Tuesday, August 09, 2005

Dangers of property tax exemptions

Here's another one from Otis White's Urban Notebook on a topic I've written about a few times before:

How to Kill a Community - Pay Up, Stranger

When cities are healthy, they’re buzzing with change. Newcomers are moving in, old-timers are moving out, new housing is built, old housing is rehabilitated, and streets that rarely saw a baby carriage in the past are suddenly chockablock with strollers. Want to kill all that? Enact a “welcome stranger” law.

What’s a welcome stranger law? That’s what they call special property-tax exemptions for longtime residents in the Atlanta area. They work by freezing property assessments, slowing their rise or simply granting ever-larger tax exemptions to homeowners — until they sell their houses. Then the new owner pays taxes on the full value.

These tax breaks are harmful — they penalize new residents, who are the lifeblood of communities — and blatantly discriminatory. How discriminatory? The Atlanta Journal-Constitution looked at two houses in the same suburban Atlanta neighborhood with vastly different tax bills, even though both were valued at about $400,000. One, owned by an old-timer, paid $970 in county taxes; the other, owned by a newcomer, paid $2,798.

So why do we have these harmful and discriminatory tax breaks? Because they’re wildly popular with voters. Georgia’s legislature permitted voters to enact welcome stranger laws in 2000; five years later, 24 counties have voted them in and another five are voting on them later this year. As the Journal-Constitution observed, “Approval is a near certainty.”

Fortunately, they may not last for long in Georgia. A former county commissioner from rural Dade County has filed a lawsuit challenging the constitutionality of the welcome stranger laws. Like other states, Georgia’s constitution requires that taxation “be uniform upon the same class of subjects,” and some legal observers believe that the uniformity principle applies to all residents, no matter how long they’ve lived in a community.

As for the man filing the lawsuit, Chuck Blevins has two objections. First, he believes the exemptions hurt communities. “It’s going to be the ruination of us,” he told the Journal-Constitution, “not now but five or six years down the road.” Second, he thinks the tax breaks are unfair. “Most people know when something is just plain wrong,” he said, “but if these people are saying, ’I don’t care if my neighbor is paying higher taxes,’ then fine.”

Unfortunately, this article doesn't do a good job articulating the other negative consequences. One is that houses stop selling and start renting as the tax discrepancy gets larger and larger (why pay extra money to the government when it can stay between two private parties?), and owners make for stronger communities and better upkeep than renters. This is a chronic problem in California.

The other problem is that as local governments need more money, they're forced to squeeze more and more of it out of newcomers, which discourages growth and can lead to stagnation.

Finally, it can be almost impossible to correct the problem after going down this road. Look at California. Warren Buffett pointed out how screwed up their tax system is, but it's impossible for voters to agree to a steep increase in their property taxes, especially since many have now bought the most house they can possibly afford on a cash flow basis, so the money just isn't available to handle the tax increase (i.e. low property tax assumptions are built into housing values and mortgage payments).

Let's hope Texas and Houston never end up being tempted down this road. I'd love to hear other stories and thoughts on this topic in the comments if you have them.

16 Comments:

At 10:15 PM, August 09, 2005, Anonymous RJ said...

Tory,

I think you and Otis White have laid-out some excellent points. For the sake of stoking the discussion, I'm going to raise a counterpoint.

Many of our neighborhoods in Houston are changing very rapidly. Where once stood a modest house, you'll now find a McMansion or two shiny new townhouses (of sometimes shoddy quality, but we won't get into that). Some greet this trend with excitement, while others resent it. Regardless of how these new neighbors are received, some of these communities are faced with sharply rising property values. What happens to existing residents - perhaps people who spent their entire lives in the neighborhood - when they can't afford to pay their newly skyrocketing property taxes? Should the very people who held a community together for years suddenly be forced out of their homes because a few developers have succeeded in making the address fashionable? Is a city's commitment to its neighborhoods only lip service when there's money to be made? Is this the urban equivalent of the land-rich cash-poor farmer, who has to sell out against his wishes because he can't pay the taxes?

OK, just wanted to put out a different take to further illustrate the complexity of this issue.

 
At 10:18 PM, August 09, 2005, Blogger Owen said...

Tory,

I've got to disagree here. The alternative to appraisal caps is to let appraisals skyrocket, thus taxing people out of their own homes simply because their property becomes more valuable in the eyes of appraisers. It's one thing to point out that slowing the rise in home values can cause market distortions, but you have to point out the grisly alternative.

It also isn't enough to say that property tax rates can be adjusted periodically to minimize the harm. The legislative process is not so predictable, and the worst of the harm tends to be sporatically located. There's simply no silver bullet for solving the problem; a balance needs to be reached with reasonable appraisal caps (my support is for 5%).

Furthermore, I believe the market distortions exist with or without the caps. Tax appraisers are notoriously bad throughout Texas -- you'll frequently see identically-situated homes in the same area with wildly different tax appraisals, seemingly not based in reality (i.e. the best realtor on the planet couldn't sell the home for the appraised value). The problem of misappraised homes is not solely a function of caps.

 
At 8:58 AM, August 10, 2005, Blogger David said...

"These tax breaks are harmful — they penalize new residents, who are the lifeblood of communities..." New residents are the lifeblood of communities? What are the existing residents? So is this saying that the 80 percent of new residents who are coming to Houston from Mexican and other South and Central American cities are Houston's lifeblood? If so, then why are all our public policies aimed at others?

 
At 9:12 AM, August 10, 2005, Blogger Tory Gattis said...

First, I think market value appraisals should always be accurate to avoid market distortions. That said, there might be options on adjusting the tax rate for individual homes. I don't mind capping overall revenue like Houston has at population plus inflation, although the inflation metric needs to measure the cost of providing city services, not the broad national inflation rate. Governments provide a lot of labor-intensive, high-inflation services like education and health care. And arbitrary numbers like 5% are dangerous if inflation ever rears up again.

But, even with a cap on overall revenues, some particular homeowners could be hit very hard in high appreciation areas. The extremes are caps for everybody or nobody, and they both have obvious downsides. I would advocate a very narrowly defined "hardship exemption license" for specific people in specific homes, with narrow criteria and a self-funding fee the homeowner has to pay to have an evaluator come out and verify their circumstances and that they live there and don't rent the place out, renewable every couple years or so. It wouldn't get them out of taxes entirely, just put a lower cap on their growth in a high-appreciation area.

 
At 11:12 AM, August 10, 2005, Blogger Owen said...

Tory,

First, I think market value appraisals should always be accurate to avoid market distortions.

Is that really possible? Somebody who knows more about the economics of real estate is free to correct me, but it has always been my understanding that the value of real estate is not awfully clear and quite manipulatable. This makes it difficult to hold appraisers accountable.

I would advocate a very narrowly defined "hardship exemption license" for specific people in specific homes, with narrow criteria and a self-funding fee the homeowner has to pay to have an evaluator come out and verify their circumstances and that they live there and don't rent the place out, renewable every couple years or so. It wouldn't get them out of taxes entirely, just put a lower cap on their growth in a high-appreciation area.

A noble idea, but I still feel it does too little. Even if a person can afford to pay rising property taxes, it isn't entirely fair that all this excess income he expected to have is sapped away by property taxes. You point out that creeping inflation can impact the government with a 5% cap -- but what about the impact on an individual's plans if their home value unexpectedly rises? It doesn't have to become a major financial hardship for homeowners to be unfairly hurt.

Moreover, you'd be setting up a new bureacracy to manage these exemptions, which would likely have the same problems as the current system whereby homeowners have to protest their appraisals, and become at the whim of bureaucrats, deadlines, etc. It's very unpleasant. Caps have their downsides, but at this point they appear to be the best solution available.

 
At 2:34 PM, August 10, 2005, Blogger Tory Gattis said...

Owen,

On appraisals: I just think they should be as accurate as possible, not artificially capped like CA where a house that is really worth $500K+ is only appraised at $250K because of very low caps. Owners won't sell or make improvements because it triggers a clean-sheet re-appraisal.

On hardship exemptions: in the US, we tax capital gains, unless they're on your home, in which case there's no cap gains tax, but your property taxes go up. That's just how we choose to do it, and people know that going into a home investment or a stock investment. Home equity loans are always available to pay the taxes if necessary. If we undertax homes relative to other investments, we get a nation of real estate speculators instead of real-value company builders.

In general, I oppose a state income tax in Texas, but I also don't want to see a purely regressive tax system. Property taxes are a good compromise, because you can choose to live in a $200K home or a $1M home, and pay accordingly. It's really the ultimate consumption tax. And if you want to encourage home ownership among the poor? Have a high base exemption (like $80K), so cheap houses have a low tax burden.

BTW, everything I've said only applies to residential real estate. I think commercial should never have caps, because then older buildings have a competitive advantage vs. new developments (lower taxes = cheaper leases), and your commercial stock will stagnate.

 
At 4:00 PM, August 10, 2005, Blogger Owen said...

Tory,

I think the problem I see is with the person who buys a home with the intention of living there indefinitely (i.e., not speculating), and simply because the area booms, or his appraiser is a cruel jerk (this happens), he ends up paying huge amounts of property taxes. Now his dream home -- though not too expensive for him to pay taxes on -- has still become a huge tax liability. He can either keep his home, or move, which he really, really doesn't want to do (let's say there are personal/sentimental reasons here).

Is this fair? I really don't think so. It's not necessarily expected, and people don't generally think of buying a home as being a major gamble in terms of taxes becoming prohibitive. I don't think they should have to, either.

And I also don't believe that a 5% cap is unreasonable. A home can still double in appraised value every twenty years on a 5% cap. The market reaction vis-a-vis taxes is simply delayed, not stopped altogether. That way the amount of taxes paid can still increase annually, but they won't be as jarring for homeowners.

 
At 4:34 PM, August 10, 2005, Anonymous RJ said...

Owen -

Minor point...

re: A home can still double in appraised value every twenty years on a 5% cap.

The growth is compounding, so the home actually doubles in value every 14.4 years (using the rule of 72).

 
At 5:05 PM, August 10, 2005, Blogger Tory Gattis said...

Owen,

I sympathize, which is why I proposed the hardship exemption. Maybe it could be a little broader. Maybe caps could be ok too, but I think they have to be pretty high. The 2% cap in California has been a big mess. 5% seems reasonable, but only given today's inflation and wage growth numbers. I think a safer cap would be twice inflation (which works out to your 5% today, and has a good possibility of going lower). Inflation is a composite with a lot of parts, some lower and some higher (like education and health care). A cap of twice inflation is high enough to be flexible but low enough to prevent strong shocks - no worse than higher ed or health care cost increases.

 
At 5:09 PM, August 10, 2005, Anonymous Adam Block said...

The Texas system is actually a lot better than the California one because it prevents the kind of outlandish discrepencies in Taxes that Tory cites.

Two of the biggest sources of discrepancy in our tax system are the non-disclosure of sale prices, and the contest procedure. I don't oppose anyone contesting their valuations and trying to manage their tax bites. However, the rule of thumb, as it has been related to me, is that you can get your assesment lowered to aboiut 65% of the market value of the property.

This diminuition of the taxable base means that to get the same amount of money, the tax rate would go up. The unfairness here is that while one group of people had their taxable appraisals go down, everyone had their rates go up.

(This means relatively higher taxes for those who don't actively contest the appraisals, no matter what level you set taxes at.)

Disclosing sale prices for tax purposes would take all the guess work out of this process immediately. It would also do a good job of sorting out the long time owners whose homes appreciate in value from the speculators who are betting on rising prices.

 
At 5:45 AM, December 04, 2006, Blogger Koda said...

Property taxes need to be based on income, not on the value of the house. Like the person in Houston said though, people are being priced out of their neighborhoods by rising property values. That is why people like the property tax system. Makes it easy to force people out of the neighborhood. Raise their taxes till they leave and it looks like it was their choice.

 
At 5:51 AM, December 04, 2006, Anonymous Anonymous said...

What other item do we own that we pay tax on year after year after year? We don't own our homes, we pay rent on them to the state.

You have a great paying job for years, you live in a nice expensive house and you suddenly lose your job 10 years before retirement. You can't make what you used to make, if you can find a job at all. Your house is paid for but you can't afford the taxes anymore. You sell your house or lose it to the state. That is just wrong! Taxes need to be based on income, not on what you own, or on what you bought in the past before you got divorced or lost your job.

 
At 5:57 AM, December 04, 2006, Anonymous Oliver said...

Lets not forget that people over 65 and disabled people get good exemptions and have barely any tax to pay.

Wait, I work with several people in their 70's. They make 6 times as much money as I do and also get social security. Why do they pay less tax than I do? I only make 30,000 a year?

What about the disabled guy that got a 1 million dollar settlement from the BP plant explosion? Why does he pay less tax than me?
With MUD taxes my tax rate is 3.75%
Would you let someone charge you that much tax on your car every year, year after year? That would be 750 a year on a 20,000 car. The whole idea is ridiculous. Tax should be based on INCOME. Even the IRS doesn't tax people with no income.

 
At 11:39 AM, December 17, 2006, Anonymous Anonymous said...

The elderly and the disabled are indeed being forced out of the homes that they have worked a lifetime to own. If you think they are getting a great tax break, why don't you check their school taxes. In some cases, taxes and insurance are 1/2 or more of their little social security check. I know people in this situation personally. One elderly man died owing $30K in taxes to the Pasadena School District. His income was $700 monthly. He lived in fear of his house being sold and living on the street. Why don't we just take the elderly and disabled out and shoot them, it would be more humane.

Texas should have a INCOME TAX and low property taxes. There is no real argument except the reasons given by the rich.

AND, who but the insane thinks all of this growth is good anyway. I came to Houston when there were about 1/2 million in the area. It wasn't a bad place to live. Its not now -- by almost any measure you would like to use - crime, traffic, illegals, drugs, taxes, flooding, cost of living, etc. etc. I wish I had never moved here in 1966) but now I cannot leave because my disabled daughter needs me to help with my granddaughter. She can't leave because her ex has visitation.

I hope you can understand the impact of high property taxes has on millions of people's lives with limited income. Do you want them all on welfare and in public housing because of taxes?? That is stupid.

Please do your research before you post, some previous posts were totally uncaring toward for the backbone of Houston citizens - the old timers. If you live long enough you will be one too, and if you don't correct the problem now, you will be moving too.

 
At 11:56 AM, December 17, 2006, Anonymous Anonymous said...

"in the US, we tax capital gains, unless they're on your home, in which case there's no cap gains tax, but your property taxes go up. That's just how we choose to do it"

This is NOT A TRUE statement, but it is true in Texas and many other states. The same house in Arkansas, for instance,would pay probably 1/10 of the property taxes, but they do have a 10 percent of federal taxes. This at least give the elderly a chance to keep their houses. I have a friend who owns 60 acres of great land with timber and roads that could easily be made into a subdivision, and he pays $220 per year. Another has commercial property on 12 acres with a 15,000 sq foot warehouse, worth at least 1/2 million and he pays $550 per year in taxes. That should give you some comparison.


Now you might think the income tax would cause the rich to move. Apparently not. Several of the richest people in the world live there - most of the Waltons, of Sams and Wal Mart fame, for instance. Remember, its based upon your income tax, which may be low if you haven't cashed in your stock, sold your property or business, etc. etc.

 
At 12:33 PM, December 17, 2006, Blogger Tory Gattis said...

I am not opposed to higher starting exemptions (the first X value of a house) or senior citizen exemptions or automatic tax rate rollbacks, but I am opposed to arbitrary appraisal caps that value a house differently than how the market does, which cause all sorts of distortions I've posted on elsewhere in this blog.
(here's one good articulation by someone else:
http://www.taptp.org/multi/perils.pdf )

Here's another idea I endorsed to help elderly home owners:
http://houstonstrategies.blogspot.com/2006/
03/brilliant-idea-on-property-taxes.html

I am opposed to an income tax for Texas, which I believe to be a dangerous slippery slope to out-of-control state and local government (see the northeast and CA).

I'm sorry you hate Houston, but I think it just keeps getting better and better - and obviously hundreds of thousands of others agree and keep voting with their feet by coming here.

 

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