CHANGES IN THE BENEFITS OF THE TAXABLE VALUE CAP WHEN PROPERTY VALUES ARE DECREASING: EVIDENCE FROM MICHIGAN.

Author:Hodge, Timothy R.
  1. INTRODUCTION

    In an effort to reduce the extent to which property taxes can increase in the face of rapidly rising housing prices, many U.S. states have enacted limitations on the growth rate of residential property-tax assessments. (1) In addition, most states with a taxable value cap have an "acquisition value feature", under which the taxable value of a property will "pop up" to full market value when the property is sold or transferred. When these two features of tax law are combined, it becomes possible for identical properties in the same jurisdiction to have very different property-tax obligations.

    In Michigan, as in many parts of the United States, residential real-estate prices began to fall in the middle of the first decade of the 21 (st) century, although there is considerable variation in the exact timing and extent of the price decreases. Recent research has focused primarily on the distributional consequences of assessment growth limits during periods when housing prices are rising. However, there has been little research regarding the evolution of distributional inequities when housing prices are falling.

    We use data from a survey of Michigan residents to analyze the distributional effects of the taxable value cap. The survey was conducted in 2012, by which time aggregate assessed values of residential real estate in Michigan had been falling for five years. Our estimates indicate that, on average, homeowners received a reduction in their effective property-tax rate of 0.36 mills for each additional year of ownership. (2) Despite substantial decreases in property values in many parts of the state, this estimate is only slightly smaller than the estimate by Skidmore, Ballard, and Hodge (2010) for 2008, when assessed values were very near their peak. They found that long-time homeowners received an average reduction in their effective tax rate of 0.39 mills for each additional year of homeownership. Thus, when we compare the results for 2012 with the results for 2008, we find only a modest reduction in the average size of the benefit from the taxable value cap. However, we find much larger effects on the dispersion of those benefits across different areas. In areas with low and medium rates of population growth, the tax savings for long-time homeowners were reduced substantially. This result is consistent with Sexton and Sheffrin (1998), who found that the benefits from the taxable value cap decreased in areas with decreasing property values. However, in areas with high population growth, we find that long-time homeowners experienced greater tax reductions in 2012 than in 2008.

    We also examine how the effects of the taxable value cap vary across areas with different price trends before and during Michigan's housing-market decline. In areas with housing-price appreciation before 2006 that was much greater than depreciation during the decline, long-time homeowners had reductions in their effective property-tax rates of up to 1.08 mills for each year of ownership. This estimate is considerably larger than any reduction measured by Skidmore et al. (2010). However, in areas with pre-crisis appreciation that was substantially smaller than the subsequent depreciation, long-time homeowners actually experienced higher effective tax rates, on average. This seemingly paradoxical result appears to be due to downward adjustment lags in the assessment of properties. The adjustment lags appear to have had the most serious consequences for those who bought their homes near the peak of prices. We discuss this further below. These results indicate that, when we compare 2012 with 2008, the most important effects are on the dispersion of the benefits of the taxable value cap, rather than on its statewide average.

    Finally, we explore the non-linearity of our results, comparing "older" and "newer" homeowners. Defining "newer" homeowners as those who purchased their property during the housing-market decline, we expect larger benefits for "older" homeowners since recent research has shown inaccurate assessments for many areas in Michigan during the housing-market decline. In particular, many newer homeowners were subject to severe overassessment, as assessors were slow to follow the downward trend of the market. When newer homeowners are excluded from the sample, the estimated benefit of the taxable-value cap for long-time homeowners are nearly doubled. Thus higher effective tax rates for newer homeowners are the driving force behind the higher effective tax rates mentioned in the previous paragraph.

    In Section II, we discuss the literature related to assessment growth limits, with particular emphasis on previous research examining Michigan's limit and the effects of a limit in housing markets with decreasing property values. In Section III, we describe the assessment growth limit in Michigan and its potential to create different property-tax obligations for comparable properties in the same jurisdiction. Our data and the regression model are described in Section IV. The results are presented in Section V, and we conclude with Section VI.

  2. PREVIOUS RESEARCH

    Empirical research on assessment growth limits has focused primarily on:

    (1) the degree to which these limitations have constrained the growth of property-tax revenues (Mullins and Joyce, 1996; Skidmore, 1999; Dye, McGuire, and McMillen, 2005; Amiel, Deller, Stallmann, and Maher, 2014; Connolly and Bell, 2014; Maher, Deller, Stallmann, and Park, 2016);

    (2) the distributional implications of assessment growth limits during periods of property-value growth (Dye, McMillen, and Merriman, 2006; Muhammad, 2007; Skidmore, Ballard, and Hodge, 2010; Connolly and Bell, 2014);

    (3) the potential "lock-in" effect, by which the taxable value cap provides an incentive for homeowners to stay in their current home (Nagy, 1997; Stohs, Childs, and Stevenson, 2001; Wasi, White, Sheffrin, and Ferreira, 2005; Stansel, Jackson, and Finch, 2007; Ferreira, 2009; Ferreira, Gyourko, and Tracy, 2010; Ihlanfeldt, 2011; Hodge, Skidmore, and Sands, 2015); and

    (4) the effect of these limitations on property values (Guilfoyle, 1998; Bradley, 2011).

    Skidmore et al. (2010) and Sexton and Sheffrin (1998) are of particular relevance for the present work. Skidmore et al. (2010) use survey data to examine the distributional consequences of the assessment growth limit in Michigan. As mentioned earlier, they find that, in 2008, effective property-tax rates were reduced by an average of 0.39 mills for every year of homeownership, all else equal. However, this effect varied across jurisdictions within Michigan. The estimated benefit for homeowners in areas with low rates of population growth was 0.29 mills for every year of homeownership, but this effect fell short of statistical significance. On the other hand, effective tax rates in medium- and high-growth areas were reduced by 0.48 mills for every year of homeownership, and these effects were strongly significant. We extend the work of Skidmore et al. (2010) by examining the ways in which the inequities from Michigan's taxable value cap have changed as a result of decreasing home values.

    To date, only one other study has examined the effect of a housing slump on the inequities created by an assessment growth limit. As an update to the work by O'Sullivan, Sexton, and Sheffrin (1995), Sexton and Sheffrin (1998) examine the effects of California's recession from 1991 to 1995. They find that California's declining real-estate market reduced the inequities resulting from the taxable value cap that was instituted in 1978, with the passage of Proposition 13. Specifically, the average tax savings for those owning their home since the passage of Proposition 13 decreased by 26% in Los Angeles County, and by 5.7% in San Mateo County. These reductions mirrored the reductions in housing values experienced in the two counties. We add to the work of Sexton and Sheffrin in two ways. First, we examine a larger number of areas (representative of the entire State of Michigan), which experienced different price trends before and after the peak of housing prices. Second, we consider a period with larger reductions in housing prices.

  3. EFFECTS OF MICHIGAN'S ASSESSMENT GROWTH LIMIT

    Michigan's assessment growth cap was established as a result of Proposal A, an education finance reform approved by voters in 1994. (3) Prior to the passage of Proposal A, the property tax for any individual property was based on its state equalized value (SEV), which is equal to 50% of the property's assessed market value. After 1994, property taxes were based on the taxable value of the property (TV), which could either be equal to or less than SEV, but not greater than SEV. The increase in TV for each successive year of homeownership is limited to the rate of inflation, regardless of the increase in SEV. (4) Proposal A also specifies that the TV of a property must return to its market-based SEV when the property is sold or transferred. (5) Thus, substantial inequity in the tax treatment of similar properties within a jurisdiction may arise when housing prices grow more rapidly than the general price level; the TV of a newly sold property will be equal to SEV while, over time, the TV for a long-time homeowner will fall further and further below SEV.

    However, when assessed market values are falling, Michigan law specifies that TV may continue to increase until it is equal to SEV. Once TV and SEV are equal, they will continue to be equal until the property's assessed market value once again increases at a rate faster than inflation. The effective propertytax rate faced by a homeowner is therefore a function of the time path of changes in assessed market value, the time path of the rate of inflation, and the owner's length of residence.

    In an effort to provide the reader with a sense of the complicated dynamics that may arise from Michigan's taxable value cap, Figure 1 shows the...

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