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Chapter 10Property Taxes
Property Taxes
Solely implemented by State and local govt.Accounts for about $240 billion annuallyLess than either local income or sales taxGenerally unpopular, but they tend to
produce stable revenue for government units closest to the electorate
US has a heavier reliance on property taxes than do most industrialized democracies
Historically, property taxes form the basis for most of local govt. revenue
Today, states gain only about 2% of revenue from property taxes, while local govt. about 75%
School districts rely on property taxes for about 96% of revenue
Property tax as wealth tax
Applies to cumulated wealth not income, so less effect on work and investment incentives
However, since they are not based on economic transactions (cannot use a market price to estimate value as with sales tax) they rely on value assessment
Two main types of property
1. Real Property – Real estate and any rights that accompany it. Land and all attributes of that land that may affect its value (soil quality, crops, plants). Improvements to the land (buildings, dams, roads, etc.). And any other rights associated with the land (air, water, mineral rights).
2. Personal property a). Tangible property – machinery, jewelry,
autos, inventory, etc. b). Intangible property – stocks, bonds, financial
assets, patents.
Some states rely heavily on personal property taxes, while other only tax real property
Most taxes are set by legislation and require a change in law to alter the rate
Property taxes are often set as part of the annual budget process
Rates are adopted at a level sufficient to yield enough revenue to balance the operating budget financing costs (debt)
Formula for setting tax rates
Property tax rate (r)
r = (E – NPR)/NAVTotal approved expenditure (E)Estimate of revenue from non-property tax
sources (NPR)Property tax levy – amount govt. plans to
collect (E – NPR)Net assessed value (NAV) – value of
assets (as assessed)
Example:Suppose a town estimates that it needs
$95,000 for the fiscal year (E=95,000)It estimates it will receive $15,000 from
non-property tax sources (NPR=15,000)Assessed value of all property in the town
is $1.75 million (NAV =1,750,000)Property tax rate is then
r = (E – NPR)/NAV r = (95,000 – 15,000) /
1,750,000r = 0.0457 or 4.57%
A land parcel would then be taxes $4.58 for every $100 of assessed value
If total assessed value was $8,000; total tax bill would be $366.40
Typically different jurisdictions have different rates, so while a county rate might be 4.58%, there would also be a state and maybe city rate
Typically only one payment is made (at county level)
Assessed value and effective tax rate
If City A has a tax rate of 10% and City B has a rate of 15%, is a property worth $100,000 taxed at 50% more in City B?
Not necessarily.The legal rate (incidence) is higher, but it
says nothing about the assessed value of the property
To compare two tax rates, need to adjust the legal tax rate for different assessed values
Assessed value
Market value is the price at which a property would be exchanged between a willing seller and willing buyer
“Assessment” is the assigned value of a property, by a professional property assessor
May follow a legally-specified standard or may even be determined by the skills of the assessor
Effective property tax rate
Effective tax rate (ETR) = T / MV
T = property tax
MV = Market value of the property
Property tax rate (T) = r * AVr = legal tax rate
AV = assess property value
So, ETR = r * (AV / MV)
Where AV/MV is the assessment ratio
Assume that City A assesses property values at 100% of market value and City B only assesses its property at 50% of market value.
City A assesses at 10% and City B at 15% But the assessment ratios are: City A = 100% and
City B 50%, so
City A ETR = r * (AV / MV) = .10 (1) = 0.10 City B ETR = .15 (.50) = 0.075
The effective tax rate is higher in City A = 10%
than City B = 7.5%
Doing Property Assessments
Purpose of any property assessment is to match the tax value of a property with the capacity to pay, in other words, to estimate the value of a property as a source of wealth
Choosing the standard to use
Market value is the best (or most common) standard
Assumes a competitive, open market: 1. Adequate time to function and reach an
equilibrium between demand and supply 2. No pressure is exerted by buyer or seller
(exchange is voluntary) 3. Both buyer and seller have adequate
information about the value of the property 4. There are not too many intermediaries that
provide information or other market information
Exceptions for using market price as the standard of value
Agricultural properties – the potential for a different use (housing development or commercial use) may increase the real value of a property against its current assessed value
Important when there is a changing land market, such as urban expansion
Assessed values attempt to protect the current user from higher tax rates until a property is actually exchanged and to prevent land markets from being distorted by property tax policies
Most assessment systems use something that is based on market value
Some states use market value directly, others try to approximate it
California, Michigan, Florida uses acquisition value or assessment-on-sale system
Properties are re-valued for taxation only when sold and at the new transaction price
State argument for assessment-on-sale
1. Avoids taxing owners on unrealized gains in value and possibly taxing people out of their homes
2. Assures predictable tax payments over time for the property owner
3. Assures revenue stability for local governments
Assessment Cycles
Refers to how and how often value of a parcel is assessed
Three types within the US
1. Mass cyclical assessment 2. Segmental assessment 3. Annual assessment
Mass cyclical assessment
All properties are assessed for tax purposes in a particular year and value does not change unless significant change to the assets on a parcel (demolition of buildings, construction, etc.)
Can be anywhere from 2 to 10 yearsMay include a physical inspection of a
property
Segmental assessment
Partial amount of all properties in a jurisdiction is re-assessed, moving across all properties in sequence
Ex: 1/3rd year 1, 1/3rd year 2, 1/3rd year 3
Typically annual assessment
Some inequity since inflation occurs between years and land values may change, but method is retained to minimize administrative costs of assessment
Annual assessment
Updates values for all parcels each year
Since an annual physical inspection is usually not possible, computer models are typically used
Conducting assessments
Three general approaches to conducting assessments. All are related to private appraisal techniques used in real estate.
1. Market-data 2. Income approach 3. Cost approach
1. Market-data
Uses data on comparable sales by examining the selling price of properties with similar characteristics
Requires actual transaction and does not work for unique properties (specific residential properties, commercial or industrial)
2. Income approach
Converts future returns from ownership to present-value equivalent
Uses idea that property is equal to the value of the stream of benefits it provides in the future
Requires knowing returns from holding the parcel, expenses, rate of interest.
Most useful for evaluating value of revenue producing properties such as apartments, commercial areas, retail, agricultural, etc.
3. Cost approach
Cost method – adds the depreciated cost of improvements to a parcel to the estimated basic land value
Estimates the value of a standard unit (ex: house with two bedrooms) and adds the additional value of extra features based on the cost of that improvement
Two methods of Cost Approach
Reproduction costs – how much it would cost to rebuild an exact replicate of the improvement
Replacement cost – the costs of having a building with the exact same characteristics (using current standards but having the same utility)
Selecting which approach to use
Each approach has different applicationsIncome approach useful for income-
producing propertiesCost approach is generally useful, but
especially for unique properties that are seldom exchanged on the market and have characteristics difficult to compare
Market data approach useful whenever there is sufficient number of transactions, such as private residential homes
Property Tax Relief Mechanisms
Just as there is tax relief provided to individuals for income spent on activities deemed socially desirable (charitable deductions) or necessary (job training) there are similar types of tax forgiveness programs direct to relief the tax burden of specific individuals or activities
Individually specified, Type of property or Use of property
Reasons to forgive property tax burdens
1. Specific characteristics of the owner – exemption is granted on conditions of ownership.
Examples:Government property not used for commercial
purposesProperty held by religious, educational, charitable
or nonprofit entitiesResidential properties through homestead,
veteran’s, mortgage or old-age exemption
Problems with individually-specified exemptions (veteran, old-age, etc.)
1. Programs are administered at the State level, but revenue consequences are local
Ex: while a program may be popular at State level, can impact local govts. Severely (ex: School districts and CA prop 13).
2. No way to focus program on needy since not means-tested
Problems with individually-specified exemptions (veteran, old-age, etc.)
3. If too wide-spread it may force tax burden on other properties
4. Can only reach homeowners and not renters (lower income). Limits overall impact.
2. Characteristics of the property
Commercial and industrial properties May include tax breaks to attract
investment Or for rehabilitation (urban depressed
areas, brownfields, etc.)
3. Use of the property
- tax breaks intended to induce favorable activities
- economic development- pollution control facilities- natural areas
Property Tax Instruments
Methods to equalize tax burden among property owners Circuit-Breakers Deferrals Classification
Methods to induce economic development Tax Increment Financing
Circuit-Breakers
Because property taxes cannot target low income households, system of “circuit-breakers” is used
Focuses relief of property tax by ratio of income to property tax
Integrates both state’s individual income tax and property tax structure
State then returns some portion of excess payment as a refund
Serves to reduce the tax burden, but at State govts. expense
Deferrals
Additional form of tax relief applicable to elderly, disabled, low income, and farmers on edge of developing areas
Individuals whose property values have risen dramatically are permitted to pay tax based on old value
Difference is deferred, not forgiven With agricultural land it is paid when the land is
converted into development (higher-valued use) With elderly, the claim is charged against the estate
after death
Classification
Different tax rates applied to different types of properties
Assumes some properties represent better ability to bear tax burden than others
Can be accomplished via assessment ratio that devalues the effective rate
Ex: Owner-occupied housing vs. seasonal housing
Tax Increment Financing (TIF)
Reducing the tax burden to attract investment, simply shifts the burden elsewhere and is not always efficient
(if development is large enough, it may increase the overall revenues to pay for the lost revenue source, if not, then both a revenue and economic loss)
TIF Offers an alternative to inducing development Usually used in economically depressed areas TIF program freezes the assessed value of all
properties in an designated area (development district)
Those tax rates go to overall public services same as any property tax
Any tax above the frozen value only goes toward new infrastructure within the development district
Becomes a geographically-designated tax and expenditure tool
Popular with industry and development officials, but not with other public service agencies
Argued that they serve as a means to bypass paying for broad public goods
Also that it allows industries to re-coup costs not directly related to infrastructure (tax “kickback”)
Limits and Controls
Established tax rates set the basic taxation level
There may be other limits beyond rates establish a special tax structure
Four primary types:
1. Statutory property-tax rate limits
2. Property-tax rate freeze
3. Levy limits
4. Local expenditure lid
Through late 1970’s early 1980’s there were a series of “property tax revolts” due to rising property values and increasing demand for public services
Led to a number of public referendums creating mechanisms limiting tax rate increases
Often these targeting the rate property is taxed at (Statutory property-tax rate limits, Property-tax rate freeze)
Others limit the total dollars that property can be assessed at, rather than the rate (Levy limits, Expenditure limits)
Response of government to limits
Since demand for services still exists, local governments have been forced to look elsewhere for funds
1. Burden other government entities or non-governmental organizations with additional services
2. Increased use of intergovernmental revenues3. Use more charge for service instruments and
search from revenues outside jurisdiction. 4. Hide property taxes with new fee services (ex: fire
or police protection charge based on property value)
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