, particularly in special elections or in regularly scheduled elections without prominent contests, such as that for president or state offices. Thus school boards may time their override attempts strategically for election periods more likely to produce a favorable result (Gerber and McCubbins 2007). On the other hand, as we discussed earlier, some states do not allow unlimited overrides, either in terms of revenue amount or of duration. Depending on their stringency, these override limits can effectively restrict the advantage the agenda setter has over the electorate. The Literature on School Finance Referenda While the determinants of TEL override success or failure have yet to receive much attention in the literature, there is a substantial literature on why referenda in general, and school finance referenda in particular, pass or fail. The body of research on school finance referenda is rather small and depends on studies of single elections and single states. Also the literature varies between survey studies at the individual level and studies aggregated at the district level. Consequently it features few consistent and reliable findings, and care always must be taken to avoid fallacious inferences. At the same time this literature should provide some insights into what correlates with TEL override referenda outcomes if voters look at TEL override referenda in much the same way they do for other types of school finance referenda, such as bond issues. Most scholars tend to agree that voters support policies that directly benefit them or their families and oppose policies that impose a direct cost on them (Sears and Funk 1990). With respect to school bond referenda it follows that

2. A similar phenomenon occurs with congressional elections. High incumbent reelection rates overstate the power of incumbency because vulnerable incumbents often opt to retire (Jacobson 2008). 3. Gerber and McCubbins (2007) demonstrate that local governments use another variant of agenda power: sequential elimination (Ordeshook and Schwartz 1987). That is, the agenda setter proposes different measures in sequence across multiple elections in ways that disadvantage voters since they cannot evaluate all alternatives simultaneously.

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adults with school age children should be more likely to favor a bond issue than elderly people with no children in the school system (Berkman and Plutzer 2005). This phenomenon is referred to as the “Generation Gap” (Berkman and Plutzer 2005; Ponza et al. 1988) or “Gray Peril” (Duncombe, Robbins, and Stonecash 2003) and is becoming more prominent in the research because the baby boomer population is aging at the same time that many school districts are suffering financially. Note, however, the somewhat contrary argument that while higher property taxes likely reduce property values, higher service quality, especially higher school quality, potentially enhances property values. Thus depending on the mix between tax and school quality, it may be rational for voters to support school funding even without children in school (Fischel 2005). These contradictory incentives perhaps partially explain the mixed empirical results for the Gray Peril. Most studies either show a negative relationship between seniors and support for school finance measures or find no evidence either way (Meridith 2004; Duncombe, Robbins, and Stonecash 2003; Theobald and Meier 2002; Tedin, Matland, and Weiher. 2001; Ladd and Murray 2001; Poterba 1997; Button 1992). In contrast, Berkman and Plutzer (2005) argue that the literature conflates age effects with cohort effects and that the Gray Peril is essentially spurious. They show that each cohort becomes more supportive of education finance as it reaches senior years. Furthermore, Berkman and Plutzer (2004) and Ladd and Murray (2001) find evidence that long-term ties to a community correlate with senior support for education spending. As mentioned previously with respect to school bonds, parents of school-age children are more likely to support education spending (Tedin, Matland, and Weiher, 2001; Chew 1992; Chew 1990; Bergstrom, Rubinfeld, and Shapiro 1982; Rubinfeld 1977; Piele and Hall 1973). Higher levels of education among voters translate into more support for school finances (Chew 1992; Bergstrom, Rubinfeld, and Shapiro 1982; Piele and Hall 1973). Scholars predict that certain minority groups are likely to vote similarly to one another in initiative elections. A 2001 study of Houston and a 1997 study of Tampa both found wider support for bond issues among blacks than whites. Among the Hispanics in these two studies, the results are a bit more mixed (Tedin, Matland and Weiher 2001; MacManus 1997). At the same time, some research (e.g., Ladd and Murray 2001), finds that voters may be less likely to support school finance referenda if the district has a high percentage of students from other races. Finally, being a homeowner is said to influence voter behavior. Because most local government operations are financed through property taxes, homeowners directly bear many of the costs of this spending. Thus property tax

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burdens by themselves should affect outcomes. Note however that inasmuch as property tax burdens contribute to higher quality schools, homeowners face somewhat contradictory incentives (Berkman and Plutzer, 2005; Theobald and Meier 2002; Fischel, 2001). As we discussed earlier, there is a good deal of literature examining the use of strategic behavior with respect to direct democracy (Meredith 2004; Gerber 1999; Pequet, Coats, and Yen 1996; Gerber 1996). Some states place more restrictions on when a referendum can occur—usually only during general elections— to limit local legislative bodies’ use of their agenda-setting power to strategically influence the outcome of the election. With this literature as a guide we now turn to an analysis of TEL override referenda for school districts in Wisconsin between 1995 and 2007. Override Attempts in Wisconsin School Districts Table 7.3 shows pass and fail results for Wisconsin TEL override referenda.4 We include data on all school district attempts to override the revenue cap. As a comparison, we also present data on referenda to allow school districts to issue debt through bonds. Wisconsin requires a simple-majority vote for passage in both cases. As Table 7.3 prominently displays, TEL override attempts frequently fail in Wisconsin. From 1995 through 2007, 667 revenue cap overrides faced voter approval; only 285 (43 percent) passed. Overall the bond issues fared better. Of the 1231 bond referenda, 666 (54 percent) passed. Wisconsin’s TELs thus clearly constitute a genuine constraint on school finances. Attempts to override the revenue cap are frequent, but they fail more often than not. Moreover, if school boards in fact want to pursue overrides even more often than they do, but do not from fear of failure, then the TEL constraint is greater than reflected in these numbers. Less clear from Table 7.3 is the presence of a trend in passage rates for TELs or bonds over time. Figure 7.3 shows the passage rates for both types of referenda. TEL override attempts are no less likely to pass today than ten years ago, though there is variance over the years. The same is true of bond measures. However, both measures exhibit a dip in success rates in the early part of this decade. Indeed, while there are too few years to show statistical significance, the success rates for both bonds and TEL overrides clearly track together. Returning to Table 7.3, the number of override attempts has not gone down, though here too there is variance. In contrast, for bond measures there is a marked drop in attempts starting in 2002. 4. Referenda outcome data were gathered from Wisconsin’s Department of Public Instruction.

Pass Fail Total

Pass Fail Total

Pass Fail Total

TELs

Bonds

All

70 56 126

105 61 166

103 61 164

2 0 2

89 85 174

85 62 147

4 23 27

1997

118 125 243

94 77 171

24 48 72

1998

79 90 169

56 48 104

23 42 65

1999

110 84 194

67 45 112

43 39 82

2000

71 95 166

35 49 84

36 46 82

2001

37 66 103

24 35 59

13 31 44

2002

26 81 107

13 44 57

13 37 50

2003

58 40 98

32 18 50

26 22 48

2004

43 52 95

17 25 42

26 27 53

2005

82 55 137

40 22 62

42 33 75

2006

63 57 120

31 25 56

32 32 64

2007

951 947 1898

666 565 1231

285 382 667

Total

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69 54 123

1 2 3

1996

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Referenda Outcomes for TEL Overrides in Wisconsin, 1995–2007

TABLE 7.3

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FIGURE 7.3

Wisconsin School District TEL Override and Bond Passage Rates 1.2

Proportion Passed

1

0.8

0.6

TELs Bonds

0.4

0.2

0 1995

1997

1999

2001 Year

2003

2005

2007

Another factor that emerges from the data is that successful TEL overrides win rather comfortably, while failed overrides lose big. For example, the mean support percentage for successful overrides was 58.1 with a 6.8 standard deviation. The mean support percentage for unsuccessful overrides was 38.7 with an 8.0 standard deviation. Either out of desperation, gross miscalculation, or strategy, school boards are not presenting measures that barely lose. In most cases they are losing quite substantially. (Bonds, by contrast, tend to win bigger and lose smaller.) The TEL loss results raise interesting possibilities. One is that school boards find it hard to predict their likelihood of override success. Another is that school boards can predict outcomes fairly accurately, but break into three groups: (1) those who are likely to win comfortably and thus proceed to the ballot; (2) those who are uncertain about the outcome and thus avoid the ballot; and (3) those who are fairly certain they will lose but proceed to the ballot anyway, either out of desperation or as a way to shift the blame for declining schools to the electorate. Wisconsin authorizes two types of revenue cap overrides, recurring and nonrecurring. Recurring overrides persist indefinitely, while nonrecurring are limited to a set number of years. For example, in 2000 the Greendale school

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district passed an override that raised the revenue cap by $550,000 in each of four years beginning in 2000–2001. In 1998 the Hustisford school district passed an override that raised the revenue cap by $178,000 just for the 1998–1999 school year. For override measures in Wisconsin the time span for nonrecurring measures was typically five years or less. Given that recurring overrides persist over time while nonrecurring overrides do not, we would expect recurring TEL overrides to fare worse at the ballot box. Indeed they do. Table 7.4 shows that of the 362 recurring override attempts, only 124 (or 34 percent) passed. In contrast, 161 (or 53 percent) of the 305 nonrecurring override attempts passed. For the nonrecurring attempts, it did not matter if the override was for one year or several years. Lurking in Table 7.4 is a provocative trend. For obvious reasons school boards prefer recurring over nonrecurring overrides, but presumably prefer some override to none at all. Given the low success rate of recurring override attempts, do we see school boards strategically shifting to nonrecurring overrides? The answer appears to be yes. In Figure 7.4 we track the number of recurring override attempts against the number of nonrecurring override attempts. Starting in the early part of this decade, school boards started shifting to nonrecurring overrides. FIGURE 7.4

Nonrecurring versus Recurring Override Attempts as a Percentage of All Override Attempts

Percentage of All TEL Override Attempts

100 90 80 70 60 50

Nonrecurring Recurring

40 30 20 10 0 1994

1996

1998

2000 2002 Year

2004

2006

2008

Pass Fail Total

Pass Fail Total

Non-Recurring

1 0 1

0 2 2 1 0 1

1 0 1

1996

1 2 3

3 21 24

1997

7 7 14

17 41 58

1998

12 17 29

11 25 36

1999

17 16 33

26 23 49

2000

16 13 29

20 33 53

2001

11 13 24

2 18 20

2002

8 13 21

5 24 29

2003

16 9 25

10 13 23

2004

16 14 30

10 13 23

2005

32 22 54

10 11 21

2006

23 18 41

9 14 23

2007

161 144 305

124 238 362

Total

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Recurring

1995

Referenda Outcomes for Recurring and Nonrecurring TEL Overrides in Wisconsin, 1995–2007

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TABLE 7.4

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Correlations with TEL Override Success We turn now to developing a simple statistical model of referendum success and failure. Using the literature as our guide we tested a range of variables hypothesized to correlate with override success or failure. The data for most of our independent variables were developed from the Common Core of Data provided by the National Center for Education Statistics. Most of the literature that examines school finance referenda at the district level rather than the individual level ignores variables meant to measure ideology and partisanship. One of the main reasons for this oversight surely relates to the difficulty of compiling direct measures, since political data, such as voting patterns for president, are rarely collected at the school district level. Also, school board elections typically are nonpartisan, making it difficult to gauge a district electorate’s partisan inclinations through school elections. Arguably, the omission of such political variables does not invalidate research on bond issues, as it is not clear that bond issues necessarily divide electorates along partisan lines. Yet with tax issues, especially those related to TELs, it is quite likely that electorates do divide along partisan lines and the composition of parties in individual districts will affect override attempt outcomes. Unfortunately, the measurement problem persists. We opted for the less than fully satisfactory solution of using the most recent presidential vote in the district’s county. Typically a school district covers just a portion of its county and partisans do not normally distribute themselves evenly within counties; thus one key flaw in our measure is its assumption that the partisan composition of a school district closely resembles that of the greater county. Yet we have no reason to believe that this measure will create systematic bias. Thus as our measure of district partisanship we created the variable Democratic Vote, scored as the percentage of the vote received in the county by the Democratic candidate for president in the election preceding the referendum. We expect a positive relationship between Democratic Vote and successful override attempts. To distinguish between recurring and nonrecurring overrides we created the variable Recurring (recurring = 1; nonrecurring = 0) and expect a negative relationship between Recurring and passage of overrides. We also expect the amount of the increase to affect override passage negatively. The variable Amount measures the per capita annual amount of the override. We expect that the higher the override amount, the less likely it is to pass. As a measure of need we used the Pupil to Teacher Ratio, hypothesizing that larger classrooms mean greater need and thus make it easier for school boards to argue for the override (Theobald and Meier 2002; Tedin et al. 2001).

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We expect that voters will be less likely to support further taxes in districts where expenditures are already high. To test this we used a measure of the total Expenditures Per Student in the district for the year of the referendum. Fischel (2005) argues that the loss of local control over schools will lessen the amount that school quality is capitalized into housing prices. As a consequence homeowners may be less supportive of local taxes for schools when revenues are centralized. To test this we created a Local School Revenue variable based on the percentage of school revenues raised locally (rather than from state or federal sources) during the year of the referendum. To test for the “Gray Peril” we created the variable Seniors as the percentage of voting-age school district residents 65 and older. To capture racial polarization we scored a Racial Distance variable as the absolute difference between a district’s percent of white voting age residents and the percent of white students in the district. As this difference increases we expect success to drop (Theobald and Meier 2002). We expect higher-income districts to support overrides more than poorer districts and higher educated electorates to support overrides. To capture socioeconomic dynamics we scored variables for Per Capita Income and Education Levels in the district (the latter being defined as the percentage of persons in the district with a college degree according to the 2000 census). To capture Property Owners as a potential factor we created a variable for the percentage of owner-occupied residences in the district. We considered the issue of strategic agenda-setter behavior by scoring a variable for Special Election. As we noted earlier, agenda setters have the ability to set the dollar amount of a TEL override strategically. In some states they also have the advantage of choosing the election date, and theoretically school boards will try to time the election in the most advantageous way based on factors such as expected turnout dynamics. In her study of Wisconsin bond referenda, Meredith (2004) finds evidence of this kind of strategic behavior. Thus we gave the dummy variable Special Election a value of 1 if the TEL override referendum occurred in a special election. Finally, we included a control for Concurrent Referenda, expecting that the more measures a district places on the ballot at the same time, the less likely it is that any one of the measures will pass. Table 7.5 shows logit estimates with Passage (=1) as the dependent variable. The first variable of interest is Democratic Vote. As expected, the variable is positive and statistically significant. The higher the Democratic vote for president in the county, the more likely the district electorate will pass revenue cap overrides for its schools. To gauge the substantive impact of Democratic Vote we set all other variables at their means and toggled the Democratic Vote variable from its minimal to its maximal in-sample values. Passage probability shifted from .30 to .53.

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TABLE 7.5

Logit Estimates of TEL Override & Bond Passage in Wisconsin, 1995–2007 TEL Override Measures Variable

∆Pr(Y = Pass)

Coefficient (s.e.)

.027** .012

+.23

.001 .008

−.665*** .190

−.16

Coefficient (s.e.)

Democratic Vote Recurring Amount Pupil to Teacher Ratio

Bond Measures ∆Pr(Y = Pass)

.001 .001

−.0004*** .0001

−.61

−.015 .025

.242*** .057

+.73

.0004*** .00005

+.74

+.44

Expenditures Per Student

.0001** .00005

Local School Revenue

.007 .009

−.023*** .007

−.44

Seniors

−.025 .023

.025* .016

+.17

Racial Distance

−.005 .022

−.032* .018

−.30

Per Capita Income

−.00007 .00004

.00004 .00004 +.46

Education Levels

.064* .034

Property Owners

.003 .014

−.016 .010

Special Election

.271 .195

−.050 .141

Concurrent Referenda Constant n

−.480** .200 −.523 1.88 667

2

McKelvey/Zavoina’s R

0.17

−.11

.002 .025

−.696*** .137 −4.97*** 1.56

−.17

1,231 .28

note: ∆PR(Y = Pass) indicates the shift in probability of passage by shifting the statistically significant variable of interest from its minimal to its maximal value while holding all other equation variables at their mean. Model includes dummy variables for 1996–2007. *** p < .01 *** p < .05 *** p < .10 (two-tailed)

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Also as expected, the Recurring variable is negative and statistically significant. With all other variables set at their means, shifting a measure from recurring to nonrecurring enhances its prospects for passage by .16. Surprisingly, however, the Amount of the override yielded null results. At least for TEL overrides, the actual amount of an override (per capita) does not correlate with success or failure. For the most part the other demographic variables are not statistically significant. Surprisingly, the Expenditures Per Student variable is both positive and statistically significant. High-expenditure districts correlate positively with override success, which may be an indication that the variable taps perceived (and real) need. The Education Levels variable suggests that districts with higher proportions of college graduates support TEL overrides. Though weakly statistically significant (in a two-tailed test), the substantive effect is a large .46 increase in passage probability in districts with highest-level higher education over those with lowest-level higher education. Finally, the Concurrent Referenda variable shows a negative and statistically significant effect. The probability of passage drops .11 if the measure shares the ballot with at least one other override or bond measure. We include estimates for bond measures in Table 7.5. We specified the same model, without the Recurring variable. The results differ dramatically. The most direct political measure, Democratic Vote, is not statistically significant. Amount, however, dramatically affects passage probability. The greater the per capita amount of the proposed debt, the less the chances of passage. Toggling from the minimal to the maximal in-sample Amount reduced the probability of passage by .61. The need variable Pupil to Teacher Ratio is positive, statistically significant, and has a large substantive effect. As with overrides, the Expenditures Per Student variable is positive and statistically significant. In addition, the Local School Revenue variable is negative and statistically significant and the Seniors variable is positive and statistically significant. All three of these measures suffer from ambiguity, a major problem in all of this literature. Do higher expenditures suggest more need or more waste? Does greater local revenue suggest more local control (and thus a more direct impact on housing values) or does it signify a greater tax burden? Finally, as with overrides, Concurrent Referenda are more likely to fail than stand-alone measures. Conclusion The extant literature on school finance referenda, such as it is, has always demonstrated consistently inconsistent results across different states, jurisdictions, levels of analysis, and modeling choices. Our analysis of TEL override referenda and bond referenda for Wisconsin does not necessarily clarify things,

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but it does raise some interesting possibilities and questions. We address these with several takeaway points. TEL overrides fail and they fail often. A school board that faces revenue shortfalls due to Wisconsin’s cap faces an uncertain and potentially difficult challenge to get the additional revenue through an override. This reinforces evidence that the TELs have a substantive impact on school spending, fiscal policy, and school governance. The override hurdle creates incentives, if not the necessity, for school boards to find other means to address revenue shortfalls, be it through other revenue sources or spending cuts (Gerber 2007). In addition, the unpopularity of recurring overrides appears to have induced boards to shift to nonrecurring measures. Thus the boards are acting strategically and adjusting as they gain experience with the TEL regime. This and other types of strategic behavior pose problems for studying override referenda. Examining the referenda attempts alone risks missing other actions school boards take to address the TEL, so that estimates potentially suffer from a variety of selection effect and simultaneity biases. It is also true that the referendum requirement changes the nature of school board governance. Revenue decisions cannot be made in-house, but now rely heavily on the ability of the school board to convince wary voters to tax themselves more. As observers are seeing in many other contexts (e.g., Tolbert 1998), this is a very different form of representative governance than the one school boards and other local governments carried out traditionally. Another takeaway is that bond and TEL referenda appear to differ. The key difference is probably wrapped up in partisan and ideological politics. The link between higher taxes and bonds is sometimes hard for voters to see or for bond opponents to explain and exploit. This is not the case with a TEL override. Thus the override elections in Wisconsin appear to tap into the sort of partisan divisions that we see in other policy arenas. From an analytical standpoint one implication of this is that the analogy for studying TEL overrides may not be bond elections but other types of elections that also induce partisan division.

REFERENCES

Bergstrom, Theodore, Daniel Rubinfeld, and Perry Shapiro. 1982. Micro-Based estimates of demand functions for local school expenditures. Econometrica 50:1183–1205. Berkman, Michael, and Eric Plutzer. 2004. Gray peril or loyal support: The elderly and expenditures on American education. Social Science Quarterly 85:1178–1193. ———. 2005. Ten thousand democracies: Politics and public opinion in America’s school districts. Washington, DC: Georgetown University Press.

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Brunori, David, Michael Bell, Joseph Cordes, and Bing Yuan. 2007. Tax and expenditure limitations and their effects on local finances and urban areas. Unpublished manuscript, George Washington University, Washington, DC. Button, James. 1992. A sign of generational conflict: The impact of Florida’s aging voters on local school and tax referenda. Social Science Quarterly 73:786–797. Chew, Kenneth. 1990. Is there a parent gap in pocketbook politics? Journal of Marriage and the Family 52:723–734. ———. 1992. The demographic erosions of public support for public education: A suburban case study. Sociology of Education 65(4):280–292. Cornia, Gary C., and Lawrence C. Walters. 2006. Full disclosure: Controlling property tax increase during periods of increasing housing values. National Tax Journal 59:735–749. Cutler, David M., Douglas W. Elmendorf, and Richard Zeckhauser. 1999. Restraining the leviathan: Property tax limitation in Massachusetts. Journal of Public Economics 71:313–334. Duncombe, William, Mark Robbins, and Jeffrey Stonecash. 2003. Measuring citizen preferences for public services using surveys: Does “Gray Peril” threaten funding for education? Public Budgeting and Finance 45–73. Dye, Richard F., and Therese J. McGuire. 1997. The effect of property tax limitation measures on local government fiscal behavior. Journal of Public Economics 66:469–487. Dye, Richard F., Therese J. McGuire, and Daniel P. McMillen. 2005. Are property tax limitations more binding over time? National Tax Journal 58 (June):215–225. Elder, Harold W. 1992. Exploring the tax revolt: An analysis of the effects of state tax and expenditure limitation laws. Public Finance Quarterly 20:47–63. Fischel, William. 2005. The homevoter hypothesis. Cambridge, MA: Harvard University Press. Gerber, Elisabeth R. 1996. Legislative response to the threat of popular incentives. American Journal of Political Science 40(1):99–128. ———. 1999. The populist paradox: Interest group influence and the promise of direct legislation. Princeton, NJ: Princeton University Press. ———. 2007. The impact of direct democracy on local government fiscal policy. Unpublished manuscript, University of Michigan, Ann Arbor. Gerber, Elisabeth, and Mathew McCubbins. 2007. When voters make laws: How direct democracy is shaping american cities. USC Legal Studies Research Paper No. 07-13, University of Southern California, Los Angeles, CA. Jacobe, Dennis. 2005. Which is the unfairest tax of them all? Gallup Poll Tuesday Briefing (April 19). Jacobson, Gary. 2008. The politics of congressional elections, 7th ed. New York: Longman Press. Joyce, Philip G., and Daniel R. Mullins. 1991. The changing fiscal structure of the state and local public sector: The impact of tax and expenditure limitations. Public Administration Review 51:240–253.

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Ladd, Helen, and Sheila Murray. 2001. Intergenerational conflict reconsidered. Economics of Education Review 20:343–357. MacManus, Susan. 1997. Selling school taxes and bond issues to a generationally diverse electorate: Lessons from the Florida referenda. Government Finance Review 13 (April):17–22. Meredith, Marc. 2004. Strategic timing of ballot initiatives. Unpublished manuscript, Stanford University, Palo Alto, CA. Mullins, Daniel R., and Philip G. Joyce. 1996. Tax and expenditure limitations and state and local fiscal structure: An empirical assessment. Public Budgeting and Finance (Spring):75–101. Ordeshook, Peter, and Thomas Schwartz. 1987. Agendas and the control of political outcomes. American Political Science Review 81:179–199. O’Sullivan, Arthur, Terri A. Sexton, and Steven M. Sheffrin. 1995. Property taxes and tax revolts: The legacy of Proposition 13. New York: Cambridge University Press. Pequet, Gary, R. Morris Coats, and Steven Yen. 1996. Special versus general elections and the composition of voters. Public Finance Quarterly 24:131–147. Piele, Philip, and John S. Hall. 1973. Budgets, ballots, and bonds. Lexington, MA: Lexington Books. Ponza, Michael, Greg J. Duncan, Mary Corcoran, and Fred Groskind. 1988. The guns of autumn? Age differences in support for income transfers to the young and old. Public Opinion Quarterly 52(4):441–466. Poterba, James. 1997. Demographic structure and the political economy of public education. Journal of Policy Analysis and Management 16:48–67. Preston, Anne E., and Casey Ichniowski. 1991. A national perspective on the nature and effects of the local property tax revolt, 1976–1986. National Tax Journal 44 (June):123–145. Romer, Thomas, and Howard Rosenthal. 1978. Political resource allocation, controlled agendas, and the status quo. Public Choice 33:27–43. ———. 1979. Bureaucrats versus voters: On the political economy of resource allocation by direct democracy. Quarterly Journal of Economics 93:563–587. Rubinfeld, Daniel. 1977. Voting in a local school election: A micro-analysis. Review of Economics and Statistics 59:30–42. ———. 2007. The instrumental and educative effects of ballot measures: Research on direct democracy in the American states. State Politics and Policy Quarterly 7:417– 446. Smith, Daniel A., and Caroline Tolbert. 2007. The instrumental and educative effects of ballot measures: Research on direct democracy in the American states,” State Politics and Policy Quarterly 7(4):417–446. Sokolow, Alvin D. 1998. The changing property tax and state-local relations. Publius 28 (Winter):165–187. ———. 2000. The changing property tax in the west: State centralization of local finances. Public Budgeting and Finance 20 (Spring):85–104.

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Theobald, Nick, and Kenneth J. Meier. 2002. The politics of school finance: Passing school bonds. Presented at Midwest Political Science Association, April 25–28. Tedin, Kent, Richard Matland, and Gregory R. Weiher. 2001. Race, self-interest, the collective interest and financing public schools through referenda. Journal of Politics 63(1):270–294. Tolbert, Caroline. 1998. Changing rules for state legislatures: Direct democracy and governance policies. In Citizens as legislators: Direct democracy in the United States, ed. Shaun, Bowler, Todd Donovan, and Caroline Tolbert. Columbus: Ohio State University Press.

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8 Property Tax Abatement as a Means of Promoting State and Local Economic Activity ROBERT W. WASSMER

Tax exemption for industrial encouragement, like a protective tariff, is a device of local mercantilist policy. It must be justified or opposed on the same grounds as a tariff. On economic grounds, the presumption is against both. The principal claim for exemption must be the infant industry argument. In the industrially developing southern states, there are probably valid bases for exemption on that ground, despite the hazards that such a policy, adopted in one state, must tend to lead others in self-defense to adopt it also. (Jensen 1931, 158)

The Property Tax Abatement Glass: Half Empty or Half Full? A business is driven by the profit motive when deciding where to locate a new facility or to rehabilitate an existing facility. Holding all else constant, a reduction in property taxes through abatement raises a business’s expected profit in a given location. Realizing this, many subnational governments in the United States grant temporary relief for certain parcels from the nonresidential property tax payments that are normally due. The desired outcome is an increase in the attractiveness of a particular jurisdiction to business, whether for new investment or the rehabilitation or retention of an existing investment. But it must be

John Anderson, Nathan Anderson, Nancy Augustine, Michael Bell, and David Brunori offered helpful comments on an earlier draft.

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remembered that property tax abatement is only one strategy by which to attract or retain a business by appealing to its profit motive. Others include an increase in subnational expenditures that benefit business or the skills of the labor it employs, or a reduction in regulations that business views as burdensome. Dalehite, Mikesell, and Zorn (2005) use the phrase “stand-alone property tax abatement programs,” or “SAPTAPs,” to characterize programs that: (1) allow for a full or partial reduction in property tax liability for selected manufacturing, commercial, and/or retail parcels; (2) impose a time limit on the reduction; (3) have a stated purpose beyond relief from high property taxes; and (4) need not be used in conjunction with other state or local economic development programs. The stated goal of most SAPTAPs is an increase in employment or income generated in the jurisdiction offering them. Nevertheless, practitioners often endorse the idea that these programs can also increase a jurisdiction’s property tax base and the revenue generated from it (Wolman and Spitzley 1996). As an illustration, consider that cities or townships in Michigan can grant a stand-alone property tax abatement to a manufacturer under the state’s Plant Rehabilitation and Industrial Development Act. Enacted in 1974, this act allows officials to freeze the assessed value of a rehabilitated industrial parcel at its prerehabilitation level, or for the owner of a new industrial parcel to pay property tax equivalent to half of what would be due without the act. This industrial abatement can last for up to 12 years and is renewable.1 Had the manufacturer completed the rehabilitation of its existing parcel or built its new plant without the abatement, then the abatement would have been a loss of property tax revenue to all the levels of local government that normally would have collected it (including the city or township’s independent school district[s] and overlapping county government). If but for the abatement the manufacturer would have left the jurisdiction or the new industrial parcel would not have been located there, then the abatement has resulted in a retention or gain in property tax revenue that otherwise would have been lost. Where the proverbial glass represents the property tax bases in subnational jurisdictions throughout the entire United States, is it best considered half full or half empty because of SAPTAPs? In our example, if the economic activity would not have occurred but for the 50 percent abatement, the appropriate conclusion is that the glass is half full. On the other hand, if the economic activity would have occurred even without the 50 percent abatement, the glass is half empty. 1. See Anderson and Wassmer (2000, Chapter 3) for details on this abatement program and an analogous abatement program once available in Michigan for commercial property.

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The assertion that the activity would or would not have occurred but for the SAPTAP is crucial to discussing its role in property tax base erosion in the United States. Assuming that the nonabated rate of average property taxation across the entire United States is not sufficiently high to drive business activity out of the country, then it is reasonable to conclude that the existence of SAPTAPs drives down the entire country’s nonresidential property tax base, causing the glass to approach half empty. However, business activity is observed to move between subnational locations caused, some believe, by the rate of property taxation. These beliefs lead many to conclude that the SAPTAPs in otherwise high-property-tax-rate jurisdictions leaves their nonresidential property tax bases half full. The remainder of this section reviews the forms of evidence on the increasing use of property tax abatement in the United States and existing arguments for and against this form of industrial incentive, and concludes with a description of the chapter’s remaining layout. The Increasing Use of Property Tax Abatement in the United States The earliest recorded use of property tax abatement in North America occurred in 1640 in what would become the state of Connecticut. Throughout the nineteenth century Connecticut, like other eastern states, regularly granted property tax exemptions for the production of manufacturing items such as oil from flax seed (to generate employment for the poor), iron and steel (to keep the large sums of money spent on input purchases in the state), and malt liquor (to reduce citizens’ use of stronger spirits).2 After the Civil War, the practice of temporarily excusing certain industrial property tax payments spread to the southern states with the express goal of recruiting industry from the Midwest and Northeast. The post–World War II boom in United States manufacturing, combined with state and local officials’ desire to provide high-paying employment opportunities to returning veterans and later their baby-boomer children, stimulated a further increase in the number of states allowing SAPTAPs. In one of the earliest inventories of programs, Alyea (1967) found that 15 states (30 percent) offered them in 1964. For the two decades that followed Alyea’s account of stand-alone property tax abatement programs, Kantor and David (1988) document the simultaneous rapid increases in the allowance by states of local economic development programs and the number, size, and power of local governments in the United States. 2. See Alyea (1967), 140.

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As recorded in Gold (1979), the number of states in 1979 allowing state or local exemptions for the taxation of business property had grown to 31 (62 percent). The National Association of State Development Agencies tallied the number of states allowing SAPTAPs in 1991 at 33 (66 percent). In the most recent and perhaps most comprehensive inventory ever taken of these programs, Dalehite, Mikesell, and Zorn (2005) found that 35 states (70 percent) allowed for some form of stand-alone property tax abatement in 2004. As of 2007, at least seven other states allow localities to offer a full or partial reduction in subnational property taxes paid within their boundaries, but only in conjunction with a larger economic development program; therefore, these abatements are not stand-alone. Wolman and Spitzley (1996) point to four complementary reasons for the rapid rise in the use of abatement in recent decades: (1) a perceived increase in the potential mobility of all business activity; (2) an international economic restructuring that has even further increased the potential and actual mobility of traditional manufacturing; (3) slower industrial growth nationwide; and (4) cutbacks in intergovernmental aid to local governments. Even so, there is still a vigorous debate as to whether the pros of subnational property tax abatement use in the United States outweigh the cons. Pros and Cons of Property Tax Abatement Use If there were widespread agreement that the overall benefits of stand-alone property tax abatements were greater than the costs, then it would be easy to view the nationwide erosion in subnational property tax bases they have generated as a necessary social cost that yields a greater social benefit. There is no such agreement. A scan of the literature generates a list of arguments against standalone property tax abatements as long as the list in their favor. In their second edition of a Council of State Governments’ report on the prevalence of state business incentives, Chi and Leatherby (2000) include the following arguments that have been used to dissuade policy makers from the use of such incentives: (1) taxes are not the only factor considered in business location decisions; (2) the selective use of abatements raises questions of equity; (3) some empirical studies have shown abatements to be cost-ineffective; (4) abatements pull public dollars away from local expenditures that benefit business; and (5) the ability to offer abatements creates a self destructive zero-sum game. Gold (1979) and Nunn (1994) also point out that local property taxes are a small portion of overall costs faced by a firm and are deductible against federal income taxes, and that high subnational business tax rates often go hand in hand with a higher provision of subnational services that benefit business. Bartik (1991), Fisher and Peters (1998), and Anderson and Wassmer (2000) all argue that the potential

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attractiveness of abatements to business is mitigated by the rise in local land prices they can cause, and their attractiveness to local job seekers is diminished by the inflow of new nonlocal job seekers that the offering of an abatement can generate. In the same Council of State Governments’ report, Chi and Leatherby record the alternative arguments used to persuade policy makers to use SAPTAPs: (1) surveys of business leaders and some empirical evidence show that taxes affect business location decisions; (2) abatements finance local job creation and thus are cost-effective; (3) abatements foster competitiveness and dissuade subnational governments from imposing too high a business property tax burden; and (4) abatements offer local officials the ability to be “action oriented” in their approach to economic development. Alyea (1967) notes that SAPTAPs allow a local jurisdiction to neutralize a state and local tax system, often viewed by business interests as onerous, that they otherwise have little influence over. Gold believes that the offering of local abatements allows politicians to send out a positive signal about the locality’s “probusiness climate.” Bartik, Fisher and Peters, and Anderson and Wassmer note that if abatement offers are restricted to localities with high poverty and unemployment rates, they can benefit people of color and of low income disproportionately. The increase in jurisdictions in the United States that allow property tax abatements (from 30 percent of the states in 1964 to 70 percent in 2004), the nationwide erosion in property tax base these programs likely generate, and the wide variety of arguments (both pro and con) for their continued existence are reasons enough for their further exploration. I conduct such an exploration in the five sections that follow. In the next section I summarize the economic theory indicating why subnational abatement may promote subnational economic development. Next, I describe the types and prevalence of SAPTAPs currently in the United States. Then, I summarize the best empirical evidence that exists on the effects of property tax abatements. I conclude with my own recommendations about how subnational decision makers should view SAPTAPs and with policy suggestions for the future of abatement in the United States. How Property Tax Abatement Could Promote Economic Development This section describes in relatively simple terms the somewhat complex theories developed by economists to better understand how subnational property taxation and its abatement can influence the location of business activity. But as Bartik (1991, 37) aptly concludes: “The effect of taxes on state and local

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business growth is the most controversial issue in economic development policy.” Property Taxation and Subnational Business Activity To understand the impact of subnational property tax abatement on business location choices it is first necessary to have a rudimentary understanding of the expected “incidence” (meaning, in this context, who pays the tax) of a state or local tax levied on business property. Zodrow (2001) offers an accessible summary of the two views that now dominate economic thinking on this issue. Though 35 years have passed since Mieszkowski (1972) first proposed it, the “New View” considers business property taxation to be a distortionary levy on land and equipment (that is, capital) used in production. The distortion arises from both a nationally generated “profits tax” component and a locally generated “excise tax” component. Assuming that the amount of land and capital available in the country is fixed, the New View predicts the rate of return on business property to fall by the average burden imposed by all subnational business property tax rates in the United States—the profits tax distortion. The distortion induced by the excise tax component occurs because of the difference between the jurisdiction’s rate of property taxation and the national average. Holding other factors constant, business capital is attracted by the profit motive to subnational jurisdictions with a local rate of property taxation below the average national rate.3 A jurisdiction (fixed in square miles) that imposes a lower rate of business taxation than others, while maintaining its level of locally provided business services, is expected to experience a rise in business activity, an increase in land prices because of increased business demand for land, and an increase in employment, wages, or both. (Which possibility is realized depends on the mobility of the local labor force. If it is fully mobile, employment alone will rise; if it is not mobile at all, only wages will rise; if it is partly mobile, both will rise.) Working through this theory uncovers the sources of pressure placed on state and local politicians to lower their jurisdiction’s rate of business property taxation: not only current and potential local business interests, but also local land owners and citizens desiring employment in the locality where they reside. The appropriately named “Benefit View,” concurrently developed by Fischel (1975) and White (1975), offers a different way of looking at the incidence of business property taxation. The Benefit View considers the effects of 3. See Wassmer (1993) for a further graphical explanation of the New View.

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firm mobility if all subnational jurisdictions practice “perfect fiscal zoning” or if “perfect fiscal capitalization” occurs. Perfect fiscal zoning takes place when a jurisdiction always refuses the entry of a firm whose total benefits to the jurisdiction (revenues, employment, agglomeration, and so forth) are less than all the additional costs it is expected to generate (expenditures, environmental costs, and so on). Perfect fiscal capitalization occurs when the net benefit to a specific type of firm of locating in a jurisdiction is positively capitalized into the land price paid to locate there. Given these perfect conditions, the property tax that a firm pays in any subnational jurisdiction in the United States is identical to the benefits it receives from paying them. Under the Benefit View, local property taxes levied on business no longer distort business location decisions. In every subnational jurisdiction, business property taxation becomes a benefit tax (or acts like a user charge in that business pays for exactly the benefits it receives in a jurisdiction) and cannot, of itself, motivate business to leave one jurisdiction for another. The choice between the appropriateness of the New View and the Benefit View as a theory about the impact of subnational property taxation on distorting business location depends upon the soundness of the assumptions made in each. Though Fischel (2001) offers a compelling survey of evidence in support of fiscal zoning and fiscal capitalization in the housing sector, little to no evidence exists for these perfect conditions in the taxation of business property. In fact, as described in Wolman and Spitzley (1996), there is ample evidence that political factors (such as short-term time horizon and credit-claiming), uncertainty, and imperfect information drive many subnational decision makers to implement less than perfect fiscal zoning in economic development decision making. Zodrow (2001, 98) observes that there is modest evidence that the degree of intrajurisdictional capitalization of differences in business property taxes is perfect. As Nechyba (2001, 117) concludes, the evidence “lead[s] us in the direction of the New View when thinking about business property taxes.” Why Abate Business Property Tax Payments? The New View of the expected economic effects of business property taxation offers a theoretical insight as to why SAPTAPs exist in the United States. Excise tax effects illustrate the incentive for mobile business capital never to enter (or if already there, to leave) a jurisdiction that levies a higher rate of property taxation than others. Driven by the profit motive, business firms searching for new locations or existing firms that can reasonably threaten to move lobby politicians representing high-property-tax jurisdictions for relief as a condition for

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entry or remaining.4 Local representatives of high-business-tax jurisdictions then proceed to ask their state’s lawmakers for the right to grant the requested exemption, and the ability to offer stand-alone property tax abatements within a state is born.5 However, once the previously highest-tax jurisdiction offers abatement, another jurisdiction in the state or region must assume that role and faces the same pressure. This series of events is the likely reason for the observed proliferation of SAPTAPs across the states and the copycat behavior of local abatement offers within a state, as documented by Anderson and Wassmer (1995, 2000). Encompassing the basic theoretical argument just given for the abatement of business property taxes, Glaeser (2002) offers five reasons for the existence of subnational tax incentives. The first is that some firms generate a “consumer surplus” to citizens in the jurisdiction they locate. That is, they offer benefits greater than what the jurisdiction pays in the form of locally provided business services or possible local environmental degradation. A second reason is that the increased capital investment and educated workforce some firms bring to a locality generate “agglomeration economies” to local firms in the form of increased productivity (through a greater exchange of ideas or a bigger pool of labor to draw from). A firm’s demand for abatement is an attempt to recapture all or a portion of these two kinds of benefits. If the firm can reasonably locate elsewhere, it is rational for the jurisdiction to offer an incentive (including abatement) up to the value of these benefits. A third reason stems from the fact that most local incentives are intended to be temporary. By locating in a jurisdiction, a business commits immobile and taxable capital to that place for longer than the incentive is supposed to last. The incentive thus becomes an up-front inducement for a stream of guaranteed future tax payments. Glaeser’s fourth reason for the existence of subnational incentives stems from the fact that a jurisdiction often possesses the monopoly power of offering a unique product, location, that some firms desire more than others. If so, it is in the best interest of the jurisdiction trying to capture the greatest business property tax revenue to charge different tax prices to different types of firms. A jurisdiction charges a higher tax price (the standard property tax assessment) to firms that really want to be there, while revenue maximization 4. It is also in the interest of businesses to convey to the general public, landowners, and labor that they stay away from some subnational jurisdictions for these reasons. For evidence of this, see the business climate and site survey literature reviewed in Fisher (2005), Anderson and Wassmer (2000, 32), and Bartik (1991, 36). 5. In the preface to their book on economic development incentives in the metropolitan Detroit area, Anderson and Wassmer (2000, xi–xii) describe this exact occurrence in the real world creation of the manufacturing property tax abatement program that currently exists in Michigan.

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requires a lower tax price (through abatement) to firms that have other location options. Furthermore, a community could attract capital with a low tax rate at one point in time, and then exploit the immobility of that capital by later raising the tax rate on that capital. The final reason offered for abatement is corruption and influence. As Glaeser sees it, instead of a tool designed to maximize the welfare of the jurisdiction or future tax revenues, business incentives could be a result of coercion or bribery by the firm or the corruption of subnational government leadership. All of the previous explanations offered for the existence and continued propagation of SAPTAPs rely on the idea that differences in the rate of property taxation influence the actual or potential mobility of business firms across subnational jurisdictions. After reviewing the theoretical and empirical evidence on the relationship between subnational taxes and business location, both Bartik (1991) and Anderson and Wassmer (2000) conclude that for many firms, locations in different jurisdictions provide similar access to desired markets, labor, and suppliers and serve their bottom line equally well. Thus, high subnational property taxes tend to dissuade a business from selecting one location over another, and abatement could theoretically mitigate this tendency. I turn next to a description of the different forms of SAPTAPs currently used in the United States and how these forms have evolved over time. Types of Property Tax Abatement and Their Use in the United States Trends in Use over Time Johnson (1962) offered one of the first nationwide summaries of SAPTAPs in the United States and found that 14 states had formal programs in 1961. Based on information gathered for 12 of these states, the average maximum abatement allowed by law was 7.4 years. Seven of the nine states for which information was recorded ceded the authority to grant SAPTAPs to local jurisdictions. In a similar report on state and local industrial incentive programs in the United States in 1963, Bridges (1965) found that in just two years, two more states had allowed SAPTAPs. Information on the 14 states offering abatements in 1963 and the maximum abatement allowed by law in 12 of them appears in column 2 of Table 8.1. Bridges (9) observes that in the early 1960s only jurisdictions in Alabama, Kentucky, Louisiana, Mississippi, Rhode Island, South Carolina, and Vermont frequently used their legal authorization to offer abatement. Just over a quarter of the states allowed stand-alone property tax abatement in 1963. However, as shown by the census region groupings in Table 8.1, this

Yes

Yes - 4 Yes - 2

Indiana

80%

East North Central

Illinois

Yes - 1

Pennsylvania

None

Yes - 3

100%

New York

None

Mid-Atlantic

Yes - 2

Yes - 1

Yes - n/a

Vermont

Yes - 3

New Jersey

Yes - 10yrs

Rhode Island

New Hampshire

LD

LD, GUA

LD

SLD, GUA

LD

SD, SLD

LD

SD

LD, GUA

Award ProcessD

10 & 5 yrs, C, S

20 yrs, C

10 yrs

10 & 3 yrs

5 yrs, S

10 & 2 yrs, C

25, 20, & 1 yrs

12 yrs

7, 5, & 2 yrs

Duration— Clawback or SunsetE

C, M, & R

C, M, & R

C, M, P & R

C, M, & R

R

C&M

C, M, & R

C, M, & P

C, M, & R

Abated Property TypeF

VA

CR

AV

VA

VA

AV

AV & VF

RE

AV & VF

Method of Property AbatementG

LO

LO & AW

AW

LO

AW

SLO & RM

AW

RM

AW & RM

Who Bears CostH

10:45 AM

Massachusetts

Yes - 1 I

66%

Maine

New England

SAPTAPs in 2007— Number Programs

Yes - 3

33%

Census Region/ State

Other PTAPs in 2007B

Characteristics of SAPTAPs in 2007C

4/4/09

Connecticut

SAPTAPs in 1963— DurationA

Property Tax Abatement Programs by State

TABLE 8.1

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Yes - 2

Missouri

YesJ

Yes - 6

Minnesota

West Virginia

Virginia

South Carolina

North Carolina

Maryland

Georgia

Florida

Yes - 5yrs

Yes - na

Yes

K

50%

South Atlantic

Yes - 2

Yes - 1

Yes - 7

Yes - 1

Yes - 1

South Dakota

Delaware

Yes - 2

SD

GUA

LD

LD, PREF

LD

LD

LD, GUA

LD, SLD

SLD

10 & 5 yrs, S

5 yrs

12, 10 & 1 yrs, C

10 yrs, S

5 yrs

20 & 10 yrs

25 yrs

15, 10, & 5 yrs, C

10 yrs, C

10 yrs

15 yrs, C, S

12 & 15 yrs, S

C&M

M

C, M, P & R

C&M

C, M, P & R

C, M, & R

C, M, P & R

C, M, & R

C&M

C, M, P & R

C, M, & R

C&M

AV

RE

CR & VA

VA

VF

CR, VA, & PA

AV, VA, & PA

CR & VA

AV

VA

AV

VF

(continued)

LO

CO

AW

AW

LO

SLO

LO, SLO, AW

LO, SLO, AW

SLO & SE

LO

LO

LO, SE, & RM

10:45 AM

North Dakota

25%

Yes - 1

Kansas

LD

LD

SLD

4/4/09

Nebraska

Yes - 2

86%

Iowa

West North Central

None

Yes - 2

Ohio

Wisconsin

Yes - 4

Michigan

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75%

Yes - 10yrs

Yes - 5 yrs

Yes - 10yrs

Census Region/ State

East South Central

Alabama

Kentucky

Mississippi

Yes - 2

YesN

Colorado

Idaho

YesM

Arizona Yes - 1

37.5%

12.5%

Yes - 5 yrs

Oklahoma

Yes - 2

Mountain

Yes - 10yrs

Louisiana

Yes - 1

Yes - 7yrs

Arkansas

75%

Texas

75%

Yes - 1

Yes - 2

Yes - 1

75%

SAPTAPs in 2007— Number Programs

LD

LD

LD, GUA

SD, SLD

SLD

LD

LD, PREF

Award ProcessD

10 yrs, C

10 yrs, C, S

10 & 5 yrs, C

10 yrs

10 yrs

5 yrs

10 yrs

Duration— Clawback or SunsetE

C, M, & P

C, M, & R

M

C, M, & R

C&M

C, M, & R

M

Abated Property TypeF

CR & RE

VA

AV & VA

VA & VF

VA & PA

AV & VF

CR

Method of Property AbatementG

AW & RM

AW

LO & RM

LO

LO & SE

AW

SLO & SE

Who Bears CostH

10:45 AM

West South Central

YesL

Other PTAPs in 2007B

Characteristics of SAPTAPs in 2007C

4/4/09

Tennessee

SAPTAPs in 1963— DurationA

TABLE 8.1 (continued)

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Yes - 1

LD

SLD, GUA 10 yrs, C

17 & 15 yrs, C, S

5 yrs, C

15 & 5 yrs, C, S

10 yrs

10 yrs

10 yrs

R

C&M

C&M

M

C, M, & R

C, M, P & R

C, M, & P

AV

AV

CL

CR & RE

VA & VF

CR

VA

AW

SLO

LO

AW & SE

LO

LO

AW

(continued)

notes: A Derived from Johnson (1962, Table 1) and Bridges (1965, Table 1). B Derived from Google search. C Derived from Dalehite, Mikesell, and Zorn (2005, Table 1) and Google search to confirm continued existence. D “LD” indicates local discretion on case-by-case basis, “SD” indicates state discretion on case-by-case basis, “SLD” indicates joint state/local discretion on case-by-case basis, “GUA” indicates guaranteed to all who apply and meet stated criteria, and “PREF” indicates public referendum required. E “C” indicates clawback, which refers to the taking away of a specific abatement before its full duration if the abatement grantee does not meet certain economic conditions. “S” indicates a sunset provision in abatement legislation, under which an entire specific statewide program terminates after a specified number of years unless renewed by law. F “C” indicates commercial property, “M” indicates manufacturing property, “P” indicates primary property (agriculture, forestry, and mining), and “R” indicates residential property. G “CR” indicates credit based on property taxes owed, “RE” indicates reimbursement after property taxes paid, “AV” indicates percentage reduction in total assessed value used for property tax calculation, “VA” indicates percentage reduction in additional assessed value due to new property investment, “VF” indicates property taxation based on value before new investment, “CL” indicates a reclassification of property into a different class with a lower rate of taxation, “PA” indicates a negotiated payment in place of taxes that is lower than what property tax payments would have been, and “DF” indicates a deferral of owed property taxes to a later date. H “LO” indicates all overlapping localities, “SLO” indicates state and all overlapping localities, “AW” indicates the awarding locality, “SE” indicates property tax payments to local schools excluded from abatement, “CO” indicates county only, and “RM” indicates the state reimburses localities for all or a portion of property tax payments lost through abatement.

Washington

Yes - 2 yrs

Oregon

SD

LD

LD, PREF

SD

LD

10:45 AM

Yes - 3

Yes - 1

Yes - 5 yrs

Hawaii

Yes - 1

100%

Yes - 2

Yes - 10yrs

Alaska

YesO

Yes - 1

Yes - 2

4/4/09

California

60%

Yes - 3yrs

Pacific

Wyoming

Utah

New Mexico

Nevada

Montana

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J

Massachusetts’s Economic Development Incentive Program offers a special property tax assessment in the form of a phased-in assessment of the total value of the project’s property. In addition to property tax abatement, companies investing in Georgia’s less developed counties and in less developed areas in otherwise generally affluent counties are eligible for state grants based on investment and the number of full-time jobs created. K Fifty-seven enterprise zones have been designated in Virginia in which property tax abatements are offered to businesses and investors locating within them. L Local governments in Tennessee are not permitted to grant abatement to private properties. As an alternative, the PILOT program conveys the ownership of private property to the Industrial Development Board, which results in the reclassification of the property as “tax exempt”; the private owner then leases the property from the IDB for a specified annual payment. M Arizona’s Government Property Lease Excise Tax (GPLET) eliminates the real property tax obligation for a company in a central business district, replacing it with a predetermined excise tax that is dependent on the type of use. N Colorado’s Enterprise Zone program provides incentives to encourage businesses to locate and expand in designated economically distressed areas of the state. In addition to other incentives; any city, county, or special district within an enterprise zone is authorized to negotiate an incentive payment or property tax credit with individual taxpayers who have qualifying new business facilities. O A property participating in Wyoming’s Qualified Empire Zone Enterprise (QEZE) is allowed a refundable credit, available for a 10-year period, against their business tax equal to adding the percentage of real property taxes paid in the zone to the percentage of employment increase.

I

(continued)

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fraction of the states was far from uniformly distributed geographically. Nearly three-quarters of the states in the East South Central, West South Central, and Pacific regions of the United States allowed abatement, while no states in the Mid-Atlantic, East North Central, and West North Central regions allowed it. Since a much larger fraction of the nation’s manufacturing activity in the early 1960s was concentrated in regions that did not allow abatement, this pattern is indicative of states adopting abatement programs out of a desire to gain their share of manufacturing. In the early 1960s, states that had more than their share of the nation’s industrial activity did not feel compelled to offer abatement. This has clearly changed in the four and a half decades that have followed. Gold (1979, Table 6.1) found that in 1979 there were 32 states that offered full or partial exemptions (not necessarily SAPTAPs) for business real and personal property. As recorded by Dalehite, Mikesell, and Zorn (2005, Table 1), the number of states allowing SAPTAPs rose to 35 in 2004 (or by 150 percent from the 14 states offering them in 1963). A Google search confirmed that in 2007 these 35 stand-alone abatement programs still exist and that no new states have adopted SAPTAPs. The same search found that of the 15 states without SAPTAPs in 2007, seven allow the abatement of property taxes within the state’s borders in conjunction with a larger program. Column 3 of Table 8.1 indicates the states with these Other PTAPs [property tax abatement programs]. The growth in the number of states that adopted SAPTAPs in the United States during the last four and a half decades is astounding. The Mid-Atlantic, East North Central, and West North Central regions of the United States have gone from no states offering abatement, to 100, 80, and 86 percent respectively of states within these regions offering them. In the Mountain and Pacific regions, the percentage of states offering SAPTAPs has risen in the last 45 years from 13 and 60 percent to 43 and 100 percent respectively. State activity on abatements in both the New England and South Atlantic regions doubled during this period; two-thirds and half of the states, respectively, in these regions offer them. The only census regions that experienced no increase were the East South Central and West South Central regions. However, three-quarters of the states in these southern regions were already offering SAPTAPs in the early 1960s. Counting other PTAPs along with SAPTAPs, property tax abatement is now available in 42 of the 50 states. Thus, there has been a relatively recent diffusion of SAPTAPs throughout the United States. Before turning to a discussion of the likely effects of the now prevalent use of abatement, I offer a description of variations in some of the important characteristics of these programs.

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Types and Methods of Abatements The last five columns in Table 8.1 list important characteristics of the stand-alone property tax abatement programs currently available in the United States. As shown in column 7 of Table 8.1, abatements are offered to all possible types of uses: manufacturing (M), commercial (C), primary (P), and residential (R). As compiled by Dalehite, Mikesell, and Zorn (2005), of the 35 states that offer SAPTAPs, 33 offer some form to manufacturing and 29 states allow commercial abatement. Next in popularity is the promise to developers of abatement of future residential property taxes if a housing development is built in a certain location (20 states of 35).6 Only 9—or about one fourth of the 35 states offering any form of SAPTAPs—allow abatement in the primary sector (agriculture, forestry, and mining). There has been little to no research on the effect of the primary and residential forms of SAPTAPs.7 Primary sector production at a particular location is heavily dependent on the presence of the natural resources necessary for it (fertile soil and water, trees, and mineral deposits). Housing production is heavily dependent on the presence of residents that desire to live at a specific location. Offering a SAPTAP in these two sectors is much less likely to be the deciding factor in whether primary production or residential activity occurs at a specific location. The motivation for the offering of abatements in these sectors is primarily the political desire to offer concessions to a special interest. Because manufacturing property is more mobile between jurisdictions within a state and between states, and larger forms of commercial property (whose customer base extends beyond a locality) are more mobile between jurisdictions within a metropolitan area, it is easier to argue that the offering of a SAPTAP within these sectors would more likely help decide where a business of this type decides to locate. Therefore, it is not surprising that these types of abatements are the most prevalent and thus the most studied. It is also interesting to consider the variety of methods by which a reduction in normal property tax payments occurs through abatement. For the 35 states currently offering SAPTAPs, column 8 of Table 8.1 offers a summary of abatement methods used. The most popular form of abatement, with 15 states using it for one or more of their abatement programs, is a reduction in a firm’s prop-

6. The residential SAPTAPs referred to here are promised to the developers of residential property before construction to encourage development on a specific site or in a specific jurisdiction. This is different from the residential property tax relief measures given to the owners of such property after acquisition. Bowman discusses the prevalence of these measures elsewhere in this book. 7. One exception is the working paper by Swenson and Eathington (1998) discussed later. There is a definite need for more work like this.

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erty tax payments based upon the value of the incremental property added to a site after abatement (VA). This approach, along with a value freeze (VF) whereby renovated business property is taxed based upon the assessed value before renovation (used by six states), are the two methods that best tie the magnitude of the property tax reduction given by the jurisdiction to the possible benefits (increased current and future employment, increased current and future income, or increased future property tax revenues after the abatement expires) received by the granting jurisdiction after abatement. Only eleven states (Alaska, Florida, Indiana, Iowa, Louisiana, Michigan, Montana, New Jersey, New York, South Dakota, and Texas) chose to restrict their method of property tax reduction to one or both of these two preferred methods. The least desirable ways for a jurisdiction to match an abatement award to the possible benefits derived from it are through a property tax credit (CR), a percentage reduction in assessed value (AV), or a reclassification of property for tax purposes (CL). The calculation of these award methods relies on the total amount of property in use at a site, not the amount that is new or rehabilitated. I call these least desirable because there is little to no relationship between a jurisdiction’s abatement award and the benefits conveyed to the jurisdiction from the new or rehabilitated property. Of the 35 states using SAPTAPs in 2007, 8 use the CR method, 12 use the AV method, and 1 uses the CL method in figuring out the abatement amount offered in at least one of their programs. A total of 11 states (Alabama, Hawaii, Illinois, Kansas, Nevada, Ohio, Oregon, Pennsylvania, Vermont, Washington, and West Virginia) exclusively use one or both of these methods in figuring out the value of all abatements granted in their state. Furthermore, there are 3 states (Mississippi, Missouri, and North Dakota) that allow abatements in the form of a negotiated payment in lieu of higher property taxes (PA); and 4 state programs (California, Colorado, Maine, and South Carolina) that require the payment of all property taxes, but instead offer a negotiated reimbursement (RE) to the firm. Though there could be a tie between these negotiated payments and reimbursements, there is nothing inherent to their design that requires it. Finally, one of the SAPTAPs in Alaska allows for a deferral (DF) of property tax payments due now and not their complete forgiveness. Process for Granting and Administering Abatements There are also procedural differences across the states in granting and administering SAPTAPs. All local governments in the United States can only grant abatement after a program to do so has been authorized by the state. As shown in column 5 of Table 8.1, about two-thirds of the states (23 out of

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35) allow full local discretion in regard to what firms receive abatement. However, in three of these local discretion states (Alaska, Alabama, and Florida) the abatement decided upon by a local official must also be confirmed by public referendum.8 In six states, discretion on a case-by-case basis regarding what firms receive abatement is held only by the state. In eight states, abatement is given only after both the state and affected local government approve it. Case-by-case discretion has been taken away from both the state and local decision makers in seven state abatement programs and instead given as of right. There are theoretical arguments for both the discretionary and as-of-right method of granting SAPTAPs. An as-of-right abatement requires an award to any firm meeting certain requirements, usually related to the increase in employment or property value they are expected to bring to a jurisdiction. In favor of this method, such a requirement protects citizens from political decision makers who are willing to grant abatement for less than the as-ofright stipulation. Against this method, the as-of-right requirement forbids the possibility for a rational decision maker to deny abatement to a firm meeting the state-set requirements but that is judged to offer long-term benefits less than the costs of abatement, or to offer abatement to a firm not meeting the state requirement but that is judged to offer other long-term benefits that outweigh the costs. As discussed in Burnier (1992), Wolman and Spitzley (1996), and Loveridge (1996), the debate whether abatement has a rational or a political motivation remains unresolved (though perhaps unsurprisingly, economists tend to take the rational side political scientists the political side), making a judgment on the desirability of as-of-right versus discretion in abatement offers difficult. No matter what the motive, if abatement offers are made to firms on a case-by-case basis with discretion, some form of both state and local approval is the best course since both parties have a stake in the decision. The state’s stake is in desiring that abatement is only used to lure a business from another state or to locate a business in a jurisdiction that serves more than just the local interest.9 Localities need the ability to veto a state-approved abatement because of the loss in local property tax revenue it entails. Two interesting features adopted for some SAPTAPs are a “sunset” clause in the enabling legislation and a “clawback” feature in the award to a specific

8. Nunn (1994) offers a compelling argument in favor of a public vote requirement for the granting of a local abatement. 9. See Anderson and Wassmer (1995) for empirical evidence of such in the form of copycat abatements in a metropolitan area.

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firm. Nine of the 35 states have abatement programs that are scheduled to end in the future unless new enabling legislation is passed. In principle, sunset is a positive feature since it requires a future assessment of the efficacy of a program. However, anecdotal evidence points to most state programs being renewed with little formal evaluation. Fourteen abatement programs also allow a jurisdiction to rescind a previously granted abatement to a firm if contractually promised outcomes are not achieved. As discussed in Ledebur and Woodward (1990, 53) such arrangements can help policy makers “avoid expensive mistakes if they tie incentives to written guarantees of job creation and other benefits.” Still, policy makers are hesitant to adopt such clauses because they reduce the expected value of abatement to a firm. The data offered in column 6 of Table 8.1 indicate that abatements are most commonly offered for a maximum of 10 years. At the extremes are Missouri and Rhode Island, which allow certain abatements for up to 25 years, and Rhode Island and Maryland, which have SAPTAPs that grant only a 1-year period of property tax forgiveness. Though as Wassmer and Anderson (2000, chapter 3) observed for Michigan, most of these programs allow renewal of abatement terms upon expiration, which jurisdictions are usually quick to provide. The final administrative issue that varies across state abatement programs is which entity suffers the loss in potential property tax revenue. In 16 state programs, all overlapping substate property tax collecting units (local governments, schools, special districts, and county) grant an abatement of their property taxes regardless of which one chose to offer it (LO); in 15 states, only the awarding unit’s property tax payments are reduced (AW). In seven state programs similar to LO, the state is also required to cut its property tax collections when a substate jurisdiction makes an award (SLO). In Colorado, Connecticut, Maine, Michigan, Oklahoma, and Vermont the state chooses to reimburse local government for all or a portion of the local property tax revenue lost through abatement. Recognizing the importance of property tax revenue to local school districts, SAPTAPs in Alabama, California, Kansas, Michigan, and Mississippi explicitly exclude the school portion of a firm’s property tax payment from abatement. Empirical Evidence on the Effects of Property Tax Abatements Taxes are much more effective in determining business location within a metropolitan area than between metropolitan areas or states, but the benefits [of such location] basically accrue to one locality at the expense of another in the same area. (Dardia 1997, 17)

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Dardia’s statement offers a concise summary of current thinking by economists on the role of property taxation and its abatement in determining the location of interregional and intraregional business activity. This thinking is largely the result of data-based regression studies that correlate some measure of a jurisdiction’s existing economic activity or a change in this activity with a set of explanatory variables that are theoretically expected to affect it. The beauty of regression for policy analysis is that it allows the researcher to separate the independent effect of one causal variable of interest, in this case the degree of property taxation or abatement, from other casual variables also expected to influence subnational economic activity. Based upon the results of regression analysis, researchers can reasonably claim that holding other important causal factors constant, a given change in property taxation or abatement results in an expected change in a chosen measure of economic activity. However, regression analysis is not the only data-based method researchers have used to assess the effect of property taxation or abatement on subnational business activity. Other methods include surveys and case studies using a “representative” firm. In this section of this chapter I describe these nonregression methods and the empirical evidence they have produced on the expected effects of abatements. But since much of the available evidence is derived through regression analysis, more space is devoted in the later part of this section to a summary of empirical results derived from this method. Surveys Surveys that ask individual decision makers within firms about the importance of subnational taxes to business location have been used to gather such information for its own sake and in the creation of state “business climate” studies.10 The now classic survey of Fortune 500 firms by Schmenner (1982) found that only 1 percent of respondents listed taxes as a “must factor” in selecting an interregional location, but 35 percent of them described low taxes as “desirable” in helping to steer their choice to a particular site within a region. Few surveys have specifically asked a firm’s decision makers about abatement, but Walker and Greenstreet (1991) found that 37 percent of new manufacturing firms surveyed in Appalachia reported that tax incentives were decisive in their final location decision. Burnier (1992) interviewed local economic development officials in Ohio and summarized relevant findings with the declaration that firms now expect tax abatements to be offered. Fisher and Peters (1998, 14) observe that surveys administered in the late 1980s and 1990s are more likely to report that 10. See Fisher (2005) for a highly critical assessment of the value of business climate studies.

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subnational tax levels are important to business location decisions than ones completed earlier. However, academics (e.g., Courant and Fulton [1985] and Fisher [2005]) have long been skeptical of soliciting only the personal opinions of business proprietors on this issue. Decision makers in business are very likely to view such a question as an opportunity to lobby for a public policy change that increases their bottom line, without considering the possible secondary effects of low business taxes—low business services. Usually the reported findings from a survey are too vague to aid in the true understanding of the specific effect of a given SAPTAP, and the questions asked do not get at the specific stage of a business location decision where taxes become important. Case Studies of Representative Firms A second way to evaluate the degree that abatements influence business activity is through case studies of “representative” firms. To accomplish this, a researcher categorizes the specific industrial sectors to be studied and builds a model for a typical firm in each sector that shows how differences in subnational taxes and tax incentives affect the different typical firms’ profit margins. Leslie Papke (1987) and James Papke (1995) are two of the earlier and better-constructed studies that have used this method. James Papke found that abatements exhibit very modest influence on the net returns to different forms of new manufacturing investment across the Great Lakes states. He found that certain state tax provisions (such as the apportionment formula used for corporate taxes and the treatment of sales to nonnexus states) affect the after-tax rate of return across these states more than differences in feasible abatement offers. To date, the most thorough hypothetical-firm study of the effects of tax incentives on subnational economic development is contained in Fisher and Peters (1998). Using 1992 data from the 24 largest manufacturing states and a sample of 112 cities within these states, Fisher and Peters first calculated subnational tax differences and the “standing offer” tax incentive expected in each place. They then built a mathematical model that predicts the earnings for a typical firm in 16 different manufacturing sectors across all of these locations. They found that existing state tax systems tend to yield higher manufacturing returns in states with lower unemployment rates. Fisher and Peters also found that this perverse result is not offset by the pattern of state and local tax incentives across the country. They concluded that after “the widespread adoption of pro-development tax policies and incentives, states and cities have produced a tax and incentive system that provides no clear inducement for firms to invest in higher-unemployment places” (Fisher and Peters 1998, 200).

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There is much to be said in support of the hypothetical-firm approach to studying the effect of SAPTAPs. It is thus regrettable that more studies of this type do not exist and that their findings are not more frequently used by policy makers. Exceptions to this are the works of Persky, Felsenstein, and Wiewel (1997) and Luger and Bae (2005) that show how a relatively simple version of this approach could respectively be used in Chicago, Illinois, and is being used in North Carolina to analyze the effectiveness of business tax incentives. Bartik et al. (1987) also offers a superb ex post application of this method to General Motors’s decision on where to locate its new Saturn plant among six different Midwestern locations. Even so, caveats to the hypothetical-firm approach must be noted. Results are extremely sensitive to the assumptions made about who ultimately pays each of the taxes considered in the model; differences in personal taxes (sales and income) that can also influence business location decisions are usually not controlled for; and all firms in a specific manufacturing sector do not necessarily behave in the “average” way modeled. Regression Analyses Regression analysis is a highly appropriate way in which to investigate the influence of property taxes and abatement on subnational economic activity. It allows for the calculation of the expected effect that taxes or abatement exert on some measure of state or local economic development, holding the other factors that can influence differences in subnational economic development constant. An illustrative example of such analysis begins with the researcher gathering data from a metropolitan area where the unit of analysis would be all local jurisdictions in the area. The dependent variable, or the measure exhibiting observed differences that the researcher desires to explain, could be the number of manufacturing jobs in each of the local jurisdictions. To complete the regression analysis, the researcher would need to gather data on all independent variables expected to cause differences in this dependent variable. The crucial explanatory variable would be some measure of difference in manufacturing property tax abatement across these jurisdictions. To measure the true marginal effect of abatement—what would be expected to happen to manufacturing employment if a jurisdiction offered more manufacturing abatement—the researcher also needs to gather data on other factors expected to cause differences in this dependent variable. These would necessarily include measures of the square mile size of the localities; local transportation networks desired by manufacturing, local business expenditure programs that can attract manufacturing; and local tax, regulatory, or zoning activities that can discourage manufacturing. Once these appropriate variables are gathered, a statistical process called regression analysis yields a regression coeffi-

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cient for the manufacturing property tax explanatory variable that is interpreted as the expected percentage change in local manufacturing employment if local manufacturing tax abatement activity increases by 1 percent. Economists refer to this measure as the abatement elasticity of manufacturing activity. Findings in regard to these elasticities are discussed next. When considering the evidence that has been produced through regression analysis on the effect of abatements on economic activity it is important to divide the examination into two categories: studies that attempt to determine the overall influence of property taxes (or business taxation) on different measures of economic activity, and studies that attempt to determine the specific influence of abatement activity on different measures of economic activity. The first category of regression study is by far more prevalent. Bartik (1991) produced a comprehensive review of all U.S.-based studies in the first category that had been completed prior to the publication of his book. His conclusions that “most recent business location studies have found some significant negative effects of state and local taxes on regional business growth” and “tax effects on business location decisions are generally much larger for intra-metropolitan business location decisions than for inter-metropolitan or inter-state” (38–39) are now accepted by the majority of economists working in the area.11 Bartik observed that most of the 57 studies completed before 1991 that used regression analysis to examine how intermetropolitan or interstate activity is influenced by subnational taxation used some aggregate measure of state and local business taxes weighted by population or income, while a majority of the 24 intrametropolitan or intrastate studies used a measure of the local effective property tax rate. From the 70 percent of interarea studies that contained statistically significant tax effects, Bartik calculated a middle-value elasticity of between –0.15 and –0.35. In lay terms, a 1 percent increase in a state or region’s subnational rate of taxation is expected in the long term to reduce a measure of economic activity in the state or region by between 0.15 and 0.35 percent. From the 62 percent of intraarea studies that contained statistically significant results, Bartik reported a median elasticity between –1.59 and –1.95. Again in lay terms, a 1 percent increase in the effective rate of property taxation in a locality is expected in the long term to reduce a measure of economic activity in the locality by between 1.59 and 1.95 percent. These empirical findings are consistent with the theories of property tax incidence described earlier, in that subnational taxes are expected to exert a greater influence on subnational economic activity the greater the potential mobility of firms. Wasylenko (1997) has also completed a review of the economic literature on taxation and economic development, and concluded that taxes do not appear to have 11. For a critical assessment of Bartik’s conclusions, see McGuire (1992).

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a substantial effect on economic activity across states; however, he does find convincing evidence that subnational taxes can matter to intrastate levels of local employment, employment growth, manufacturing employment, and creation of manufacturing firms. He reports a reasonable range, very similar to Bartik’s, for the taxation elasticity of business activity within a region. It must be remembered that the range of negative elasticities reported above has been calculated from regression studies that attempt to determine the overall influence of business taxation on some measure of aggregate economic activity. That is, they relate to the expected change in economic activity in a jurisdiction if it changes its subnational tax policy for all firms in the jurisdiction. SAPTAPs by definition are selective and do no such thing. Instead they result in property tax reductions only to selected firms. It is therefore unwise to assume that a certain percentage reduction in overall property taxation in a jurisdiction caused by stand-alone property tax abatements will result in a change in economic activity in the jurisdiction equivalent to the abatementinduced percentage reduction multiplied by the elasticities quoted above. It is for this reason that I separately describe the limited regression studies that determine the specific influence of abatement alone. Bartik’s (1991) survey of literature mentions only one pre-1991 study (McHone 1984) that attempted to isolate the independent effect of abatement on subnational economic activity. For 26 standard metropolitan statistical areas that straddled state borders, McHone chose the one county in the SMSA with the greatest manufacturing employment. Using shift-share analysis, he broke the 1970 to 1979 growth in this manufacturing employment down to two components; that due to national average growth and that due to the county’s competitive advantage (or disadvantage) in manufacturing. Using regression analysis, he explained variation in the comparative advantage component by factors expected to cause it, including the ability to offer abatement. He found no relationship between the two components, but when comparative advantage was reduced to a dichotomous variable, where one represented a positive comparative advantage and zero a comparative disadvantage, a second regression found that the ability to offer abatement exerted a positive influence on variation in comparative advantage across these counties and explained about 22 percent of the variation in it. More recent regression-based studies of abatement have been accomplished by Anderson and Wassmer. Wassmer (1994) tries to address the policy-relevant question of whether a positive correlation between abatement by a jurisdiction and economic activity in that jurisdiction is truly causal or just correlative. This is the “but-for” distinction emphasized earlier. Did the abatement really cause the economic improvement or was it merely offered at the same time as

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an improvement that would have occurred regardless? He attacks this question by statistically checking whether the abatement pulls the jurisdiction off its long-term trend in different measures of local economic activity. In only 5 of the 31 metropolitan Detroit area cities he examined did he find that manufacturing or commercial abatement exerted the desired positive effect. Importantly, he also found that this expected effect was more likely for measures of manufacturing activity and in localities that were particularly unattractive to business in terms of reducing their “bottom line.” The motivation for a second regression study by Anderson and Wassmer (1995) was a game-theoretic model of how localities in a metropolitan area are expected to offer manufacturing abatements over time. A community makes abatement decisions in two stages. First it must decide if it wishes to offer any form of abatement. If so, it must then decide how much of its total manufacturing property tax base, subject to state restrictions, to abate. Anderson and Wassmer’s first regression analysis revealed that the rate of property taxation, the percentage of property base in manufacturing, distance to the metropolitan area’s central business district, median income, and population all exerted a positive influence on whether or not to offer abatement. Regression coefficients on the included time dummies also increased in value the longer the state-sanctioned SAPTAP had been in place. A second regression showed that after controlling for other important causal factors, on average abatement amounts for the typical city rose nearly 12 percent a year. These findings support the notion that in part, localities in a metropolitan area offer abatement because other communities are doing the same. In a book-length treatment of the impact of Michigan’s manufacturing and commercial SAPTAPs in the Detroit metropolitan area, Anderson and Wassmer (2000) offer an analysis of the expected effects of these two forms of abatement on local values of manufacturing property base, commercial property base, employment rate, poverty rate, property tax rate, industrial development bonds, tax increment finance adoption, and downtown development adoption. They drew the data for their analysis from 112 municipalities observed over four years between 1977 and 1992. Their simulated findings about the expected effect of a $10 million dollar increase in the yearly abatement of property base in a locality on the other simultaneous outcomes in the system should be of interest to policy makers.12 For the period 1974 to 1977 (the first four years the statewide abatement program was in place), the simulated increase in manufacturing abatement resulted in a $7.6 million increase in a typical Detroit-area community’s actual 12. The average manufacturing property value in a Detroit area community over the entire period examined was $174.5 million and the average commercial property value was $148.4 million.

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(but not taxable) manufacturing property base. This increase in turn would be expected to cause the average local poverty rate to fall from 5.36 to 5.34 percent, municipal expenditure per capita to fall $0.78 from an average of $457.72, and the average property tax rate of 60.57 mills (yearly property taxes paid per $2,000 market value) to rise by 0.13. Furthermore, the offering of this additional manufacturing abatement by a locality correlates with an increase in the likelihood of the same locality offering greater commercial abatements and industrial development bonds over the same period, and a decrease in the likelihood of implementing a tax increment finance authority and downtown development authority. The same $10 million increase in manufacturing abatement was found to not be correlated with manufacturing property value if offered between 1978 and 1982 and negatively correlated with local manufacturing value if offered between 1983 and 1987. Since Anderson and Wassmer report that the average percentage of taxable property value granted abatement across the 112 Detroit communities was around 2 percent in 1977 and rose to nearly 35 percent in 1992 (66), they believe this change is very likely the result of abatements losing their potency after more and more localities began offering them and firms began expecting them. For the two periods that commercial property tax abatements were offered, in Anderson and Wassmer’s sample, regression-based simulations show that a $10 million dollar local increase in this form of abatement was related to a local decrease in commercial property value. This is consistent with communities offering this form of abatement to try and offset local losses in commercial activity to little effect. Such a result supports the theory that the intrametropolitan location of commercial activity corresponds with the strength of a local market and that local property tax reductions can do little to offset a weak local market. Jurisdictions may offer commercial abatement, but their use only negatively correlates with the decline in commercial property that spurred their offering. In wrapping up this review of regression studies it is worthwhile to briefly note four others whose findings are relevant to policy. Mullen (1990), using data drawn from cities in New York State, finds that as the percentage of a town’s total property value that is partly exempt from paying property taxes increases, so does a measure of its local fiscal stress. Specifically, a 1 percent increase in local property granted partial exemption is expected to result in a 0.8 percent increase in the jurisdiction’s property tax effort, relative to a representative tax rate necessary to generate the median revenue yield across all communities. Like Anderson and Wassmer (2000), Mullen finds that the granting of local abatement is related to an increase in the rate of property taxation applied to unabated property. Two of the remaining three regression studies yield equally gloomy results on the expected effects of abatement.

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Swenson and Eathington (1998) offer the only study found that examines the effect of SAPTAPs guaranteed to future owners of homes as a way to encourage developers to construct them. The authors assess the impact of Iowa’s widely used program that allows the abatement of residential property taxes in areas within the state’s 48 largest cities, and find no statistically significant correlation between variation in the use of local residential abatement and variation in local housing growth rates or increased local capital investment per housing unit. Bollinger and Ihlanfeldt (2003) is a regression study of determinants of variation in economic activity at the neighborhood level in Atlanta, Georgia, over 13 years beginning in 1985. Commercial and manufacturing properties newly established or relocated in census tracts that Georgia designated as “depressed” (based upon high current poverty rate, current unemployment rate, or rate of job loss over the last five years) received a guaranteed 25-year abatement—a full abatement for 5 years, declining to 20 percent in the last 5 years. In addition, “underpopulated” and economically depressed census tracts received a similar residential abatement beginning in 1987. The state program that allowed these abatements in Atlanta is not considered a SAPTAP, but a PTAP that is part of a larger enterprise zone designation. Bollinger and Ihlanfeld find that the offering of this nonresidential abatement results in about 80 new jobs per annum in a census tract. The promise of future residential abatement exerted no measurable influence on new housing development in a census tract offering it. Finally, Fullerton and Aragones-Zamudio (2006) offer evidence in support of the ineffectiveness of abatement in El Paso, Texas. They do this by performing regression causality tests between yearly changes in the total value of abatement offered in the city and measures of yearly changes in economic activity including real gross metropolitan product, median price of existing city homes, personal city income, retail city sales, and city employment. In 14 of the 16 causality regressions they run, they find that these measures of changes in economic activity are not caused by previous changes in abatement levels. What We Know and What More Needs to Be Known The following, designed for policy makers, is a bullet-point summary of what we know and what more needs to be known about abatement. What We Know • One must be very careful in the interpretation of surveys of business people regarding the expected influence of business taxes on business location. Better to observe what they actually do than rely on what they say they will do.

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• Evidence based on calculating the profit expected to be earned by hypothetical firms in different industries and in different states shows that low-unemployment states are more likely to offer business a higher rate of return after business taxes and business incentives (including abatement) are considered. • The overall reduction of business property taxes in a jurisdiction has been more consistently shown to increase business activity in that jurisdiction than the selective use of abatement to specific firms. • If one jurisdiction in a metropolitan area lowers its overall rate of business taxation and others keep theirs the same, the expected effect on business activity in that jurisdiction is expected to be far greater than if all jurisdictions in a metropolitan area lowered their rates of business taxation equally. • Stand-alone property tax abatements are far more effective at redistributing manufacturing activity among the jurisdictions in a metropolitan area than commercial activity. • There is evidence of copycat behavior regarding the offering of abatement. Over time, a jurisdiction is more likely to offer abatement just because other jurisdictions in the metropolitan area are doing so. • Copycat behavior reduces the long-term effectiveness of abatement in a metropolitan area at redirecting business activity. If all jurisdictions are offering abatements, they can no longer be the swing factor in choosing one jurisdiction over another. • Abatement is likely to generate fiscal stress through the potential revenue lost and increased business services provided after it is offered. What More Needs to Be Known • Hypothetical firm models should be used more often to better inform subnational decision makers on the likely impact of abatement at specific locations on the profitability of different types of firms. • State governments need to collect more publicly available data on the amount of abatement (indeed, on all local economic development incentives) offered by all jurisdictions within their boundaries. The lack of research on the impact of abatement is largely due to a lack of data. • More research needs to be completed on the use of abatement before any definitive conclusions can be reached on its effects in the primary and residential sectors.

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Concluding Thoughts on Abatement and Subnational Property Tax Base Erosion Summary This chapter has summarized the arguments for and against the use of standalone property tax abatement, documented its increasing prevalence and the various forms of its use across the United States, and described the theoretical and empirical evidence that can help policy makers better understand the expected effects of abatement. Since this chapter is included in a broader volume on the erosion of the subnational property tax base in the United States, it is appropriate to summarize the relationship between this issue and abatement as well. Based on the evidence offered here, a water glass representing the country’s entire subnational property tax base after abatement is better thought of as half empty than half full. Theory points to abatement not increasing overall economic activity in the country. When offered, abatement acts to reduce the country’s total subnational property base upon which taxes are levied. What about individual subnational jurisdictions? It depends. For an entire state or region, theory and empirical evidence show that abatement does little but deplete the entire base of property taxation. This is especially true if other states or regions competing for the same mobile businesses offer incentives of equal or greater value. Nonetheless, it is not unreasonable for a local policy maker to regard the glass representing the taxable jurisdiction’s manufacturing property base as half full because of a SAPTAP. In the long term, manufacturing firms can locate in different jurisdictions within a region and still earn the same profit. Local government choices that hurt a firm’s bottom line (such as taxes and regulations) or help it (such as abatement, other incentives, and business services) are thus more likely to become the swing factor that determines the particular jurisdiction that manufacturing firm locates in within a region. If a locality offers abatement (or, more likely, uses abatement in a larger incentive package) and another locality in the same region does not put together an equivalent or greater incentive, the abatement could make the difference in the manufacturing firm’s location decision. So even though abatement causes a loss of potential property tax revenue, the local policy maker can believe that the firm would not have come without it. Thus the local policy maker often considers the property tax base glass as half full, not half empty. Of course, stressing the importance of abatement to securing mobile business activity serves the self-interest of firms, business lobbyists, and site location services. As indicated by the increasing prevalence of SAPTAPs in the United States, all this results in a sort of arms race mentality among state governments that, carried to an extreme, causes them all to allow abatement and all jurisdictions

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within them to offer it. At such an extreme, the distribution of mobile business activity is unchanged from what it would have been if there had been no abatement. The only change is that business is paying fewer taxes to subnational governments (the glass is half empty). These scenarios are helpful in the formulation of advice to the administrators of abatement programs and in the crafting of recommended changes in the way SAPTAPs are offered in the United States. I next offer advice and policy recommendations to administrators of abatement programs in the United States. I am assuming that the abatement administrator at the state level has the interest of the entire state in mind, while the local official is only interested in what is best for the locality when deciding whether or not to offer abatement. Advice to Administrators on Expected Effects of Abatement Economic theory indicates that the expected effect of abatement on subnational economic activity depends on the degree of mobility of the business that is offered the property tax reduction. In the empirical work just reviewed, this is reflected in a clear difference in findings depending both on the unit of analysis and on the type of business examined. Because interregional mobility is more likely than intraregional mobility, data sets drawn from localities within a region show a greater response to abatement than do data sets drawn from jurisdictions across different states/regions. Empirical analysis also shows that manufacturing activity is more responsive to abatement than commercial (or residential) activity because it can choose alternate locations more easily. Therefore, if asked to advise a subnational policy maker about the influence of abatement on economic activity in their jurisdiction, I would first need to know whether I was speaking to a state policy maker considering the effect of abatement on the interstate location of large manufacturing firms, or a local policy maker considering the effect of abatement on the intermetropolitan location of commercial firms or small manufacturing firms or housing that were very unlikely to leave the state even if an abatement were not offered. The advice that follows is not about whether granting abatement to one firm will make the difference in its location decision. Such advice is best given on a case-by-case basis and by modeling the cost factors important to the firm offered abatement, and assessing whether competing jurisdictions are likely to match the abatement offer.13 I offer advice about the expected long-term effect of abatement on an aggregate economic measure if it can be reasonably interpreted as cutting business property taxation in the jurisdiction by a certain percentage. 13. See the decision criteria offered later in this chapter.

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Though policy makers do not like it, honest advice can only be given within wide margins of possibility, due to the range of findings derived primarily from regression analysis. Abatement is a sound strategy only under certain circumstances, depending on the level of government from which abatements are offered, how the proposed abatements are structured, and the expected response from other jurisdictions vying for the same economic development activity. For instance, can an abatement program, in and of itself, attract new manufacturing to a state or stem the flow of existing manufacturing out of it? On the existing evidence, the answer ranges from “absolutely not” to “if pursued greatly enough, and in conjunction with other statewide industrial incentives, then perhaps only slightly.” At the upper end, a statewide property abatement program that resulted in an overall 10 percent decrease in business taxation would be likely to increase manufacturing activity in the state by only 1.5 to 3.5 percent. Very importantly, this assumes that other states competing for new manufacturing activity will keep their business taxes and incentives constant rather than matching this state’s offers. Very likely, an abatement program targeted at commercial or residential activity in the state would have no effect. The chance that an abatement program can reallocate manufacturing or commercial activity between localities within a state or within a metropolitan area in a state is far greater than its chance of attracting new or retaining existing state business activity. Holding other factors constant, the evidence indicates that a 10 percent reduction in overall local business taxation accomplished through abatement is likely to result in a long-term 15 to 20 percent increase in local economic activity generated by firms that are mobile between communities. But in accepting these numbers, one must also realize that the predicted change: (1) is very likely zero-sum (one locality’s gain is another locality within the state’s loss); (2) will only occur if state policy makers are diligent in restricting abatement and other business incentives to localities that exhibit characteristics that reduce a firm’s profitability; and (3) it is predicted for most manufacturing firms and only some commercial firms (like regional retail malls, auto malls, or big box stores) whose market consists of most of the region). Abatement benefits a jurisdiction by increasing economic activity, that should in turn create more jobs for residents, more tax revenue, and greater agglomeration economies for existing firms in the locality. Abatement costs a jurisdiction, even when it generates greater economic activity, if it also generates fiscal stress (public service needs that additional post-abatement revenue cannot provide for) or a reduction in the physical environment of a community. Thus, a policy maker considering the offering of a new SAPTAP should fully and rationally weigh the likely benefits against the likely costs. Abatement should only be chosen

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if reasonable expectations of benefits outweigh costs by a healthy margin.14 Of note for such an assessment, Mullen (1990) offered empirical evidence that a percentage increase in partial property tax exemptions through abatement is also likely to yield a near-equal increase in one measure of local stress. Decision Criteria Economic decision criteria for whether a state or local decision maker should offer abatement to a specific firm that ignore the political reasons to offer abatement involve a four-step sequential question process: Question 1: With a significantly high probability, can the business asking for the abatement legitimately locate elsewhere? Answer yes: Ask next question. Answer no: Do not grant abatement. Question 2: Is the profitability of the business asking for the abatement likely to be higher in the possible alternative location(s) if your jurisdiction offers abatement (and other foreseeable incentives) and the alternative location(s) do the same? Answer yes: Do not grant abatement. Answer no: Ask next question. Question 3: Is the offering of the abatement (and other foreseeable incentives) to this firm expected to generate greater or less fiscal stress in your jurisdiction? (That is, will the foreseeable revenues that come from this firm after abatement and the incentive package offered to it be greater than the anticipated increase in expenditures due to it locating or remaining in your jurisdiction?) Answer less fiscal stress: Grant abatement. Answer greater fiscal stress: Ask next question. Question 4: Is the cost of the increased fiscal stress generated in your jurisdiction by offering the abatement and getting the business to locate there more than offset by other tangible benefits offered by the firm (e.g., jobs for residents, the attraction of other taxpaying firms, and revitalization of a neighborhood)? To answer the question the decision maker must necessarily must put a dollar value on these other tangible benefits. 14. Anderson and Wassmer (2000, 147) offer an example of how to balance costs and benefits using data generated for a typical community in the Detroit metropolitan area.

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Answer yes: Grant abatement. Answer no: Never grant abatement.

Policy Recommendations Regarding the Continued Use of SAPTAPs In a chapter in Reining in the Competition for Capital, Thomas (2007) reemphasizes that subnational business incentives like SAPTAPs exist for at least the following reasons. First, subnational governments need the revenue and jobs provided by basic economic investment within their boundaries. Second, much of this investment is quite mobile. In such a market for subnational business investment the sellers (business) have three advantages over the buyers (state and local governments): the potential mobility of business is rising, relevant information asymmetries favor sellers, and sellers usually act in a coordinated matter while buyers do not. Thomas suggests that the answer is greater coordination among all subnational governments on abatement and other activities related to the offering of economic development incentives. Others have suggested the outright elimination of SAPTAPs and other subnational incentive programs, while still others believe that nothing needs to be done and that any policy changes would in fact lead to a less socially desirable outcome. These arguments are summarized next.

Do Nothing Mattey and Spiegel (1997) and Glaeser (2002) have looked at some of the same evidence presented in this chapter and concluded that nothing needs to be done to curtail the use of SAPTAPs. They reason that the subnational use of abatement actually enhances the efficiency of business location decisions. Firms generate a benefit, varying by location and by firm, to the jurisdictions in which they locate. If abatement or some other form of tailored economic development incentive cannot be offered to firms, jurisdictions will extract these benefits for distribution to their citizens without the appropriate compensation to the business owners and corporate shareholders that generate them. According to this argument, rational policy makers competing with each other for mobile business activity offer an incentive to a specific firm equal to the value of the benefits that the firm is expected to convey to the locality if it locates there. The greatest local incentive is offered where the business conveys the greatest local benefits, and if other location factors are constant, that is where the business locates after receiving full compensation for providing the location-specific benefits it generates. Mattey and Spiegel and Glaeser all recognize that this could limit the redistribution of resources from wealthy to poor residents within subnational jurisdictions, because

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the surpluses provided by business to fund such redistribution are lost. But their response is that redistribution is better done at the federal level. This line of reasoning is theoretically sound, providing that there are no information asymmetries on the benefits and costs of a firm locating in a jurisdiction, and that policy makers act in a purely rational fashion in crafting an incentive offer. Since, like Thomas (2007), I believe that information asymmetries greatly favor business in the abatement process, and side with Wolman and Spitzley’s (1996) conclusion that the type and amount of a subnational incentive is usually not determined through a purely rational process, I reject the do-nothing policy course.

Eliminate Them An extreme policy course in regard to SAPTAPs in the United States would be to eliminate them outright. Burnstein and Rolnick (1995), Lynch (1996), and McEntee (1997) are among those who reach this conclusion. The argument usually given for elimination is that in the long term, abatement produces state and local property tax base glasses that are only half full. The loss in property tax revenue generated by abatement has forced subnational governments to seek other, more regressive ways to raise local revenue (sales taxes, user charges, or fees) or to cut services that primarily benefit the poor. Furthermore, supporters of elimination believe that the impact of abatement on redirecting economic activity to more socially beneficial locations is minimal at best. I respectfully disagree, and do not favor outright prohibition of SAPTAPs (and all other subnational economic development incentives) for two reasons. The first is purely practical. How could the federal government possibly prevent state and local governments from using their own funds to attract business? As noted by Fisher and Peters (1998, 220), participants in a national conference on ending the “economic war between states” offered few proposals on how to do so and the measures suggested would surely be challenged as unconstitutional. My second reason for not favoring an outright ban is that I agree with Bartik (2007) that selectively offered abatement under the reformed system suggested next is very likely to produce socially beneficial outcomes by directing basic economic activity to jurisdictions most in need of it. Mend, But Do Not End The majority of previous academic studies that examined subnational business incentives and concluded with a policy prescription choose the remaining alternative: “mend, but do not end.”15 This prescription involves finding ways to 15. For example, see Leroy (2007); Anderson and Wassmer (2000); Ihlanfeldt (1999); Fisher and Peters (1998); Wolman and Spitzley (1996); Nunn (1994); Bartik (1991).

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curtail the current use of abatement so that it is only offered by locations with existing infrastructure to support greater business activity but high levels of unemployment, poverty, regulation, and/or taxes the reduce the profitability of a business without the offering of a property tax reduction that could offset these characteristics. As discussed in Anderson and Wassmer (2000, 174–175), this may be best brought about by state legislation designed to restrict the offering of SAPTAPs to specific amounts determined for each of the different economic regions or metropolitan areas in the state. Specific reform proposals, distilled from discussions in Ihlanfeldt (1999), Bartik (2007), and Leroy (2007), include: (1) more selective use of abatement; (2) greater transparency concerning the type and amount of abatement offered in a jurisdiction; (3) more publicity on abatement availability and the goals meant to be achieved through offering abatement; (4) mandated benefit-cost assessment of each local abatement offer by a stateappointed commission of experts; (5) greater use of front-loading in abatement schemes; (6) further use of clawbacks specifically designed to better ensure the promised social benefits of abatement (e.g., increased tax revenue, quality employment of low-income residents, physical improvements to community); (7) supplemental input from school boards and other overlapping tax jurisdictions before the approval of an abatement that fiscally affects them; (8) registration of site location consultants as business lobbyists in the states they practice in; and (9) restriction of abatement to only the mobile property that meets the goal of redirecting property from one location to a more desirable one. Bartik and Bingham (1997) offer a well-reasoned response to critics who believe economic development programs cannot be evaluated and thus, that they cannot require specific outcomes. I believe that if the type of reform represented by the 9 policy suggestions just made is ever to come to the current system of SAPTAPs in the United States, it must be generated in each state from the grassroot level of cities banding together and calling for change. Many suburban communities would benefit from a reduction in the unnecessary abatement that now does little to affect the amount of economic activity in their boundaries, but does reduce their taxable property bases. If abatement is allowed in only depressed neighborhoods (usually in the central city and inner-ring suburbs), they would benefit by having a more effective tool at their disposal to attract needed economic activity. My conclusion is that stand-alone property tax abatements are only a sound policy strategy if they are used under limited circumstances that result from taking the full control of the abatement offer away from the jurisdiction. The distinction needs to be drawn between a SAPTAP in a depressed jurisdiction that more likely produces a half-full (property-tax-base) glass and an abatement offered elsewhere that yields a half-empty glass. The evidence is

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much stronger that for a depressed jurisdiction, economic activity would have more likely located elsewhere but for the abatement. But a depressed jurisdiction can only benefit from the offer of a SAPTAP if other less depressed jurisdictions vying for the same economic activity do not do the same. Thus, I must conclude that unless the state restricts the offering of abatement in the state to only truly depressed jurisdictions (possible), or the federal government restricts the offering of abatements by jurisdictions in other states to the same truly depressed jurisdictions (very unlikely), stand-alone property tax abatements cannot be considered a sound long-term economic development strategy. REFERENCES

Alyea, Paul E. 1967. Property tax inducements to attract industry. In Property taxation, USA, ed. Richard W. Lindholm, 139–158. Madison: University of Wisconsin Press. Anderson, John E., and Robert W. Wassmer. 1995. The decision to bid for business: Municipal behavior in granting property tax abatements. Regional Science and Urban Economics 25:739–757. ———. 2000. Bidding for business: The efficacy of local economic development incentives in a metropolitan area. Kalamazoo, MI: W. E. Upjohn Institute for Employment Research. Bartik, Timothy J. 1991. Who benefits from state and local economic development policies. Kalamazoo, MI: W. E. Upjohn Institute for Employment Research. ———. 2007. Solving the problems of economic development incentives. In Reining in the competition for capital, ed. Ann Markusen. Kalamazoo, MI: W. E. Upjohn Institute for Employment Research. Bartik, Timothy J., Charles Becker, Steve Lake, and John Bush. 1987. Saturn and state economic development. Forum for Applied Research and Public Policy, Spring, 29–41. Bartik, Timothy J., and Richard D. Bingham. 1997. Can economic development programs be evaluated? In Dilemmas of urban economic development: Issues in theory and practice, ed. Richard D. Bingham and Robert Mier. Thousand Oaks, CA: Sage Publications. Bollinger, Christopher R., and Keith R. Ihlanfeldt. 2003. The intra-urban spatial distribution of employment: Which government interventions make a difference? Journal of Urban Economics 53:396–412. Bridges, Benjamin. 1965. State and local inducements for industry. Pt. 1. National Tax Journal 18:1–14. Burnier, DeLysa. 1992. Becoming competitive: How policymakers view incentivebased development policy. Economic Development Quarterly 6:14–24. Burnstein, Melvin L., and Arthur J. Rolnick. 1995. Congress should end the economic war among the states. The Region 9:1–13.

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Chi, Kevin S., and Drew Leatherby. 2000. State business incentives: Trends and options for the Future, 2nd ed. Lexington, KY: Council of State Governments. Courant, Paul, and George Fulton. 1985. What do business climate studies have to do with business? The economic outlook for 1986. Ann Arbor: University of Michigan (November). Dalehite, Esteban G., John L. Mikesell, and C. Kurt Zorn. 2005. Variations in property tax abatement programs among states. Economic Development Quarterly 19:157–173. Dardia, Michael. 1997. What economic studies contribute to local development efforts. Western Cities (July):16–18. Fischel, William A. 1975. Fiscal and environmental considerations in the location of firms in suburban communities. In Fiscal zoning and land use controls, ed. Edwin S. Mills and Wallace E. Oates, 119–173. Lexington, MA: Lexington Books. ———. 2001. Municipal corporations, homeowners, and the benefit view of the property tax. In Property taxation and local government finance, ed. Wallace E. Oates, 33–78. Cambridge, MA: Lincoln Institute of Land Policy. Fisher, Peter S. 2005. Grading places: What do the business climate rankings really tell us? Washington, DC: Economic Policy Institute. Fisher, Peter S., and Alan H. Peters. 1998. Industrial incentives: Competition among American states and cities. Kalamazoo, MI: W. E. Upjohn Institute for Employment Research. Fullerton, Thomas, and Victor Aragones-Zamudio. 2006. El Paso property tax abatement ineffectiveness. International Journal of Business and Public Administration 3:79–94. http://mpra.ub.uni-muenchen.de/626. Glaeser, Edward. 2002. Comments on “Tax incentives and the city.” In BrookingsWharton papers on urban affairs, ed. William G. Gale and Janet Rothenberg Pack. Washington, DC: The Brookings Institution. Gold, Steven D. 1979. Property tax relief. Lexington, MA: D. C. Heath and Company. Ihlanfeldt, Keith R. 1999. Ten principles for state tax incentives. In Approaches to economic development, ed. John P. Blair and Laura A. Reese, 68–84. Thousand Oaks, CA: Sage Publications. Jensen, Jens P. 1931. Property taxation in the United States. Chicago: University of Chicago Press. Johnson, William A. 1962. Industrial tax exemptions: Sound investment or foolish giveaway? Proceedings of the 55th annual conference on taxation, 421–437. Washington, DC: National Tax Association. Kantor, Paul, and Stephen David. 1988. The dependent city. Boston: Scott, Foresman/ Little Brown. Ledebur, Larry C., and Douglas P. Woodward. 1990. Adding a stick to the carrot: Location incentives with clawbacks, rescissions, and recalibrations. Economic Development Quarterly 3:221–237. Leroy, Greg. 2007. Nine concrete ways to curtail the economic war among the states. In Reining in the competition for capital, ed. Ann Markusen, 183–198. Kalamazoo, MI: W. E. Upjohn Institute for Employment Research.

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Loveridge, Scott. 1996. On the continuing popularity of industrial recruitment. Economic Development Quarterly 10:151–158. Luger, Michael I., and Suho Bae. 2005. The effectiveness of state business tax incentive programs: The case of North Carolina. Economic Development Quarterly 19:327–345. Lynch, Robert G. 1996. Do state and local tax incentives work? Washington, DC: Economic Policy Institute. Mattey, Joe, and Mark Spiegel. 1997. On the efficiency effects of tax competition for firms. The economic war among the states. Minneapolis: Minnesota Public Radio. http://news.minnesota.publicradio.org/features/199605/01_wittl_econwar/study guide/matteyspiege.htm. McEntee, Gerald W. 1997. The problems with state bidding wars and some possible remedies: The economic war among the states. Minneapolis: Minnesota Public Radio. http://news.minnesota.publicradio.org/features/199605/01_wittl_econwar/study guide/mcentee.htm. McGuire, Therese. 1992. Review of “Who benefits from state and local economic development policies” by Timothy Bartik. National Tax Journal 45:457–459. McHone, Warren. 1984. State industrial development incentives and employment growth in multistate SMSAs. Growth and Change 15:8–15. Mieszkowski, Peter. 1972. The property tax: An excise tax or a profits tax? Journal of Public Economics 1:73–96. Mullen, John K. 1990. Property tax exemption and local fiscal stress. National Tax Journal 43:467–479. National Association of State Development Agencies. 1991. Directory of incentives for business investment and development in the United States. Washington, DC: Urban Institute Press. Nechyba, Thomas J. 2001. The benefit view and the new view: Where do we stand twenty-five years into the debate? In Property taxation and local government finance, ed. Wallace E. Oates, 113–122. Cambridge, MA: Lincoln Institute of Land Policy. Nunn, Samuel. 1994. Regulating local tax abatement policies: arguments and alternative policies for urban planners and administrators. Policy Studies Journal 22:574–588. Papke, James. 1995. Inter-jurisdictional business tax cost differentials: Convergence, divergence, and significance. State Tax Notes 9:1701–1711. Papke, Leslie. 1987. Sub-national taxation and capital mobility: Estimates of tax price elasticities. National Tax Journal 40:191–203. Persky, Joseph, Daniel Felsenstein, and Wim Wiewel. 1997. How do we know that “but for the incentives” the development would not have occurred? In Dilemmas of urban economic development: Issues in theory and Practice, ed. Richard D. Bingham and Robert Mier, 28–45. Thousand Oaks, CA: Sage Publications. Schmenner, Roger W. 1982. Making business location decisions. Englewood Cliffs, NJ: Prentice-Hall. Swenson, David, and Liesel Eathington. 1998. The efficacy of housing taxing abatements on housing starts. Working Paper, Ames: Iowa State University Department of Economics. http://www.econ.iastate.edu/research/webpapers/NDN0047.html.

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Thomas, Kenneth P. 2007. The sources and processes of tax and subsidy competition. In Reining in the competition for capital, ed. Ann Markusen, 43–56. Kalamazoo, MI: W. E. Upjohn Institute for Employment Research. Wassmer, Robert W. 1993. Property taxation, property base, and property value: An empirical test of the “new view.” National Tax Journal 46:136–160. ———. 1994. Can local incentives alter a metropolitan city’s economic development? Urban Studies 31:1251–1278. Wasylenko, Michael. 1997. Taxation and economic development: the state of the economic literature. New England Economic Review (March/April):37–52. Walker, Robert, and David Greenstreet. 1991. Public policy and job growth in manufacturing: An analysis of incentive and assistance programs. Regional Studies 25:13–30. White, Michelle J. 1975. Firm location in a zoned metropolitan area. In Fiscal zoning and land use controls, ed. Edwin S. Mills and Wallace E. Oates, 175–202. Lexington, MA: Lexington Books. Wolman, Harold, and David Spitzley. 1996. The politics of local economic development. Economic Development Quarterly 10:115–150. Zodrow, George R. 2001. Reflections on the new view and benefit view of the property tax. In Property taxation and local government finance, ed. Wallace E. Oates, 79–112. Cambridge, MA: Lincoln Institute of Land Policy.

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COMMENTARY

NATHAN B. ANDERSON

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obert Wassmer provides an excellent overview of the increasingly widespread use of local property tax abatements by local governments in the United States. Although these abatements are almost daunting in their heterogeneity, Wassmer’s analysis is remarkably focused and thorough. This commentary focuses its attention on three areas: (1) the relationship between abatement and property tax base; (2) the relationship between property tax base and local government revenues; and (3) empirical evidence that abatements benefit local residents by promoting economic activity. Although Wassmer explains these issues quite well, I find these topics to generally be the most confusing and therefore the most worthy of further discussion. Does Property Tax Abatement Reduce Tax Base? The loss of property tax base is seen as the primary cost of abatement for a local government. Yet, as the analysis below demonstrates, abatements do not necessarily reduce property tax base. In the simplest unfettered version of local property tax institutions, the product of the property’s estimated market value and the local property tax rate determines a property owner’s property tax payment.1 A community’s total property tax revenues equal the sum of all tax payments made by property owners in the jurisdiction, which is equivalent to the local tax rate multiplied by the sum of all estimated market values in the community. The total estimated market value in a community is the community’s tax base, and community tax revenues equal the product of the community’s tax rate and tax base. In its most common forms property tax abatement temporarily exempts a certain portion of a property’s market value from property taxation. Often

1. These unfettered institutions rarely exist, but nearly all property tax institutions require an estimate of a property’s current market value, which is then modified to produce a taxable value or an assessed value. In the United States a consistent nomenclature for the taxable value of property does not exist. For example, taxable value in Illinois is called “adjusted equalized assessed value,” while in Minnesota taxable value is called “taxable net tax capacity.”

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additions to market value, either through new construction or appreciation, are exempted from taxation.2 Abatements appear to have a very direct mechanical effect on total property tax base and revenues: abatements reduce base and revenues. As the example below emphasizes, however, the effect of abatement on the property tax base is not inherently mechanical or direct. A business property with a market value of $1 million facing a property rate of 1% would owe $10,000 in property taxes. Supposing the total market value of all properties in the community is $100 million, total community tax revenues equal $1 million. Tax abatement might be offered to induce the owner of the business property to make capital improvements or expand the business. This abatement might exempt 100% of any capital improvements from taxation for 10 years. Receipt of this abatement requires an action by the property owner. If the owner made $100,000 worth of capital improvements, the property’s market value is now $1.1 million, but its taxable value is only $1 million. Assuming the tax rate remains at 1%, the owner’s property tax liability has not changed and property tax revenues for the community have also not changed, all else being equal. Thus, the abatement appears to have no effect on property tax revenues or property tax base.3 Understanding the effect of the abatement on property tax base requires understanding what the property tax base would have been both with and without the abatement. In the above example the property tax base with the abatement is $100 million. What would the property tax base be without the abatement? One extreme assumption is that the abatement had no effect on the capital investment decision by the owner, implying that the property tax base without the abatement would equal $100.1 million, more than with the abatement. The other extreme is to assume that investment would not have occurred without the abatement, implying that the tax base without the abatement is $100 million, the same as with the abatement. If abatements exempting new improvements actually encourage investment, either by influencing its actual occurrence or its extent, a simple accounting of “lost tax base” due to abatements is misleading. Only when new-improvement abatements have no effect on investment do observed new improvements represent lost tax base.4

2. According to Table 8.1, 20 states have abatements that exempt new improvements (VA—14 states) or appreciations from taxation (VF—6 states). 3. The increase in business investment, however, could increase the costs of local service provision, possibly reducing the quality of public services provided at the same revenue level. 4. This example ignores second-order effects of abatement, which appear to only occur if new-improvement abatement does influence investment. For example, a new investment may employ local workers or help the local economy in other ways.

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Next, consider abatement that requires no action on the part of the recipient, exempting increases in the market value of eligible properties from taxation.5 Again, an analysis of the effect of such abatements depends crucially on an understanding of the proper counterfactual. What would have happened to market values without the abatement? If abatement is responsible for all increases in market values, then no tax base is lost due to the abatement. As before, if market values would appreciate by observed amounts even without the abatement, tax base is lost. Finally, consider abatement that reduces the share of market value that is taxable. Abatements of this type require no action on the part of the recipient and, according to Table 8.1, are present in 12 states. If abatements have no effect on property values, the reduction in the share of market value that is taxable results in lost tax base. However, when abatements increase market values, tax base initially lost may be regained and more than replaced. Again, a simple accounting of lost tax base may fail to identify the effect of abatement on the property tax base correctly. What Exactly Is the Problem with Losing Property Tax Base? Suppose that abatements do not affect the location and investment decisions of commercial and industrial property owners. Under all three abatement programs discussed above, property tax base is lost. How does this lost tax base affect the residents of the abatement-providing community? Constant property tax rates imply that the percentage decrease in tax base corresponds directly to a percentage decrease in revenues. Lost in this analysis, however, is that a community can increase its property tax rate and maintain revenue at its preabatement level.6 Consider again the $1 million business property and suppose that abatement, in the form of a reduction in the ratio of assessed to market value, reduces the taxable value by 100 percent to $0. If the value of other properties does not change, the tax rate required to keep revenues at $1 million is 1.01 percent, an increase of 1 percent from the original rate of 1 percent. Thus, the tax payments of all nonabatement property owners will increase by 1 percent. 5. This is the “VF” or value-freeze abatement in Table 8.1. Of course, local officials may demand some kind of action from the property owner in return for bestowing the abatement on the property. 6. In the United States the property tax base is usually known before final tax rates (and hence tax revenues) are set. This enables many local governments to select a revenue level (with the tax rate implicitly determined). Of course, the property tax base may change because of assessment appeals. These reductions in total tax base, when they occur after budgets are set, may, along with delinquencies, make setting a revenue level a somewhat unpredictable endeavor. Contrast a government’s primarily ex ante knowledge of property tax base, however, with the government’s primarily ex post knowledge of income and sales tax base.

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The reduction in tax base not does reduce the ability of the community to collect tax revenues. Reducing tax base only makes raising the same amount of revenue more expensive for nonabatement taxpayers. When providing the same quantity of a good becomes more expensive, it means that the price of that good has increased. Here the price of tax revenue, as odd as that may sound, has increased. The increase in the price of tax revenue may make voters more reluctant to support replacing lost revenues with increases in the local property tax rate. The total amount of tax base does not matter.7 Consider again our example of a community with $100 million in total market value within its boundaries. Suppose the local government decides to offer tax abatement to every single property in the community. The abatement cuts the taxable value of each property by 50 percent. Total tax base is now only $50 million. The local government, however, can simply increase the tax rate by 100 percent and maintain the same level of revenue. The income of taxpayers and the market values of their properties have not changed, and every taxpayer’s bill is identical to their tax bill before the abatement. Hence, total tax base does not matter.8 Why then do tax payments increase in response to the reduction in tax base caused by the tax abatement offered to only one property? The abatement for one property altered the composition of the tax base and tax base composition does matter.9 A reduction in the taxable value of one property requires that the tax payments of all other properties increase to maintain the same level of revenue. This is because all nonabatement properties must now finance a larger share of any increase in tax revenues. To see that it is tax base composition that matters, return again to the example of a community with $100 million in total tax base. Suppose that of this $100 million, $25 million is derived from commercial-industrial properties while the remaining $75 million is derived from residential property. With the tax rate at 1 percent, total revenue is $1 million and residential properties pay $750,000 or 75 percent of the revenue. An abatement reducing the taxable value of all commercial-industrial property by 80 percent is provided. The total tax base is reduced to $80 million, of which approximately 94 percent is 7. What does matter? Real resources and constraints affect public service provision and location decisions. Real resources include the income and wealth of residents. Constraints include the “price” of raising local revenue and the costs of service provision. 8. This example is instructive, not realistic. Nearly all abatements are selective and apply only to individual properties. The example demonstrates, however, that measuring the costs of abatement using a simple accounting of lost tax base is misleading. 9. Wassmer makes this clear when he notes that abatements cause erosion in nonresidential tax base. He also notes research on abatements increasing fiscal stress. I have simply chosen to emphasize (and possibly belabor) the point.

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residential. If the government raises $1 million in property taxes, residential properties will pay $940,000, $190,000 more, for the same amount of total tax revenue, as before the abatement. That is, the residential tax share has increased by 25 percent, from 75 percent to 94 percent. Only changes in the composition of tax base, not the total amount of tax base, should matter for policy. Rather than worrying about abatements eroding property tax base, policy analysts should worry about abatements altering the composition of the tax base. In the example above, rather than discussing a $20 million loss of tax base, the discussion should focus on the 25 percent increase in residential tax share. Unless a local government faces binding legal constraints on property tax rates, a fall in property tax revenues after abatement is a choice made as a consequence of the abatement, rather than an inevitable consequence of abatement.10 Alteration of tax base composition is implicit in much of abatement analysis, since abatements are primarily offered to commercial-industrial properties rather than residential properties. However, the effect of abatements on tax base should be measured by the extent to which they alter the composition of tax base, rather than the extent to which they reduce total tax base. This change in focus raises another question: what’s so bad about altering the composition of the tax base?11 What Constitutes Empirical Evidence? An Ideal Experiment As Wassmer notes, it is essential to understand whether or not any correlation between abatement and economic activity is truly causal or just correlative. One can think about a simple experiment that would help measure the causal effect of tax abatements on economic activity. This simple experiment would randomly assign a common abatement policy across jurisdictions. Jurisdictions could then be divided into a treatment group (those offering abatements) and a control group (those not offering abatements). Since treatment status was randomly assigned, the characteristics of jurisdictions in the treatment and control groups should be equal on average. The average difference in economic activity in the

10. If a property tax system is beset by constraints such as tax rate limitations, total tax base will actually matter for policy. But this is only because government access to the tax base is restricted. Tax rate limitations are, in fact, remarkably common. See Anderson (2006a). 11. Evidence suggests that the composition of the tax base effects expenditures by school districts and cities. See, for example, Ladd (1975) or Anderson (2006b). Changes in expenditures can have both equity and efficiency implications. Also, who pays the tax may be very different from who bears the economic burden of the tax.

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treatment and control groups could then be plausibly called the average causal effect of abatement on economic activity. Evidence In the experiment above, whether or not a jurisdiction offered abatement was completely random. Observed abatement policies, however, are not randomly distributed across jurisdictions. Instead, as Table 8.1 documents, local governments often decide whether or not to offer abatements. Why do some governments offer abatements while others do not? Perhaps a local government is convinced to offer abatements based on lobbying by business interests. Businesses may have already decided to invest or locate in a community, but may be able to extract the abatement as well. In this case, observing that communities with abatements saw an increase in economic activity would not indicate a causal effect of abatements. Failure to control for this selection into the treatment group tends to produce overestimates of the effect of abatements on economic activity.12 Another plausible scenario produces underestimates of the economic effects of abatements. Suppose communities offering abatements tend to be relatively desperate to control flight of business capital. Although abatements may allow the community to retain some businesses, others may still flee to other communities. Without the abatement the flight of business capital from the abatement jurisdiction may have been worse, but data on economic activity will show that communities with abatements tended to lose economic activity and communities without abatements tended to gain economic activity. Thus, the measured effect of abatement might be negative even though the effect is actually positive. The ability of regression analysis to control for these selection effects should not be overestimated. Despite a wealth of data on community characteristics there is likely to be information unobservable to the researcher that causes both changes in economic activity and selection into the abatement-offering treatment group. For example, a community offering abatements may also aggressively pursue businesses by offering high quality public services aimed at businesses. The inability to observe these other business attraction efforts causes the researcher to overestimate the effect of abatements.13

12. Problems with selection are related to the information asymmetry problems discussed by Wassmer and also to issues discussed by Persky, Felsenstein, and Wiewel (1997). See also Anderson and Wassmer (2000). 13. Besides Anderson and Wassmer (2000) and references therein, Dardia (1998) also features analysis that makes great effort to control credibly for selection issues.

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Future empirical work on the effects of abatements should focus on institutional factors that create artificial and plausibly random variation in the availability of abatements. For example, some abatement policies require that a property be of a certain age or under a certain market value. A recent study by Busso and Kline (2007) demonstrates this type of experimental approach. The authors look at the effect of empowerment zone designation on economic activity. Empowerment zones are much different than abatements, but are similar in that they offer benefits to businesses that choose to locate within the zone. Furthermore, they are subject to the same problems in identifying their causal effects; it is difficult to observe what would have happened had the enterprise zone not located in a particular community. To address this issue, Busso and Kline compare outcomes in communities that were barely accepted as empowerment zones to those in communities that were barely rejected as empowerment zones.14 They find that empowerment zones had substantial effects on labor market outcomes and property values. Conclusion The empirical evidence of the effects of taxation on the location and intensity of local economic activity is vast and because of data limitations, mainly limited to studies observing correlations between economic activities and abatements or other local tax policies. Wassmer’s chapter offers an excellent summary of the best studies, but there is substantial room for additional evidence on even the most basic questions of the relationship between tax incentives and business activity, if only to increase confidence in the current conventional wisdom. It is still not difficult to agree with McGuire (1992), “My message to policy makers is that the effects of state and local tax policy are so uncertain that concern over this issue should not be a driving force in general fiscal policy decisions.” REFERENCES

Anderson, John E., and Robert W. Wassmer. 2000. Bidding for business: The efficacy of local economic development incentives in a metropolitan area. Kalamazoo, MI: W. E. Upjohn Institute for Employment Research. Anderson, Nathan. B. 2006a. Property tax limitations: An interpretative review. National Tax Journal 59(3):685–694.

14. The idea is that the unobservable characteristics of communities that were just barely accepted will be very similar to those in communities that were just barely rejected. The similarity in unobservables ameloriates concerns about selection bias in many cases. Anderson and Wassmer (2000) also point to enterprise zones as offering important information about the efficacy of abatement programs.

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———. 2006b. Beggar thy neighbor? Property taxation of vacation homes. National Tax Journal 59(4):757–780. Busso, Matias, and Patrick Kline. 2007. Do local economic development programs work? Evidence from the Empowerment Zone Program. Unpublished manuscript, University of Michigan. Dardia, Michael. 1998. Subsidizing redevelopment in California. San Francisco: Public Policy Institute of California. Ladd, H. F. 1975. Local education expenditures, fiscal capacity, and the composition of the property tax base. National Tax Journal 28(2):145–158. McGuire, Therese. 1992. Review of Who Benefits from State and Local Economic Development Policies by Timothy Bartik. National Tax Journal 45(4):457–459. Persky, Joseph, Daniel Felsenstein, and Wim Wiewel. 1997. How do we know that “But for the incentives” the development would not have occurred? In Dilemmas of urban economic development: Issues in theory and practice, ed. Richard D. Bingham and Robert Mier. Thousand Oaks, CA: Sage Publications.

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9 Preferential Tax Treatment of Property Used for Social Purposes Fiscal Impacts and Public Policy Implications WOODS BOWMAN JOSEPH CORDES LORI METCALF

T

he use of preferential property tax treatment as a tool for fostering economic development has received considerable attention from policy makers and in the economics literature. Our chapter focuses on the use of property tax incentives to pursue social as well as economic development goals in two broad areas: support of local nonprofit organizations and encouraging the preservation of land used for agricultural purposes and set-asides to create green spaces. The instruments of local tax policy that can be deployed in support of one or both of these social goals are similar to those used to provide fiscal incentives for economic development. Localities and states may exempt all or a portion of the taxable value of certain property based on ownership (for example, by churches and nonprofit organizations), and use (for example, agriculture or provision of natural conservation easements). Alternatively, the taxable value of such property may be reduced through preferential assessment practices. As in the case of tax incentives for economic development, such preferential treatment can be granted on a permanent basis or extended for a more limited period of time. The common use of property tax incentives for social purposes at the local level raises a number of questions that we take up in this chapter. What administrative mechanisms are used to grant preferential tax treatment based on ownership and use? What are the fiscal impacts of such measures? What are the main policy issues raised by the use of property tax incentives by local and state government in the pursuit of local social and land use goals? 269

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Preferential Tax Treatment The property tax is unique because unlike other taxes, where tax rates are changed infrequently if at all, a local government recalculates its property tax rate every year to raise the amount of money it needs to balance its budget.1 An important consequence flows from this seemingly innocuous difference, both in discussing the administrative levers used to grant preferential property tax treatment and in defining the fiscal impact of such treatment: in a non– property tax regime, a new tax preference reduces collections with no necessary immediate impact on the taxes owed by other taxpayers, whereas a new exemption from the property tax increases the tax obligations of one or more other taxpayers in the same jurisdiction, provided the same amount of money must be raised.2 Every year a property taxing body adopts a new levy ordinance specifying the amount of property tax revenue to be raised (Lk). It is sent to the public official responsible for preparing tax bills, who then divides the levy by the assessed value of property within the jurisdiction (Ak) to calculate a tax rate (tk). If no parcel of taxable property in the jurisdiction receives preferential treatment, the statutory property tax rate is tk = Lk /Ak,

(1)

and if Aik is the assessed value of the ith parcel within the jurisdiction of the kth taxing body, the amount of tax owed on this parcel is defined by: Tik = tkAik.

(2)

Assessment practices vary considerably across the United States and assessed value may differ substantially from full market value to different degrees in different jurisdictions. If full market value is Vik, and the ratio of assessed value to full market value is ak, which reflects local assessment practice, then assuming assessment practice is uniform throughout the jurisdiction, formula (2) can be expanded: Tik = tkakVik.

(3)

Equation (3) shows that there are three policy levers available to jurisdictions that seek to grant preferential property tax treatment to parcels based on use or other attributes (e.g., characteristics of a parcel’s owner). Parcels, individually or 1. In this chapter, “property tax” refers to the real property tax. 2. In either case, a government might adopt policies to negate these effects. In a non–property tax regime, a revenue-neutral policy requires increasing the tax rate or finding other revenue sources. In a property tax regime, a rate-neutral policy requires cutting spending or finding other sources of revenue.

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by class, can receive tax benefits from preferential rates, preferential assessment, or partial or full exemptions of otherwise taxable property. Preferential rates. When property tax rates are calculated to raise a given amount of money, preferential rates can be particularly complicated to administer because the rate necessary to meet funding requirements floats from year to year. An example will suffice to illustrate the point. A test rate is calculated with respect to all property in the tax base. If the preferential rate applied to certain types of property is lower than the test rate, the preferential rate is applied to the tax-favored parcels. The combined revenue paid by owners of these parcels is then subtracted from the levy and a new, higher statutory rate is calculated for the non-tax-favored parcels in the jurisdiction to make up for the revenue that is not collected on the favored parcels. Preferential assessments. When tax preferences are provided through preferential assessments, tax-favored parcels are taxed at the same statutory rate as all other parcels in a jurisdiction, but are assessed by policies and practices that reduce the assessment ratio from aik to a*ik and reduce total assessments from Aik to A*ik respectively. If the only policy change is preferential assessment, the nominal fiscal impact is the amount by which total tax collections, LK, would have to diminish to hold the rate constant on ordinary parcels. Exemptions. Arguably exemptions are the simplest means of administering tax benefits. A full, or total, exemption is algebraically equivalent to a preferential assessment where a*ik = 0. From the equations above, it is obvious that the nominal fiscal impact of total exemption equals the amount tkakVk where akVk is the total assessed value of property receiving the exemption. A partial exemption consists of subtracting a given dollar amount from a parcel’s assessed value before the statutory tax rate is calculated, then applying the same statutory rate to all parcels after taking preferential tax rates and assessments into account. If taxing bodies do not reduce the amount of property tax levies in response to new tax benefits for real property, then the consequence of such preferences will be to increase the property tax rate on the parcels without benefits. It is fairly well established that outside of large cities, differentials in real property tax rates are capitalized into market values, although often not at 100 percent. Bloom, Ladd, and Yinger (1983) find that a “single best estimate” of tax capitalization is 90 percent, although it can go as low as 40 percent. Bowman (2001, 2002) argues that property values are discounted whenever a community’s tax-exempt sector removes property from the tax roll, because more of the tax burden shifts onto homeowners and businesses, increasing the tax rate and,

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ceteris paribus, rate differentials with other communities. Once equilibrium is reestablished, persons or firms buying into the community can acquire property there at a price lower than would have prevailed otherwise. Measuring Fiscal Impact Whether preferential property tax treatment based on ownership and use results in a reduction in the local property tax levy, or to an offsetting increase on property tax rates of property not receiving preferences, a key first step is to assess the initial impact of such treatment. Based on the relationships defined above, determining this magnitude requires knowledge of the following variables: (1) the market value of the property, i, receiving the preferential treatment in jurisdiction k, (Vik); (2) the assessment ratio if the property did not receive favorable treatment on the basis of use, aik and its preferential value based on use, a*ik; and (3) the tax rate applied to the assessed value in the absence of favorable tax treatment tk and (where applicable) the tax rate applied on the basis of use, t*k. Challenges to Estimation Estimating the revenue cost of property tax preferences granted on the basis of use and/or ownership is particularly challenging for several reasons. When property is exempted from taxation altogether, localities have weak incentives to devote scarce resources to assessing it on a regular basis, especially when there are constitutional and political impediments to taxation, as with property owned by the federal government, religious organizations, or (in many states) nonprofit organizations. When property is taxable even on preferential terms, there is an administrative need to make periodic efforts to assess current use value (not necessarily market value), but deriving such estimates may require considerable judgment to determine how current use value differs from market value. Although arriving at precise estimates of the fiscal impact of preferential treatment is challenging, some data are available that provide rough indicators of the fiscal orders of magnitude for local property tax preferences. We consider property tax preferences granted to nonprofit organizations and to land used for agricultural purposes, in turn. Property Tax Exemption for Nonprofit Organizations All 50 states completely exempt certain types of property from taxation. Such properties are specifically identified as exempt from the property tax base by statute or, in some cases, in state constitutions. Property owned by a federal,

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state, or local government is almost universally exempt, as are churches and cemeteries. Property owned by nonprofit organizations is widely, though not universally, exempt from taxation. Caution is called for in analyzing the so-called nonprofit property tax exemption because property tax exemption is a matter of state law and laws differ. Although every state generally exempts churches, educational buildings, and property used for charitable purposes, the definition of charity differs. Federal 501(c)(3) recognition of a charitable nonprofit is not an automatic basis for granting a property tax exemption in any state, although it is necessary in 27 states, and 20 states even exempt some nonprofits by name. Seventeen states also have some form of local option that allows local governments to decide explicitly whether nonprofit organizations qualify for the exemption, and if so, which ones. Range and Scope of the Exemption for Property Owned by Nonprofit Organizations As Cordes, Ganz, and Pollak (2002) note, information on the value of the tax exemption for property owned by nonprofit organizations is available from several different sources. These data include: estimates of the value of taxexempt property and the revenue impact of the nonprofit property tax exemption compiled by several states; information compiled by the Federal Reserve Board on the value of real property owned by nonprofit organizations, based in part on information from IRS Form 990 returns filed by individual nonprofits; and data taken directly from the Form 990 information returns themselves. These data sources have significant limitations; however, it is possible to use them to gauge the order of magnitude of the fiscal significance of the property tax exemption. (The estimates reported below do not include property used for houses of worship since it is assumed that such property would be exempt from taxation in any event.)

Federal Reserve Board Flow of Funds As a starting point, we present estimates of the value of real estate owned by nonprofit organizations compiled in the Federal Reserve Board Flow of Funds Accounts. These estimates are shown in Table 9.1, where the first row presents the Federal Reserve Board estimate of real estate owned by all nonprofits.3 The 3. As noted in the Federal Reserve publication, the data for the estimates of nonprofit organizations are compiled by the Statistics of Income Division of the Internal Revenue Service. These data, in turn, are based on information provided on the IRS Form 990 return filed by nonprofit organizations with $25,000 or more in gross revenue.

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TABLE 9.1

Real Estate Owned by Nonprofit Organizations: Federal Reserve Board Flow of Funds ($ billions)

Real Estate Estimated Revenue Impact

2000

2001

2002

2003

2004

2005

1,233.5

1,238.2

1,308.2

1,412.2

1,566.5

1,792.8

24.7

24.8

26.2

28.2

31.3

35.9

source: Estimates of real estate owned by nonprofit organizations are taken from the Flow of Funds Accounts of the United States, Board of Governors, Federal Reserve System, Sept. 2007. Table B-100.

second row applies an effective commercial property tax rate of 2 percent to estimate the nationwide fiscal impact of the exemption under the assumption that all property owned by nonprofit organizations would qualify for exemption from property tax.4 As a point of reference, in 2002, total revenue raised from local property taxes was just under $270 billion. The estimate of initial fiscal impact and total property tax revenues suggest that exempting all property owned by nonprofit organizations could cost state and local governments roughly 10 percent in foregone revenue that would need to made up either by raising taxes on nonpreferred property, lowering spending, or both. This estimate, however, overstates the impact of the exemption because it assumes that all nonprofit property that could be taxed would receive an exemption, even though that may not be the case, for reasons discussed above.

State-Level Estimates of Property Tax Exemption Estimates of the initial fiscal impact of the nonprofit property tax exemption are also available for some states. Although local governments do not generally provide systematic estimates of the fiscal impact of the property tax exemption for nonprofit organizations, some states do include such estimates, or provide data that allow an estimate to be made, as part of their overall analyses of state and local tax expenditures. Several such estimates are presented below in Table 9.2.

4. The 2 percent number was derived as follows: Data compiled by the Minnesota Taxpayer’s Association (2007) indicate that the average effective property tax applied to commercial property among the 50 jurisdictions with the highest estimated effective commercial property tax rate was 1.9 percent for commercial property valued at $100,000, and 2.02 percent for commercial property valued at $25 million. These percentages are likely to be on the high side because they are an average of the top 50 effective tax rates for each size class of property.

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TABLE 9.2

Estimates of the Nonprofit Property Tax Exemption from State Tax Expenditure Analyses Total Local Property Tax Revenue ($ Millions)

Estimated Property Tax Exemption ($ Millions)

California (1999)

22,290 (1999)

724.9 (1999)

District of Columbia (2004)

929.9 (2004)

105.0

11.3%

Maryland (2005)

5,062 (2005)

110.0

2.2%

Oregon (2005)

3,500 (2006)

116.6

3.3%

Wisconsin (2006)

8,300 (2006)

277.0 (2006)

3.5%

State

Tax Exemption as Share of Tax Revenue

2.5%

sources: California: Legislative Analyst’s Office. 1999. California’s Tax Expenditure Programs. http://www.lao.ca.gov/ 1999/tax_expenditure_299/tep_299_contents.html. District of Columbia: Office of Revenue. 2007. Exempt List (spreadsheet provided to authors). Maryland: State Department of Assessments and Taxation. 2007. Table XIII, Exempt Property. http://www.dat.state.md.us/sdatweb/stats/06ar_rpt.htm. Oregon: Department of Revenue. 2007. 2005–07 Tax Expenditure Report. Chapter 2. http://www.tax.ok.gov/reports/2005-2006TaxExpRpt.pdf. Wisconsin: Division of Research and Policy, Department of Revenue. 2007. Summary of Tax Exemption Devices, Table 1, p. 76. http://www.dor.state.wi.us/ra/07sumrpt.pdf.

Data from the Form 990 Last, one can use data on the basis value of land, buildings, and equipment that are reported on the balance sheets of 501(c)(3) nonprofit organizations that file the Form 990 to estimate the value of potentially taxable property owned by each nonprofit. With some adjustments, these estimates can then be aggregated to estimate the total value of potentially taxable nonprofit property in each state; and these amounts can then be multiplied by estimates of effective property tax rates to arrive at rough estimates of the potential initial fiscal impact of the exemption at the state level. This estimate, in turn, can provide some indication of the range of fiscal impact among the states. The data reported on the Form 990 returns must be subjected to several adjustments in order to arrive at such estimates. The most important is the treatment of property owned in multiple jurisdictions but reported on the Form 990 return of the national headquarters office. Because local property taxes are collected on property located within jurisdictions, the fact that, say, a nonprofit organization with headquarters in Washington, DC, reports $50 million of land and buildings on its balance sheet does not mean that Washington, DC, can tax the entire $50 million. Rather, it can tax only the property within its boundaries. Failure to account for this feature of property owned by large nonprofits operating in multiple jurisdictions can result in a significant overstatement of the value of potentially taxable property, especially in jurisdictions (such as Washington

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and New York City) that are natural magnets for the national headquarters of large nonprofits with significant assets. Our estimates based on data reported on the balance sheets of the Form 990 returns adjust for this fact as follows.5 First, we remove all property reported on balance sheets of individual nonprofits that has a reported value of $100 million or more and that is reported as owned by any nonprofit that is not engaged in land/building-intensive activities. We define “land/building-intensive activities” to include higher education, hospitals, and arts and cultural institutions. We then take the total amount of such property reported nationally, and distribute it back to each state in proportion to the number of nonprofits located in a state. The effect of this adjustment is to spread out potentially taxable property owned by large nonprofits in multiple jurisdictions more evenly among the states, instead of attributing the value of all such property to the state or city in which the national headquarters of the nonprofit is located. A further adjustment reduces the basis value of land, buildings, and equipment to reflect the fact that equipment is generally not subject to local property taxes. The adjustment factor is 10 percent, based on the breakdown of real estate and equipment estimated to be owned by nonprofits in the Federal Reserve Board Flow of Funds. To estimate the amount of potentially taxable nonprofit property in each state we also need to deal with the fact that not all property owned by 501(c)(3) organizations is automatically exempt from taxation. As a crude adjustment, we assume that one-half of the Federal Reserve Board national-level estimate of real estate owned by nonprofits in 2003 is exempt from tax. We then take this number and allocate it among the states in proportion to each state’s share of the total book value of land and buildings reported on Form 990 returns filed in 2003. This amount is then multiplied by the highest effective property tax rate for commercial property in each state, as reported by the Minnesota Taxpayers Association (2007), to estimate the potential fiscal impact of the nonprofit exemption at the state level. Even under the admittedly unrealistic assumption that each state exempts the same proportion of nonprofit property, one would still expect to find variation in fiscal impact among jurisdictions due to variation in the relative importance of exempt nonprofit property in the overall property tax base. Using the methodology outlined above, the estimated fiscal impact ranges between just under 1.5 percent and just over 10 percent of property tax revenues, with an overall average of 5 percent. (Because of the crude nature of these estimates, we 5. The National Center on Charitable Statistics/PRI Nonprofit Organization Database digitized Form 990 returns for 2003. We have relied on this source.

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do not present the estimated fiscal impacts for any single state.) This estimated range is broadly consistent with the range of fiscal impacts reported in Table 9.2.

Some Measurement Issues Each of the estimates presented above has its own limitations. In using estimates of fiscal impact at the state level (Table 9.2), one is implicitly relying on the methods used by state budget analysts to make their calculations. However, even states (such as Wisconsin) that make a serious effort to estimate the assessed value of nonprofit property note that such estimates are likely to be subject to error, as evidenced by the following quote: There are several limitations to the estimates provided in this chapter. First, the reported data are incomplete because reports from 248 taxation districts, which include 190 towns, 46 villages and 12 cities, had not been received by the time the report was prepared, and the value of exempt property in these districts had to be estimated. . . . Second, there may be systematic underestimation of exempt property values reported for at least two reasons: (1) a lack of knowledge of the value of often highlyspecialized property, which has not been on the market in many years and which is not likely to be offered for sale in the foreseeable future, and (2) a desire to minimize the perceived benefit of the tax exemption for political reasons. However, the data were not audited and, therefore, underestimation cannot be confirmed. Due to the limitations of these data, care should be taken in using them to represent exempt property values. Care should also be taken in comparing these data to prior years’ reports due to the changes in 1996 in reporting requirements and reporting forms. 6

The dollar figures reported in Table 9.1, and the range of impacts estimated directly from the IRS 990 data reflect an attempt to estimate the aggregate market value of real estate owned by nonprofit organizations, but the procedure used to make this estimate relies on several strong assumptions. Aside from the assumptions underlying the estimates of potentially taxable property, the fiscal impact calculation treats the effective property tax rate as the same across all jurisdictions within a state. Yet, in many states there is local variation in this rate. Such variation introduces an element of error in the distributional analysis, with the magnitude of the error depending on whether the localities are required by state governments to adopt uniform assessment practices and tax rates.

6. Wisconsin Division of Research and Policy (2007), 76.

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Painting a Statistical Portrait For all these reasons, as Cordes, Ganz, and Pollak (2002) have noted, these and other estimates of the nonprofit property tax expenditure resulting from the exemption of nonprofit property are best treated as indicating the order of magnitude of the fiscal impact of the property tax exemption for nonprofits, and not as providing exact estimates. Nonetheless, the results do suggest that exclusion of property owned by nonprofits from the tax base can have a measurable, if generally modest, fiscal impact. Policy Discussion Although many states have followed the federal government’s cue in exempting nonprofits from taxation, states are not obligated to do so. The arguments for and against the exemption are both economic and political in nature.

Base-Defining and Sovereignty The simplest argument in favor of excusing an entity from taxation is that it does not belong in the tax base.7 This so-called base-defining argument was first advanced by Bittker and Rahdert (1976), who argued that the exclusion of net income of nonprofit organizations from the federal income tax base should not be treated as tax expenditure, because it was never intended that nonprofit organizations should be taxable entities. Peter Swords (1981, 2002), extended this logic to the charitable property tax exemption: What we include in the tax base is money and wealth to provide funds to support the government. On the other hand, we choose not to tax money and wealth that we have turned over to entities that will use it to benefit the public only and not us individually (except as we are members of the public). We do not mean to include such money or wealth in the tax base in the first place. Such entities are what we define as charities: publicserving nonprofits that are proscribed from advancing private interests improperly and are established for the sole purpose of benefiting the community as a whole. (Swords 2002, 378)

Another rationale for the nonprofit property tax exemption is that nonprofit organizations are more like governments than businesses in both economic and political dimensions, and hence merit tax treatment comparable to what governments typically accord to other politically sovereign entities. Like

7. For a catalogue of pro-exemption economic arguments, see Steinberg and Bilodeau (1999).

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governments, nonprofits do not issue stock or distribute surpluses to private parties (Hansmann 1980). Both nonprofits and governments produce public goods (Weisbrod 1975); and federal and state governments frequently use nonprofits as agents to deliver services. Law professor Evelyn Brody (1998, 2002) has also argued that nonprofits are quasi-sovereign. “Tax exemption carries with it a sense of leaving the nonprofit sector inviolate, and the very concept of sovereignty embodies the independent power to govern” (Brody 1998, 588). The U.S. Supreme Court foreshadowed Brody in 1969 when it upheld property tax exemption of churches: “[Exemption] restricts the fiscal relationship between church and state, and tends to complement and reinforce the desired separation insulating each from the other” (Walz v. Tax Commissioners, 397 U.S. 664). Indeed, thirty-eight state constitutions make provision for tax exemption of various types of nonprofit property. Therefore, it is not far-fetched to classify charitable institutions as quasi-sovereign, and to view property tax exemption as a tool complementing and reinforcing a desired separation of government and the nonprofit sector, “insulating each from the other.” The counter-argument, however, to both the base-defining and sovereignty rationales is that if one accepts uniformity and universality as generally accepted principles of taxation, the burden of proof lies squarely on the owners of tax-exempt property to justify their exemption.

Subsidy A more explicit economic argument in favor of institutional property tax exemption is that society wants to encourage production of certain goods and services by subsidizing their producers. The 1983 Supreme Court decision in Regan v. Taxation with Representation, 461 U.S. 540, noted the equivalence between exemption and subsidy (Simon 1987), and the International Association of Assessing Officers (IAAO) defines exemptions from property taxation as “subsidies to certain owners for certain uses of property, to encourage publicly desired objectives” (1997, 16).8 Indeed, it is noteworthy that while basedefining arguments have had no impact on state property tax laws (Brody 1998, 2002), in states and local governments that do not grant property tax exemptions as a matter of right to nonreligious charities, the rationale for granting the exemption is that it provides a financial subsidy to institutions that provide community benefits.

8. Neither the Supreme Court nor the IAAO distinguished between exemptions of governmental entities and charitable exemptions.

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Assessing the Effectiveness of the Nonprofit Property Tax Exemption Viewing the nonprofit property tax exemption as a form of state subsidy, an obvious policy question is whether it is an equitable and effective one. To address this issue, it is important to recognize that the exemption only benefits nonprofits that own real property and that it does not directly subsidize nonprofit outputs; it is an input subsidy that lowers the cost of using real property (land and structures) to produce goods and services. These features of the nonprofit property tax exemption affect its performance as a nonprofit subsidy in several ways. As Cordes, Ganz, and Pollak (2002) note, most nonprofits do not own taxable property, and among those that do, the organizations that benefit most are those whose activities require a significant use of land and building inputs. Thus, the incidence of the tax benefits provided by the subsidy falls rather unevenly on nonprofits. Nonprofits that own real property benefit from the tax exemption, while nonprofits that do not either receive no benefit, or in some cases, may actually bear a cost if the effect of the exemption is to raise property tax rates on nonexempt property, and landlords of nonprofits who rent shift property taxes onto their tenants. A closely related issue is whether providing tax benefits to property-rich organizations targets these benefits on services received by less well-to-do members of the community. A principal justification for tax exemption of nonprofit hospitals, for example, is a popular notion that tax exemption of nonprofit property makes resources available to provide services to those who cannot afford to pay. However, a volume of essays measuring wealth redistribution within the various nonprofit subsectors (health, religion, education, and so on) finds little evidence that nonprofit organizations as a whole redistribute wealth, with the possible exception of higher education (Clotfelter 1992). Among nonprofits that do own potentially taxable property and hence benefit from the property tax exemption, its economic effect is twofold: (1) it induces them to substitute land and buildings for other resources in production; and (2) it allows the organization to produce the same level of output at lower cost or to produce more output, by lowering costs of production. The effect on output depends on the organization’s economic objective: maximization of surplus (the government/nonprofit analogue of profit), minimization of cost, maximization of output, or something else. There is little research and no consensus on what governments and nonprofits maximize. In the nonprofit context Steinberg (1986) and Brooks (2005) have considered surplus and output as candidates, finding that nonprofits do not maximize either unconditionally. If nonprofits and government seek to maximize output, lower input prices will increase output, but if they seek to maximize surplus, they

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will choose instead to produce any given level of output at a lower cost. Lowering the cost of using inputs such as land and buildings is thus not guaranteed to increase nonprofit output. These predicted economic effects from the property tax exemption, which operates indirectly by eliminating a tax liability on one particular input (real property), can be contrasted with the effects that would likely result if instead property owned by nonprofits were taxed, and local governments provided direct subsidies to nonprofit organizations based on their output of specific socially valued activities. In principle, such subsidies could be structured so that they (1) do not depend on how the socially desirable output is produced (e.g., with or without ownership of real property); (2) lead to increased output of the socially desired goods and services; and (3) are targeted on goods and services most likely to benefit low-income citizens. Preferential Assessments for Agricultural Use and Green Space In addition to exempting property owned by nonprofit organizations, state and local governments also use a variety of assessment practices in order to tax certain kinds of land based on current use value of the land rather than current market value, that is, the price the land would bring on the open market. This practice, often called preferential assessment or use value assessment, has a number of policy goals, including preserving farmland and open space, preventing urban sprawl, and assisting family farmers (Youngman 2005, 727). According to a recent survey of the 50 states’ use value assessment practices, 49 states (all except Michigan) do engage in preferential assessment of agricultural land (George Washington Institute of Public Policy–Lincoln Land Institute 2008).9 Some common practices among states include assessing agricultural land based on the income productivity of the land as it is currently being used, using a fixed rate per acre for calculating the tax, or using another methodology designed by the state. The overall effect of these methods is to value land at less than fair market value for tax purposes, in order to reduce the property tax burden on land that is not used in the most financially remunerative manner (that is, for development). This is especially true for land near urban areas where the market pressure to develop is high.

9. Rather than preferentially assessing agricultural land, Michigan provides tax assistance to farmers through state-funded income tax credits. Youngman (2005), 735.

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Administrative Structure of Preferential Assessment Although states have many different structures for preferential assessment programs, an IAAO use value assessment study for the state of Kansas classifies these structural procedures into three categories. First, states must establish eligibility requirements to determine what land qualifies and who may apply for use value taxation. Second, states must determine “the procedure for recovering tax savings when land no longer qualifies for use value.” Third, states must establish a method for determining the capitalization rate they will use to estimate value (International Association of Assessing Officers 2000, 34). In order to determine eligibility, many states use similarly structured programs to assess a variety of land types preferentially, which allows grouping these often diverse land groups into a single category. Some of the land uses qualifying land for preferential assessment include agricultural or farmland; conservation, open space, parks, or recreation; forest or timber production; and historic. States often further restrict lands that qualify by setting eligibility criteria including minimum or maximum size limits, or designation requirements (official recognition by a federal, state, or local agency that the property is an important resource worthy of protecting). The requisite designation may be a certification or the result of a formal review process initiated by the landowner and carried out by a federal, state, or local agency to demonstrate that the land meets certain eligibility criteria, possibly those of a separate program. States also may have programs requiring that the land, such as a forest, be covered by a management plan or environmental plan approved by some federal, state, or local agency, demonstrating that the landowner has a strategy for protecting the resource and ensuring its continued quality. Some programs require a landowner to dedicate the land to the target use (such as agriculture) for a number of years, or even permanently. This commitment is usually spelled out in the program description, but the multiyear commitment may also be implicit in provisions that penalize withdrawal of land from the program before a certain number of years have elapsed. GWIPP– Lincoln found that at least 18 states require either a specific future time commitment, or require that in order to receive the tax benefits the land already has been in the preferential use for a specified number of years (George Washington Institute of Public Policy–Lincoln Land Institute 2008). There are other assessment methodologies that require no more than an annual commitment to the target land use, made in conjunction with the filing of an annual property tax form or application. These programs may also contain provisions with a penalty for noncompliance (or disqualification) during the year for which the preferential assessment is requested. In either case, landowners can

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opt out of such annual programs by not applying for the preferential assessment, whereas programs that require an open-ended or “permanent” commitment do not allow landowners to opt out of the program without penalty. The determination and application of this penalty is the second part of the administrative structure states must address. Currently, 27 states have development penalties for taking the land out of agricultural use value programs, for at least one such state program (George Washington University–Lincoln Land Institute 2008). In order to value the land for tax purposes, states specify a particular valuation methodology. While the valuation methodologies vary by state, state practices can be grouped into some broad categories. • Income productivity of the land. One common approach is to develop a formula or set of guidelines which value land based on its estimated productivity, which in turn will depend on factors such as crops, soils present on the land, yields, or other site characteristics that influence actual or potential productivity. The formula may or may not refer to “income” productivity, but the valuation of the land is tied to how much of whatever resource it can produce, and the state must determine the method for capitalizing the income that the land is estimated to produce (see below for further discussion of capitalization rates). • Assessment ratio. This method values agricultural land as a flat or fixed percentage of fair market value (or some other taxable value). • Fixed dollar value or percentage of default (or baseline) valuation. This methodology assigns a specific dollar value per acre or unit, or a fixed percentage of market or other value, in order to calculate preferential assessment. • Exemptions/easements. These methods of determining relief include full or partial exemptions from property tax and permanent property tax relief for easements (a contractual agreement to retain the property for agricultural use). • Freeze assessments. This method of tax relief entails freezing the assessment value of a property to hold it at a constant level for a period of time, usually while historic property is being rehabilitated or brownfields are being restored. States will specify a time period for the assessment freeze, and may gradually bring the valuation back to market level. • Other state-devised formula. The state establishes a formula to be applied to land in the target use throughout the state. This can include classifications established by the state (as for land growing certain types of wood or crops), or differentiation by geography, or some other criterion, as long as the formula is set by the state. The alternative is for local property assessors to devise their own method. In this latter case, the state generally establishes guidelines to be considered by the local property appraiser.

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The income productivity methodology or some variant is the most common way of assessing land for use value taxation; currently 34 states use the income productivity of the land as a method to determine value for at least one agricultural use value program (George Washington University–Lincoln Land Institute 2008). Once a state chooses to use an income productivity methodology to value the land for tax purposes, it must determine the capitalization method for valuing the land based on its productivity. The IAAO study on Kansas use valuation notes that this is the third category of the administrative structure of a preferential or use value assessment program; and it is an area in which many states’ methods differ. While the general formula for calculating the value of an annual stream of income is used, states define the variables used in the formula differently.10 State-Level Estimates of Preferential Valuation Just as states’ administrative structures for use valuation programs are exceedingly complicated, so too is the task of determining how much land is covered by these programs, the value of such land, and the tax expenditure (revenue loss) to the government due to the preferential assessment. A major obstacle to measuring the amount of land or the value of land that is preferentially assessed is limited government resources. In order to collect and analyze the data, property tax divisions would need to shift resources from other revenue collection activities into measuring the amount of money they are not collecting because of constitutional or statutory assessment limitations. John Anderson writes about the variation across states in use value assessments based on the variation of state statutes in authorizing assessment procedures (Anderson 1998). Anderson describes the way land is valued both before and after a property tax is levied and explains varying concepts of use value. In describing different approaches taken by individual states, he explains that agricultural use value could mean just the capitalized value of the land as measured by the capitalized agricultural income stream, or, more broadly, this capitalized value plus the option value of the potential of developing the land in the future. He notes that some states use the first, more restricted definition, while others adopt the broader definition. Still other states have no statutory definition. Perhaps the vaguest concept of use value cited by Anderson was that of Massachusetts, which allowed the assessor to use “personal knowledge, judgment and experience” (Anderson 1998).

10. For more detail on the differing methods states use to calculate the value of income from land, see International Association of Assessing Officials (2000), http://www.ksrevenue.org/pdf/finalreport.pdf.

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Fiscal Impact Table 9.3 presents some rough orders of magnitude of the impact of preferential treatment in several states. As in the case of the nonprofit property tax exemption, there is considerable variation in the reported fiscal impact. Minnesota estimates that it loses about $50 million in revenue to its preferential assessment programs; in Nebraska and Oregon, the fiscal impact is in the hundreds of millions of dollars (Minnesota Department of Revenue 2006b; Nebraska Department of Property Assessment and Taxation 2007;11 Oregon Department of Revenue 2007). And by its own estimate, Texas loses about $1.5 billion in revenue because of preferential assessment (Texas Office of the Comptroller 2007). A recent report on the assessment and classification procedures in Minnesota’s “Green Acres” agricultural use valuation program offers an example TABLE 9.3

State Data on Fiscal Impact of Land Use Value Programs Revenue Lost from Use Valuation for Agricultural Land

Amount of Land Enrolled in Use Value Programs

Minnesota (FY06)1 Green Acres Program

$42,800,000

3,000,000 acres

Open Space Land

$5,100,000

300 parcels

Metropolitan Ag Preserves Land

$2,600,000

190,000 acres

Nebraska2 (2006)

$145,858,255

46,146,038 acres

Oregon3 (2005–2007)

$181,000,000

15,600,000 acres

Texas4

$1,572,300,000

143,200,834 acres5

1

http://www.taxes.state.mn.us/legal_policy/other_supporting_content/2006_tax_expenditure.pdf; pages 184–185. Authors’ calculations (see text). http://pat.nol.org/researchReports/valuation/pdf/Compare05-06_State_Value_and _Tax_by_Subdiv_and_PropType_pressrelease_attachment.pdf; # of acres from 2006 Annual Report. http://pat. ne.gov/researchReports/annual/pdf/NE%20PA&T%20Annrpt2006%20part%202%20of%204%20Tables%2019A -19B%20State%20&%20Cnty.pdf. 3 From The Oregon tax expenditure budget. Does not include forest or open space. http://www.oregon.gov/DOR/ STATS/docs/ExpR05-07/Chapter2.pdf; page 291. 4 Revenue loss is projected for 2007. http://www.window.state.tx.us/taxinfo/incidence07/incidence07.pdf. 5 Number of acres reported in 2006 receiving special agricultural and timber evaluations; via e-mail communication with Texas State Comptroller’s Office. September 25, 2007. 2

11. In the case of Nebraska, where the fiscal impact was not calculated by the state, but where information was provided about taxable value and assessed value, the difference between taxable and assessed value was taken to equal the value of property on which tax is foregone, and this difference was multiplied by the applicable tax rate to estimate the nominal fiscal impact.

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of some of the challenges that can arise in valuing land set aside for agricultural use. The Minnesota Department of Revenue (2006a) states that “current and reliable data [do] not exist, or [are] not readily available, which identifies the production potential of agricultural land in a way that is applicable for agricultural value/green acres purposes.” Specifically, the report notes that at the program’s inception the land enrolled generally surrounded the seven major metropolitan areas of the state, making it easier to assess for agricultural use purposes because the nonagricultural influences on the land were basically due to development. Since then, the enrolled territory has expanded to include 43 counties and the nonagricultural influences are more diverse and harder to quantify, encompassing such nondevelopmental uses as hunting, recreation, and investment (Minnesota Department of Revenue 2006a). These additional uses make it harder to assess the land for agricultural purposes. Policy Discussion As in the case of the exemption of nonprofit property, questions have been raised about the value of preferential assessment programs. These include an evaluation by Jane Malme (1993) of preferential assessment in the mid 1990s, when loss of farm acreage as well as farmland conversion was a continuing trend, signaling that property tax relief for such land was not achieving its goals. A decade later, Russell Kashian (2004) observed that preferential assessment programs often attempt to meet multiple goals for varying constituencies, and as such “consideration of success [is] mired in group expectations.” Joan Youngman (2005) also cautioned that “there is also much uncertainty as to whether specific policies such as preferential property taxes actually help achieve larger goals, such as long-term preservation of farmland.” It is thus not surprising that of the four states that actually review the effectiveness of tax expenditures in their own tax expenditure reports, only Oregon discusses use value, offering a brief review that gives mixed marks to the use value preferences that are examined.12 Kashian (2004) notes that one consequence of preferential assessment is the accumulated benefit to land speculators who buy farmland, hold on to it with reduced property taxes, and then sell it when it is most profitable to do so. Youngman (2005) highlights several specific examples of property tax breaks given to developers and builders waiting to build malls and subdivisions through use value assessment. As Youngman notes, this occurs in states that do

12. Oregon Department of Revenue (2007, 100), http://www.oregon.gov/DOR/STATS/docs/ExpR05-07/ Chapter2.pdf.

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not differentiate between “family farms, corporate farms, hobby farms, and even land being prepared for subdivision and development.” Further adding to the problem, 15 states do not have development or “rollback” penalties for removing the land from use value assessment (Youngman 2005). As Youngman points out, long-term preservation is not ensured if farm owners are “free to sell their land for development at any time.” Development penalties notwithstanding, there is also fear that some use value programs close to the urban fringes actually encourage “leapfrog” growth even further into the countryside, all the while protecting the most profitable land for growth down the road (Youngman 2005). Youngman recommends some concrete measures to strengthen this widely popular program while ensuring that its benefits are properly targeted and its goals achieved. First, legislatures should craft a definition of the eligibility of land that “addresses the status of hobby farmers, developers, and agribusiness”; next, they should develop an “appropriate combination of incentives for covenants to retain land in agricultural use and penalties for withdrawal from the program”; finally, they should articulate a “role for regional planning in identifying land whose long-term preservation offers the greatest public benefit” (Youngman 2005). In a similar spirit, Kashian (2004) observes that researchers have found that preferential assessment programs are most successful when “implemented in conjunction with other preservation programs,” such as state grants, transfer of development rights, and the purchase of development rights. An Example of Development Rights: The Conservation Easement Given that one of the recommendations Kashian (2004) poses for improving the use of preferential assessment is for states to buy development rights of farmland from farmers, it is instructive to look at how a form of that mechanism—the conservation easement—is being used to by states to achieve policy goals similar to preferential assessment. Thomas Daniels (2001) describes the purchase of development rights as “the voluntary exchange of money in return for strong deed restrictions on property.” In other words, the actual agreement, an easement, confers a legal status that involves the right to do or prevent something on the real property of another person. A conservation easement is simply one example. Agricultural conservation easements specifically promote farming of the land, often by requiring that the land be farmed as a condition of the easement. New York was the first state to pioneer the use of development rights in the 1970s, and has since purchased about $31 million worth of easements on over 6,000 acres from both speculators and farmers (Daniels 2001). According to

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TABLE 9.4

Land Held in Conservation Easement State

With Nature Conservancy

With Other Local and Regional Land Trusts

Total Acres

AZ

42,193

43,447

85,640

AK

3,750

700

4,450

DE

847

ID

25,370

25,798

51,168

IA

1,757

6,689

8,446

KY

11,300

11,300

ME

1,500,000+

1,500,000+

MA

135,845

135,845

847

MS

34,996

MT

232,325

1,400,000

1,632,325

NM

266,630

76,167

342,797

NY

99,000

685,000

784,000

OH

490

24,129

24,619

31,000

31,000

115,861

118,915

TN

13,177

13,177

UT

43,833

43,833

368,000

402,000

17,750

17,750

35,425

275,381

OR PA

VT

3,054.50

34,000

WV WY Total these 20 states

239,956

34,996

4,018,490

Compiled from state fact sheets. http://www.nature.org/aboutus/howwework/conservationmethods/privatelands/ conservationeasements/about/art15087.html.

The Nature Conservancy’s Web site, “The National Land Trust Census in 2000 found that local and regional land trusts have protected more than 6.2 million acres of open space, an area twice the size of Connecticut. Of this, nearly 2.6 million acres have been protected by conservation easements, almost a fivefold increase since 1990.” 13 Data from the Nature Conservancy’s Web site have been compiled in table 9.4.

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As Joan Youngman (2006) notes, there is no uniform definition of what specifically constitutes a conservation easement across states, though generally it is “an interest in the land that does not rise to the level of possession.” A landowner, who retains property rights and responsibilities, typically conveys an easement to an exempt organization, such as the Nature Conservancy or other land trust organization. Each easement is an agreement between the landowner and the land trust organization containing details on the specific activities that are or are not allowed on the land, such as building, public access, or timber cutting. The owner then expects reduced property tax liability, to reflect the limitation on the development potential of the property (Youngman 2006). The easement is generally viewed as a gift to a charitable organization, and the landowner pays taxes on the value of the land as reduced by the easement rather than the full market value. As previously noted, one of the reasons for the preferential assessment of property is to encourage open and green space, parks, and conservation generally. There is no standard way of treating easements in the property valuation and assessment process (Youngman 2006). The same difficulties that arise when assessors are trying to estimate the value of land that has not been sold on the open market for some time, or that is not used at its highest and best value, arise when determining the loss in market value that comes with an easement. Whereas most states have created formulas or specific methodologies to handle assessment of agricultural land, there is less of a standard for conservation easements. To begin to establish a standardized treatment of easements for assessment purposes, it is necessary to determine what their public benefits are, in order to evaluate the tradeoff of those benefits against their preferential property tax treatment. Youngman (2006) notes that judicial opinions on easements track changes in public opinion over the past five decades, with the benefits of open space becoming more widely recognized in recent years. Conservation easements may be a popular tool for conservation because they maintain local control over growth and agricultural traditions (King and Anderson 2004); however, one person’s public benefit is another’s unfair taking. Youngman (2006) notes that while many view the passing down of family land from one generation to the next as a benefit, others see the expenditure of 13. Nature Conservancy. How We Work: Conservation Methods—Conservation Easements—All About Conservation Easements. http://www.nature.org/aboutus/howwework/conservationmethods/privatelands/conserva tioneasements/about/allabout.html. For detailed fact sheets on easements across the United States, see How We Work: Conservation Methods—Conservation Easements—Conservation Easements Across the United States. http://www.nature.org/aboutus/howwework/conservationmethods/privatelands/conservationeasements/about/ art15087.html.

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public funds to maintain private legacies as an unjust hindrance to other families’ acquiring land. Further, she points out that in some cases, the public benefit of using some open-space land for parks and recreational purposes may have no relation to the market value of the land, as with land otherwise unsuited for development but with unimpaired value as open space. At other times, “backyard easement[s] may block valuable development but provide no significant public benefit.” Adding some empirical evidence to the debate, King and Anderson (2004) studied ten years of Vermont property tax data to look at the effects of conservation easements on towns’ property tax rates. They found that conservation easements increase taxes in the very short run, as previous studies have shown, but that they are tax neutral or tax diminishing in the long run. However, this may not mean lower tax bills for those with property nearest the easements, as the public good provided by the easement will be capitalized into the value of neighboring land, often increasing property assessments. While the public good of the easement and the land it protects may make the higher tax bills worth it for the nearby residents, King and Anderson note that fixed-income or immobile residents may be made worse off by the higher taxes (2004). The use of conservation easements has received much scrutiny in the past few years including renewed consideration in the courts. One of the main issues with such easements, as highlighted in a series of articles in the Washington Post in 2003, is the fact that many wealthy landowners are receiving major tax subsidies to enter into easements that did not affect what they would do with their property (Youngman 2006). As public finance experts well know, one of the main economic principles of tax policy is that tax breaks should be used to encourage behavior that otherwise would not have been engaged in, rather than subsidizing what citizens would have done anyway. From a policy perspective, it may not be the best use of public funds to give property tax breaks to landowners who simply maintain their land just as they otherwise would have; however, the legal viewpoint is that the landowners giving up rights should be compensated when their land is assessed for tax purposes. Youngman (2006) describes the logic on both sides of the debate, pointing out that limiting development on land in perpetuity does change the status and the market value of the land, affecting the rights of the landowner. On the other hand, some wealthier landowners seem to regard conservation easements as a status symbol, thereby providing fodder for the argument that easements increase property values.

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Conclusion Local governments pursue social as well as economic development goals through preferential property tax treatment based on use. This chapter has examined two important examples of such preferences: the widespread exemption of property owned by nonprofit organizations, and preferential tax treatment, mainly through preferential assessment of property, that is set aside for agricultural purposes and to create green spaces. Determining the magnitude of the effect of local property tax expenditures for social purposes is challenging for a number of reasons. Local assessors have weak incentives to assess the value of property that is legally exempt from taxation, and absent up-to-date estimates of assessed value, it is difficult to gauge how much revenue is foregone as a result of such exemptions. The incentive for valuing property that benefits from preferential assessment is stronger, because property values need to be assessed in order to apply the preference. However, constraints on local government resources limit estimates of the fiscal impact associated with reduced assessments for property that is set aside for agricultural and green space purposes. Despite these limitations, some states do make regular efforts to estimate the fiscal impacts from these preferences. In addition, a national data base of nonprofit organizations permits rough estimates to be made of the effect of the nonprofit property tax exemption. While these data do not provide precise estimates of the fiscal impact of preferential tax treatment of property used for social purposes, they do provide some indication of rough orders of magnitude. Our estimates, as well as those prepared by some states, suggest that the nonprofit property tax exemption may be responsible for an erosion in the local property tax base of as little as 1 percent to perhaps 10 percent. The estimates for preferential tax treatment based on use for agriculture and green spaces are considerably spottier; however, our limited estimates indicate a fiscal impact ranging from just under 1 percent of property tax revenues for the Green Acres Program in Minnesota to roughly 5 percent of property tax revenues in Nebraska, Oregon, and Texas. These estimated orders of magnitude indicate that for many states, there is a measurable fiscal impact associated with the pursuit of social objectives through the local property tax code. From a policy perspective the issue is whether the public and private benefits of such preferential tax treatment are commensurate with the revenue loss. Do the activities or entities receiving the subsidy merit subsidization on grounds of either economic efficiency or equity? Is preferential tax treatment the best mechanism for delivering the subsidy, from an economic, political, and administrative standpoint?

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Our analysis suggests that the answers are at best mixed. In any case, the first step to a useful evaluation of these preferential assessment programs is to analyze the data and determine current practices and their subsequent results for a better understanding of these significant property tax programs. We hope that this chapter is a useful first step in this direction. REFERENCES

Anderson, John. 1998. Measuring use-value assessment tax expenditures. From Lincoln Institute of Land Policy Web Site. Cambridge, MA. http://www.lincolninst .edu/subcenters/PVTL/dl/anderson.pdf. Bittker, Boris I., and George K. Rahdert. 1976. The exemption of nonprofit organizations from federal income taxation. Yale Law Journal 85:304–307. Bloom, Howard S., Helen F. Ladd, and John Yinger. 1983. Are property taxes capitalized into house values? In Local provision of public services: The Tiebout model after twenty-five years, ed. George Zodrow. New York: Academic Press. Bowman, Woods. 2001. The property tax exemption as an exit tax on capital. In Proceedings of the 93rd annual conference on taxation, National Tax Association, Santa Fe, New Mexico, November 9–11, 2000, 180–184. ———. 2002. Impact fees, an alternative to PILOTs. In The property tax exemption: Mapping the battlefield, ed. Evelyn Brody, 301–319. Washington, DC: Urban Institute Press. Brody, Evelyn. 1998. Of sovereignty and subsidy: Conceptualizing the charity tax exemption. Journal of Corporation Law 23(4):585–629. ———. 2002. Legal theories of tax exemption. In Property tax exemption for charities: Mapping the battlefield, ed. Evelyn Brody, 145–172. Washington, DC: Urban Institute Press. Brooks, Arthur. 2005. What do nonprofits seek? (And why should policymakers care?). Journal of Policy Analysis and Management 24(3):543–558. California Legislative Analyst’s Office. 1999. California’s tax expenditure programs. Sacramento. http://www.lao.ca.gov/1999/tax_expenditure_299/tep_299_contents .html. Clotfelter, Charles, ed. 1992. Who benefits from the nonprofit sector? Chicago: University of Chicago Press. Cordes, Joseph J., Marie Ganz, and Thomas Pollak. 2002. What is the property-tax exemption worth? In Property tax exemption for nonprofits: Mapping the battlefield, ed. Evelyn Brody, 81–112. Washington, DC: Urban Institute Press. Daniels, Thomas L. 2001. Coordinating opposite approaches to managing urban growth and curbing sprawl: A synthesis. Special Issue, American Journal of Economics and Sociology 60:1. Federal Reserve System Board of Governors. 2007. Flow of funds accounts of the United States. Washington, DC. September.

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George Washington Institute of Public Policy–Lincoln Land Institute. 2008. Property Tax Compendium Project. Hansmann, Henry. 1980. The role of nonprofit enterprise. Yale Law Journal 89(5):835– 901. International Association of Assessing Officials. 1997. Standard on property tax policy. Chicago. ———. 2000. Property valuation: IAAO use valuation study. Topeka. http://www. ksrevenue.org/pdf/finalreport.pdf. Kashian, Russell. 2004. State farmland preferential assessment: A comparative study. Journal of Regional Analysis & Policy. 34(1):1–12. http://www.jrap-journal.org/ pastvolumes/2000/v34/34-1-1.pdf. King, Jonathan R., and Christopher M. Anderson. 2004. Marginal Property Tax Effects of Conservation Easements: A Vermont Case Study. American Journal of Agricultural Economics. 86(4): 919–932. Malme, Jane. 1993. Preferential property tax treatment of land. Working Paper, Lincoln Institute of Land Policy, Cambridge, MA. http://www.lincolninst.edu/ subcenters/valuation_taxation/dl/malme_2.pdf. Minnesota Department of Revenue. 2006a. Assessment and classification practices report (April 12). http://www.taxes.state.mn.us/property/other_supporting_content/ ga_report_final.pdf. ———. 2006b. Minnesota tax expenditure budget fiscal years 2006–2009. February. http://www.taxes.state.mn.us/legal_policy/other_supporting_content/2006_tax _expenditure.pdf. Minnesota Taxpayers Association. 2007. 50 state property tax comparison study. Saint Paul. National League of Cities. http://www.nlc.org/about_cities/cities_101/154.cfm. Nature Conservancy. How We Work: Conservation Methods—Conservation Easements—Conservation Easements Across the United States. http://www.nature .org/aboutus/howwework/conservationmethods/privatelands/conservationeasements/ about/art15087.html. ———. How We Work: Conservation Methods—Conservation Easements—All About Conservation Easements. http://www.nature.org/aboutus/howwework/conservation methods/privatelands/conservationeasements/about/allabout.html. Nebraska Department of Property Assessment and Taxation. 2006. 2005 & 2006 comparison (December 13). http://pat.nol.org/researchReports/valuation/pdf/ Compare05-06_State_Value_and_Tax_by_Subdiv_and_PropType_pressrelease _attachment.pdf. ———. 2007. 2006 annual report. http://pat.ne.gov/researchReports/annual/pdf/NE %20PA & T %20Annrpt2006 %20part %202 %20of %204 %20Tables %2019A 19B %20State%20&%20Cnty.pdf. Oregon Department of Revenue. 2007. 2005–2006 State of Oregon tax expenditure report. http://www.oregon.gov/DOR/STATS/exp05-07-toc.html.

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Simon, John G. 1987. The tax treatment of nonprofit organizations: A review of federal and state policies. In The nonprofit sector, ed. Walter W. Powell. New Haven, CT: Yale University Press. Steinberg, Richard. 1986. The revealed objective functions of nonprofit firms. Rand Journal of Economics, 17(4):508–526. Steinberg, Richard, and Marc Bilodeau. 1999. Should nonprofit organizations pay sales and property taxes? Washington, DC: National Council of Nonprofit Associations. Swords, Peter. 1981. Public benefit real property tax exemptions in New York State. New York: Association of the Bar of the City of New York. ———. 2002. The charitable real property-tax exemption as a tax base-defining provision. In Property tax exemption for nonprofits: Mapping the battlefield, ed. Evelyn Brody, 377–379. Washington, DC: Urban Institute Press. Texas Office of the Comptroller. 2007. Tax incidence report (February 28). http:// www.window.state.tx.us/taxinfo/incidence07/incidence07.pdf. Weisbrod, Burton. 1975. Toward a theory of the voluntary sector in a three-sector economy. In Altruism, morality and economic theory, ed. E. S. Phelps, 171–195. New York: Russell Sage Foundation. Wisconsin Division of Research and Policy, Department of Revenue. 2007. Summary of tax exemption devices. http://www.dor.state.wi.us/ra/07sumrpt.pdf. Youngman, Joan. 2005. Taxing and untaxing land: Current use assessment of farmland. State Tax Notes 37: 10 (September 5). ———. 2006. Taxing and untaxing land: Open space and conservation easements. State Tax Notes 41:11 (September 11).

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COMMENTARY

JULIA FRIEDMAN

B

owman, Cordes, and Metcalf investigate the fiscal impacts and public policy implications of preferential property tax incentives used by state and local governments to pursue social as well as economic development goals in two broad areas: support of local nonprofit organizations and encouraging the preservation of land used for agricultural purposes and set-asides to create green spaces. No matter which particular policy tool is used to provide preferential treatment to certain land uses or owners, the net result is to shift more of the burden of financing government to properties that do not receive such preferential treatment. While the authors recognize the serious challenges of estimating the fiscal impact of such programs, they use the best available data to estimate that such preferences reduce property tax revenues by from 1.4 to 15.8 percent across the fifty states. The authors conclude that regardless of the economic or political arguments for or against preferential assessment programs, the information needed to provide a useful evaluation of their fiscal impact and effectiveness is extremely limited. State and local governments need to collect and analyze better data if we are actually to understand current practices and their results. The chapter presents a simple equation that provides a framework for analyzing how such preferential treatment can be given and what impact it might have across individual properties. Specifically, according to Bowman, Cordes, and Metcalf, the full market value of a property, Vik, can be used in conjunction with the ratio of assessed value to full market value ak, which reflects local assessment practice, and the statutory tax rate in the community to determine the tax liability for each individual property. This is given by the formula Tik = tkakVik. This simple accounting framework displays three policy levers available for preferential taxation. Parcels, individually or by class, receive tax benefits by preferential rates, preferential assessment, and partial or full exemptions. This same equation can be used to examine the impact of policy choices on any preferred property uses. Because the real property tax is generally agreed to 295

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be the most disliked of all taxes, it is important to formulate real property tax policy according to the highest standards. Principles for good tax policy include: 1. As much transparency as possible, so that taxpayers understand what their tax burden is and how it compares to others. We assume this is best achieved through tax rates that are representative of actual tax burdens and effective tax rates. 2. As much economic neutrality as possible, so that taxation interferes as little as possible with economic decisions. We assume this happens when property owners have little or no incentive to alter real property to avoid tax burdens. 3. As little administrative burden as possible, to reduce the cost of collecting the revenue and to reduce incentives of individual property owners to try to game the tax administration. This implies that administrators rely little on judgment calls. 4. As much equitable treatment as possible, so that those with least ability to pay have lower payment obligations. 5. As much conformity as possible to other social values, such as avoiding taxation of religious and educational institutions. In the chapter, the authors address how tax exemptions for socially favored real property uses can help implement this last principle, and how much additional tax on other uses is needed to make up for this favoritism. We can start by illustrating the same situation with a simple construct built from the equation above. Table 9.1C presents a tax district with three properties: two homes and a church. The hypothetical baseline is a rate of 1 percent of market value. If all three properties are taxed at this rate, the revenue generated is $13,000. Thus, Rate ⫻ Market Value = Revenue. In each of the three cases that follow the hypothetical baseline, the church is exempt from tax and tax burdens on the homes are increased to 1.625 percent to generate the same $13,000. The approach in Case 1 is to provide an exemption equal to the market value of the church, in Case 2 the tax rate on church real estate is dropped to 0 percent, and in Case 3 the taxable value of the church is calculated as 0 percent of market value. In each of the three cases, the revenue outcome is the same. In Cases 1 and 3, however, the announced tax rate on the church is also 1.625 percent; other calculations have reduced the tax due on the church property to $0. In case 2 the taxable value of the church remains as originally determined, but the tax rate is acknowledged to be 0 percent. Arguably case 2 provides more transparency and may be considered better tax policy.

600,000

High Value Home

–

–

1,300,000

600,000

500,000

200,000

600,000

High Value Home

1,300,000

500,000

Church

Total Tax

200,000

Low Value Home

Market Value

–

500,000

–

Exemption

800,000

600,000

–

200,000

Taxable Value

Case 1. Tax Relief for Church by Exemption from Market Value

1,300,000

500,000

Church

–

Taxable Value

1%

1%

1%

Base Tax Rate

1%

1%

1%

Base Tax Rate

8000

6,000

–

2,000

Baseline Tax

13,000

6,000

5,000

2,000

Baseline Tax

1.625%

1.625%

1.625%

Revised Tax Rate

13,000

9,750

–

3,250

Final Tax

(continued)

1.625%

0.000%

1.625%

Effective Tax Rate

10:45 AM

Total Tax

200,000

Exemption

4/4/09

Low Value Home

Market Value

Baseline Case: 2 Homes and 1 Church Baseline: All Real Property Value is Taxed

Tax Exemption for Religious Purposes

TABLE 9.1C

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600,000

High Value Home

–

–

1,300,000

600,000

500,000

200,000

Taxable Value

600,000

High Value Home

1,300,000

500,000

Church

Total Tax

200,000

Low Value Home

Market Value

–

–

–

Exemption

800,000

600,000

–

200,000

Taxable Value

1%

1%

1%

Base Tax Rate

1%

0%

1%

Base Tax Rate

8,000

6,000

–

2,000

Baseline Tax

8,000

6,000

–

2,000

Baseline Tax

1.625%

1.625%

1.625%

Revised Tax Rate

1.625%

0.000%

1.625%

13,000

9,750

–

3,250

Final Tax

13,000

9,750

–

3,250

1.625%

0.000%

1.625%

Effective Tax Rate

1.625%

0.000%

1.625%

10:45 AM

Case 3. Tax Relief for Church by Assessing at 0% of Market Value

1,300,000

500,000

Church

–

Exemption

4/4/09

Total Tax

200,000

Low Value Home

Market Value

Case 2. Tax Relief for Church by Assigning 0% Tax Rate

TABLE 9.1C (c ontinue d )

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Commentary

299

Proceeding in this way aids in more complex analysis. Consider, for example, the policy goal of providing preferential tax treatment to owners of homestead property that is valued below the area median. The tax preference could be supplied by taxing lower-valued homestead property at lower rates than other homesteads, or by assessing lower-valued homesteads at lower shares of market value than higher-valued homesteads, or by exempting a portion of market value from taxation for all homestead properties (offering a greater percentage of relief for lower-valued homes than for higher-valued homes), or by other means. Table 9.2C shows a hypothetical approach to considering tax relief policies from these various perspectives. This second hypothetical is more complex than that in Table 9.1C, but easy enough to follow. Table 9.2C has a tax district with seven homestead properties, a store and the church (which is tax exempt here, as in the previous example). In the baseline, taxable properties are taxed at a revised rate of 1.143 percent of full market value and $40,000 in revenue is generated; this is after accounting for the full exemption of the church property.1 The policy goal is to reduce the tax paid by homesteads with market value less than $250,001. Six different approaches to achieving that goal are shown in the six cases. Each approach produces a different result. When the approaches are evaluated according to the principles for good tax policy set forth above, Case 5 appears to illustrate the best policy approach to reducing the burden on lower-valued homes in this example. Not all methods of awarding tax preference are equal. In Case 1, owners of homesteads worth $250,000 or less pay tax on 85 percent of market value; all other property is taxed on 100 percent of market value. This appears to be bad policy. The outcome is not transparent (revised tax rates do not reflect relative tax burdens); the policy creates administrative burdens because of the new incentive to challenge assessments on property just over the $250,000 mark; by the same token, it creates a disincentive to maintain or improve homes just under the $250,000 level, to avoid the threshold where taxes jump by $375 when the value of the property increases to $250,001. Case 2 reduces the tax rate by 15 percent for homes worth $250,000 and less. It is transparent—tax rates reflect actual tax burdens. However, the other disadvantages of Case 1—the threshold, the disincentives, and the administrative burden—remain in place. Case 3 exempts the first $50,000 of market value for all homes. Because the exemption is large, low-valued property gets some small benefit from the 1. If the church property were taxable, all property would be taxed at the 1 percent rate and $40,000 would be generated. To raise $40,000 after exempting the church, the revised tax rate on taxable property becomes 1.143 percent.

200,000

250,000

250,001

350,000

500,000

600,000

700,000

999,999

Low Value Home

Median Value Home -$1

Median Value Home

Average Value Home

Church

High Value Home

Store

Very High Value Home 4,000,000

999,999

700,000

600,000

500,000

350,000

250,001

250,000

200,000

150,000

1%

1%

1%

0%

1%

1%

1%

1%

1%

Base Tax Rate

35,000

10,000

7,000

6,000

–

3,500

2,500

2,500

2,000

1,500

Baseline Tax

150,000

200,000

Very Low Value Home

Low Value Home

Market Value

–

–

Exemption

170,000

127,500

Taxable Value

1%

1%

Base Tax Rate

1,700

1,275

Baseline Tax

Case 1: Relief through Assessing Tax on 85% of Market Value for Homesteads Below Median Value

–

–

–

–

–

–

–

–

–

Taxable Value

1.173%

1.173%

Revised Tax Rate

1.143%

1.143%

1.143%

0.000%

1.143%

1.143%

1.143%

1.143%

1.143%

Revised Tax Rate

1,994

1,496

Final Tax

40,000

11,429

8,000

6,857

–

4,000

2,857

2,857

2,286

1,714

Final Tax

0.997%

0.997%

Effective Tax Rate

1.143%

1.143%

1.143%

0.000%

1.143%

1.143%

1.143%

1.143%

1.143%

Effective Tax Rate

10:45 AM

4,000,000

150,000

Very Low Value Home

Exemption

4/4/09

Total Tax

Market Value

Baseline

Baseline Case: Seven Homestead Properties, 1 Church (tax exempt), and 1 Store

Six Approaches to Tax Relief for Low Value Homesteads

TABLE 9.2C

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350,000

500,000

600,000

700,000

999,999

Average Value Home

Church

High Value Home

Store

Very High Value Home

–

–

–

–

–

–

3,910,000

999,999

700,000

600,000

500,000

350,000

250,001

212,500

1%

1%

1%

0%

1%

1%

1%

34,100

10,000

7,000

6,000

–

3,500

2,500

2,125

250,000

250,001

350,000

500,000

600,000

700,000

999,999

Median Value Home -$1

Median Value Home

Average Value Home

Church

High Value Home

Store

Very High Value Home

4,000,000

200,000

Low Value Home

Total Tax

150,000

Very Low Value Home

Market Value

–

–

–

–

–

–

–

–

–

Exemption

4,000,000

999,999

700,000

600,000

500,000

350,000

250,001

250,000

200,000

150,000

Taxable Value

1.00%

1.00%

1.00%

0%

1.00%

1.00%

0.85%

0.85%

0.85%

Base Tax Rate

34,100

10,000

7,000

6,000

–

3,500

2,500

2,125

1,700

1,275

Baseline Tax

1.173%

1.173%

1.173%

0.000%

1.173%

1.173%

0.997%

0.997%

0.997%

Revised Tax Rate

1.173%

1.173%

1.173%

0.000%

1.173%

1.173%

1.173%

40,000

11,730

8,211

7,038

–

4,106

2,933

2,493

1,994

1,496

Final Tax

40,000

11,730

8,211

7,038

–

4,106

2,933

2,493

(continued)

1.173%

1.173%

1.173%

0.000%

1.173%

1.173%

0.997%

0.997%

0.997%

Effective Tax Rate

1.173%

1.173%

1.173%

0.000%

1.173%

1.173%

0.997%

10:45 AM

Case 2: Relief through Taxing Those Homesteads Below Median Value at 85% of the Base Tax Rate

4,000,000

250,001

Median Value Home

–

4/4/09

Total Tax

250,000

Median Value Home -$1

531-39116_ch01_7P.qxp Page 301

250,000

250,001

350,000

500,000

600,000

700,000

999,999

Median Value Home -$1

Median Value Home

Average Value Home

Church

High Value Home

Store

Very High Value Home 3,650,000

949,999

700,000

550,000

500,000

300,000

200,001

200,000

150,000

1.00%

1.00%

1.00%

0%

1.00%

1.00%

1.00%

1.00%

1.00%

Base Tax Rate

31,500

9,500

7,000

5,500

–

3,000

2,000

2,000

1,500

1,000

Baseline Tax

150,000

200,000

250,000

Very Low Value Home

Low Value Home

Median Value Home -$1

Market Value

–

50,000

100,000

Exemption

250,000

150,000

50,000

Taxable Value

1.00%

1.00%

1.00%

Base Tax Rate

2,500

1,500

500

Baseline Tax

Case 4: Relief through Graduated Exemption Equal to $250,000 × (1 − Market Value/Median Value)

50,000

–

50,000

–

50,000

50,000

50,000

50,000

100,000

Taxable Value

1.194%

1.194%

1.194%

Revised Tax Rate

1.270%

1.270%

1.270%

0.000%

1.270%

1.270%

1.270%

1.270%

1.270%

Revised Tax Rate

2,985

1,791

597

Final Tax

40,000

12,063

8,889

6,984

–

3,810

2,540

2,540

1,905

1,270

Final Tax

1.194%

0.896%

0.398%

Effective Tax Rate

1.206%

1.270%

1.164%

0.000%

1.088%

1.016%

1.016%

0.952%

0.847%

Effective Tax Rate

10:45 AM

4,000,000

200,000

Low Value Home

50,000

Exemption

4/4/09

Total Tax

150,000

Very Low Value Home

Market Value

Case 3: “Relief” through Exempting the First $25,000 of Homestead Market Value from Taxation

TABLE 9.2C (continued)

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500,000

600,000

700,000

999,999

Church

High Value Home

Store

Very High Value Home

–

–

–

–

–

3,850,000

999,999

700,000

600,000

500,000

350,000

250,001

1.00%

1.00%

1.00%

0%

1.00%

1.00%

33,500

10,000

7,000

6,000

–

3,500

2,500

1.194%

1.194%

1.194%

0.000%

1.194%

1.194%

250,000

250,001

350,000

500,000

600,000

700,000

999,999

Median Value Home -$1

Median Value Home

Average Value Home

Church

High Value Home

Store

Very High Value Home

4,000,000

200,000

Low Value Home

Total Tax

150,000

Very Low Value Home

–

–

–

–

–

–

–

–

–

Exemption

4,000,000

999,999

700,000

600,000

500,000

350,000

250,001

250,000

200,000

150,000

Taxable Value

1.00%

1.00%

1.00%

0%

1.00%

1.00%

1.00%

0.80%

0.60%

Base Tax Rate

34,000

10,000

7,000

6,000

–

3,500

2,500

2,500

1,600

900

Baseline Tax

1.176%

1.176%

1.176%

0.000%

1.176%

1.176%

1.176%

0.941%

0.706%

Revised Tax Rate

40,000

11,765

8,235

7,059

–

4,118

2,941

2,941

1,882

1,059

Final Tax

40,000

11,940

8,358

7,164

–

4,179

2,985

(continued)

1.176%

1.176%

1.176%

0.000%

1.176%

1.176%

1.176%

0.941%

0.706%

Effective Tax Rate

1.194%

1.194%

1.194%

0.000%

1.194%

1.194%

10:45 AM

Market Value

Case 5: Relief through Graduated Rates for Low-Valued Homes Equal to {1% × (Market Value/Median Value}

4,000,000

350,000

Average Value Home

–

4/4/09

Total Tax

250,001

Median Value Home

531-39116_ch01_7P.qxp Page 303

250,000

250,001

350,000

500,000

600,000

700,000

999,999

Median Value Home -$1

Median Value Home

Average Value Home

Church

High Value Home

Store

Very High Value Home –

–

–

–

–

–

–

–

–

4,000,000

999,999

700,000

600,000

500,000

350,000

250,001

250,000

200,000

150,000

Taxable Value

1.00%

1.00%

1.00%

0%

1.00%

1.00%

1.00%

0.80%

0.60%

Base Tax Rate

34,000

10,000

7,000

6,000

–

3,500

2,500

2,500

1,600

900

Baseline Tax

1.000%

1.857%

1.000%

0.000%

1.000%

1.000%

1.000%

0.800%

0.600%

Revised Tax Rate

40,000

10,000

13,000

6,000

–

3,500

2,500

2,500

1,600

900

Final Tax

1.000%

1.857%

1.000%

0.000%

1.000%

1.000%

1.000%

0.800%

0.600%

Effective Tax Rate

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4,000,000

200,000

Low Value Home

–

Exemption

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150,000

Very Low Value Home

Market Value

Case 6: Relief through Graduated Rates for Low-Valued Homes, Paid for by Higher Rates on Stores

TABLE 9.2C (continued)

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policy; if the exemption were smaller, say $25,000, then smaller homes would actually pay more after the credit and revenue neutrality. Also in Case 3, the effective tax rate on the store becomes higher than the effective rate on any of the homes, creating some disincentive to use real property for commercial purposes. In the hypothetical, this is not an efficient approach for delivering tax relief to low-valued properties. Case 4 offers an exemption only to homes valued at $250,000 or less and the exemption declines as value nears the target amount. This approach has Revised Tax Rates that fail to reflect effective tax burden. The “shelf” effect identified in Cases 1 and 2, however, is gone and owners have no incentive to try to stay just under the target amount. Case 5 would tax low-valued homes at lower rates, based on a sliding-scale tax rate that phases to the full tax rate at the target home value of $250,000. This case is transparent (the revised tax rate is an accurate reflection of the relative tax burden) and there is no threshold or undue administrative burden. Taxpayers may have trouble understanding what their tax rate will be, however. Case 6 is a variant of Case 5, making up for the revenue loss from the slidingscale tax rate by increasing the tax rate on the store. Owners with homes valued above the target pay no more tax. This approach is transparent. The administrative burden is higher because assessors must determine how the property is used in order to calculate the tax liability. The approach creates an economic disincentive to use real property for commercial purposes. The point in Table 9.2C is not to find a best solution. The point is to illustrate ways of thinking about better and worse solutions. The construct provided by Bowman, Cordes, and Metcalf is a perfect starting point. In combination with principles for evaluating tax policy, and improved data, it can be very useful for tax policy makers at the state and local level.

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10 The Politics of the Property Tax Base JOHN F. WITTE

T

here is a grand irony in tax policy. Regardless of historical time period, the form of tax, and ideology or partisan proclivity, tax policy experts generally agree on the principles of ideal tax systems. An ideal tax system should be 1. broad-based and uniformly applied, devoid of exemptions, exclusions, special rates, or special provisions; 2. neutral in terms of taxing economic activity; 3. fair in terms of horizontal equity, and at least not regressive; 4. efficient to administer; 5. simple in its provisions; and 6. accountable in a democratic system. However, in practice, tax systems are often 1. narrowly based, with differential treatment between taxpayers, and rife with exemptions, exclusions, special rates, and provisions; 2. biased in effective rates for or against different economic sectors; 3. abusive of horizontal equity, and often of vertical equity; 4. more expensive to administer than any ideal structure; 5. hopelessly complex; and 6. seemingly divorced from democratic accountability.

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But usually in the developed world, tax systems still produce enough revenue to satisfy government demands. So tax systems are imperfect in comparison to an agreed ideal. This chapter analyzes the property tax in the United States in light of that basic premise. The heart of the chapter analyzes the political factors and forces that produce our imperfect system. The underlying problem and result are crucial to policy makers in that they put considerable stress on a tax that remains a core source of revenue for local governments. While the theoretical derivation and deviation from the ideal are of interest to academics, the results are important for citizens and their political leaders. The first section of the chapter defines the ideal principles of taxation as applied to the property tax and how those principles are violated by common constraints on the property tax across the country. The second section describes the political factors and pressures on the property tax that lead to extremely suboptimal results. The third section considers a set of empirical facts and case studies exemplifying why property taxes deviate so far from the ideal. The final section speculates on what, if anything, might be done to reorient the property tax in the direction of the ideal model. Property Tax Principles and Reality The principles on which an ideal property tax would be constructed are very similar to the principles that apply to ideal income, sales, and value-added taxes. I listed them above and now discuss them in relation to property taxes. Characteristics of an Ideal Property Tax

Broad-Based Restricting the concept of property to real, land-based, tangible property (and not private possessions or wealth which were at one time taxed in many locales), an ideal property tax would include all forms of property in a geographic region. That would include land and structures for residential property, and land, structures, and other income-producing items for commercial property.1 Agricultural property would ideally be split between its residential use and business use with each component listed separately. Government-owned properties would probably not be included because the revenue production would be redundant. Not-for-profit and charitable properties would be included.

1. That would be particularly true if assessed values of commercial property are based on some form of income flow from the property. See Fischer (1996, 193–194) for a discussion of assessment methods.

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Neutral Property tax assessment and levy rates should be consistent across varying types of economic activity. This applies to different business sectors (finance, manufacturing, retail, real estate, and agriculture). It also applies to economic activities that require different levels of labor, capital (financial and human), or land. Thus educational facilities, banks, agricultural land, and economic development activities should be exposed to the same property tax rates. Fair Although there is considerable debate about the degree of vertical equity that is desirable in a tax system, few would argue for effective tax rates that are regressive. Also, it is difficult on the face of things to argue against horizontal tax equity, or the proposition that those with similar economic circumstances should pay the same tax rates. Both of these conditions would apply to an ideal property tax.2 Efficient An ideal property tax system would be efficient to administer, as measured by minimizing the ratio of the cost of the compliance to revenue. This would imply minimal administrative and monetized compliance costs for citizens. For the property tax this would include minimizing costs of assessing property, billing taxpayers, handling appeals, and collecting the taxes due. From the perspective of citizens this would mean limiting time on appeals and payment procedures. Simple Simplicity in property tax systems would involve uniformity in assessment procedures and methodologies and minimizing special exclusions, exemptions, deductions, credits, and delayed timing provisions. Many of these special provisions require citizen data and applications, as well as administrative approval, guidance, oversight, and audit. Accountable A tax system should respond to the preferences of the public. And in a representative democracy, the will of constituents on tax matters should be translated into tax policy. These various characteristics of ideal tax systems are not independent. Rather, their rationales fit together into a fairly compact theoretical system. A broadbased system is the key. If that condition could be met, it would be neutral in the 2. For a more complicated discussion of the difficulty of specifying either vertical or horizontal equity, see Witte (1976), Chapter 2.

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sense that different economic factors would not be specially privileged, as they would for example if certain types of economic assets are given special treatment. Similarly, expanding specialized tax provisions that erode the base adds to complexity and the cost of administration while undercutting a sense of fairness understood as equal treatment for all taxpayers. In a broad-based system with a common asset base (rather than multiple property classifications), equivalent assessment methods, and common rates across all property, all of the criteria described above are maximized. Thus the theoretical rationale for the system of principles above is strong. That is why so many tax experts agree, more or less, on the criteria and the best way to achieve them. The problem, which will be addressed in the rest of this chapter, is why the reality of the property tax ends up so far from each principle. And a key question will be whether property tax systems, as they have developed, are accountable in a democratic sense or not. If they are, the deviation from the ideal is inherent in the democratic process itself, and if the ideal is to be pursued, the implications lead to increasing insulation of tax policymaking from democratic procedures. The Reality of Property Tax Systems Obviously property tax systems vary considerably across the United States. They vary enormously between states, and within states. State laws govern much of what is allowed within a property tax system, but local governments often retain control over the use of options, administration, and rates and levies. For example, states may allow tax credits for historic building renovation, but if local districts do not designate buildings as historic, no credit will be granted. Similarly, local districts may chose not to allow Tax Incremental Finance (TIF) districts even if allowed by state law. Despite this heterogeneity, there are enough common deviations from the ideal tax system outlined above to deserve description, analysis, and discussion of possible remedies. Table 10.1 portrays deviations from that ideal system along two important dimensions. The first is the type of benefit, varying from “particularistic” to broad-based or universal. Particularistic beneficiaries are identifiable as specific groups of individuals defined by membership in specific organizations or participation in specific economic activities (such as farming), or membership in or clear demographic groups (for example, the elderly poor). The second dimension is the range of provision of the statute. Particularistic benefits can be very narrow (applying to specific individuals or businesses), or broad yet applying to specific groups (e.g., all charitable organizations). The benefits dimension is meant to be continuous so that items spaced closer to an end point will more

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TABLE 10.1

A Taxonomy of Property Tax “Expenditures” Provisions

Benefits Particularistic

Narrow

Broad-based/Universal

Country Club Exclusions Individual Exclusions Forestry Districts

Tax Incremental Finance Districts

Historic Districts

Economic Development Districts

Special Agriculture Rates Farmland Preservation Soil Conservation Exclusions Machinery and Equipment Exemptions Nonprofit Exclusions Government Property Exclusions

Broad

Charitable Property Exclusions

Levy Limits

Low-Income and Elderly Limits

Caps on Increases

closely match that point. Thus, for example, country club provisions are very narrow in their specification compared to say a middle provision such as farmland preservation.

Narrowly Based The entries in Table 10.1, which are suggestive, not exhaustive, indicate that there are numerous, substantial property tax expenditures that erode any notion of a broad-based tax. The idea of property tax expenditures carries over from the federal income tax. The basic idea is that exemptions, exclusions, special credits, and the like are essentially tax subsidy programs for the identified activity or group. And as such they are the tax equivalent of an expenditure program. Thus a low-income circuit breaker property tax policy is the equivalent of providing a low-income support payment in the form of a check (or maybe as an Earned Income Tax Credit on the federal income tax). The problem is so significant for the federal income tax that a budget supplement is required by law to be reported each year.

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The range of property tax expenditures (exclusions, exemptions, caps, and limits) indicated in Table 10.1 suggests that any pure theory of a property tax base is idealistic. The attack on that broad base comes from many quarters: proponents of special districts (as with forestry exclusions), broad constituencies (such as the elderly, the poor, or farmers), many interests promoting economic development (advocates of TIFs, Economic Development Districts, or policies excluding manufacturing equipment); and all of us (as recipients of general caps and limits). In most cases changes that deviate from the ideal of a broad base are wellmeaning reactions to particular and time-specific problems or community needs. Thus, farmers will have an especially bad year or years and the always festering anger over high property taxes uncorrelated with income will push special agriculture assessment to the front of the agenda. Or industry and job loss will add to the continuous pressure to provide property tax relief for new or expanded businesses. What is perhaps most relevant is that all these changes accumulate and are rarely reversed. In this sense, the accumulation of policy choices becomes what Charles Anderson once termed “living policy museums” (Anderson 1963).3 It is thus the accumulation of incremental decisions that leads to the fragmented and confusing sets of policies and rules that is the modern property tax.

Nonneutral Neutrality means that taxes do not favor one economic activity or factor over another. It is impossible to determine the economic neutrality of property taxes systematically because they vary so much between states. Some states, like Wisconsin, have passed major benefits for agriculture, at the relative expense of homeowners. Other states have promoted economic development through urban development or TIF districts and other incentives. These favor capital formation. Overall there seems to be a total disregard in state legislatures for the idea that the property tax should be levied in an economically neutral manner. There are simply so many property tax expenditures that it is hard to judge which economic activity may be favored. Unfair In one sense significant efforts have been made to implement the property tax fairly in terms of horizontal equity. That comes through assessment methods that try to impose equal taxes on properties in similar situations. Thus, all residential property will be subject to common rules of assessment and valua3. Michael Pagano provided these helpful insights.

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tion. Commercial property may differ from residential property. However, economic development districts, TIFs, and special considerations for agriculture, forest, and mineral property suggest substantial inequality in the treatment of commercial property. The division between charitable property, government property, and private property also provides interesting examples of the problems of equal treatment of similar economic activity. Consider education. Not only are public school buildings off the tax rolls, but public schools receive other people’s property tax payments. Private schools are also often off the rolls if not-for-profit or religious, but do not get public revenues. The for-profit school is subject to property taxes and receives nothing from tax revenues. But the activity is essentially the same for all three providers. Vertical equity is an even more difficult issue to discuss.4 Property tax expenditures are all over the place in terms of who benefits. Circuit breakers based on income or a combination of income and property values favor the poor. Provisions targeting the elderly also probably favor the poor. On the other hand, although TIF districts were originally based on redevelopment of blighted areas, TIF-related property tax expenditures go most directly into the pockets of developers (who are usually not poor), with the hope of eventual benefits for the community and all its members. There are no reliable estimates of the accrued benefits of property tax expenditures for the nation, or, to my knowledge, for any state.

Inefficient In theory we can measure the efficiency of a tax structure by quantifying the administrative cost per dollar collected. The problem with this simple idea is that costs extend outward like a flood. Do we count citizens’ time to question, appeal, and consult others, including attorneys? The property tax is unique in this respect because all states have processes to appeal assessments and decisions on special circumstances (such as denial of a TIF). The property tax differs considerably in this respect from other taxes, such as sales taxes or fees and licenses, where governments simply tax an action taken. Thus, although efficiency is difficult to measure, it seems obvious that the current systems of property taxation are considerably less efficient to administer than either sales taxes or fees and licenses. That may be one reason

4. The debate over the progressivity or regressivity of the property tax continues without resolution. According to a recent piece by Zodrow (2006), much depends on whether one conceptualizes the tax as a “benefit” or “capital” tax. If one assumes the former it may be proportional; if the latter it will be progressive, as a tax on general capital holders. Youngman (2002) reviews the substantial literature that points to the tax as regressive.

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these latter taxes are growing sources of revenue for state and local governments.

Complex As all the exemptions, exclusions, limits, special rates, and types of property tax districts multiply, property tax structures obviously become more complex. This direct correlation between the adoption of ever more property tax expenditures and complexity is similar across all tax systems. Witte (1976) has described this phenomenon at length for the federal income tax, but it also applies to state income taxes, special exemptions to sales taxes (including differential rates for different geographic locations), and provisions that attempt to ameliorate the regressive nature of value-added tax systems. The complexity of the property tax leads to two general problems. It makes administration more costly, and it confuses taxpayers to the extent that in some cases they fail to apply for special provisions, such as circuit breakers or refundable tax credits, that benefit them. Unaccountable The degree to which the property tax follows the preferences of taxpayers or specific constituencies in our republican political process is probably impossible to ascertain in any rigorous way. There are suggestive pieces of evidence, some of which may be subject to various interpretations. For example, as we shall see below, there is public opinion evidence to indicate that taxpayers strongly dislike the property tax, which might suggest to politicians that lowering effective rates through whatever device they can find is democratically accountable. On the other hand, judging the property tax as the least fair tax may reflect the confusing special-privilege structure that results from lowering rates through provision of property tax expenditures. Accountability is clearly affected by the confusing and opaque jumble of special provisions that accumulate as the broad base of the property tax is destroyed. This complexity affects accountability in two important ways. First, it makes it very difficult for citizens to understand and hence to protest elements in the system other than those directly affecting them. Thus, taxpayers will protest their own assessment, but never question why commercial or agricultural property is assessed differently even though those differential assessments may be behind the increase the taxpayer has to bear. Second, a system with so many moving parts, so many special circumstances, is difficult for even the most knowledgeable experts to reform. It is not only hard to gain traction for radical reform, it is often hard even to know where or how to start.

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Political Factors Affecting Property Tax Policy Political Means and Property Tax Provision Often the discussion of tax politics begins with the relationship between types of policies posited by James Q. Wilson (1998). In that taxonomy Wilson laid out a simple two-by-two table based on wide or narrow costs and benefits of different types of policies. His taxonomy is depicted in Table 10.2. Not only do I agree with Wilson’s political characterizations for policies in general, I find the basic divisions just as useful for understanding tax policy specifically. Table 10.3 is a depiction based on a Wilson-type conceptualization, but with an important twist. What is depicted are the political means that may be associated with property tax provisions, broken down in the same way as the specific provisions are shown in Table 10.1. Thus the basic axes are the same in the two figures: beneficiaries are particularistic (narrow) or broad-based (universal) while the provisions themselves apply to either narrow or broad constituencies. What is implied is that political mechanisms, approaches, and arguments will vary not with the general policy (of taxation), but with micro policies within a policy field. In general, the mechanisms are consistent with the two important characteristics of property tax politics noted by Brunori (2003): responsiveness to constituent interests and an electoral imperative that appeals to broad-based groups across a district. Thus narrow provisions, such as those that are given to local taxpayers or groups through local contacts, are primarily guided by politics based on intimate lobbying by local organizations (such as the Chamber of Commerce) or local hired lobbyists. Although those provisions still apply to a relatively narrowly identified set of beneficiaries they are general

TABLE 10.2

Typology of Politics Based on Costs and Benefits Benefits Costs

Broadly Distributed

Concentrated

Broadly Distributed

Majoritarian Politics

Client Politics

Entrepreneurial Politics

Interest Group Politics

Concentrated

source: James Q. Wilson, 1998.

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TABLE 10.3

Political Means for Property Tax “Expenditures” Provisions

Narrow

Broad

Benefits Particularistic

Broad-based/Universal

Narrow Lobbying:

Large-scale Lobbying Groups:

Local Groups; Individuals

Business Roundtable; Chamber of Commerce; NEA; AARP

Large-scale Lobbying:

Major Electoral Issues:

Referenda; Initiatives;

Voter Referenda; Initiatives

Electoral Agendas

policies that include all those engaged in an activity (e.g., people in economic development and TIF districts); thus, the groups lobbying for them are broader and usually more powerful and visible, such as business roundtables, state-level business organizations, and state unions and coalitions. As provisions become broader in their impact even if still identified with specific groups, the politics engages the same of state-level interest groups but may also raise electoral issues or become subject to state initiatives or referenda. For example, in Wisconsin in 1974, a major change in the Wisconsin constitution allowing use-based assessment of agricultural property was enacted through the state referendum process. Finally, when benefits of specific yet very broad provisions apply to all taxpayers, the political pressures affect electoral activities, and the provisions are more likely to be subjected to direct initiatives, such as those that occurred in almost all states in the late 1970s and early 1980s. What is powerful about this taxonomy is that the political means easily align with the types of provisions and the needs of both claimants and politicians. Thus narrow, micronegotiations for special treatments within tax districts can be had by engaging local lobbyists or lawyers within a transparent or an opaque political process. The dimensions of local TIFs, assessment appeals, arguing for exclusion of a property under charitable exclusions for a quasinonprofit organization, become routine actions within a lobbying/bureaucratic system. This may or may not involve locally elected politicians at the city or county levels. As provisions and benefits become broader and established, professional groups are engaged, often negotiating directly with elected officials at the state

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level. Depending on the outcome at this level, the issues may ultimately be taken directly to voters in the form of initiatives or referenda. At times this occurs in waves across the states, as with statutes and initiatives that were passed to set limits on property taxes in 43 states in the early 1980s (Brunori 2003, 40). These general limitation provisions establish limits on tax levels, but do not affect the base. The provisions that affect the tax base are in the upper and leftward sectors of Table 10.1—those that apply to specific constituents with narrow provisions. Why Do Minority Preferences Succeed? The problem for those interested in property tax reforms that attempt to recover the base by reversing the expansion of property tax expenditures is that majority interests fail to block benefits from going to minority interests. That failure runs counter to basic democratic theory, which posits majority rule. It also challenges the assumptions underlying median voter theories. Finally, it also turns our Founding Fathers’ basic fear of majority tyranny on its head.5 But the phenomenon is obvious in both budget and tax policy. And it does not apply just to small off-the-radar beneficiaries. For example, broad constituent groups, such as the elderly, teachers, or farmers are in the minority compared to the larger electorate. And it is in the rational interest of most taxpayers to oppose particularized benefits going to those groups. In all districts and states these groups, despite their political power, are considerable minorities in both local districts and state populations. The grand question for the politics of the property tax, as well as for other taxes and indeed for the general structure of politics in America, is why coalitions that should oppose narrow, particularistic, minority interests do not form and block either tax expenditures or direct expenditures going to these groups. This issue, when first presented in modern guise following World War II, was posed as a general problem of democracy—that a powerful, elite minority would capture a democratic system and force its positions on a majority whose interests it opposed. Nazi Germany loomed large. Robert Dahl and Charles Lindblom were the most precise in describing these possibilities (Dahl 1956; Dahl and Lindblom 1953). The problem we face today is nothing that grand. But it may be just as important, in a smaller, more incremental form. Our fiscal system of governance is riddled with programs and tax expenditures that benefit a minority of citizens, coming at a cost to the majority. In a legislative setting this “benefit to a 5. That fear is best expressed by James Madison Federalist #10 and #51.

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minority” can be defined precisely as benefits that accrue to voters who would be below the median voter in any ranking of preferences. The question, as with minority control of the entire system, is why the majority allows this to happen. Explanations of this phenomenon need to follow the structure of American democracy. That structure allows reactions and inputs from mass publics (individual citizens) and elites who represent geographic units of citizens in a republican system. Four different explanations as to why majorities fail to deter minorities are depicted in Table 10.4. The first explanation is the most common: minority benefits arise because those who gain have an intense interest in forwarding their position, and they are opposed by an unformed or indifferent majority. Individuals in the majority will either be unaware of what is happening or do not want to go the trouble to protest. But it is unclear how the elite will react. If they represent a minority that is a majority in their district, and we assume reelection motives, the answer for them is clear—support your constituents. But most representatives will come from districts in which minority benefits will not benefit the majority of constituents in their district. Representatives should be watchdogs, in the know about policies, and should therefore, citing what is best for their constituents and the public at large, oppose the

TABLE 10.4

Why Majorities Do Not Reject Minority Benefit Provisions Explanation

Individuals

Elite/Representatives

1. Intense Minority Interests vs. Diffuse Majority Interests

In Minority: Lobby Hard In Majority: RangeIndifferent or Uninformed to Enlightened and Active

Majority-Minority: Support Minority-Majority: Unclear—Depends on Majority Orientation

2. Overlapping Interests (e.g., Children vs. Elders)

In Minority: Lobby Hard In Majority: May Empathize with Minority— Support or Acquiesce

Both: Support Minority Position

3. “General” Policy Agreement (e.g., “We All Hate Taxes”)

Both: Support Minority Position

Both: Support Minority Position

4. Consideration of Future Policy Positions

Both: Unclear—Depends on Community Connections

Both: Time-Dependent, Logrolling Adds to Support of Minority Position

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minority policies. They may not because there are other models of behavior and other explanations for why minority interests prevail. One other explanation is that in considering individual preferences, there may be at least perceived overlap between minority interests and the majority. A poignant example may be the young who consider benefits for the elderly to overlap with their own interests. They may perceive this overlap out of empathy for grandma, or through projection of their position into the future. Whatever the reason, majority individuals would support minority positions that work to their disadvantage in the short run. Given this scenario, I cannot see why representatives would act differently. Another explanation is that narrow interests and provisions are subordinated to more general policy positions felt both by individuals and elites. Thus, a general dislike of taxes or of a particular form of tax might lead citizens who would not benefit from a minority provision (who in fact would ultimately pay for it) to support it or, more likely, acquiesce to its inclusion in legislation that purports to lower the disapproved tax. A final, more conventional explanation is logrolling. Unless one assumes a tight, well-informed community where individuals are thinking about future positions vis-à-vis their neighbors, this explanation applies primarily to elected representatives in a republican context. Elected officials in legislatures will have continuous and future contacts and negotiations with their colleagues. Thus future considerations will play an important role. Turning the issue around, why should future-thinking politicians representing majority interests rise up to oppose a provision that grants benefits only to a minority that does not include their constituents? There may be a Don Quixote answer. Such politicians may consider that they have a reputation as a battler for truth, justice, and the American way. Thus, they reason, they will simply do what is right, especially if they can point to other considerations such as balancing the budget as a general rationale. On the other hand, many would assess constituent or public opinion and then focus on the future. If they anticipate being in a minority with respect to an important future issue, they may well acquiesce to the current demand, which seems trivial and may go unnoticed by constituents or future opponents. That allows them to use their acquiescence as a future bargaining chip as they try to form a majority for their future minority position. Summary Both the analysis of political means and of minority dominance suggest that the chances of reforming the property tax to broaden its base are slight. However, these arguments are just that—arguments—and they often turn on empirical

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assumptions. For example, the overlapping-interests argument for why majorities fail to block minority benefit provisions is predicated on a general dislike of a certain type of tax. Also, the general thrust of the arguments can easily be overturned by policy experiences in states that go in the opposite direction and toward base broadening. Unfortunately, as we turn to the empirical picture, most of the basic facts do not seem to engender optimism for the possibility of base-broadening property tax reform. The Empirical Situation Changing Property Tax Levels Figure 10.1 depicts the latest statistics on revenue sources for state and local governments in the United States. As is clear, property taxes constitute a substantial part of those revenues. At 16.6 percent they are behind only federal aid (21.7 percent) and “charges and miscellaneous” (21.2 percent). Also, when compared to own-source revenues, property taxes are close to 50 percent of all state and FIGURE 10.1

Sources of State and Local Government Revenue in 2005 as a Percentage of Total Revenue Corporate Income Tax 2.1% Individual Income Tax General Sales Tax 11.9% 13.0%

Excise Tax 6.0%

Property Taxes 16.6%

Other Taxes 3.7%

Charges and Miscellaneous 21.2% Federal Aid 21.7% Interest Income 3.7% source: U.S. Census Bureau, June 2007.

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local revenues. For example, measuring tax collections as revenues per $100 of personal income in 2004, state taxes totaled $6.49 per $100, of which property taxes (state and local) made up $3.11 (National Conference of State Legislatures 2007). The level of property taxes ranged from a low in Alabama of $1.23 per $100 to a high of $5.17 in Maine. In a very perceptive article, Fred Giertz showed that for the years 1988 through 2005, property taxes consistently produced more revenue than individual and corporate income or sales taxes, measured as a percentage (approximately 30 percent) of total state and local revenue (Giertz 2006, Figure 2). More important may be the changes in property tax collections over time. They are depicted in Figure 10.2, and the results of tax initiatives of the 1980s are quite clear. In 1971, property taxes were the largest source of state and local revenues at 26.1 percent, followed by federal aid (18.0 percent) and charges and miscellaneous (14.1 percent). Following the wave of property-taxlimiting initiatives of the late 1970s and 1980s, the proportion of taxes from the property tax plummeted to 18.3 percent in 1990 and 16.6 percent in 2005. The lost revenues from the property taxes were replaced by a shift primarily to charges and miscellaneous which went up 7.1 percent over this 34-year period. This category includes a range of license fees, excise taxes, and other user fees. They have two important political characteristics: they are not overtly visible, as is the property tax, and they are connected to uses. The latter fact gives rise to the argument that taxpayers can avoid them by not partaking in the taxed activity. These changes mask two important caveats. First, overall state and local tax rates and spending have increased even in the states with the most pronounced antitax initiatives. Galles and Sexton (1998) demonstrate this for California and Massachusetts. In California, with the passage of Proposition 13 in 1978, per capita property tax collections dropped from $815 in 1977 to $408 in 1978, reaching a low of $360 in 1982. By 1990 the tax had rebounded to $500 (Galles and Sexton 1998, 127). In 2004, California ranked 30th in the country in per capita property tax collections (National Conference of State Legislatures 2007). As with the nation as a whole, charges and miscellaneous revenues made up for the property tax shortfall in California. In Massachusetts property taxes fell much less following the passage of Proposition 21/2 in 1980. By 1990 they had rebounded to 89 percent of 1980 levels, but overall tax collections were 123 percent of the 1980 levels, and the state ranked eighth in property tax collections per capita by 2004 (National Conference of State Legislatures 2007; Galles and Sexton 1998, 130). As was true for the country as whole, charges and miscellaneous revenues nearly doubled in Massachusetts in the 1980s.

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FIGURE 10.2

Sources of State and Local Government Revenue, 1971, 1990, 1998, and 2005 as a Percentage of Total Revenue 26.1% 18.3% 16.8% 16.6%

Property Taxes 8.2%

Individual Income Tax Corporate Income Tax

12.6% 12.9% 11.9% 2.4% 2.6% 2.5% 2.1%

FY 1971

12.3% 14.3% 13.8% 13.0%

General Sales

FY 1990 FY 1998

10.6%

Other Taxes

FY 2005

6.7% 7.4% 6.0%

Excise Taxes

5.9% 4.6% 3.2% 3.6% 14.1%

Charges and Miscellaneous

17.9% 19.9% 21.2% 2.3%

Interest

6.9% 4.8% 3.7% 18.0% 16.1% 18.7%

Federal Aid

21.7%

0%

5%

10%

15%

20%

25%

30%

source: U.S. Census Bureau, June 2007.

Second, as Giertz shows, the real growth in the property tax from 1988 to 2005 was approximately 60 percent (Giertz 2006, Figure 1). This growth rate is similar to the growth in state and local income and sales taxes. Thus despite the wave of property tax limits, caps, specialized property tax expenditures, and local spending limitations passed in the last 30 years to reduce property tax collections, the property tax remains resilient as a source of local revenue. Tellingly, so does the public’s opposition to it.

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Public Opinion One obvious issue for understanding the politics of the property tax is how the public feels about the property tax. Fortunately, since 1983 the Gallup Poll has fairly consistently asked a question aimed at determining what respondents perceive to be the least fair tax. And the property tax does not do well by that measure of public opinion. The responses to the question have varied over time, with Social Security not given as an option in earlier polls. Thus I have split Table 10.5 into two sections. One interesting note, which may add to the credibility of the question, is that between 1991 and 1993, the federal income tax lost considerable favor. 1993 was the year in which the new Clinton administration introduced a major income tax bill, which raised the rates of many taxpayers. However, for both ways of asking the question, the property tax is either the least fair tax or, less often, the second least fair. When Social Security is included, TABLE 10.5

Public Opinion on America’s “Worst, Least Fair Tax,” 1983–2005 Panel A. Question Without Inclusion of Social Security (percentages) Worst Tax

1983

1988

1989

1991

1993

Federal Income Tax

35

33

27

26

36

State Income Tax

11

10

10

12

10

State Sales Tax

13

18

18

19

16

Local Property Tax

26

28

32

30

26

Don’t Know

15

11

9

14

14

Panel B. Question With Inclusion of Social Security (percentages) Worst Tax

1988

1989

1990

1992

1994

2003

2005(a)

2005(b)

Federal Income Tax

26

21

26

25

27

21

20

20

Federal Social Security

17

18

15

10

12

11

10

12

9

9

10

9

7

11

7

14

State Sales Tax

15

14

12

16

14

13

17

14

Local Property Tax

24

28

28

25

28

38

42

35

9

10

9

15

11

6

4

5

State Income Tax

Don’t Know source: Gallup Poll.

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only one time did it not rank as the least desirable tax (1989, tying with the federal income tax in 1992). And in recent years it has grown dramatically less popular than any other tax. Since 2003, over one-third of the all respondents have said the property tax is the least fair tax of the six listed. That is between 15 and 22 points more than the federal income tax.6 Thus, from a public opinion perspective, it is quite obvious that representatives of local or state elected bodies may well perceive themselves to be acting in accordance with their constituents’ preferences when increasing property tax expenditures or limiting the rates. In terms of the reasons to support minority benefits, either they will perceive their constituents in that minority and overtly promote such actions, or they will sense an overlap of general attitudes. Or they may take future bargaining into consideration and acquiesce to the benefits provided to minority groups not in their core constituency. A series of state studies provides a further look at how these property tax provisions are enacted. Individual State Actions One of the many ironies about property taxes is that they are in a sense selflimiting in the absence of regular action. That is, because property continually changes in value (usually increasing), unless properties are consistently reassessed, the tax base will shrink and inequities will be introduced because different forms of property appreciate at different rates. Thus states that do not require periodic, most often annual, reassessments are automatically limiting their property taxes and introducing horizontal inequities. Recognizing this situation, Anderson notes that only one state has no statutory limits on property revenues, rates, and reassessments, and also requires annual reassessment: New Hampshire (Anderson 2006, 692–693). He also notes that 34 states have enacted tax rate limits, 29 have revenue limits, and 19 have some form of assessment limit (including local options) while only 21 require mandatory annual assessments (Anderson 2006, 688). Thus it is nearly impossible to find states that have resisted reducing property taxes through these broad state-level provisions. It is similarly difficult to discover states that have resisted hundreds of narrower devices for reducing property taxes. For example, a recent analysis found that all of the states had enacted some form of relief for the elderly or poor. Forty-five states had home-

6. A recent article from the Gallup organization indicates that “1 in 3 Americans point to local property taxes” (as the worst tax) as late as April 2007 (Jacobe 2007). The jump from 1994 to the present levels of disapproval of the property tax coincides with rapid increase in property values in many places. Given the recent break in residential prices (and presumably lagged assessment declines) it will be interesting to note if public opinion follows these residential price declines.

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stead exemption laws of one kind or another; 36 had circuit breaker provisions; and 24 had provisions allowing the elderly to defer payment of property taxes. A number of states had all three forms of relief (Oregon Legislative Revenue Office 2001, 12–13). The vignettes below are meant to illustrate some of the approaches states have taken to the property tax problem and the political pressures that have led and continue to lead to property tax reductions. They have been selected to represent major deviations from a uniform, broad property tax base, and also because they represent provisions that have been enacted in many states (such as agricultural exemptions and circuit breakers). Both the Wisconsin and Oregon cases cover longer periods and a range of different types of provisions. Kansas is an example of the pressure to provide agricultural relief; Maine illustrates the provision of a circuit breaker law. The Demise of the Uniformity Clause in Wisconsin From a period before Wisconsin became a state in 1848 through the first years of the twentieth century, property taxes were essentially the only significant source of revenue for the state and local governments.7 The property tax had two essential properties. It was extremely broad, applying to land, buildings, machinery, inventories, livestock, and many personal property items and wealth (including monetary assets). Second, from the beginning it was understood that the tax needed to be levied in a uniform way. When the Wisconsin constitution was written in 1848, Article 8, Section 1 contained a uniformity clause, which provided: “The rule of taxation shall be uniform but the legislature may empower cities, villages, or towns to collect and return taxes on real estate located therein by optional methods. Taxes shall be levied upon such property . . . as the legislature shall prescribe.” The clause was clarified twice in important court cases upholding the uniformity principle. The first was Knowlton v. Supervisors of Rock County, 9 Wis. 378 (1859). In that case the City of Janesville had attempted to tax farm property in the city at half the rate of residential property. The court ruled that violated the uniformity clause. A similar opinion was rendered over 100 years later in Gottlieb v. Milwaukee, 33 Wis. 2d 408 (1967). The issue in that case was the creation of a 30-year tax exemption for property owned by a redevelopment corporation in a blighted area of Milwaukee. The demise of the uniformity clause came about through a number of constitutional amendments and a consequent series of statutory changes. The 7. Much of what follows is taken from Stark (1991).

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Wisconsin constitution is difficult to amend. The language of a proposed amendment must be passed by both houses in two separate sessions (sessions last two years), and then be approved by a majority of voters in a general election referendum. The first Wisconsin constitutional amendment was approved in 1903; it paved the way for the first income tax to be passed in the United States, in 1909. The issue that led to the amendment was that the state was having great difficulty with the property tax on assets and interests. People were not reporting assets or interests and banks and other financial organizations were not cooperating, citing privacy concerns. The state’s reaction was to amend the constitution to allow the taxation of income in the teeth of the U.S. Supreme Court’s famous Pollack decision, which ruled that the 1894 federal income tax was unconstitutional because it would not be levied in a uniform manner.8 Thus the first major break in uniformity in the Wisconsin property tax, occurring during a very progressive period, substituted a more progressive tax for a decline in property taxation. The second amendment, followed by implementing statutes, was an exemption passed in 1927 for forestry and mineral properties. The beneficiaries of these lower rates were mostly companies and individuals with large lumber and mineral holdings, but of course the small landowner and miner were used as the justification. The next major constitutional amendment, in 1961, followed by a series of statutory exemptions and special classifications, exempted livestock, merchant’s inventory, and manufacturers’ materials and finished products. The amendment was later interpreted in statutes and court rulings to include machinery and manufacturing buildings. In 1963, the state created a homestead tax credit. At first this credit applied only to those over 65, but was amended 10 years later to include all taxpayers over 18 after a court ruled the income tax credit on property taxes paid did not violate the uniformity clause. Also, in 1975, commercial developers received a major incentive with the creation of Tax Incremental Finance Districts, which were originally meant to be used only in blighted areas but are now used for almost all commercial development projects. The final major assault on the property tax was an exemption from the uniformity clause for agricultural land, passed in 1974 by a close vote of 353,377 to 340,578. That led first to a property tax credit on income taxes for farmers entering a farmland preservation program, and later in 1999 and 2001 to income “use value” assessment (rather than market land value) for agricultural property. The latter was so severe a change in some rural counties that one 8. Pollack v. Farmers Loan and Trust Company, 157 U.S. 429c (1985).

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county, Lafayette, threatened bankruptcy. Other counties have dramatically reduced services, with one large school district going bankrupt in 2006. What is interesting in this historical decline is that both political parties were equally willing, nay eager, to contribute. The Progressive Republicans had unified control when the income tax and forestry and mining provisions were added. However, Gaylord Nelson (a liberal Democrat) was governor, facing a Republican legislature, when constitutional exemptions for livestock and manufacturer inventories and supplies were introduced and the homestead tax credit was enacted.9 Similarly, when the statutes were written providing manufacturing and livestock exemptions, the amendment for agricultural land, and the creation of TIFs, Democrats were in unified control of the governorship and the legislature for all but one session, in which the Republicans controlled only the senate. Finally, Republicans in unified control passed the recent use value statutes for agricultural land in 1999 and 2001. Oregon Two idiosyncratic factors contribute to the erratic history of the property tax in Oregon. The first is Oregonians’ persistent devotion to keeping a considerable amount of land in its natural state. This translates into what one prominent author called the state’s “low level of utilization of land” (Lindholm 1978, 48). The second is the absence of a sales tax in the state. The first factor led to a host of specialized land-based exemptions for property; the second led the state, in search of revenue, to impose some later restrictions on those specialized provisions. However, overall, the history of the property tax in Oregon is not that dissimilar to Wisconsin’s—a clear early emphasis on uniformity, followed by a number of constitutional amendments and statutes dismantling the idea of a broad base and uniform treatment. As with Wisconsin, in Oregon’s early years, property taxes were the basis for almost all state and local revenues. That changed when a constitutional amendment was passed in 1917 authorizing an income tax; such a tax was finally enacted permanently in 1930. By 1940 the revenue from the income tax supplanted the state property tax and the property tax was discontinued. It remained by far the largest source of revenue at the local level (Oregon Legislative Revenue Office, 2006). Over the years, there have been hundreds of changes in Oregon property tax laws. I focus on three sets: land exemptions, 9. The governor cannot be blamed for a constitutional amendment exempting livestock and manufacturing inventories and equipment because, unlike statutes, he has no veto over proposed constitutional amendments. Nelson was, however, instrumental in passage of the homestead tax credit.

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provisions for the poor and elderly, and general limitation initiatives and statutes passed during the 1990s. Oregon gave special treatment to forests from the beginning. At first it taxed timber and timberland as property, but later taxed only land. In the immediate postwar period, citing the need for land preservation and low utilization of natural lands, special exemptions to the uniformity provisions of the property tax had been granted by the state to forest land, exclusive farm use (EFU) land, and “open spaces.” Complicated provisions governed each set of exemptions, but the effective rate of taxation of each of category of exempt land was considerably lower than other commercial or residential land. By 1973, exposed by a Land Conservation and Development Commission, it was clear that the EFU exemption had been stretched and was being applied very differently in different counties. Thus the law, reversing normal tax politics, tightened up considerably on the definition of EFU and on the administrative procedures for regularly inspecting and assessing the land to ensure its use had not changed (Lindholm 1978, 42–46). Provisions affecting open spaces were also tightened. Part of the reason for these changes may have been that at the same time, the Oregon legislature was passing a property owners’ and renters’ homestead tax credit (or refund) on state income taxes. When it was enacted, Lindholm noted: “The legislation is very expensive and will cost $77 million in fiscal year 1977” (Lindholm 1978, 46). This compared to total state revenue of $760 million. This program complemented a 1963 property tax deferral program for the elderly, which was also income targeted, but which was used by only 4 percent of eligible taxpayers because it allowed the state to place a lien on the property and charged 6 percent interest per year. A final program, lowincome elderly renters assistance, was passed in 1975, but it was much less expensive than the homestead tax credit. The homestead provisions were repealed in 1991, as the result of the passage of Measure 5 (approved by voters in 1990 codified in 1991). That measure put a cap on property tax revenues in response to political pressure created by increasing property taxes and a sustained recession in Oregon. School district revenues were capped at 0.5 percent ($5 per $1000 property value) and general government districts at 1 percent. Very complicated rates were enacted (and amended later) for forestry and other special districts. Because this measure reduced taxes for all taxpayers, and because of the expense, the homestead tax credit was repealed as part of this legislation. The effect of Measure 5 was immediate and dramatic. In the 10 years prior to 1991, the average annual increase in property tax receipts was 8.0 percent. Between 1991 and 1997, when the next major tax initiative was passed, the

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average increase was .28 percent (Oregon Legislative Revenue Office 2006, A8). Anderson (2006) documents the decline in property tax collections but then notes: “The revenue limits appear to be very effective and yet in 1997 voters passed Measure 50 limiting annual growth in all assessed values to three percent” (691). This limitation was undoubtedly related to a dramatic increase in assessed property values in Oregon from 1990 to 1997. The legislation following voter approval of Measure 50 changed the standard of assessment to less than market value (averaging 73 percent), and limited assessment increases to 3 percent per year. Oregon represents both types of major across-the-board limitations authorized by voter initiatives: those limiting revenues and those limiting assessment increases. It took Oregon 20 years to catch up to California’s Proposition 13, but it seems to have done it. However, there have been moves in Oregon to tighten up on some exemptions for agriculture and open space special classifications, and as noted, the homestead tax credit, a major, expensive program, was eliminated when broader-based reductions were enacted in 1991. Agriculture “Use Value” Assessments in Kansas Farmers have a lot of property that can be taxed. They have land, expensive equipment, and homes. And, according to most of them, no income—ever! They are a minority in almost any state, but they can be the majority of constituents for their representatives. Thus they pose a clear challenge to majority blocking when they seek special treatment under property tax laws—and they often succeed. Glenn Fisher has written a definitive history of the property tax in America, with large sections of his book focusing on Kansas (Fisher 1996). He describes the systematic erosion of Kansas’s property tax from more or less uniform taxing of all forms of property wealth at the beginning of the twentieth century to a tax riddled with exclusions for agriculture, the elderly, general limits, and economic development. But his story is also one of modest redemption. He describes the dissolution of the belief in uniformity in the post–World War II world, as happened in Wisconsin and Oregon. This trend culminated when major pressure led to a referendum that passed a constitutional amendment imposing “use value” assessment in 1976. This was the first exception to the general proposition that taxes had to be levied on all properties based on a uniform market value. Fisher claims that when Kansas enacted the amendment, 40 states already had some form of use value exception (Fisher 1996, 171). However, implementation of use value assessment, which was left to counties, was a nightmare of confusion over different types of use values for land

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(such as productive, fallow, vacant lots, irrigable lands). The result was a patchwork of differences across counties. The new valuation also produced a strong reaction from other commercial property holders who thought they would get stuck with higher taxes, in light of constant or increasing local expenditures. In addition, all agreed that the assessment process was arcane, based on pencil and paper technology. Thus, forces were put in place to reform Kansas’s property tax system. The reform, following a tax commission that produced several studies and a number of recommendations, was finally enacted by the legislature in 1985 and approved by an impressive 68 percent of the voters in November 1986. The reform did modernize the assessment process, requiring uniform assessment procedures with appeals and control at the state level. However, it did so by codifying differential classification and value assessment levels for different categories of property, and it kept use value taxation for agricultural land intact, in a more uniform structure. It also exempted all farm machinery, livestock, and merchant and manufacturing inventory (Fisher 1996, chapter 10). Residential property was to be appraised at 12 percent of value, with commercial and agricultural property at 30 percent. Thus the price of reform was to accept a narrower base with major exemptions and special-privilege classifications of property. Maine Maine had some of the highest property taxes in the country in 2004. It ranked first in property taxes per $100 in personal income ($5.17) and seventh in taxes per capita ($1,531) (National Conference of State Legislatures 2007). Property taxes were also increasing in Maine for a number of reasons: coastal properties were rapidly increasing in value, depressed areas were losing property from the rolls, and municipal services were increasing (Allen and Woodbury 2006, 667). Thus in 2004 Maine voters passed a referendum labeled LD1, which was followed by major property tax reform legislation in 2005. Prior to enactment of tax reform in 2005, Maine had already passed a number of provisions deviating from a uniform tax base. It had a modest homestead tax credit, exempting the first $13,000 of value from property taxes for Maine residents. It also had a business equipment refund program (not an exemption as in many states), and a circuit-breaker program that was capped at a maximum refund of $1,000 for the poorest households (Allen and Woodbury 2006, 672). The 2005 legislation was a model of restrained compromises. Assessment limits and revenue caps had been discussed, but were not seriously considered.

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Instead, the focus was on increasing the circuit breaker to aid income-poor property owners. The legislation did that by increasing the maximum allowed refund to $2,000, and by changing and “smoothing out” eligibility requirements to eliminate a cliff provision that made taxpayers completely ineligible at a specified level of income. The compromise, and the way to pay for the changes, was to set K–12 education spending “benchmark targets,” and to shift more K–12 funding to the state.10 A final property tax issue, which I believe is unique in the United States, is currently under legislative review in Maine. In 2005, Maine voters approved an initiative to establish a special property classification, presumably with lower rates, for “Working Waterfront” property. Whether this is directed primarily at the Bush compound in Kennebunkport will be the subject of future investigation. What Can Be Done? There are significant political obstacles to reversing the narrowing of the property tax base and cutting back on property tax expenditures. The attack on a uniform base is formidable. Figure 10.1 suggests only some of the possible devices. The major devices (revenue limitations, assessment caps, agricultural and business exemptions, elderly and poor provisions) have been widely adopted across the states. In addition, the theoretical political factors seem to be strongly aligned with the empirical outcomes.11 There are some possibilities for at least slowing down future dilution of the property tax base. But the most likely to work is very unlikely to happen. What Would Work But Will Not Happen: Limiting Referenda From the preceding it is clear that many of the major statutory property tax changes are preceded by referenda and initiatives that must be approved by a majority of state voters. Almost always these referenda are required in order to exempt a certain activity or property class from a uniformity clause in the state constitution. It may be refreshing to frustrated tax reformers to recall that there was a time, a shining hour, when political elites decided that uniformity in

10. These benchmark targets are a common idea that have resulted in a considerable increase in state funding of education over the last three decades. I would suggest that they result primarily from the pressure to reduce property taxes rather than analysis and discussion of their merits for education policy. 11. The assumption of property tax experts and academics seems to be that the property tax is in crisis. But most of the changes and political forces presented in this paper are in a singular direction against higher property taxes by whatever means necessary. Maybe the people are repeatedly telling the experts that they are wrong.

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taxation was central to a just tax system. The way to prevent further erosion of the uniform tax base is to repeal the procedures for referenda and initiatives in state constitutions, or make them increasingly difficult to bring to the ballot. I am unsure if any state has taken such actions to restrict this form of direct democracy, but I doubt it. And I cannot envision the speech that would introduce such a change. What Might Work and Could Be Implemented: Truth in Taxation Let us build on the assumption that the American people do not like property taxes, and that they really dislike uncertain increases in property taxes. The questions are how you can provide certainty and restrict increases, yet keep the tax respectable relative to the principles with which I began this essay. The answer may exist in Virginia and Utah. Virginia, operating under enormous pressures from rising residential property values, relies on “truth in taxation” provisions for tax controls. These provisions require that any property tax unit (schools, counties, and so on) that proposes tax increases of over 1 percent of actual taxes to be collected must advertise the increase, identifying itself as the unit proposing to raise taxes, and specifically indicating that the proposed increase is not the result of assessment increases. And it must hold public hearings based on these representations. The only evidence that this procedure works is that Virginia, unlike its neighbors in Maryland and the District of Columbia, has not enacted the types of general limitations and caps that they have (Bowman 2006). A similar provision in Utah, entitled “Full Disclosure,” is reported to be successful in holding down property tax increases in that state (Cornia and Walter 2006). Several additions and cautions may make these systems of transparency even more effective. The first would be to tie the increases to exact changes and increases in services that will result from the tax increase. This connection is already clear in the most obvious use of these rules—school districts asking for increases to build new buildings. Other authorities should make such links where the use of new revenues is not as obvious. A final caution is the importance of translating what is actually being done into common language. For example, government officials often claim that tax rates have been lowered when taxes have actually been raised, as when the millage rate declines only because the assessed value of property has increased. This is the very opposite of truth in taxation, and if the public disclosure of tax changes follows this pattern it at best fails the test of transparency and at worst simply fails.12 12. Michael Pagano provided these insightful observations.

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How truth in taxation might be incorporated in an effort to reverse the existing provisions in state laws is not readily apparent. But if it is coupled with removal of existing limits on assessment increase or revenue caps, it may be an incremental way to begin the long climb back toward uniformity and a broadbased property tax. REFERENCES

Allen, Michael, and Richard Woodbury. 2006. Containing the individual burden of property taxes: A case study of circuit breaker expansion in Maine. National Tax Journal 59:3 (September):665–684. Anderson, Charles. 1963. The political economy of Mexico: Two studies. Madison: University of Wisconsin Press. Anderson, Nathan B. 2006. Property tax limitations: An interpretive review. National Tax Journal 59:3 (September):685–694. Bowman, John H. 2006. Property tax policy responses to rapidly rising home values: District of Columbia, Maryland, and Virginia. National Tax Journal 59:3 (September):717–733. Brunori, David. 2003. Local property tax. Washington, DC: Urban Institute Press. Dahl, Robert A. 1956. A preface to democratic theory. Chicago: University of Chicago Press. Dahl, Robert A., and Charles E. Lindblom. 1953. Politics, economics, and welfare. Chicago: University of Chicago Press. Fisher, Glenn W. 1996. The worst tax? A history of the property tax in the United States. Lawrence: University of Kansas Press. Galles, Gary M., and Robert L. Sexton. 1998. A tale of two tax jurisdictions: The surprising effects of California’s Proposition 13 and Massachusetts Proposition 21/2. American Journal of Economics and Sociology 57:2 (April): 123–133. Giertz, J. Fred. 2006. The property tax bound. National Tax Journal 59:3 (September): 695–705. Jacobe, Dennis. 2007. Which is the unfairest tax of them all? The Gallup Organization. http://www.galluppoll.com. Lindholm, Richard W. 1978. Property taxation and land use policies in Oregon. In Metropolitan financing and growth management policies: Principles and practice, ed. George F. Break, 31–50. Madison: University of Wisconsin Press. Oregon Legislative Revenue Office. 2001. Oregon’s Senior Population Growth and Property Tax Relief Programs. Report #7-01. Salem. ———. 2006. 2006 Oregon Public Finance: Basic Facts. Research Report #1-06. Salem. Stark, Jack. 1991. A history of the property tax and property tax relief in Wisconsin. Madison, WI. Blue book: 100–165. Legislative Reference Bureau. Wilson, James Q. 1998. The politics of regulation. New York: Basic Books.

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Witte, John F. 1976. The politics and development of the federal income tax. Madison: University of Wisconsin Press. Youngman, Joan M. 2002. Enlarging the property tax debate—Regressivity and fairness. State Tax Notes 26:1 (October 7):45–52. Zodrow, George. 2006. Who pays the property tax? Land Lines 18:2 (April):14–19.

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COMMENTARY

MICHAEL A. PAGANO

S

tudies, commentaries, lobbyist activities, and public pronouncements on property taxes (and taxes in general, actually) are legion. Their focus, without exception, is on a certain city’s property tax levy, a certain school district’s building tax proposal, a certain county’s children services board’s tax needs. Just as all politics is local, the daily political bombardment by pols and pundits about the demands on exacting the pound of flesh in the form of taxes from the Homevoter is local as well.1 Because there are so many of these local government units responsible for providing a diverse range of services, they are almost never brought together for consideration. Much like Littlechap, the protagonist in Stop the World—I Want to Get Off (a musical by Leslie Bricusse and Anthony Newley), who shouts out “stop” several times during the play, causing it and the players to take a breather while he ponders his next move, John Witte asks his readers to take a time out, look around the landscape, and ask if we have learned anything since the heady days of the Antitax Rebellion of 1978. In addition to having this “stop” feature, the chapter is also timely. Data from 2005 indicate that 68 percent, a supermajority of American households, own their own homes and are property tax payers (74.9 million homeowners, as opposed to 33.9 million renters). However, in 2007, the “irrational exuberance” of the real estate market’s bubble burst. Default notices were up over 57 percent in March 2008 compared with March 2007, and bank repossessions were up nearly 129 percent.2 With defaults in the subprime industry creating a bear market and property values demonstrating weakness in major metropolitan areas, one could easily conclude that the political question of property tax base broadening or property tax reform ought to be center stage—again. The Problem Witte outlines a fairly conventional approach to evaluating a tax and revenue system for the provision of public services. The “ideal property tax” is broad1. Fischel (2001). 2. RealtyTrac.

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based, neutral, fair, efficient, simple, and accountable. Governments should be guided by these principles, but instead Witte contends that the system of property taxation that has evolved over the last 50 to 70 years appears to be based on less-than-ideal principles: it is narrowly based, varies in effective rates, is abusive of horizontal equity, expensive to administer, hopelessly complex, and divorced from accountability. Witte proceeds to examine the apparent disconnect of reality from ideal. The question raised by Witte is “why . . . the property tax ends up so far from each principle.” Or, why can’t voters just follow sound principles of property taxation at all? This is the quintessential public policy question in any democratic society, in a polity in which the right to vote supersedes the right of philosopher-kings to impose their will, right or wrong. Part of the answer is that taxation policy questions are not neatly compartmentalized into separate revenue questions (revenue structures) and identifiable spending category decisions (service delivery). That is, designing a property tax structure for a local government is not an abstract activity. Rather, the task is undertaken with some purpose and with some programs or projects in mind. Who benefits from such programs, who owns what type of property, what type of community is desired, and other issues are woven into the fabric of political discourse about, and the design and detailing of, a property tax system. Part of the answer resides in understanding the “living museums” legacy of societies, by which I mean that policies tend to accrete over time without ever remedying or replacing disparities and internal inconsistencies.3 Consequently, the purity of principles, even if they were initially applied as close to what “ought to be” as possible, erodes over time as exemptions, exclusions, limits, special rates, tax expenditures, subsidies, and other (often reasonable) exceptions to the principles make a mockery of a uniform system of property taxation. Instead, the property tax regime has become balkanized nationally and regionally, even within the same city or county. It becomes extraordinarily difficult to speak about, let alone analyze, a system of property taxation in the United States. Instead, discussions center on specific cases. Hence, we read the proliferation of city- or school-district–specific studies and we find ourselves saying “stop the world” so we can review what we know.

3. Charles Anderson used this term to describe Latin American politics over 40 years ago. The term “living museums” referred to a series of power struggles in which the victor keeps getting added to the collection of beneficiaries of state beneficence without ever replacing the former victors. In that respect, political institutions represented a living museum, combining the old political winners with the new. See Glade and Anderson (1963).

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On Aspirations and Representation The system of property taxation, like all other social systems, has had to evolve over time by adapting to a changing environment. Concern about confiscatory property tax rates has resulted in locally created or state-created exemptions, circuit breakers, tax limitations and a host of other adjustments to the property tax system. Demands to enhance the competitive position of cities or regions encourage creation of other “economic development” programs, such as tax abatements, tax increment financing, business development districts, and others. Local property taxes, then, are a complex and seemingly irrational system of preferential treatment that seemingly benefits a minority of property owners. Why, then, don’t representatives “oppose the minority policies?” That is, why don’t political majorities stand up and oppose specialized benefits? Why does the system of property tax policy deviate so radically from a purer, more efficient “ideal” system? Witte proposes that the answer can be found by examining three “models of behavior.” On the first, both the minority (beneficiaries) and the majority (nonbeneficiaries) actually have overlapping interests; the nonbeneficiary majority perceives that one day it may become part of the “advantaged” minority. Voters’ behavior is influenced today by personal aspirations and ambitions that their station in life will be different in the future. Taxpayers, then, do consider the discounted (and probabilistic) benefits of future actions and they vote accordingly. Second is that Witte repeats the familiar refrain that there is a general dislike of taxes, regardless of whether one benefits or not. He argues that majorities fail to block minority benefit provisions precisely due to their general dislike of a certain type of tax. Because the property tax is “disliked” it’s relatively easy to understand why majorities don’t stand up to minorities in disputes over the property tax. Indeed, survey data from Gallup, which Witte cites, suggest that the property tax is not well liked. Indeed, according to Gallup it is the most disliked tax in recent years. Witte even implies that the experts who sing the praises of the property tax might have gotten it wrong: “Maybe the people are repeatedly telling the experts that they are wrong.” Or maybe the significance of people decrying the property tax is another example of “speaking truth [from the public’s point of view] to power [from the experts’ point of view].” For Witte’s conclusion underscores the perspective that the people’s perceptions of their tax situation and their capacity to link tax burden to service delivery is accurate. Indeed, there’s something more interesting at work here that affects taxpayers’ perception of the property tax. Majorities (and minorities) perceive they dislike a certain type of tax for at least the following reasons. First, the

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property tax is often the only tax that is put before the voters, providing them an opportunity to “just say no” to something, anything. Second, the property tax is not paid daily the way the sales tax is, but in one large payment (like the income tax, which explains its ranking as the next “worst tax”). Third, there are misperceptions about which level of government is authorized to impose the property tax due in large part to the complex system of local government in the United States that counts over 87,000 separate, autonomous governments. The resulting complexity from the vantage point of the taxpayer who receives a mix of services from a host of overlapping governments makes it exceptionally difficult to know which local government is actually providing which specific service. And fourth, voters do recognize that they pay taxes on unrealized property appreciation even if their income remains flat or declines. There may be evidence that people do not “dislike” taxes at all. Recently, economists and psychologists teamed up to study the brain’s reaction to charitable giving and to paying taxes. They found that the same neural centers in the brain that respond to eating dessert respond to paying taxes. Moreover, they concluded that “the fact that mandatory transfers to a charity elicit activity in reward-related areas [of the brain] suggests that even mandatory taxation can produce satisfaction for taxpayers. In other words, we feel good when we pay taxes.”4 Third, Witte explains that the political world of policymaking is not as neat and clean as models of rational individual behavior predict by venturing into the realm of political logrolling, which he argues “applies primarily to representatives in a republican context.” Logrolling ought to be expected. As a form of compromise among a host of disparate interests clamoring to gain something for their constituents, it provides an efficient outcome if everyone gains something in exchange for promoting a policy that protects only minority property interests. This argument raises the general question of representation in a republican government, a point that Montesquieu noted in The Spirit of Laws published in 1752. His argument is that there are two ways by which representatives reflect the views of their constituents: The great advantage of representatives is their capacity of discussing public affairs. For this the people collectively are extremely unfit, which is one of the chief inconveniences of a democracy. . . . It is not at all necessary that the representatives who have received a general instruction from their constituents should wait to be directed on each particular affair, as is practised in the diets of Germany. True it is that by this way of proceeding the

4. Harbaugh, Mayr, and Burghart (2007), Supporting Online Material, 2.

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speeches of the deputies might with greater propriety be called the voice of the nation; but, on the other hand, this would occasion infinite delays; would give each deputy a power of controlling the assembly; and, on the most urgent and pressing occasions, the wheels of government might be stopped by the caprice of a single person.5

Representatives, then, are expected to reflect their constituents’ interests, but at the same time citizens expect timely and effective outcomes through political compromise and logrolling. To expect representatives to behave in a manner that protects only the economic interests of their constituents ignores other values and aspirations of the citizenry. This possible conflict between economic and “values” interests of the public was examined in Thomas Frank’s What’s the Matter with Kansas and later addressed in the context of liberal Manhattan residents’ voting against their economic interests.6 Transparency The refrain to the catchy and melodramatic song “Cellophane,” in the musical Chicago is, “ ‘Cause you can look right through me / Walk right by me /And never know I’m there.” Unfortunately, “cellophane” is hardly an apt metaphor for the system of public finance and taxation at the local level. Indeed, scholars routinely argue that governments become inefficient because of the complexity and lack of transparency in their budgeting and accounting networks. How, they ask, can the average citizen know whether or not local government services are produced and provided efficiently if the administrators and elected officials are the only ones who possess the information to make that rational judgment? Transparency is one reason for the surge in the adoption and expansion of user charges and fees at the state and local level. Consumers can monitor what they purchase and how much they spend. The property tax today represents a smaller proportion of own-source revenues for local governments than it ever has. Diversification of taxes is part of the explanation, but the adoption of user fees is the other, more important part. Witte states: “When compared to own source revenues, property taxes are close to 50 percent of all state and local revenues.” Although this statement is true on its face, it masks enormous variation across local governments and across time. According to Census Bureau data on government finances, school districts generated nearly 80 percent of their own-source revenues from the property tax, but cities and counties generate a much smaller 29 percent and 39 percent, respectively. Three decades 5. Montesquieu, xxx. 6. Frank (2004); Gross (2008).

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ago, in 1972, city reliance on the property tax was 46 percent, while county reliance was 62 percent. The trend is the opposite for fees and charges (Table 10.1C). In 1972, 24 percent of local governments’ own source revenue came from the category of fees and charges; by 2002, it was 38 percent. Counties and cities in 2002 received 43 percent and 40 percent, respectively, of their own source receipts from fees and charges, up substantially from 26 percent and 28 percent in 1972. In important ways, this profound shift in the composition of own-source revenues over a 30-year period speaks volumes to taxpayers’ capacity to discern the characteristics of government-provided goods. User fees signal the value of a good, which the consumer can pay for or not. Government services provided by general tax support are much more difficult to measure. What makes the tax system even less transparent, as Witte documents, are the layers upon layers of exceptions to the general property tax. Once the public sees the exceptions, and recognizes that the tax system is impenetrable, transparency is clearly violated. Policy Prescription At the end of the paper, Witte suggests a way of moving the national discourse on property taxes to a focus on something that “might work and could be implemented.” His proposal is to promote “full disclosure” by local governments, citing Virginia’s and Utah’s truth in taxation provisions. Although their systems are certainly praiseworthy, neither full-disclosure state has a mecha-

TABLE 10.1C

Fees and Charges as a Percentage of Own-Source Revenues U.S. Local Total

U.S. Counties

U.S. Cities

U.S. Townships

U.S. School Distr.

FY2002

38

43

40

21

18

FY1997

38

43

41

21

17

FY1992

37

40

39

21

16

FY1987

38

42

40

20

16

FY1982

37

41

38

20

19

FY1977

27

30

29

12

13

FY1972

24

26

28

11

12

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nism for linking the individual’s tax liability to a specific benefit. Thus, Witte leaves us with a generally weak, albeit critical, piece of advice. How can believers in democratic governance and libertarian values disagree with a proposal to shine a bright light on government information and activity? An important premise of the federalist system in the United States is that it allows for, indeed requires, multiple points of entry for the public to debate and discuss policies, problems, proposals, and liberties. Multiple levels of government with multiple points of access are a better hedge against monarchy, authoritarian rule, and arbitrary public policy decisions than a centralized or unitary political system.7 But full disclosure is not enough and would matter little to the majority of decisions that are linked to the system of property taxation. The taxpayervoter may better trust the elected politician after full disclosure is implemented (no mean task and one that should not be undervalued) but it does not necessarily move the policy discussion, let alone action, to a place that aligns “reality” closer to “ideal principles.” If only representatives would effectively reflect the interests of individuals, the four “explanations” presented in Witte’s Table 10.2 could be addressed. I propose that at least two additional factors need to be incorporated in the framework: nexus and translational language. Nexus. The marketplace of government fiscal transactions has failed. Public services are not produced in a way that reflects the private market system, no matter how many people argue to the contrary. Citizens cannot or do not link their payments to a receipt of a unit of service or a util of satisfaction. Even studies on user–fee financed public services suffer from the overgeneralization that they behave like the private market. A monopoly, or even a favored status, makes this analogy unbelievable and stretched. Just ask any citizen how much she’s paying for a government service and what its worth is. And when you drill down to property–tax funded government activities, especially when multiple overlapping governments access the same asset for tax revenue, the response is just goofy. The citizens’ response to such a query illustrates the confusion in their mind and the complexity of the federal system. For example, mayors are often blamed for raising property taxes that support ineffective schools when these schools are independent government units, counties are blamed for deteriorating roads that are on the city grid, and so on. Proposals to raise or lower general tax revenue for public services seldom link the tax to a service. Is it not possible to link a one mill increase in the property tax

7. See, e.g., Beer (1993).

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to some percentage increase in service quality? Or to link a school tax increase to some measurable improvement in education outcomes? People understand subsidies; they don’t understand exchange value of public products. The challenge then is to allow taxpayers to make the link between their property tax increases and some level of public services or some acceptable redistribution of wealth. Unfortunately, the easy way out has always been for public officials to identify a “need” but then find the easiest revenue source to meet it, not the one that might serve as a nexus to the service. Governments that impose a tax on cigarette consumption and then direct those revenues to a public health activity meet the nexus requirement; governments that direct revenue raised by a lottery tax to public schools do not meet the nexus requirement, unless students are taught probabilitiy theory that would demonstrate the near impossibility of ever winning the lottery. Translational Language. Witte’s viewpoint is that administration of the property tax is costly because of its complexity and because “it confuses taxpayers.” Elected representatives have been ill served by students and scholars of public finance. By design, we speak an obscure language; by profession, we attack fuzzy problems with mathematical precision and by pretending to “know what’s best” we have forgotten the fundamental dictum of public policy discourse: Eschew Obfuscation. That dictum requires that we adopt a language that “translates” technical issues into understandable information relevant to political discourse. Unless and until we find a common language that is easily understood by taxpayers, policy analysts, economists, and politicians, we’ll continue to face the constant public refrain “don’t raise my taxes,” as homeowners can rightfully claim their tax bill went up (because valuation increased and the school district raised tax rates) while the mayor can also rightfully claim, “I didn’t raise your taxes” (because the municipal tax rate stayed the same). Half Full Full disclosure, then, is a powerful instrument of accountability in a democratic republic. But much more is needed if we are interested in relying on ideal principles to inform and be part of the reality of property tax finance in the United States and, importantly, to be part of the national discourse on property tax reform and tax base broadening. On the other hand, the discourse is likely to pit majority against majority, confounding any rational denouement and perpetuating a system that is far from the ideal. If so, rather than arguing for major transformations of the nation’s property tax system, we might ponder a lesson from the “living museum” concept: museums pre-

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serve and protect what was and always will be; they don’t recreate the ideal world from whole cloth. Revolutions don’t happen in museums. REFERENCES

Beer, Samuel. 1993. To make a nation. Cambridge, MA: Harvard University Press. Fischel, William. 2001. The homevoter hypothesis. Cambridge, MA: Harvard University Press. Frank, Thomas. 2004. What’s the matter with Kansas? New York: Henry Holt. Glade, William, and Charles Anderson. 1963. The political economy of Mexico: Two studies. Madison: University of Wisconsin Press. Gross, Daniel. 2008. What’s the matter with Greenwich? Slate (November) at http:// www.slate.com/id/2204043/. Harbaugh, William T., Ulrich Mayr, and Daniel R. Burghart. 2007. Neural responses to taxation and voluntary giving reveal motives for charitable donations. Science 316:1622–1625. Montesquieu, Charles de Secondat, Baron de. Spirit of the laws. Book XI. Of the laws which establish political liberty, with regard to the constitution. http://www.constitution .org/cm/sol.htm. RealtyTrac. Foreclosure Activity Increases 5 Percent in March (April 15, 2008). http:// www.realtytrac .com/ ContentManagement/ pressrelease .aspx ?ChannelID = 9 & ItemID=4450.

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CONTRIBUTORS

Editors

Authors

NANCY Y. AUGUSTINE

JOHN H. BOWMAN

Senior Research Associate George Washington Institute of Public Policy The George Washington University Washington, DC

Emeritus Professor of Economics Virginia Commonwealth University Richmond, Virginia

MICHAEL E. BELL

Research Professor George Washington Institute of Public Policy The George Washington University Washington, DC DAVID BRUNORI

Research Professor George Washington Institute of Public Policy The George Washington University Washington, DC JOAN M. YOUNGMAN

Senior Fellow and Chair Department of Valuation and Taxation Lincoln Institute of Land Policy Cambridge, Massachusetts

WOODS BOWMAN

Associate Professor of Public Service Management DePaul University Chicago, Illinois KELLY BROWN

MPP student in Public Policy and Administration Trachtenberg School of Public Policy and Public Administration The George Washington University Washington, DC JOSEPH CORDES

Director Trachtenberg School of Public Policy and Public Administration Professor of Economics and Public Policy and Public Administration The George Washington University Washington, DC

345

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Contributors

JENNIFER GRAVELLE

TERRI A. SEXTON

Senior Analyst, Tax Issues Strategic Issues Team U. S. Government Accountability Office Washington, DC

Professor of Economics California State University, Sacramento Associate Director Center for State and Local Taxation Institute of Governmental Affairs University of California, Davis

RICHARD K. GREEN

Professor School of Policy, Planning, and Development Director USC Lusk Center for Real Estate Marshall School of Business University of Southern California Los Angeles JESSICA MENTER

MPP student in Public Policy and Administration Trachtenberg School of Public Policy and Public Administration The George Washington University Washington, DC

SALLY WALLACE

Professor of Economics and Associate Director Fiscal Research Center Andrew Young School of Policy Studies Georgia State University, Atlanta ROBERT W. WASSMER

Professor and Chairperson Department of Public Policy and Administration California State University, Sacramento

LORI METCALF

ELAINE WEISS

Research Assistant George Washington Institute of Public Policy The George Washington University Washington, DC

Senior Research Associate Partnership for America’s Economic Success Pew Charitable Trusts Washington, DC

MARGARET SALAS

JOHN F. WITTE

MPP student in Public Policy and Administration Trachtenberg School of Public Policy and Public Administration The George Washington University Washington, DC

Professor of Political Science and Public Affairs Department of Political Science Robert La Follette School of Public Affairs University of Wisconsin—Madison

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GARRY YOUNG

JULIA FRIEDMAN

Associate Director George Washington Institute of Public Policy The George Washington University Washington, DC

Research Professor George Washington Institute of Public Policy The George Washington University Washington, DC

BING YUAN

TRACY M. GORDON

Research Assistant George Washington Institute of Public Policy The George Washington University Washington, DC

Assistant Professor School of Public Policy University of Maryland College Park MICHAEL A. PAGANO

Commentators JOHN E. ANDERSON

Associate Dean and Baird Family Professor of Economics College of Business Administration University of Nebraska Lincoln NATHAN B. ANDERSON

Assistant Professor Department of Economics Institute of Government and Public Affairs University of Illinois at Chicago RICHARD M. BIRD

Professor of Economics Emeritus Rotman School of Management University of Toronto Ontario, Canada

Dean and Professor of Public Administration College of Urban Planning and Public Affairs University of Illinois at Chicago ROBERT M. SCHWAB

Associate Dean College of Behavioral and Social Sciences University of Maryland College Park JON SONSTELIE

Professor Department of Economics University of California at Santa Barbara

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INDEX

AARP (American Association of Retired Persons), 90–93, 91n30, 92n32 abatements. See property tax abatements accountability, 18, 20, 309–310, 314 ACIR (Advisory Commission on Intergovernmental Relations), 78, 84, 85nn21–22, 86–89, 86t, 150 acquisition value rule, 119, 122, 125, 128, 132–137, 147 administration, tax relief, 97–98, 113, 154–156, 282–284 ad valorem taxation, 54, 103–104, 104n48, 114 agricultural land, 55, 112, 129, 269, 281–292, 285t; in Wisconsin, 58, 58n17–21, 60, 64–65, 326–327 Alabama, 35, 229, 237–239, 321 Alaska, 22, 237–238 Alyea, Paul E., 223, 225 Anderson, Charles, 312, 336n3 Anderson, Christopher M., 289–290 Anderson, John, 34n10, 93n36, 112, 284; abatements and, 224–225, 228n5, 229, 239, 244–246, 252n14, 255, 266n14 Anderson, Nathan B., 39–40, 121, 157, 264n11, 324, 329 Ando, A., 53 Aragones-Zamudio, Victor, 247 Arizona, 83–84, 95, 234nM; assessments in, 35, 37n13, 95, 119, 120t, 123; TELs in, 78, 92n34, 127n6, 153 Arkansas, 120t, 122, 127n6 assessed values, 26–27, 35–36, 39, 237, 271; differential, 55, 56–63, 83–84; indexed, 35, 36f; property type shares of, 37f, 38f; statutory, 35, 41, 41n19. See also AV (taxable assessed value); use valuation

assessment limits, 31n6, 117–148, 154–155; alternatives to, 138–139; evaluation of, 139–140; impact of, 125–137; prevalence of, 119–125; by state, 120–121t, 144–146t, 174–176t; turnover and, 128, 134–135; types of, 118–119 assessment ratio (AV/TMV), 34–39, 36f, 37f, 38f, 41, 283 Atkins, Patricia, 26, 35 Augustine, Nancy, 26, 35 AV (taxable assessed value), 34–40, 34n10, 260n1 Bae, Suho, 154, 242 Baer, David, 90, 92n32 Bahl, Roy, 18, 21, 113 ballot access, overrides and, 204–206 Bartik, Timothy J., 224–226, 229, 242–244, 254–255 bases, property tax. See property tax bases Benefit View of business property taxation, 226–227 Berkman, Michael, 207–208 Bingham, Richard D., 255 Bird, Richard M., 1, 149–150 Bittker, Boris I., 278 Bland, Robert L., 159 Bloom, Howard S., 271 Bollinger, Christopher R., 247 bond issues, overrides and, 206–208, 209t, 210, 210f, 215t, 217 Bowman, John H., 2–3, 15, 76, 78, 78n12, 81, 123, 332; on relief evaluation, 95, 95n42, 96n44, 101–102; on relief history, 83–84, 88n26, 90, 92nn34–35, 93, 93n37, 93n39 Bowman, Woods, 271–272

349

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Index

Branham, Thomas, 131 Bridges, Benjamin, 229 Brody, Evelyn, 30, 279 Brooks, Arthur, 280–281 Brown, Tom, 159, 169 Brueckner, Jan, 113 Brunori, David, 15, 149, 197, 203, 315, 317 Buffet, Warren, 132 Burnier, DeLysa, 238, 240 Burnstein, Melvin L., 254 businesses: studies of, 240–242, 240n10, 247–248; subnational, 226–229, 239–253. See also commercial and industrial (business) property; property tax abatements Busso, Matias, 266 California, 53, 93, 93n39, 111, 161, 321; abatements and, 237, 239; acquisition-value-based system of, 132–134, 136–138, 140; assessments and, 34, 39, 117, 119, 120t, 122, 126–127, 155; housing prices in, 131–132; property tax shares by area, 173–174; tax limitations in, 78, 92n34, 127n6, 152–153, 169–170. See also Propositions 13, 60 and 90 (CA) Canada, 49, 125 capitalization, tax/fiscal, 113, 227, 271–272 Census of Governments, 93, 93nn37–38 charities, 30–31. See also preferential tax Chen, Yung-Ping, 85–89, 85n22 Chi, Kevin S., 224–225 Chicagoland Chamber of Commerce, 129 churches, 279, 297–298t circuit breakers, 53, 76–82, 95, 111–112, 138, 313, 330–331; current status of, 91–93, 92n32, 93n36; history of, 87–89, 88n26; multiple programs of, 92, 92n34; sliding-scale approach to, 76, 79–80, 79n14, 80n15, 82, 82n19, 92, 99; threshold approach to, 76, 78–79, 82, 92, 99, 106–107 Cities and the Future of Public Finance (National League of Cities), 2 Citrin, Jack, 117, 153

classification, tax, 26–27, 37n13, 80–81, 97, 112, 237; de facto, 84–85; dynamic, 93–94, 93n39; history of, 83–85, 104 “clawback” feature, and abatements, 230–234t, 238–239 collection ratio (Tc /T1), 40 collections, property tax, 22–40, 47–49, 321–322 Colorado, 124, 169, 234nN, 237, 239; assessments and, 84, 120t, 124, 155; TELs in, 92n34, 127n6, 153, 159 Colwell, Peter F., 39 commercial and industrial (business) property, 48–49, 137; assessments and, 38f, 124, 129–130; tax inequities and, 55, 81, 135. See also property tax abatements compliance costs, 97–98 Congressional Budget Act/Office, 66, 113 Connecticut, 92n34, 104, 119, 120t, 121, 124–125, 223, 239 conservation easements, 269, 287–290, 288t Cordes, Joseph J., 273, 278, 280 Cornia, Gary C., 139, 159–160, 332 Council of State Government’s report (Chi and Leatherby), 224–225 credits, tax. See tax credits Crenson, Matthew A., 3 current use, 281. See also use valuation Dalehite, Esteban G., 222, 224, 235–236 Daniels, Thomas, 287–288 Dardia, Michael, 239–240 David, Stephen, 223 decomposition of property tax changes, 21–22, 47, 169n19 deferrals, tax, 80, 80nn16–17, 89, 89n27, 93, 112, 138, 237 delinquencies, tax, 40, 151 Depression, 48–49, 151–152 De Tray, Dennis, 169–170, 173 development rights, 287–290 Dingemans, Dennis, 131 DiPasquale, Denise, 54 direct democracy, 204–208 disabled persons, 92n33, 125

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District of Columbia, 83–84, 123, 131; assessments in, 120t, 123, 123n4; circuit breakers in, 88n26, 89, 92, 92n34 Dornfest, Alan, 130–131 Downes, Thomas A., 157, 162–164, 170, 174 Dye, Richard, 39–40, 129–131, 157, 162–164, 169, 203 easements, 283; conservation, 269, 287–290, 288t Eathington, Liesel, 247 economic development, 3, 221–267; New View and Benefit View of, 226–227; SAPTAPs and, 222–225, 227–229; subnational business activity and, 226–229 economy, changes in, 2, 20, 41 education, 54, 57, 331, 331n10; levels of, and overrides, 214, 215t, 216; state revenue distribution for, 61–62, 62n38, 160–161; TELs and, 157–158, 162–167, 170, 172. See also schools/school districts efficiency, 20, 52, 97–98, 113, 135–137, 309, 313–314 elderly population, 55–56, 56n11, 139, 215t, 216; assessment limits and, 125, 130, 134; circuit breakers and, 78, 85n22, 89; Gray Peril and, 205–207, 214; tax relief for, 20, 34, 59–60, 85–87, 86t, 89–93, 328 Epple, Dennis, 193 equity and property tax, 20, 40, 43, 55, 94–98, 112, 128; appreciation and, 129–132; horizontal inequities and, 94, 132–135, 170, 324; politics and, 309, 312–313; redistribution of burden and, 128–132, 147–148; theory and reality of, 52–53; vertical inequities and, 94, 170 Ervin, Roger, 56–57, 63 exemptions, 26, 30–31, 31n5, 34n10, 49, 51–58, 85n21; constant amount vs. percentage, 75–76, 76n6, 84; costs of, 63–67, 64nn42–43, 69–70, 70t; federal tax code and, 65–66; preferential taxes

351

and, 58–63, 271–272; property tax growth and, 29–34, 32t, 33t; real and personal property (WI), 56–58. See also homestead exemptions/ credits; nonprofit organizations exemptions expenditure limits, 61, 61n33, 155–156, 222; school districts and, 199–201t, 202t; by state, 184–188 expenditures, 39, 53–55; direct, 53–54; per student, overrides and, 214, 215t, 216. See also tax expenditures fair market value (FMV), 123 Farkas, Sarah, 93n36, 138 farmers and farm land. See agricultural land federalism, 15–16 Federal Reserve Board Flow of Funds Accounts, 273–274, 274t Felsenstein, Daniel, 242 Fernandez, Judith, 169–170, 173 Ferreira, Fernando, 137 Figlio, David N., 157, 162–164, 170, 174 Fischel, William, 62, 152, 192, 207–208, 214, 226–227 Fisher, Glenn W., 65, 80–81, 83, 90, 102, 105, 329–330 Fisher, Peter S., 224–225, 240–241, 240n10, 254 Florida, 17, 127n6, 173, 237–238; assessments in, 119, 120t, 122, 127–128, 135, 140, 155 forest land, 58, 58n20–21, 282, 326, 328 Frank, Thomas, 339 freezes, assessment, 119, 122, 125, 134–135, 237, 262n5, 283 full disclosure. See truth in taxation Fullerton, Howard N., Jr., 85–86 Fullerton, Thomas, 247 full market value (FMV), 58 Galles, Gary M., 161, 321 Ganz, Marie, 278, 280 George, Henry, 55, 55n9 George Washington Institute for Public Policy, 4, 65, 82n20, 194, 281–283

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Georgia, 17, 31, 34–35, 34n10, 38, 127n6, 234nJ, 247; assessments in, 119, 120t, 122, 126, 134–135, 137, 140 Gerber, Elizabeth, 204n1, 205, 206n3, 208, 217 Giertz, Fred, 26n3, 321–322 Gile, Crystal, 65 Ginsberg, Benjamin, 3 Glaeser, Edward L., 54, 228–229, 253–254 Glickman, Mark M., 161 Gold, Stephen David, 78, 86, 90, 93, 224–225, 235 Goodman, Allen C., 44 Goolsby, William C., 39 government sector, 31, 33t, 43, 160 Gramlich, Edward M., 1, 149 Gravelle, Jennifer, 26, 33 Gray Peril, 205–207, 214 Green, Richard K., 53–54 green (open) spaces, 269, 281–292, 285t, 328 Greenstreet, David, 240 Groves, Harold M., 83 Hatfield, Roland, 97 Haurin, Donald, 54 Haurin, R. Jean, 54 Hawaii, 237 Hawkins, Richard, 127–128, 135 Helsley, Robert W., 193 Hoene, Christopher, 150–151, 173 Holland, David W., 170, 173 homeownership, 54, 207–208, 214, 215t, 216, 335 homestead exemptions/credits, 34, 59–60, 75–76, 90–91, 92n32, 328, 330; approaches to, 299, 300–304t, 305; history of, 83, 104, 152; multiple, 91, 91n29 housing prices, 117–118, 128–132, 134, 143, 144–146t, 151 Ichniowski, Casey, 159 Idaho, 130–131, 140, 153 Ihlanfeldt, Keith R., 247, 255

Illinois, 127n6, 159, 162–163, 169, 237; assessments in, 35, 39, 119, 120t, 122–123, 129–130 incentives. See preferential tax; property tax abatements income, 55n10, 86–88, 92n35; ceilings/ limits, 91–93, 91nn30–31, 96, 107, 107n51; circuit breakers and, 77, 81–82; elasticity, 53, 114; housing price increases vs., 117–118; per capita, and overrides, 214, 215t; property tax and, 19f, 22, 23–25t, 48, 96, 105 Indiana, 77, 89, 94, 117, 237 initiatives, 203–204, 206, 214, 321 International Association of Assessing Officers (IAAO), 112, 279, 282, 284 Iowa, 92n34, 93n39, 120t, 124, 127n6, 237 Jensen, Jens P., 221 Johnson, Nicholas, 93n36, 138 Joyce, Philip, 39, 154, 156, 158–161, 164 Kansas, 52, 55, 65, 237, 239; assessments in, 35, 282, 284, 329–330 Kantor, Paul, 223 Kashian, Russell, 286–287 Kentucky, 202, 229 Kenyon, Daphne, 139 King, Jonathan R., 289–290 Kline, Patrick, 266 Kowalski, Joseph G., 39 Ladd, Helen, 113, 207, 264n11, 271 land, valuation of. See use valuation Laosirirat, Phanit, 159 Leatherby, Drew, 224–225 Ledebur, Larry C., 239 Leroy, Greg, 255 limitations on property taxes, 3, 17–19, 39–41, 43, 138. See also assessment limits; property tax rates, limits on; revenue limits; TELs (tax and expenditure limitations) limited property value (LPV), 123 Lincoln Institute of Land Policy, 3–4, 82n20, 194, 281–283 Lindholm, Richard W., 327–328

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lobbying, 90, 315–316 local option taxes/programs, 18, 43, 91, 94, 98, 119 logrolling, 319, 338–339 lotteries, 61–62, 154, 161 Louisiana, 153, 202, 229, 237 Loveridge, Scott, 238 Luger, Michael I., 242 Lynch, Robert G., 254 Lynn, Arthur, 103–104 Lyons, Karen, 93n36, 138 Maine, 92n34, 140, 237, 239, 321, 330–331 Malme, Jane, 286 Malpezzi, Stephen, 53 Mankiw, N. Gregory, 44 market value, 58; taxation, 133, 136. See also MV (market value) Martinez-Vasquez, Jorge, 113 Maryland, 55, 79, 89, 92n34, 131, 239; assessments in, 38, 119, 120t, 121, 123–124 Massachusetts, 56, 94, 153, 161, 234nI, 284; Proposition 21 ⁄ 2, 17, 168, 172, 321 Mattey, Joe, 253–254 Matthews, John, 31 McEntee, Gerald W., 254 McGuire, Therese J., 157, 159, 162–164, 169, 203 McMillen, Daniel, 39–40, 129–131, 159, 203 Measures 5 and 50 (OR), 122, 170, 172, 328–329 Meier, Kenneth J. 207–208, 213 Meredith, Marc, 207–208, 214 Merriman, David, 129–130, 168–169 Michigan, 111, 120t, 122, 222, 281n9; abatements and, 237, 239, 245–246, 245n12; TELs in, 89, 92n34, 96n44, 127n6, 152, 153 Mieszkowski, Peter, 20, 226 Mikesell, John L., 222, 224, 235–236 Minnesota, 34n10, 52, 83–84, 92n34, 95, 102n47, 198, 202; assessments in, 119, 121t, 123, 123n3, 127, 129, 285–286, 285t

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Minnesota Taxpayer’s Association, 274n4, 276 Mississippi, 35, 229, 237, 239 Missouri, 35, 138, 202, 237, 239 Moak, Casey & Associates, 126, 132 mobility, 20, 226, 228–229; assessment limits and, 133–137, 147; businesses and, 137, 243, 250, 253 Modigliani, F., 53 Montana, 83–84, 92n34, 121t, 124, 127n6, 237 Montesquieu, Charles de Secondat, Baron de, 338–339 Morain, Dan, 135 mortgages, 54, 66–67, 80, 139 Mullen, John K., 246, 252 Mullins, Daniel, 39, 154, 156, 158–161, 164, 169 municipalities, aid to, 60–63, 60nn29–30, 61n33 Munn, Andrew, 131 MV (market value), 27–34 National Association of State Development Agencies, 224 National League of Cities, 150; Cities and the Future of Public Finance, 2 Nature Conservancy, 288–289 NCSL (National Conference of State Legislatures), 1, 90–93, 91n29, 92n32, 149, 321, 330 Nebraska, 92n32, 92n34, 285, 285n11, 285t Nechyba, Thomas J., 54, 227 Nelson, Gaylord, 327, 327n9 Netzer, Dick, 26–27, 30–31 neutrality, 97, 312 Nevada, 35–36, 39, 138, 152, 237 New Hampshire, 76, 92n34, 122, 324 New Jersey, 86–87, 92n34, 153, 168–170, 172, 237 New Mexico, 35, 119, 121t, 122, 127n6, 155 New View of business property taxation, 226–227 New York, 79n13, 92n32, 92n34, 127n6, 237, 246, 287–288; assessments in, 36, 93n39, 119, 121t, 155 New York City, 34, 123

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nonexemption ratio (TMV/MV), 29–34, 32t, 33t, 41 nonprofit organizations exemptions, 56–57, 269–272, 291–292, 296, 297–298t; arguments for, 278–279; effectiveness of, 280–281; Federal 501 (c) (3) and, 273, 275–276; fiscal impact of, 30–31, 32t, 43, 272–278, 274t, 275t North Dakota, 84, 92n32, 92n34, 202, 237 notch effect/problem, 77, 77n10, 87, 96, 96n44 Nunn, Samuel, 224, 238n8 Oates, Wallace E., 1, 149 Office of Management and Budget (OMB), 66 Ohio, 35, 237, 240; TELs in, 88n26, 92n32, 92n34, 93n39, 94n40, 100–101, 152 Oklahoma, 91n29, 127n6, 152, 239; assessments and, 119, 121t, 122, 155 Oregon, 33–34, 40, 89, 202, 237, 327–329; assessments in, 119, 121t, 122, 285, 285t; Measures 5 and 50 in, 122, 170, 172, 328–329; tax limitations in, 34n10, 92, 93n39, 127n6, 153, 163 O’Sullivan, Arthur, 126, 133, 135–137, 151–152, 157, 163–164, 170 overrides, 155, 157, 163n16 overrides, school districts and, 163, 197–219; recurring and nonrecurring, 210–217, 211f, 212t, 215t; referenda and, 204–208; school boards and, 198, 202t, 204–206; by state, 199–201t, 202t; success and failure of, 210, 213–217, 215t; TELs and, 197–203, 202t; in Wisconsin study, 208–212, 209t, 210f, 211f, 212t, 215t Painter, Gary D., 161 Pandey, Lakshmi, 126, 134, 137 Papke, James, 241 Papke, Leslie, 241 Parcel, Toby, 54 Pennsylvania, 36, 91nn29–30, 92n34, 237 Persky, Joseph, 242 Peters, Alan H., 224–225, 240–241, 254 Peterson, Paul E., 1, 150

PILOTS (payments in lieu of taxes), 43, 61, 70–71, 234nL, 237 Plutzer, Eric, 207–208 politics, 307–343; empirical tax situation and, 320–324; limiting referenda and, 331–332; minorities vs. majorities and, 317–319, 337–339; nexus and, 341–342; overrides and, 213–214, 215t, 217; state actions and, 324–331; tax policy and, 315–320, 315t, 316f, 318t; tax principles vs. reality and, 307–314, 336; translational language and, 342; transparency and, 339–340; truth in taxation and, 332–333, 340–341 Pollak, Thomas, 278, 280 Poterba, James M., 156–157, 160, 194, 207 preferential tax, 58–63, 169–305; for agricultural use and green space, 281–292, 285t; for nonprofit organizations, 272–281, 291–292, 296, 297–298t Preston, Anne E., 159 progressivity of taxes, 20, 49, 53, 53n6, 313n4 property: homestead, 74n4; relative growth in stock of (MV/Y), 27–29, 28f, 29f, 30f, 41; SAPTAPs and, 236; utility, 81, 124. See also commercial and industrial (business) property; residential property property tax: benefits and provisions, 310–312, 311f, 315–317, 315t, 316t; bills, 74–75; collections (see collections); cycle, 103–105, 114; distortion, 226; exemptions (see exemptions); expenditures, 33–34, 310–313, 311f, 317–318; importance of, 17, 102, 149–150, 192; principles/theory of vs. reality, 52–53, 296, 307–314; public opinion on, 43, 47–49, 150–152, 192, 323–324, 323t, 324n6, 337–338; regime, 111, 270n2; under siege, 1–16 property tax abatements, 221–267; economic development and, 225–229; elasticity of, 243–244; empirical evidence and, 239–248, 264–266; granting and administering, 237–239,

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250–253; policy recommendations on, 253–256; pros and cons of, 224–225, 249–253; by state, 230–234t; types and methods of, 230–234t, 236–237; use of, 223–224, 229, 230–234t, 235 property tax bases, 22–40, 48, 53; abatements and, 222, 245–247, 249, 260–264; assessment limits and, 125–127; changes in, 37, 44, 47, 263–264, 263n9, 264n11; indirect effects on, 113–114; politics of, 307–343; types of property and, 48–49 property tax incidence, 49, 169–170, 169n19, 226–227, 243 property tax levy limits, 138, 159, 198, 199–201t, 202t, 203 Property Tax Policy Roundtable, 3–4 property tax rates, 26, 53, 55, 271, 321; assessment limits and, 127–131, 143; calculation of, 270–271, 270n2; effective, 69, 74, 76, 80, 84, 94–95, 133; property tax bases and, 262–263, 262n6; statutory, 39; tax rate ratio (T1 /AV) and, 39–41 property tax rates, limits on, 39, 155, 159; assessment limits and, 121–122, 127, 127n6, 130, 146–147, 171; school districts and, 198, 199–201t, 202, 202t; by state, 176–183t property tax relief, 1–3, 73–115, 299, 300–304t, 305; costs of, 97–102; current status of, 89–94; direct and indirect, 73–74, 73–74n1; evaluation of, 94–103, 112–114; future of, 105–107; history of, 82–94, 82n20, 103–105; impact of universal, 54–55; to individuals, 59–60; to municipalities, 60–63; payment mechanisms vs., 81; types of, 74–82 property tax revenues, 19f, 42t, 48; assessment limits and, 127–128; changes in, 2–3, 18, 18n1, 21–22, 47, 320–322, 320f, 322f; elasticity of, 26, 28–29, 40; impact of TELs on, 159–161; residential share of, 2–3, 15, 37, 101, 264; as share of local revenue, 18, 22, 26, 40, 73–74n1; by state, 23–25t; tax

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relief and, 98–102. See also revenue limits property values, 48, 59, 59n23, 167–168, 207, 335 Proposition 21 ⁄ 2 (MA), 17, 168, 172, 321 Propositions 13, 60 and 90 (CA), 3, 17, 53, 93, 93n39, 117, 122, 137; cost of, 126–127, 140, 153, 321; equity and, 170, 172; history of, 152–153, 192–193 PTAP, vs. SAPTAP, 230–234t, 247 public finance, 53–54, 157–170 Rahdert, George K., 278 Ramsey Tax, 52 Rappa, John, 125 rates, property tax. See property tax rates Reagan, Ronald, 143, 146, 152 real estate, 27–28, 30f, 32t, 274t. See also housing prices; property recession, 134 redistribution, of state revenue for education, 61–62 Reeves, H. Clyde, 15 referenda, 197–198, 202t, 238; concurrent, 214, 215t, 216; direct democracy and local, 204–208; limiting, 331–332; literature on school finance, 206–208; success and failure of, 210, 213–217, 215t; in Wisconsin study, 208–212, 209t, 210f, 211f, 212t regression analysis, 240, 242–247, 265 regressivity of taxes, 49, 51–52n3, 53, 55, 313n4 religious exemptions, 56, 297–298t renters, 55, 78, 81n18, 85n21, 87–89, 92, 106, 328 residential property: compared to nonresidential, 48–49; as primary source of revenue, 37, 37f, 38f, 40–41; SAPTAPs and, 236, 236n6, 247; seasonal, 135; share of property tax, 2–3, 15, 101, 264 revenue: adequacy, 98–102, 113–114; importance of local, 1, 17, 102, 149–150; per capita, 146; school, overrides and, 214, 215t, 216; shift to

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revenue (continued) nontax, 161; sources of, 147t, 320f, 322f, 339–340, 340t; stability, 20, 102–103, 114; user fees/charges as, 153–154, 161, 339–340. See also property tax revenues; state revenue revenue limits, 155–156, 159; assessment limits and, 121, 138, 143, 146–147; school districts and, 199–201t, 202t; by state, 184–188 Rhode Island, 79n13, 91n29, 229, 239 Rolnick, Arthur J., 254 Rueben, Kim S., 156–157, 160, 163–164, 194 sales taxes, 18, 20, 43 SAPTAPs (stand-alone property tax abatement programs), 222–225, 227–239, 241–242, 245, 247; policy recommendations on, 253–256; pros and cons of, 249–250; residential property and, 236, 236n6, 247; by state, 230–234t. See also property tax abatements Schmenner, Roger W., 240 school boards, overrides and, 198, 202, 202t, 204–206, 210–211, 217 schools/school districts, 152, 194, 339; assessment limits and, 121, 127, 203; TELs and, 157, 164, 165–166t, 197–203, 199–201t, 202t, 217. See also education; overrides, school districts and Sexton, Robert L., 161, 321 Sexton, Terri, 39–40, 90, 93–94, 126, 133–134, 135–137, 164, 170 Shadbegian, Ronald J., 154, 156, 158–160, 164 Sheffrin, Steven, 39, 126, 133–137, 164, 170 SILOTS (services in lieu of taxes), 43 Sjoquist, David, 31, 34, 113, 126, 134, 137 Sliger, Bernard F., 83, 85, 85n21 Smith, Daniel A., 203–204 Sokolow, Alvin, 17, 157, 161, 203 South Carolina, 35, 119, 121–122, 121t, 229, 237 South Dakota, 92n34, 237

spending, 18, 321; TELs and, 158–161. See also expenditure limits; expenditures Spiegel, Mark, 253–254 Spitzley, David, 222, 224, 227, 238, 254 state revenue: redistribution of, for education, 61–62, 62n38, 157, 160–161; replacing local revenue, 157, 160–161; tax relief funding through, 81, 88, 98–99, 106 Steinberg, Richard, 280–281 Stocker, Frederick D., 85–87, 85n22, 89–90 student-teacher ratios, 163–164, 213, 215t, 216 “sunset” clause and abatements, 230–234t, 238–239 supermajority requirements, 198, 202, 202t Swenson, David, 247 Swords, Peter, 278 taxable assessed value. See AV (taxable assessed value) tax credits, 53, 61–62, 75–76, 81, 237 Tax Expenditure Budget, 66 tax expenditures, 54, 66–67, 71–72, 278; property, 33–34, 310–313, 311f, 317–318 tax rate ratio (T1 /AV), 39–41 tax rates. See property tax rates tax revolts, 3, 17, 52, 152–153 Tc (property tax collections), 40 teacher salaries, 163–164 Tedin, Kent, 207, 213 TELs (tax and expenditure limitations), 39, 149–195; binding and nonbinding, 156–161, 171; current status of, 153–157; effects of, 150–151, 162–170, 173–174; future research on, 171–174; history of, 151–153; public finances and, 157–170; six categories of, 156, 156nn3–8; by state, 199–201t, 202t; state vs. local, 154 Tennessee, 35, 77, 139, 234nL Texas, 83, 127n6, 159, 237, 247; assessments in, 119, 121t, 123–124, 126, 285, 285t Theobald, Nick, 207–208, 213 Thomas, Kenneth P., 253–254

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Tiebout hypothesis, 54, 167 TIF (tax incremental financing) districts, 58–59, 58n22, 310, 312–313 TMV (taxable market value), 29–39, 34n10 Tolbert, Caroline, 204, 217 T1 (property tax liability), 39–41 transparency, tax policy and, 66–67, 339–340 trends, property tax, 17–50, 19f, 42t; in bases and collections, 22–40; decomposing changes in revenues and, 21–22, 47, 169n19 truth in taxation, 111, 138–139, 156n8, 159–160; politics and, 332–333, 340–341 user fees/charges as revenue, 153–154, 161, 339–340, 340t use valuation, 26–27, 53, 55, 84, 269, 272, 281–292, 285t; in Kansas, 329–330; in Wisconsin, 58, 58n17–21, 64–65, 326–327 Utah, 35–36, 84, 92n34, 139, 153, 160, 332 valuation. See assessed values; property values; use valuation value freezes (VF), 237, 262n5 Vermont, 92n34, 104, 229, 237, 239, 290 Vigdor, Jacob L., 168, 172 Virginia, 81, 89n27, 138, 139, 234nK, 332; homestead exemptions in, 91, 91n31; residential share of property tax in, 101–102 Walker, Mabel, 83, 87 Walker, Robert, 240 Wallace, Sally, 27, 30, 34 Walters, Lawrence C., 139, 159–160, 332

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Washington (state), 89n27, 92n32, 92n34, 237; assessments in, 39, 140; TELs in, 152, 153, 163 Wasi, Nada, 137 Wassmer, Robert W., 224–225, 228n5, 229, 239, 244–246, 252n14, 255, 266n14 Wasylenko, Michael, 243–244 Waters, Edward C., 170, 173 Watson, Phil, 152 Weber, Bruce A., 170, 173 Weil, David N., 44 West Virginia, 35, 76, 83, 92n34, 152, 202, 237 Wheeler, Laura, 31 White, Michelle J., 54, 137, 226 Wiewel, Wim, 242 Wilson, James Q., 315 Wisconsin, 85n22, 86, 86n24, 87–89, 100, 325–327; exemptions and valuation in, 56–63, 69–70, 316; override referenda in, 208–212, 209t, 210f, 211f, 212t, 215t Witte, John F., 314 Wolcott, Oliver, 104 Wolman, Harold, vii, 150, 222, 224, 227, 238, 254 Woodbury, Richard, 56n11, 330 Woodward, Douglas P., 239 Wyoming, 78, 92n34, 234nO Y (GSP or other measure of income), 27–29 Yinger, John, 29, 113, 271 Youngman, Joan, 281, 281n9, 286–287, 289–290, 313n4 Yuan, Bing, 164, 167 Zelenitz, Allan, 193 Zodrow, George R., 226–227, 313n4 zones/zoning, 55n9, 266; enterprise, 127, 234nN, 234nO, 266n14; fiscal, 62, 227 Zorn, C. Kurt, 222, 224, 235–236