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The Practical Realities of Property Tax Reforms

Proposals to eliminate them usually ignore the basic facts of life in state and local revenue management. Successful changes will be focused and surgical, and there is an intriguing opportunity to apply AI to local tax relief.

A tax form
It’s an election year, so nobody should be surprised to see eye-catching proposals for sweeping tax cuts in various jurisdictions. Some folks want to abolish the property tax altogether; others are pushing to eliminate their state’s income tax. Their proponents’ rationales are familiar and longstanding. Generally speaking, it’s progressives and liberals who think property taxes are regressive, whereas conservatives and libertarians despise income taxes — especially graduated levies — as soak-the-rich schemes that destroy incentives for production.

The fundamental problem for those who think they can simply eliminate either tax, of course, is that these levies provide revenue needed for basic governmental operations. No matter how much fraud, waste and inefficiency the tax-haters think they can find, it’s impossible to fund fire and police departments, schools, criminal justice systems, public transportation and other essential public services without some combination of one tax or the other. Likewise, the fiscal liberals seeking to equalize tax burdens between communities of differing wealth need to find viable replacement revenues.

Unless they can come up with something out of the blue to replace the foregone revenue, such as an integrated federal-state value-added tax, both sides of this political divide would be wiser to focus on property tax reforms — specifically smaller, incremental tweaks to the tax base that can be achieved in ways that neutralize some of the negative features of the unpopular levy, whose inflation-driven collections rose 6.9 percent nationwide in 2023. To prevent political blow-ups, pragmatism needs to prevail over ideology, as the Government Finance Officers Association’s recent report on equitable assessment techniques explains.

This past decade’s rapid run-up in residential property prices was driven foremost by super-low interest rates and a decade of insufficient new housing, coupled with a huge pandemic-related increase in government spending and the Federal Reserve’s accommodative monetary policy that propelled inflation. This real estate scenario had a clear precedent in the 1970s, when inflation pushed home values higher, which in turn spurred successful rebellious voter ballot proposals to curb property tax escalation.

The most famous of these was California’s Proposition 13, which limited property assessments and the maximum tax rates that local governments could set. Other states adopted tax and revenue limitations of various kinds that capped the revenues of municipal governments and school districts. The common thread of these laws was that property value inflation should not automatically drive up tax bills and boost governments’ revenues at the expense of homeowners.

Today’s agitas over property taxes is pretty much a replay of that scenario. So let’s look for ways to reduce inflation-induced burdens on households without mucking up the entire system and giving tax-dodgers the upper hand.

Sensible Solutions

There are essentially two approaches to property tax limitations: Cap the growth of either property assessments or revenues. Prop. 13 did both, but its longer-lasting distortion of tax policy has been its limitations on individual property assessments, which are not allowed to exceed 2 percent annually unless and until a property changes hands.

Local voters in California can approve a tax-rate increase with a supermajority vote, but they cannot change the property assessment limits without a constitutional amendment. As a result, longtime businesses and in-place senior citizens enjoy valuations that were assessed 45 years ago. For perspective, while their assessments have increased by 150 percent since Prop. 13’s passage in 1978, the CPI has increased by 370 percent and market values of California houses have risen by 1,070 percent. As a result, a first-time homebuyer inequitably bears a property tax burden 4.5 times as high as Granny living down the street, or the McDonalds and neighborhood strip mall held in an LLC all these years. Similar extreme inequalities have surfaced in New York City, where selective assessment limits also apply.

Such massive distortions of assessment valuations give huge incentives for property in such states to be held by legal entities and not “natural persons,” the legal parlance for individuals rather than corporations, partnerships and trusts. Corporations and partnerships can often retain their perpetually preferential assessment basis as long as the entity remains intact. Family trusts and LLCs have been crafted to provide similar tax shelters to affluent residential owners. Meanwhile, most homeowners forfeit their tax limitations when they sell and buy anew. Such a privileged caste of long-term property holders is an anachronism that cannot endure forever.

In California, the schools’ and teachers’ lobbyists tried unsuccessfully in 2020 to eliminate the Prop. 13 tax shelter for businesses, but failed at election time after a clever opposition TV ad campaign depicted a sorrowful housewife fretting that corrective property assessment adjustments for businesses and farms would devastate her meager family budget. But over time, as the disparity of tax treatment becomes increasingly indefensible, local governments and public employee unions will likely sponsor a new proposal to limit the assessment freezes under Prop. 13 to natural persons only.

Should such a reform come to pass, I’d suggest a reasonable and fair five-year transition period for artificially depressed assessments to revert to full market value, plus a windfall limitation — perhaps 4 percent annually — on how much additional overall tax revenue a local jurisdiction can capture simply as a result of the re-establishment of fair valuations. Beyond that allowance, the local tax rates should be correspondingly reduced overall, for the benefit of all property owners. Being natural persons, sensible voters could be educated that it’s in their own self-interest to clean up the mess that Prop. 13 has left behind after the past 45 years.

Other Approaches

In other states, the most prominent form of property tax limitation has been a curb on the annual growth of local tax receipts derived from inflating property assessments. A good example is Michigan’s 1978 “Headlee amendment,” which limits increases in each jurisdiction’s property tax revenues to the lesser of the latest CPI increase or 5 percent annually, plus growth from improvements to the properties. These revenue caps are far less prone to abuses and inequitable distortions. Governing bodies that seek more revenue than allowed by the statewide cap can present a referendum option for voters to tax themselves at a higher rate. That policy model should satisfy all but the most ardent tax-haters, if they actually believe in democracy.

The important concept here is that property assessments should continue to reflect fair market value, and revenue limitations are derived from applying limits or rollbacks to the tax rate times the total tax base. Revenue rollbacks like these are at least equitable solutions to the problem of property price appreciation that outstrips household budgets.

A third approach is to exempt a certain portion of property taxes for “homesteads” or senior citizens and other natural persons deemed to be deserving of protections. In most states, the local tax collector is responsible for administering this tax relief, and in most of those cases the dollar amounts are relatively trivial in the context of total local government revenues. State laws typically make no distinction between elderly poor or elderly rich, and it’s a nightmare to try to invoke an income test in the formulas at the local level.

A Role for AI

Emerging technology may offer a new and smarter way to provide property tax relief. A few states offer it indirectly through their income tax deductions, but the shortcoming in that approach is that the economics are right but the politics are not: Those tax breaks are typically viewed as state income tax relief and not local property tax relief. It hasn’t been possible to show income-based credits on property tax bills. Soon, however, computerized data-sharing interfaces linking local jurisdictions with state income tax authorities could apply artificial intelligence to confidentially match local property parcels with owners’ latest state income tax returns.

Such a network could enable state revenue departments to calculate and reimburse personalized income- and needs-based credits to apply on local property tax bills and perform the unique calculations for each household, sending a customized parcel-specific data file to local tax collectors. The result would be precision-targeted property tax relief for eligible homeowners.

The beauty of this AI-based system is that its application could be limited to natural persons and provide relief only to those who file state tax returns with incomes below a statutory threshold, with proportionally larger credits for those with lower incomes, which could greatly reduce the regressive drawbacks of the property tax. AI could even make it possible to provide equivalent relief to tenants through rent-reduction vouchers or credits on their utility bills. The question for tax reformers is how comfortable they and their constituents would be with such Big Brother databases.

Ultimately, the preferable solution to many of these issues would be a revision of the federal income tax code to provide better deductions and credits for state and local taxes, at least partially undoing the limits imposed by the 2017 tax law. But until the next Congress convenes, there is no point in trying to outline possible solutions because the contours of the next tax bill will depend largely on the outcome of the upcoming elections. That’s a topic worth some serious discussions in December and January, but not until then.

Ultimately, the challenges facing state and local policymakers when these proposals to eliminate property and income taxes are advanced is that they never include a specific list of what should be cut on the expense side of the ledger. The anti-taxers may believe that they can just starve the beast, to shrink the size of government overall, but most of them have never sat through a budget session. Maybe it’s time for more state controllers and treasurers to schedule meetings every year with the various taxpayer unions and would-be reformers, if only to make their leaders aware of how things actually work in the real world of financial administration.

Governing's opinion columns reflect the views of their authors and not necessarily those of Governing's editors or management.
Girard Miller is the finance columnist for Governing. He can be reached at
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