Property taxes and their limits: evidence from New York City.

• Author: Hayashi, Andrew T.

INTRODUCTION I. WHY ARE PROPERTY TAXES SO HATED? II. TAKING THE EDGES OFF WITH ASSESSMENT CAPS A. The Proliferation of Assessment Caps B. Assessment Caps Are Tax Expenditures III. THE BENEFICIARIES OF PROPERTY TAX CAPS IN NEW YORK CITY A. Overview of New York City's Property Tax Caps B. Data C. Analysis 1. Who Currently Benefits from the Caps? 2. What Has Changed in Neighborhoods with the Largest Cap Benefits? IV. EVALUATING NEW YORK CITY'S CAPS CONCLUSION INTRODUCTION

The property tax is the largest source of tax revenue for local governments and an irresistible policy instrument for municipalities wanting to influence the urban landscape and the local distribution of income and wealth. (1) But the widespread use of the property tax for planning and redistribution means that virtually no jurisdiction straightforwardly calculates the tax liability for a property as a fixed percentage of its market value. (2) Instead, property tax rates tend to vary with the use to which a property is put or the identity of its owner. As a consequence, many of the potential benefits of the property tax, such as ease of administration, transparency, the clear reflection of the costs and benefits of local services, and the intuitive fairness of imposing taxes in proportion to property wealth, are lost.'

At the same time, each of these rate variations is designed to remedy a perceived defect with taxing only in proportion to property value. In this Article I report empirical evidence on the distributional effects of one such deviation: caps on annual assessment increases. Assessment caps limit the rate at which a property owner's taxes can increase from year to year, and are ubiquitous. (4) From a policy perspective, assessment caps are designed to create neighborhood stability and prevent cash-poor homeowners from being forced out of their homes because of escalating property values. I find that, in New York City, property tax caps on small residential properties represent a significant tax benefit that accrues to the most valuable properties and in the wealthiest neighborhoods. Moreover, rather than benefiting long-time homeowners on fixed incomes, who are their putative targets, the largest benefits go to the properties that are most likely to have been recently sold and to be located in neighborhoods where cash incomes have increased the most.

My study provides a more comprehensive and detailed description of who benefits from assessment caps than has previously been reported. This study is also the first to examine how the neighborhoods that benefit the most from assessment caps have changed over time. One justification for assessment caps is to foster neighborhood stability, particularly for cash-poor households, yet previous work has not explored how the dynamics of neighborhood change correlated with assessment caps. (5) Part I describes the context in which assessment caps were popularized: one of widespread dissatisfaction with particular features of the property tax. Part II describes how assessment caps proliferated in response to taxpayer frustration and the harms that they were meant to address. In Part III, I report the original results from my study of assessment caps in New York City, and in Part IV I evaluate how well the caps have achieved their purposes. I find that, in the case of New York City's property tax caps, the cure for what ails the property tax has been worse than the disease, and I propose either a means-tested circuit breaker or a property tax deferral regime to address the liquidity issues facing truly cash-poor homeowners without conferring an unnecessary and expensive tax benefit on other households.

1. WHY ARE PROPERTY TAXES SO HATED?

   The property tax is one of the most hated taxes in the United States. (6) A number of reasons have been offered for its unpopularity: (i) it is very salient to property owners, (7) (ii) valuation can seem arbitrary or, worse, discriminatory, (8) and (iii) it is often perceived as regressive, imposing relatively greater burdens on middle class and lower income households. (9) Perhaps the most common complaint is that property taxes can increase sharply from year to year with changes in property values. (10) This raises a puzzle. An individual's income taxes can also increase from one year to the next with increases in her income, yet those fluctuations do not create the same frustration. If tax variability were something that taxpayers disliked, one might expect at least as much resistance to it in the case of the income tax. However, there are no smoothing provisions under the income tax to mitigate the effects of wage income volatility and no apparent taxpayer agitation for them. It seems like tax variability is not, in itself, a sufficient explanation for why the property tax is so hated.

   A likely explanation lies in the fact that income generated by an increase in property value is not accompanied by cash to pay the property owner's tax liability. (11) Income without cash is known as "phantom income" and is, for many taxpayers, as scary as it sounds because it may require the liquidation of the taxpayer's assets, or borrowing secured by those assets, to pay the tax bill. In general, federal income tax law is reluctant to require individual taxpayers to pay tax on non-cash income. As a consequence, income is not taxed until it is recognized, which, for cash-basis taxpayers, typically happens upon an event that also provides them with cash. For example, a taxpayer holding appreciated stock has income, but does not pay tax on that income until it is recognized, such as upon disposition of the stock. In the absence of a recognition requirement the taxpayer might be forced to sell some of her stock in order to get the cash to pay her tax bill. Property taxes do not have a recognition requirement. When a property increases in value, a homeowner's tax bill generally goes up even if their cash income has remained unchanged. This taxation of "paper gains" is very unpopular. (12)

   The phantom income issue is more complex in the case of the property tax. It is often not feasible to sell a piece of the property to raise cash for a tax payment, and there is strong political resistance to the idea that homeowners should have to sell their homes if they cannot afford the property tax payments. (13) Moreover, in contrast to the case of marketable securities, homeowners often value their properties in more complex ways than they value stocks or bonds, which are generally held solely for their income-generating potential. Many owners have sentimental and emotional attachments to their properties that make selling them a more traumatic proposition than selling part of their investment portfolio. There are also significant financial costs involved in the selling of real property and emotional costs involved in relocation, particularly for families with school-age children. These concerns helped motivate a wave of limitations on property taxes that began thirty-five years ago and continues to this day.

2. TAKING THE EDGES OFF WITH ASSESSMENT CAPS

   1. The Proliferation of Assessment Caps

      Beginning in 1978 with the adoption of Proposition 13 in California, jurisdictions across the country have imposed limits of various kinds on property taxes. (14) Some of these are limits that apply on a jurisdiction-wide basis, such as limiting the total amount of revenues that can be collected, or restricting the property tax rate. (15) In other cases these limits apply at the level of individual properties to restrain year-to-year increases in their assessed (taxable) values. As of 2008, eighteen states had limits that applied to individual property assessments. (16)

      One commentator notes that "[t]he popularity of [individualized] assessment limits is due, in part, to the perception that they will prevent sudden increases in property tax bills.... Voters fear that the elderly, especially those on fixed incomes, will be forced from their homes." (17) Joan Youngman suggests that the imposition of property tax limits is not surprising in light of the fact that "increases in annual payments can be unpredictable, highly visible, and unrelated to cash income." (18) Nathan Anderson argues that the caps serve as insurance against unexpected increases in property value. (19) Anderson notes that, as of 2006, six states had voted to cap increases in assessments after already having revenue limits in place, (20) suggesting that factors beyond limiting the size of local government motivate adopting caps.

      The introduction of property-level caps on assessment increases introduces another difficult decision: whether to reassess properties at their full market values when they are sold. Both California's Proposition 13 and Florida's Save Our Homes law, for example, permit annual adjustments to assessed values at the lower of a specified rate and the rate of inflation. (21) Assessments are then reset to market value upon the sale of the properties. This reset discourages long-time homeowners from moving out of houses that may no longer be suitable for them, on account of the large increase in taxes that they would likely owe upon purchasing another home. (22) This lock-in effect results in an inefficient allocation of housing. Arizona, Minnesota, New York City, and Oregon, on the other hand, do not reset assessed values upon a sale, (23) avoiding lock-in but generating persistent differences between property values and tax liabilities, thereby undermining the correspondence that is the foundation of the property tax.

   2. Assessment Caps Are Tax Expenditures

      Whereas...