Detroit property tax delinquency: social contract in crisis.

Author:Alm, James
Position:Report
 
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  1. INTRODUCTION

    The nationwide real estate crisis and ensuing decline in the property tax base have affected local government finances throughout the United States. The housing market in Detroit, Michigan, was hit particularly hard. According to Hodge et al. (2013a), in 2010 the average "arms-length" selling price of a residential parcel with a structure was just $12,700. In 2013 the city's fiscal challenges came to a head when Governor Snyder appointed an emergency financial manager, who subsequently set in motion a filing for bankruptcy. Despite the near complete collapse of the real estate market within the city (1), the property tax is still an important revenue source and the quality of its administration can help or hinder economic and fiscal recovery. Currently, about half of Detroit properties are tax delinquent. The extraordinarily high rate of tax delinquency results from a confluence of factors: city and county officials have failed to fully enforce property tax compliance, particularly for low value, low tax properties; many citizens perceive the tax to be unfair, partly because of the over-assessment of property; and many property owners seem frustrated by the lack of public service provision, so that citizens may not pay taxes because local authorities have failed to provide basic public services such as public safety. (2) In many respects, the basic social contract between the city and its residents seems to be broken.

    Detroit is not the only city to experience significant property tax delinquency. A recent report by the Pew Charitable Trusts (2013) highlights emerging challenges with property tax delinquency across the nation, identifying the cities of Flint, Cleveland, and Detroit as localities that are estimated to have lost more than 20% of potential tax revenue to tax delinquency in 2011. All other cities cited in the report are below 10% in lost tax revenues, with most of the 30 cities in the study below 5%. Detroit stands out for its high delinquency rate. Indeed, as discussed by Bahl and Martinez-Vazquez (2007), the collection rate in Detroit is comparable to cities in developing countries where the property tax is used as a local revenue source such as the Philippines (collection rate of 40-50%), Jamaica (collection rate of 40%) and Chile (collection rate of 26%).

    Perhaps surprisingly, there is relatively little work on property tax delinquency, even though the related issue of noncompliance with taxes in general has attracted increased attention in recent years. Langsdorf (1973) offers an evaluation of property tax delinquency in the previously declining city of St. Louis, bemoaning a 9% property tax delinquency rate that he attributed to the high rate of property abandonment. He describes a cycle by which the value of property becomes so low that the income generating potential is insufficient for the owner and so the property is abandoned. In such cases, local authorities have no effective means by which to enforce tax compliance. (3) By U.S. historical standards, a 9% delinquency rate is high, but it pales in comparison to the current tax delinquency problem in Detroit. White (1986) also considers the role of property taxes in the decision to abandon property in New York City. Using neighborhood level data on abandonment in the late 1970s, she finds that the abandonment rate is very sensitive to property taxes, with estimates suggesting that a 1% increase in property taxes leads to a 2.1% increase in abandonment. More recently, Bradley (2013) considers tax delinquency in the much wealthier Michigan community of Ann Arbor during the 2006-2009 period, where the delinquency rate was about 8% which is high relative to historical standards. However, his focus was on assessing the role of "saliency" in tax delinquency. Bradley (2013) hypothesizes that new homeowners systematically underestimate the amount of taxes that they must pay and that this error contributes to the financial challenge of paying property taxes on time. Indeed, he finds a small but statistically significant effect of the difference between "anticipated tax payments" and actual taxes due on delinquency. Finally, Waldhart and Reschovsky (2012) explore the role that tax administration can play in tax delinquency. Using data from Wisconsin they show that increasing the number of property tax payment installments from two to three (and thus reducing the amount needed for any single given installment) reduces the delinquency rate by a third, but no additional improvements are observed by increasing the number of installments beyond three.

    The Great Recession brought to light vulnerabilities across the globe; Detroit's challenges are a small part of a much larger context. Among industrialized countries, Greece could be called the "poster child" of tax evasion, where about a third of government revenue is lost to tax evasion. In writing about the Greek crisis, Surowiecki (2011) succinctly summarized the tax compliance challenge:

    It isn't just a matter of lax enforcement, though Greek citizens also have what social scientists call very low "tax morale." In most countries, tax-compliance rates are much higher than a calculation of risks would imply. We don't pay our taxes just because we're afraid of getting caught; we also feel a responsibility to contribute to the common good. But that sense of responsibility comes with conditions. We're generally what Swiss behavioral economist Benno Torgler calls "social taxpayers": we'll chip in as long as we have faith that our fellow-citizens are doing the same, and that our government is basically legitimate. Countries where people feel that they have some say in how government acts, and where there are high levels of trust, tend to have high rates of tax compliance. As we show in our evaluation, Surowiecki's statement could have easily been written about Detroit. While Detroit is an outlier among U.S. cities, it offers important lessons for governments at the sub-national and national levels who must maintain the perception of legitimacy in order to foster high citizen tax morale and tax compliance.

    To evaluate tax delinquency in Detroit, we develop a theoretical model of the individual decision to become delinquent on one's property tax payments.

    We then estimate this model using detailed parcel-level data from the City of Detroit to examine both the factors that determine the likelihood that a property owner will be tax delinquent and, conditional upon delinquency, the factors that determine how much back taxes are owed. We find important linkages between a number of property characteristics and the likelihood and magnitude of tax delinquency. Properties that are of lower value, are non-homestead (non-owner occupied residential properties), are owned by a financial institution or by a Detroit resident, and are delinquent on water bills are more likely to be delinquent. Turning to the policy variables, our primary interest, estimates suggest that properties with a high statutory tax rate, a high assessed value relative to estimated market value, longer police response times, and for which the tax is less likely to be enforced are more likely to be tax delinquent. These findings can be used by city and county officials to improve compliance.

    In the next section we provide an overview of economic and fiscal conditions in Detroit, including a description of property tax policies and guidelines in managing tax delinquent properties. We then develop a theoretical model of individual property tax delinquency, and we estimate this model in the following section. We conclude with a discussion of the implications of these findings for Detroit in the final section.

  2. ECONOMIC AND FISCAL CONDITIONS IN DETROIT

    Since the middle of the 20th century, the City of Detroit has endured one of the longest and most severe declines of any American city. The causes of this decline range from broad macro-economic trends (globalization, de-industrialization) to idiosyncratic, local issues (corruption, mismanagement). A number of authors have chronicled Detroit's decline (Binelli, 2012; Ryan, 2012; Bomey and Gallagher, 2013). Here we provide only a brief outline of the major factors.

    For some time now, Detroit has been shrinking in every dimension except in its land area. Population, employment, resident jobs, businesses and housing units have all declined, often by staggering amounts (Figure 1). During the 1970s, Detroit's population fell by more than 310,000; the total population lost between 1970 and 2010 exceeds 888,000. The number of business establishments in Detroit fell by two-thirds, accompanying a drop of 53% in the number of jobs in Detroit. The number of Detroit residents with jobs fell by more than half.

    Trends since 2000 have continued to be negative with population losses accelerating in the last decade, with a net loss of more than 237,000 persons between 2000 and 2010. Estimates from the American Community Survey indicate continued decline. Despite an active program of demolishing dilapidated buildings, the residential vacancy rate increased from 10.4% in 2000 to 28.3% in 2013 (US Department of Housing and Urban Development, 2013).

    The numbers of jobs and real earnings in the city have fallen dramatically. Despite attracting several thousand new white-collar jobs to the downtown area, including those jobs generated by Compuware and Quicken Loans, Detroit has experienced a net loss of 74,000 jobs since 2000, including a decline of 10,000 jobs downtown (County Business Patterns, 2000-12). Average real (4) earnings for Detroit residents have fallen from $27,900 in 1999 to $21,400 in 2010 (U.S. Census of Population, 2000; American Community Survey, 2012). The value of Detroit payrolls has declined by 35% in current dollars, from $14.1 billion to $9.2 billion during the same period.

    These employment and population declines, combined with the real estate crisis, have taken an...

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