Income based property tax relief: circuit breaker tax expenditures.

Author:Anderson, John E.
Position:Report
 
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  1. INTRODUCTION

    Circuit breakers are a form of direct residential property tax relief provided to households based on income. Most states provide some form of income-based property tax relief, but most of those states do not use the term circuit breaker. Property tax credits, or refunds, are the more common names used. The basic concept of a circuit breaker draws on the electrical breaker analogy-to provide property tax relief to households who are overburdened by their property tax bill. The distinctive element in providing property tax relief via a circuit breaker, however, is that the property tax relief falls as income rises. Hence, more general property tax relief programs such as classified property tax, homestead exemptions provided to all home owners, or use-value assessment programs for agricultural land owners, are not considered circuit breakers because they are not directly linked to the property tax paid as a share of household income. In this paper we will examine various circuit breaker mechanisms that provide property tax relief directly tied to the homeowner or renter property tax bill as a share of household income.

    The primary advantage of a circuit breaker approach to providing property tax relief is that state resources are targeted specifically to those who need the relief the most. A general property tax exemption would provide the same relief to all homeowners, whereas a circuit breaker can specifically target those whose property tax bills are high relative to their income. The result is that for a given amount of property tax relief provided by the state ($100 million, say), more substantial relief for those who need it most can be provided using a circuit breaker. Alternatively, we can say that the circuit breaker is a less expensive way to provide property tax relief because it does not waste relief on those who do not need it. Of course, defining need is a central issue in the design of any circuit breaker mechanism.

    The majority of circuit breaker programs in the United States are focused on providing relief to elderly homeowners and renters. Table 1 lists the state funded circuit breakers by type of coverage. Twenty-one states provide relief to the elderly only. Beyond coverage for the elderly, another thirteen states (including the District of Columbia) provide relief to homeowners and renters of all ages. There are seventeen states without any form of state-funded circuit breaker property tax relief. (2)

    Recent studies of circuit breakers include Anderson (2005), Augustine et al (2009), Bell et al (2010), Bowman (2008), Bowman et al (2009), Langley (2009), and Lyons et al (2007).

    In following sections of this article circuit breaker features are reviewed, benefits, costs and distributional consequences of circuit breakers are considered, methods of estimating circuit breaker tax expenditures are presented, and a case study of the Idaho program is analyzed.

  2. CIRCUIT BREAKER FEATURES

    A variety of circuit breaker mechanisms are used in the United States. In this section the various types of circuit breakers are presented based on their differing design features.

    Circuit breakers can be classified by type: threshold type (single, or multiple), sliding scale type, or hybrid and quasi type. Table 2 provides a taxonomy of circuit breakers describing each type. Langley (2009) reports that for elderly homeowners and renters in 2008 five states used a single threshold circuit breaker, 9 states used multiple thresholds, 10 used a sliding scale type of circuit breaker, 7 states applied quasi circuit breakers, and 3 states employed a hybrid form of circuit breaker. Allen and Woodbury (2006) provide a good overview of circuit breakers and a case study of the Maine circuit breaker expansion that took place in 2005. Table 3 lists the primary type of state-funded circuit breaker used by states for both elderly and non-elderly homeowners.

    Threshold-type circuit breakers define a level of property tax relative to income and then provide tax relief for all or a portion of the property taxes in excess of that threshold. Advocates of this type of circuit breaker promote the view that taxpayers should not have to pay more than a maximal amount of income in property tax. Above that level, relief is provided. Critics of this type of circuit breaker argue that homeowners with more expensive homes should pay more tax, even after the relief provided by the circuit breaker. Homeowners in communities that choose to provide high levels of public services, and consequently have high property taxes, should have to bear the burden of the higher tax rates and not be held harmless by a threshold type circuit breaker.

    Sliding-scale type circuit breakers provide property tax relief based on the income of the taxpayer, with the amount of relief declining as income rises. This type of circuit breaker provides tax relief for low-income homeowners without leveling the net tax burden relative to income, thereby retaining (although muting) difference across communities due to voter choices regarding public services. Advocates of this form of tax relief argue that the differences in housing markets and public service levels are maintained with this mechanism, unlike the threshold-type circuit breakers.

    Single Threshold Circuit Breaker Design

    A simple single threshold type of circuit breaker usually takes the form of an income tax credit for which a taxpayer qualifies if her property tax liability exceeds a threshold share of her income. The credit is then a fraction of the amount by which the property tax exceeds the specified share of income. The credit can be written as C = a(P -bY) where P is the property tax, Y is income, and a, b are parameters specified by policymakers. If the property tax exceeds a threshold level of income, P > bY, the taxpayer qualifies for the credit; otherwise no credit is provided. The parameter b, defines the threshold where the circuit breaker is triggered and is therefore viewed as the critical factor in determining the credit. The parameter a specifies how much of the property tax liability in excess of the threshold is covered by the credit. The polar case for the parameter b is a credit that provides relief for all property taxes paid in excess of the threshold level: b = 1 .In that case the credit pays the entire property tax bill in excess of the threshold level of income. While states vary widely in their credit mechanism specifications, as reported in Lyons et al (2007), the parameter a is often in the range of .03 to .05 and the parameter b is often .50 to .75. States may also set a cap for the credit, limiting the credit to a maximum amount.

    Consider an example where policymakers specify the credit as 50% of the property tax paid in excess of 5% of income, subject to a cap of $1,000. In that the credit can be written as, C = .5(P -.05Y). The taxpayer qualifies for the credit if her property tax bill exceeds 5 % of her income: P > .05Y. A qualifying taxpayer then receives a credit of one-half of the amount by which her property tax exceeds 5% of her income, up to a maximum of $1,000.

    Policymakers may make the credit more generous by (1) making the threshold easier to reach, (2) by making the credit a larger share of the property tax in excess of the threshold, or (3) increasing the credit cap. All of these actions increase the property tax relief cost to the state, however. It should be recognized that all three ways to make the credit more generous also have the effect of lowering the taxpayer net cost of an additional dollar of property tax, and do so for more taxpayers by the first method. This may have the unintended consequence of encouraging recipients to support additional increases in the property tax rate. (3)

    Multiple Threshold Circuit Breaker Design

    Multiple threshold circuit breakers allow for more progressive tax relief. As income rises, the size of the property tax credit is scaled down and eventually disappears. With this type of circuit breaker, as income increases the level of property tax burden relative to income where tax relief is provided also increases. Progressivity is provided with a lower threshold level of property tax burden for low income households than for high income households. For example, a state could specify that property tax relief is available when property tax bills exceed 3% of income for households with incomes below $20,000, 5% of income for households with incomes between $20,000 and $30,000, and 7% of income for households with incomes between $30,000 and $40,000. The threshold percentages are applied incrementally as with a graduated income tax structure.

    For eligible households with varying incomes [Y.sub.i], a multiple threshold circuit breaker with three income brackets, [Y.sub.1], [Y.sub.2], [Y.sub.3] and three corresponding threshold percentages ([b.sub.1]

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    With this type of circuit breaker, as income rises, [Y.sub.1]

    Sliding Scale Circuit Breaker Design

    With a sliding scale circuit breaker, income brackets are specified with all households in the group eligible for tax relief (e.g., elderly owners, owners of all ages). In each bracket tax relief is a given percentage reduction in property taxes, regardless of the size of their property tax bill. Housing expenditures generally rise with family income, but not proportionately. Consequently, we expect that low income families will pay a larger share of family income on housing and therefore on property taxes in comparison with high income families. The sliding scale form of circuit breaker provides property tax relief based on income with the explicit intention of leaving remaining differences across taxpayers in place. Those differences may be due to individual choices regarding the amount of housing to consume, or may be due to differences in voter preferences for public services.

    For example, consider a sliding...

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