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Government and People
|Preliminary Report on Real Property Tax Relief
in the District of Columbia
by John H. Bowman, Ph.D.
Draft report prepared for the District of Columbia Tax Revision Commission
Table of Contents
Real Property Tax Relief
Property tax relief has come to be a very common feature of real property taxation. At least one form of real property tax relief is found in each state. The popularity of property tax relief is explained in part by the unpopularity of the property tax. Property taxation is the least popular of the three major state-local taxes, according to public opinion surveys such as the former annual series done for the U.S. Advisory Commission on Intergovernmental Relations (ACIR). The tax's relatively poor standing in the public's eye is, in turn, attributable to several features. One is its sheer magnitude, for property taxation accounts for more state-local revenue than either of the other major state local taxes, the general sales tax and personal income tax. Further, property taxation is levied on accumulated asset values, whereas income and consumption taxes are on current economic flows. Because property tax liability does not vary with changes in current economic circumstances, it can pose cash-flow problems. Moreover, property taxes are paid less frequently and in larger amounts at a time, and thus tend to be more visible than other taxes.
Property tax relief takes many forms. Casting the net very broadly, any revenue source that takes pressure off the property tax is a form of property tax relief. In this light, local income and sales taxes, intergovernmental grants, and other revenue sources are property tax relief [Gold 1979]. Such relief is termed indirect property tax relief. Direct property tax relief, by contrast, is extended in ways that relate clearly to the property tax. Some instruments of direct property tax relief work through features of the property tax itself. These include property classification, homestead exemptions, and use-value assessment of farm land. Other direct relief mechanisms also tie explicitly to the property tax, but lie outside that tax's structure. Examples are credits against income taxes, or separate refund programs, designed to relieve a portion of property taxes [Bowman 1986, 281-93]. The focus here is on direct relief mechanisms, excluding full exemptions for certain property owner groups (e.g., government, religious, education) and full or partial exemptions granted to certain businesses as part of an economic development program. In other words, the interest here is primarily in property tax relief for residential properties.
Types of Direct Property Tax Relief
It is fairly common for a single state to provide more than one type of property tax relief.(1) The District of Columbia is a case in point. Direct real property tax relief excluding full exemptions for government, religious, educational, and such entities includes:
The array of real property tax relief programs in the District is quite broad, even considering that most states provide more than one relief program, and often more than one program for residential property. Thus, the District's system might seem overly complex. Whether it is depends in part on the rationale for relief.
Property tax relief may be undertaken for a variety of reasons. Equity is the most commonly given motive for relief measures. If equity is viewed from the benefits-received perspective, relief would be targeted to properties not receiving some service benefits. The trash-collection tax credit for condominium and cooperative housing not receiving city trash collection service seems to be an example of such relief.
More commonly, equity arguments are based on ability to pay. Attention then is focused on the level of the tax rather than the level of services. Ability might be represented by proxy, such as use of property (e.g., residential versus non-residential), occupancy status (owner- versus renter-occupied), or some characteristic of the owner or occupant (e.g., age or disability). Within such broad groupings, however, the merits of tax relief surely varies because circumstances vary, often considerably. For example, home values in the District in 1995 are said to have ranged from well under $1,000 to over $50 million [O'Cleireacain 1997, 59-60], which suggests great diversity in households' financial circumstances, including taxpaying ability. Similarly, old age no longer is associated with financial need to the degree it once was, as a larger percentage of the non-elderly now are below the poverty line. And not all persons with a given disability, such as blindness, are equally diminished in their ability to earn a living. Thus, consideration of personal financial circumstance is preferable to reliance upon flawed proxies. In other words, if relief is undertaken to improve equity under the ability-to-pay rationale, it should be targeted based upon a measure of ability. Income certainly is a basic measure of ability, provided it is defined more broadly than in income tax statutes.
Aside from equity, the major argument for tax relief is to provide incentives for certain actions. One of the basic principles of taxation is neutrality (an aspect of what economists term efficiency), and the objective is to avoid tax-induced behavior changes. When taxes cause actions to become preferred that otherwise would be considered inferior, the behavior-altering features of the tax direct resources to less-desirable uses and thus reduce overall well-being. If wasteful use of scarce resources is not the desired outcome, therefore, the case for deliberately rewarding certain actions with lower taxes i.e., for subsidizing those actions must rest upon the proposition that the tax incentive is needed to offset other distortions.
The first two of the District's direct property tax relief programs listed above - property classification and the homestead exemption grant tax relief to owner-occupants of residential property (class 1 property owners), regardless of their need for tax relief. The senior citizen tax reduction, although still very broad, is targeted somewhat more narrowly.
Classification is the subject of a portion of the property report presented last fall, and thus is not gone into in detail here. In that report, it was suggested that the system creates differentials that are at best hard to justify, at least on the basis of ability to pay.
The usual ability-based argument for extending relief (i.e., subsidy) to all owner-occupied residential property is that such property unlike commercial property, including renter-occupied residences - is not income-generating property. As argued in the earlier classification report, however, this is an overly-narrow view. It considers only cash income, and ignores the stream of housing benefits provided to the owner-occupant(3) benefits that renters have to pay for out of after-tax income. Moreover, the income tax code fails to pick up the housing benefits going to owner-occupants, but allows key expenses associated with their generation to be deducted (i.e., mortgage interest and property taxes). Thus, both the property tax and the income tax favor owner-occupied housing. The case for classification falls short, from an ability-to-pay perspective. Indeed, if one wished to use the property tax to redress inequities arising elsewhere, classification might be used to impose relatively heavier burdens on owner-occupants than on renters to offset to some degree the income-tax preference for owner-occupancy. In its current form in the District, the classification distinction between owner- and renter-occupied housing (i.e., between classes 1 and 2) seems indefensible and it is, moreover, inconsistent with the circuit breaker programs that assume renters pay property taxes.
The same basic comments apply to the homestead exemption. It is an extension of the classification system, in that it is available only to class 1 property owners. The homestead exemption is largely redundant, in that similar relief could be given through the basic classification provisions. One difference, however, is that the $30,000 homestead exemption provides relatively more relief to owners of low-value homes than to those with more valuable homes, because the exempt amount is a larger percentage of total value for the low-value homes.(4) Thus, while classification alone would leave all class 1 property owners with an effective tax rate of 0.96 percent (assuming assessment at 100 percent of market value), data for tax year 1995 show that the constant $30,000 homestead exemption caused effective tax rates to range from a low of 0.53 percent for owner-occupants falling within the first decile of home values to 0.91 percent for those in the top decile [O'Cleireacain 1997, 60].
If not wholly redundant, the separate homestead exemption like classification can be criticized for its high cost. For each home worth at least $30,000, the exemption is worth $288 annually the product of the class 1 tax rate times the exempt amount (0.96 * $30,000). The aggregate base reduction in tax year 1996 was $2.7 billion, or nearly six percent of the real property tax base. This relief goes to virtually all class 1 homeowners regardless of their need for relief.(5)
Although somewhat more targeted than classification and the homestead exemption, the senior citizen tax relief is extremely generous. It gives a 50 percent reduction in tax for all age-eligible households with under $100,000 of adjusted gross income. Adding this on top of classification and the general homestead exemption reduced 1995 effective tax rates further, to a low of 0.18 percent for homes within the first value decile to 0.46 percent for those in the highest value decile. Even in the highest decile, with homes worth $358,000 and up, 14 percent of homes received this tax break. The aggregate base reduction of $1.4 billion was roughly half that of the general homestead exemption [O'Cleireacain 1997, 58-61].
The $100,000 income ceiling for claimants of senior citizen relief is extraordinarily high, and defining it in terms of adjusted gross income makes the relief especially generous. Income tax code distinctions based on sources of income are meaningless in terms of ability to pay; a dollar of Social Security income, for example, will buy the same as a dollar of income from wages, interest, or any other source. A broader income definition, such as that used for circuit breaker relief, would provide somewhat better targeting.
The circuit breaker approach to property tax relief conditions relief inversely in
relation to income, and thus
As noted in the earlier sketch of the District's direct property tax relief, one circuit breaker is for those aged 62 or over and/or blind or disabled, and the other is for other taxpayers. Renters are assumed to pay property tax equal to 15 percent of their rent, and on this basis may qualify for circuit breaker relief. Circuit breaker relief is obtained through a refundable credit against the District's income tax. Under either program, eligibility is restricted to those with less than $20,000 income and the maximum credit is $750. In other ways, however, the circuit breaker for te elderly or disabled is more generous. Details are given below in tables CB1 and CB2.
Although the unifying characteristic of circuit breakers is that they provide relief that declines as income rises, they come in a variety of forms. The two basic ones often are referred to as the threshold and sliding scale approaches.(6)
Some states adopt hybrids rather than going with either basic approach. The District of Columbia is in this category.
The general circuit breaker is basically of the threshold type (table CB1). It is made more complicated than most, however, through use of six different threshold percentages, ranging from 0.5 percent of household gross income (HGI) to 4.0 percent. Additionally, it uses two different "co-insurance" percentages - 5 percent (95 percent relief of the property tax in excess of the threshold percentage) for those with HGI below$3,000, and 25 percent (relieving 75 percent of the property tax over the threshold level) for those in the higher HGI brackets. The six threshold percentages thus define the six HGI brackets that are used.
The basic structure of relief for the elderly and disabled is the same as in the general circuit breaker. Both define HGI brackets to receive different treatments through specification of different threshold percentages. This more restricted program, however, has only four HGI brackets, compared to six for the general circuit breaker. Also, the thresholds start lower at any given income level, topping out at 2.5 percent for the $15,000 - 20,000 HGI range, compared to 4.0 percent for the general program. Another difference is that there is no "co-insurance" in the more restricted program; 100 percent of the tax in excess of the threshold level is relieved, up to the $750 maximum.
Among the other direct property tax relief programs listed above, the only one seemingly based on the benefits-received rationale is the trash collection credit for condominium and cooperative housing owners whose buildings do not receive trash collection services from the city. On this basis, this may be a reasonable provision, for it is linked to a service that is very visible and that must be provided privately, if the city does not do it. However, if there are other examples of properties not receiving credits for services not received, equity would require similar treatment. One must be careful in going down this path, though, for the beneficiaries of many services cannot be identified very precisely. Indeed, a basic reason for using general taxation rather that user charges is the difficulty, or even inability, in many cases to identify beneficiaries, quantify their benefits, and impose charges that can be collected.
The property tax deferral approach is one that has appeal to many analysts [Aaron 1973], but that generally is not very popular with intended beneficiaries. The same features explain both groups' reactions. Noting that property owners are better off than persons who do not own property, all else equal, many students of public finance argue that if relief from the possible cash-flow crunch of the property tax is to be provided, deferral is the way to go. In this way, the immediate cash-flow problem is ameliorated, but a permanent subsidy is not given, assuming that a market interest rate is charged against the deferred balance. If this is done, the deferral is simply a loan. Property owners typically prefer an outright gift to a loan. The District's 8 percent interest rate probably is reasonable under current circumstances. Long-term mortgages can be gotten at somewhat lower interest rates, but there may be some risk differences.
The District has numerous direct real property tax relief programs. Some, such as the homestead exemption and the class 1-class 2 distinction, reinforce each other. Thus, they have logical consistency going for them. However, there is no compelling justification for these very broad, very generous programs. They are quite costly, and of dubious merit on equity and neutrality (efficiency) grounds. Probably the main consideration favoring keeping them is the fact that the programs now exist, and their repeal or reduction would be unpopular with the recipients.
The senior citizen reduction similarly is difficult to justify by standard criteria. The $100,000 income ceiling for eligibility is very high. For example, it is five times as high as the income ceiling used for the circuit breaker programs, even without taking into account that the income definition under the latter programs is broader than for the senior citizen reduction.
The first three, and largest, of the relief programs all favor owner-occupancy over renter-occupied units. The effective-tax-rate differences are quite large. This is difficult to justify from a benefits-received perspective. And if renters pay at least a portion of the property taxes imposed on their dwellings, the sharply different treatments also are at odds with ability-based equity. It also should be noted that these programs are logically inconsistent with the District's circuit breakers, which include renters on the assumption that 15 percent of rent constitutes property tax. Perhaps the justification is that homeownership is to be encouraged. As noted earlier, however, the income tax provides this encouragement. Joint consideration of the two taxes is desirable, to determine whether the degree of subsidy provided by them is appropriate. One suspects that it is not.
If the most persuasive rationale for direct property tax relief is relief of hardships caused or exacerbated by the tax, then the circuit breaker approach is preferable to the others. It can relieve hardships where they occur without lavishing money on all home-owners. Thus, the cost of relief could be reduced. Given the reality of relatively few available dollars, each dollar of foregone property tax revenue, due to whatever relief program, is a dollar not available for other uses including more appropriately targeted property tax relief.
While states typically have more than one real property tax relief program, the array of them within the District seems excessive, unduly complex, and often extremely generous.
Classification is considered above because it is a form of direct property tax relief. It is not the subject of the recommendations that follow, though, because an earlier report dealt separately with classification. The recommendations below are not considered to be inconsistent with those made earlier regarding classification.
The District should eliminate the homestead exemption and senior citizen reduction and replace them with a single circuit breaker program.
First and foremost, the property tax should be a revenue instrument. Its provisions should be relatively simple, with differences in tax treatments across categories of owners and of property uses being kept to a minimum. Ideally, those differences should be justified by one or more of the major criteria for evaluating taxes. The strongest case for treatment differing from the basic (or baseline, before tax relief) provisions is ability-based equity. As discussed above, the homestead exemption and senior citizen tax reduction are not warranted under this criterion. They provide large amounts of tax relief with the spray of a shotgun blast, rather than targeting the relief to those most in need in a manner more akin to a rifle shot.
These programs also do not fare well under the other primary criteria. While there may be some external, community-wide benefits from homeownership that some might feel warrant the very favorable treatments of these programs, caution must be exercised. First, a healthy, dynamic city requires a wide range of property uses, each of which contributes to the well-being of the area. Owner-occupied housing is not unique in that regard. Additionally, the tax advantages bestowed by these programs are very generous, and are in addition to income tax preferences; taken together, these two major taxes provide very substantial subsidies to owner-occupied residences. The joint or cumulative effects of the two taxes should be considered.
The District should place primary reliance upon the circuit breaker approach for providing property tax relief. To this end, it should adopt a new sliding scale program with the same provisions applicable to all, regardless of age, disability, and other proxies for need; a broad definition is the best gauge of ability.
The broad income definition of the current circuit breakers is appropriate, and should be retained.(8) The circuit breaker is preferable to other forms of property tax relief (with the exception of a deferral), because it can achieve the objective of relieving tax-related hardships with the least damage to the property tax i.e., less revenue loss and fewer distortions and inequities.
The separate, more generous circuit breaker based on age and disability suffers the same weakness as the separate tax reduction program for the elderly. They do not stack up well against basic evaluation criteria. To address hardships caused by the property tax, targeting by income clearly is desirable. Moreover, a sufficiently broad definition of income will assure greater equity among taxpayers in need of some assistance with their taxes. With such a tax relief program, there is no need for special provisions based on aged, disability, or other proxies for need.
Clearly, age is not as good a proxy for need as it was a few decades ago, as poverty incidence among the elderly has dropped below that for the non-elderly. Nor are disabilities necessarily good proxies for need. Even those with the same sort of disability e.g., blindness may experience different degrees of impairment in their earning abilities. More importantly, in attempting to define disabilities that might serve as proxies for need, it is necessary to enumerate those disabilities, and the disability percentages, that are to qualify individuals for tax relief. Any such attempt almost certainly will omit some people who are at least as needy as many who would qualify, because they are unfortunate enough to have the "wrong" form of disability. There also may be significant administrative and compliance costs attending use of such proxies. Consider, for example, the definitions of blindness and disability in the District's circuit breaker [District Code, 47-1806.6(b)]:
In the case of blindness, those falling short of the 20/200 standard, for example, by even a little bit, are to be denied relief, while those meeting that criterion qualify. Such sharp cutoffs, or notches, may be necessary in spelling out qualifications for such programs. It is highly doubtful, however that they reflect accurately the debilitating effects of the disability, which probably occur more gradually.
But why use proxies for need, when income can be measured? If income-earning ability is low, whether due to a particular degree of vision impairment, a "medically determinable physical or mental impairment," or some other circumstance or combination of circumstances, it will show up in income.
The exact provisions of the circuit breaker could cover a very broad range; there is not one right formula. One consideration is the current relief offerings. Each has its constituency. The more of them that are being replaced, the more generous the circuit breaker is likely to have to be to gain acceptance. This was the case in Michigan a few decades ago when it consolidated tax relief. Thus, if classification were eliminated, the circuit breaker might be made more generous than if it were retained. A gain still would be made in buying into the basic logic of targeting tax relief, even though it might not be feasible to achieve initially the targeting that might ultimately be desired. Still, there are several considerations to be addressed.
One is the sliding scale approach. When differences in taxes across households are determined to a considerable extent by differences in fiscal capacity per capita or per household, the threshold approach is preferable [Bowman 1980]. Within the District, however, inter-jurisdictional capacity disparities are not an issue. Because differences in property tax liability across households should reflect only differences in home value, it is appropriate to leave in place the relative highs and lows, simply reducing all via the sliding scale formula.
Under the sliding scale approach, a threshold percentage is not needed. The multiple thresholds of the District's programs add to the complexity. By relieving only a fraction of the tax in each income bracket defined by the formula, no household goes to zero tax liability. This takes care of the "co-insurance" concern.
The number of brackets to be defined is an issue. Some states define many more than others. Use of a relatively large number of brackets with relatively small differences in the relief percentages will avoid large "notch" problems in effective tax rates with respect to income. For example, instead of having, say, five brackets with relief percentages declining by 10 percentage points or more from one to the next, it is preferable to have a large number of brackets featuring small decreases in the relief percentage in moving up the income scale. Thus, one might envision brackets $5,000 wide with five percentage-point reductions in the relief percentage: Under $5,000 of money income, relief 85 percent of property tax; $5,000-10,000 of income, relieve 80 percent; and so on. If no relief were given above $40,000 of income, the lowest relief percentage under this formula would be 50 percent. I have not had the data needed to cost this or any other proposal.
A separate issue that may fit generally within the area of property tax relief concerns the tax treatment of dwellings in buildings owned by cooperative housing associations. Such housing qualifies for other forms of tax relief listed above, although sometimes with some differences, but also receives different treatment in determining assessed values. Some have proposed eliminating the valuation difference, while the Cooperative Housing Association argues that the difference is justified. After defining cooperative housing and sketching the treatment of such housing under the tax relief programs, the issue of its valuation is taken up.
As noted, cooperative housing is owned by a cooperative housing association. The District code offers the following definition:
Common areas exist in both condominiums and cooperative housing, causing them to differ from single-family, detached housing. In condominium buildings, each dwelling unit is owned individually, whereas in cooperative housing, people have an ownership stake in the property owned by an association, and that stake may permit them to occupy a dwelling unit.
For purposes of classification, if at least 50 percent of the dwelling units in property owned by a cooperative housing association are occupied by shareholders or members, the property qualifies as class 1 property; otherwise, it is class 2 [District Code, 47-813(c-3)(1)(B) and (2)(B)]. The homestead exemption reduces the estimated market value of cooperative housing association property by 60 percent, up to the amount equal to the $30,000 exemption times the number of dwelling units occupied by shareholders or members of the association [District Code, 47-850(d)(2)]. The cooperative and condominium trash collection tax credit is granted to a cooperative housing association for each dwelling unit occupied by its shareholders or members as their primary residences, provided there are more than three dwelling units and trash collection is not provided by the city [District Code 47-873].
Two options are provided for determining the assessed value of improved residential property owned by a cooperative housing association [District Code, 47-820.1(a)]:
Justification for the 65 percent factor (35 percent reduction) is provided. It rests on "factors common to all sales of improved residential real property owned by cooperative housing associations" but implicitly not other forms of housing? and assumes that one year is required "for the purchaser of the real property to sell out the proprietary leases, stock, or other cooperative interests in the real property [District Code, 47-820.1(c)]. Those factors include discounting eventual receipts to their present value; taxes and interest costs during the one-year period; operating and marketing expenses during the one-year period; other costs during that period, such as appraisal, surveying, and legal fees; and profit.
Assuming that valuation starts in the manner it would for condominiums, the net result is that cooperative housing would be valued at less than half as much as condominiums, if the only difference were ownership form [.7 * .65 = .455].
The District should eliminate the special reduction factors spelled out above.
The justification for not treating cooperative housing the same as condominiums is not convincing. The tax treatment accorded cooperative housing seems unduly favorable. If insufficient information exists to value based on leases, stock, and the like, and valuation in the first instance is as if the property were condominium property, the value so determined is reduced by 30 percent. The further reduction of 35 percent applied whichever valuation method is used. In other words, if there were two properties, identical except for ownership form one being owned by a cooperative housing association, the other being under condominium ownership and each determined in the first instance to be worth $100,000, the one owned by the cooperative housing association would be valued for tax purposes at $45,500 ($100,000 * .7 *.65), while the other would be valued at $100,000. It is hard to believe that ownership form effectively destroy over half the value of the property.
While not all state laws have been searched, several have, and that search failed to turn up similar provisions. Moreover, discussions with a private valuer and offices of the Real Property Tax Administration failed to identify a convincing rationale for the differential treatment of cooperative housing in relation to condominiums.
With regard to the separate 65 percent factor (35 percent reduction), the justification in the statute seems to suggest that the sort of cost factors enumerated are not applicable to other forms of real estate. Certainly, financing fees, interest, legal fees, and the like, are incurred by developers and sellers of other types of real estate, as well as concern for making a profit. Whether the "sell-out period" is more or less than the one year assumed for cooperative housing, there almost certainly is a period before full occupancy occurs.
1. For summary listings, see U.S. Advisory Commission on Intergovernmental Relations [1994a, 138-49] and Gold .
2. For details, see tables CB1 and CB2. Under the general circuit breaker, however, relief ranges from 95 percent of the tax over 1.5 percent of household gross income (HGI) for those whose household income is under $3,000, to 75 percent of the property tax over 4 percent of HGI for those with household income between $15,000 and $20,000. For the elderly, blind, and disabled, the relief ranges from all property tax over 1 percent of HGI for those with less than $5,000 of such income, to all the tax over 2.5 percent of HGI for those with $15,000 to $20,000 of such income. Note that "household gross income" is much broader than "household income," the latter of which is the same as adjusted gross income for income tax purposes, while the former includes essentially all cash income.
3. Official personal income measures of the U.S. Department of Commerce's Bureau of Economic Analysis include imputed rental value of owner-occupied housing in income.
4. The requirement that homestead exemption claimants be subject to District income tax, however, tends to narrow the range of eligibility somewhat, eliminating those who may reside in the District while being domiciled elsewhere.
5. Recall the requirement of liability for the District's income tax. Over 99 percent of all homeowners in each home-value decile (other than the lowest one) received the exemption for tax year 1995 [O'Cleireacain 1997, 60].
6. For discussions, see ACIR [ -- ]; Bowman ; and Gold [ -- ].
7. Both this term and the circuit breaker name itself were coined by John Shannon in the 1960s, when this form or tax relief was new and he was at ACIR.
8. If recommendation 1 is not adopted, to improve horizontal equity the income definition used for the senior citizen reduction should be changed to that used for the circuit breaker.
Provisions of General Property Tax Circuit Breaker
Note: Renters treat 15% of rent as property tax equivalent.
Provisions of Property Tax Circuit Breaker Credit for Persons Who Are at Least 62 Years Old, or Who Are Blind or Disabled
Note: Renters treat 15% of rent as property tax equivalent.
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