Impacts of the Residential Property Tax Value Limitation and Overview of Possible Alternatives

Impacts of the Residential Property Tax Value Limitation and Overview of

Possible Alternatives

Richard Anklam, Executive DirectorTom Clifford, Research Director

N.M. Tax Research Institute

Presented toRevenue Stabilization and Tax Policy Committee

November 20, 2007

2

Background

• 3% Limitation was adopted by HB 366 (2000 Legislative Session) in response to 1998 Constitutional Amendment

• Other provisions limiting property taxes:– 20-mill limit on non-voter approved levies; – Yield Control on operating levies;– Total debt limits for different purposes;– Value limits for low-income homeowners who are over 65 or disabled (Section 7-36-21.3).

• 25 states have some form of limit on the growth of property tax revenue. – 5 limit the growth of total revenue collections to a maximum percentage (AZ, ID,

KY, MA, WV)– 3 limit total revenue growth to no more than the inflation rate (CO, MI, MT)– 6 limit growth to the lesser of a fixed percentage or the inflation rate (CA, IL, MO,

NM, SD, WA)– In most states, limits exclude new construction and can be overridden by voters

3

Role of the 3% Limitation in the Property Tax System

• Limit applies only to existing properties that do not change hands; does not apply to new properties, improvements or to properties for which the use or zoning has changed.

• Properties subject to the limit are part of the “valuation maintenance” calculation for applying Yield Control to determine operating tax rates. By limiting valuation increases, the 3% limit leads to operating levies that are higher than they would be otherwise.

• Valuation maintenance can increase by more than 3% in total because it includes the existing properties that have been re-sold, which are not subject to the limit.

• Debt service levies are also higher than they would be otherwise because the same total revenue must be generated by the smaller tax base.

4

Tax Policy Issues Raised by the 3% Limitation

• Are house prices rising faster or slower than 3% -- i.e. is the limitation binding?

• What are the impacts of the 3% limitation on total Property Tax revenue?

• Has the 3% limit caused a shift of the tax base from residential to non-residential taxpayers?

• How does the 3% Limit affect operating and debt service levies?

• Has the 3% limit caused a shift of the tax base from existing property owners to new owners?

• Does the limit cause economic inefficiency in the housing market?

Is the 3% Limitation Binding?

5

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006

-2.0

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

16.0 Figure 1: Annual Change in New Mexico House Prices

Perc

ent C

hang

e vs

. Prio

r Yea

rHome prices have risen sharply since 2000. Increases have exceeded 3%

in 11 of the last 17 years.

Source: U.S. Office of Housing Enterprise Oversight.

6

Net Taxable Value Growth Since 2000

Residential Net Taxable Value has grown by more than the 3% limit in every year since 2000.

Figure 2: Growth Rate of Net Taxable Value

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

16.0%

1999 2000 2001 2002 2003 2004 2005 2006

Property Tax Year

Residential Nonresidential

Source: NMTRI calculations using information from “Property Tax Facts” publication of N.M. Taxation and revenue Department.

7

Average Property Tax RatesAverage Tax rates have increased despite rising property values

Source: NMTRI calculations using information from “Property Tax Facts” publication of N.M. Taxation and Revenue Department.

1998 1999 2000 2001 2002 2003 2004 2005 2006$24.00

$24.50

$25.00

$25.50

$26.00

$26.50

$27.00

$27.50

$28.00

Figure 3: Average Property Tax Rate:Tax Obligations / Net Taxable Value

Residential Total

Property Tax Year

$ P

er $

1,00

0 Ta

xabl

e V

alue

8

Trends in Property Tax RevenueProperty Tax obligations have grown by more than 50% as of tax year 2006, a

compound rate of almost 7%. Residential tax liabilities have grown faster than non-residential.

Source: NMTRI calculations based on information from the N.M. Taxation and Revenue Department.

2001 2002 2003 2004 2005 2006 100

110

120

130

140

150

160

170

Figure 4: Growth of Property Tax Obligations Since 2000

Residential Nonresidential Total Personal Income

Property Tax Year

2000

Lev

el =

100

9

Residential vs. Non-Residential Property ValuesResidential taxable value has increased relative to Non-residential. Without

the 3% Limit, this trend would have been more pronounced.

Source: NMTRI calculations using information from “Property Tax Facts” publication of N.M. Taxation and Revenue Department.

1998 1999 2000 2001 2002 2003 2004 2005 200655.0%

60.0%

65.0%

70.0%

Figure 5Residential Share of Residential + Nonresidential NTV

Property Tax Year

10

Impacts on Property Tax Rates

• Under the Yield control formula lower assessed values due to the 3% limit lead to higher tax rates for operating purposes

• Debt service rates will also increase in response to lower assessed values due to the 3% limit.

• For existing homeowners, lower values will offset the higher rates. The net effect depends on the magnitude of each.

• For new property owners the higher rates will cause tax liabilities to be higher.

11

Impact on Operating Tax Liabilities of Existing Homes

Increased tax rates appear to have offset much of the benefits of the 3% limit for existing property owners. Assumes average house price inflation of 5% per year and

turnover of 5% per year.

Source: NMTRI calculations

2001 2002 2003 2004 2005 2006 2007-15%

-10%

-5%

0%

5%

10%

15%

Figure 6: Illustration: Effects of 3% Limit on Existing Owners

3% Limit vs No Limit Tax rate change Tax liability change

Perc

ent C

hang

e vs

No

Lim

its

12

Existing vs. New Property Owners

Price inflation above the 3% level causes new owners’ values and liabilities to increase above those of existing owners.

Source: NMTRI calculations.

2001 2002 2003 2004 2005 2006 20070%

2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

Figure 7: Illustration: Tax Increase of New vs. Existing Owners

Exce

ss O

ver E

xist

ing

Ow

ners

Val

uatio

n

Potential Impacts on the Housing Market

• Existing homeowners:– Prospect of higher taxes if they move may cause them to hold on to their properties,

reducing turnover, increasing tenure and reducing the supply of existing homes. – Reduced supply leads to higher prices and lower total sales. – These effects grow over time as the tax liability difference grows.

• New homeowners:– Face higher taxes because limit pushes up both debt and operating levies. – Higher “tax price” for the same public services may reduce their demand for those

services; e.g. more likely to vote against new debt issues.

• New construction:– Face higher taxes because limit pushes up both debt and operating levies. – Discourages demand for new construction;– Raises the tax price of public services for new homeowners.

13

Summary: Impacts of the 3% Limitation

• Are house prices rising faster or slower than 3% -- i.e. is the limitation binding?– Yes over the first 5 years – probably not for the next few.

• What are the impacts of the 3% limitation on total Property Tax revenue?– Small so far. Values have risen quickly and rates have

remained stable or risen.

• Has the 3% limit caused a shift of the tax base from residential to non-residential taxpayers?– Has not prevented residential values from increasing

faster than non-residential.

14

Summary: Impacts of the 3% Limitation (cont.)

• How does the 3% Limit affect property tax rates?– Both operating and debt service rates will be higher, but the

effect is small as long as turnover of existing homes is strong.

• Has the 3% limit caused a shift of the tax base from existing property owners to new owners?– Yes, but more data are needed to quantify this effect.

• Does the limit cause economic inefficiency in the housing market?– Yes, but more data are needed to quantify.

• Conclusion: 3% Limit does not have a major impact on revenues generated by the property tax. It does create inequity between existing and new property owners.

15

Possible Alternatives

Modify the Yield Control statute:• Eliminate the 3% limitation• Lower the allowed 5% growth rate of total operating tax liabilities

from existing properties

Pros:• Eliminates inequity between new and existing property owners.

Cons:• Reduces revenue growth from existing properties• Revenue would continue to grow due to new construction

Notes: Potential impacts of this proposal can be simulated using existing property tax information.

16

Possible Alternatives (cont.)

Tie debt service levies more closely to voter approval:• Debt service levies should adjust automatically downward in response to

higher property values, but aggregate debt service levies have not decreased despite sharp increases in values.

• Why are these levies not adjusting? • A study of debt service levies could be undertaken to illustrate whether the

process is sufficiently transparent to prevent “sticker shock” for voters.• Study could recommend ways to tie the levy impositions more directly to

voter actions.

Pros: • Provide a clear picture of forces driving property tax rates.

17

Possible Alternatives (cont.)

Increase Head of household exemption:• Exemption – currently $2,000 – has not been increased in many years

Pros:• Property tax relief would be targeted at lower-income households, although

all home-owning households would derive some relief

Cons:• Renting households would not receive relief

18

Possible Alternatives (cont.)

Expand the state’s “circuit breaker” program:• Provides property tax relief through the personal income tax• State – rather than local governments -- bears the fiscal burden

Pros:• Targets relief at lowest income households

Cons:• “Cash flow” problem because property taxes must be paid 2 to 3 months

before income tax refund is available.

19

Possible Alternatives (cont.)

Other measures or hybrids of existing alternatives-

Limiting residential valuation limitations by differing rates (i.e. 2% or 4%) will result in greater inequity and more protections, or vice a versa, depending on the policy objectives.

For example the poorer could be more protected with a “circuit breaker” and/or increased homestead exemption, while the valuation limitation could be increased to smooth inequities and speed current and correct valuations.

As is some other states, valuations could be limited to primary residences rather than all residential property

Other revenues could be used to offset residential tax limitations; however, they would come with a cost as well.