Explaining the Complexities of Property Tax Calculations

Many people believe the property tax is the most onerous tax as it has no direct relationship to one’s annual income. Most property taxes are collected and used at the local levels of government, including municipalities, counties and school districts. And it cannot be readily reduced and is very difficult to control.

According to the Tax Foundation, property taxes account for 31 percent of all U.S. state and local tax collections—trailed by the sales tax (23.5 percent), the individual income tax (23.5 percent) and the corporate income tax (3.7 percent), and other sources (18.2 percent).

Depending on the state, the property tax can be more burdensome. The U.S average per capita is $1,518. Property taxes are highest in the Northeast and each of the New England states is among the 10 states with the highest per capita property.

Overall the District of Columbia is first ($3,350), followed by New Jersey ($3,074), New Hampshire ($3,054), and Connecticut ($2,874). Among the 10 states with the lowest per capita property taxes are in the South where sales taxes are more dominant—Texas is an exception relying on the property tax as it has no individual or corporate income taxes. The lowest per capita property tax is in Alabama at $540 and Oklahoma at $678.

Perhaps a more dramatic way to view the size and impact of the property tax is to compare states based on actual taxes paid on homes priced at the state median value. In this regard New Jersey leads the league at $7,601—followed by Connecticut at $5,443; Alabama is the lowest at $550. The average household spends $2,197.

Regardless of the tax bill, it is my experience that most folks do not understand the nuts and bolts of what factors determine their individual tax bill; how the tax bill is computed; and what factors influence the dynamics between local government who depend on property taxes and how state governments might help local units.    

Factors Which Determine the Property Tax Bill

Usually taxpayers receive a tax bill yearly from the municipality. The first reaction: Why is the bill so high? To answer properly one needs to understand all factors related to the computation and how and why it might change each year. Six factors determine the bill:

• Market value of the property one owns,
• Annual budgets for municipal, county and K-12 schools,
• Availability of other revenues,
• Value of the taxable property in the municipality,
• Tax exempt property in the municipality.
• Tax rate

The value of property can increases due to structural additions to the home, but the principal way to determine the value of property is accomplished in one of three ways: (1) house value is based on “comparable sales” transacted during the past year; (2) commercial or industrial property is usually determined by “replacement value” or; (3) income generated.

The challenge is to keep the assessment value current. If assessments are current the assessment ratio is 100 percent of true value. But, for several reasons, the assessed value may be less than true value—in which case the ratio might be at 80 percent or lower. We will examine this issue later.

How to Compute Your Tax Bill

But first, let’s look at a typical situation for an individual who lives in a state where the proceeds from the property tax bill pays for all local services, including schools, the county government and the local municipality—and examine how a property tax bill is computed:

• First. Let’s say the assessor determines the value of your home is $400,000.

• Second. Governing bodies for the municipality, the county, and the school district approve budgets for the upcoming year.

• Third. Let’s say that each local unit (let’s keep it simple) receives $2 million in revenue from other sources. For example, most school district receives state aid based on a formula of some sort. The total budget of each governmental unit less other revenues is the amount that must come from the property tax.

• Fourth. Let’s say the assessor determines the value of all property in the municipality is $4 billion. This includes homes, apartment complexes, industrial property and commercial property, etc.

• Fifth. Tax-exempt property is determined. For example, most states exclude churches, non-profit organizations and other such entities from paying property taxes.
• Six. Tax rate is determined (see below). In some states tax rate must be a single rate for every property in that municipality—whether a home or a major pharmaceutical company. Other states have different rates for commercial properties and corporations, etc. In the example below let’s assume a single rate for all property in the municipality.

We are now ready to do the computation. For example:

TOTAL $ NEEDED FROM PROPERTY TAX …………………      $82,000,000

• The tax rate for the municipality is: Total Money needed DIVIDED by Assessed Value
•  $82,000,000 DIVIDED by $4,000,000,000 = .0205
• This rate is often expressed as $2.05 cents                           

The rate is applied to the home’s assessed value of $400,000; and the tax bill for the year is $8,200.

Thus, there are five moving parts—the total assessed value in the community; the assessed value of your home; the size of each budget; other revenues available, and the tax rate. A change in any of these components will result in a tax bill change. A change in more than one component might offset another in terms of the effect on the taxpayer.

Equalization Process and Coefficient of Deviation

There are two terms one should know—‘Equalization’ and ‘Co-Efficient of Deviation (or Dispersion)’ both terms are complicated—but essential to understand property taxes. The first process allows comparisons among municipalities; the latter process identifies fairness within a municipality.

The process of Equalization ensures that each municipality in the county pays its fair share of county taxes, and most important each school district or municipality receives its fair share of assistance from the state government. Let’s consider, for example, the issue of school aid allocations to each school district.

A major component of the school formulae in many states is property value—the less property values the more state aid. Let’s say there are two jurisdictions—one whose ratio of true value (based on comparable sales) to assessed value (by the assessor) is 70 percent—and another municipality in the same county has a ratio of 98 percent. If money was distributed based on assessed value, the municipality with the lower value would receive more. But, it would not be fair. To correct this situation the state “equalizes” the aggregate value in each municipality and brings all property to 100 percent. This is basically an artificial number and is used only for the purpose of distributing state aid. The underlying assessed value is not changed—albeit, hopefully the jurisdiction would take future action to be at 100 percent. Now state aid is distributed on an equal basis.

A “Coefficient of Deviation” is also critical, and is done so everyone in the same municipality is paying one’s fair share of taxes v. other taxpayers. Complicated—yes! But, suffice to say if the variation in the assessed value among homes is in excess of 15 percent or more (percentage might be different in each state) of a “mean value calculation,” one would be pretty sure that there is unfair assessment among the properties—and people with basically the same property are paying more or less than their fair share. A computation greater than 15 percent might lead the state to direct the jurisdiction to initiate a re-evaluation of all property in the community to make tax allocation fair.

So, in summary “Equalization” insures that each jurisdiction in the aggregate is paying its fair share of taxes to the county and the municipality and school district is receiving its fair share of state aid. A computation of “coefficient of deviation” is a check to make sure everyone in the municipality is paying their fair share of taxes compared to other taxpayers in the municipality.

Options for Controlling Property Taxes

Historically, the most dramatic action to control the growth of property taxes was in California in 1978 when the voters approved Proposition 13, an initiative that limited the property tax rate to 1 percent of market value and other provisions. It is not the purpose of this short article neither to discuss the impact of this action nor to discuss in detail the actions in other states to limit property taxes, such as enacting laws to CAP the increase in either the rate or the total amount to be levied and collected. Suffice to say most states have taken some actions to control property tax growth.

In some states actions are taken to lessen the burden of the property tax, such as increasing state aid to local governments—particularly to school districts (California and New Jersey significantly increased the income tax); or the passage of laws to reduce or limit property taxes on veterans and particularly senior citizens; or to provide direct cash rebates to folks below certain incomes. Some states enact circuit breaker programs which limit property taxes to a percentage of one’s income with the state filling in the gap to the local jurisdictions. Each of these actions and more are worthy of deeper discussion.

Conclusions

Many argue—particularly in high property tax states, such as in New Jersey, Connecticut and, New York—that property tax are still too high and is the reason people and corporations are leaving these states. Others argue the tax is not fair as there is no direct relationship to income and is regressive. Some argue the property tax should be reduced and the gap filled by increasing the income tax on the wealthy. Others simply say too much is spent on government services especially for schools.

Let me observe some good things about the property tax. Unlike the income tax which is highly volatile and decreases when the economy sinks (aka—fiscal year 2008), the property tax is dependable and relatively stable. The tax is very difficult to evade; and one might argue it promotes local autonomy. Finally, from a tax administration viewpoint, most people pay their property taxes.

The obvious and logistical way to reduce property taxes is to reduce costs. Cost reductions might involve a combination of the following very difficult decisions: reduce number of jurisdictions; enforce joint service agreements among and between jurisdictions; reduce employee benefits; constrain personnel costs; eliminate or limit retirement payments for unused sick time; increase class sizes in schools and reduce administrative overhead. I could go on, but you get what would need to be done. Not pleasant and very difficult.  

These observations and facts generate another whole range of questions and consequences. Like many situations in public finance an action regarding reductions in the property tax by any of the above actions generates other reactions which may not be favorable or acceptable. Realistically, I see no significant relief in property taxes particularly in states that are currently heavily dependent on this revenue source. But hopefully, at the very least—you understand better how property taxes are developed and levied!