The puzzle of local double taxation: why do private community associations exist?

• Author: Nelson, Robert H.

The most important change in local government in the United States in the last quarter of the twentieth century was the rise of the private community association (Dilger 1992; Foldvary 1994; McKenzie 1994; Nelson 2005). From 1980 to 2000, about half the new housing built in the United States was subject to the private governance of a community association. At present, in California, 60 percent of all new housing is being built in a community association (Lyon 2004, iii). Indeed, in many areas of the South and the West today, essentially all development--other than small infill projects--is being built in conjunction with the creation of such a form of private government. As a result, 20 percent of all Americans now live in community associations, up from 1 percent in 1970. However, urban scholars have given only limited attention to this major development in urban governance, which represents the widest extent of privatization in any area of American life since the Homestead Act of 1862 sought to privatize the public lands.

One important neglected issue is why community associations exist at all, given that they are subject to a large financial disincentive in the form of double taxation. Much as business profits are taxed both as corporate income and as individually received dividends, private community associations are also subject, if in a different way, to double taxation. Many community associations deliver common services privately that are also provided publicly in other parts of the same jurisdiction in which the community association is located. The association unit owners, however, pay twice, first in the form of private assessments to cover the costs of their own privately provided association services and second through property and other local taxes to cover the costs of the same publicly provided services elsewhere in the same jurisdiction.

Just as double taxation of corporate dividends distorts business investment, the double taxation of community associations creates incentives for inefficient local service delivery. Recipients of publicly provided services receive a "subsidy," paid by the residents of the private communities, to obtain higher levels of services than they would be willing to pay for themselves. Residents of the private communities have a strong financial incentive to seek service provision in the public sector, even if private community provision is more efficient. Adding to the incentives working against private-sector provision, municipal taxes are deductible for the federal income tax, whereas community association assessments are not.

Moreover, the fiscal disadvantages of private community status extend to other matters. Local municipal governments, in part because they are regarded legally as appendages or extensions of state government, often receive large intergovernmental transfers of revenues. Overall, almost 40 percent of local government revenue in 2005 came from the states and the federal government. Although much local spending is for education and social services that community associations typically do not provide, local governments did spend $27 billion in 2005 for parks and recreation and $18 billion for garbage collection, areas of significant overlapping responsibility. Federal and state funds generally are not available to a community association, in part because the communities are regarded as a form of private activity not eligible for such public support. In one recent example, federal disaster assistance was available to municipal governments in the aftermath of Hurricane Katrina but was largely denied to nearby private community associations in similar circumstances.

So why do private community associations exist at all when significant financial advantages favor municipal public organization? One possible answer is that a private government has other advantages that compensate for the negative fiscal elements. Another possible answer is that county and other wider public governments may prefer private governments at the neighborhood level and may insist on their creation as a condition of development approval. I maintain that both answers have merit.

Private "Tax" Levels

The significance of local double taxation depends on the magnitudes of the additional financial burdens imposed. Unfortunately, systematic data on community associations is difficult to obtain, which is one reason why this important new social phenomenon has received less scholarly attention than it deserves. The U.S. Census collects few data on community associations. The Census of Governments collects none at all, reflecting the Census Bureau's view that a private community association is not a governmental body, but instead a form of private business activity. The American Housing Survey collects data on the number of owner occupants who pay community association fees and the magnitudes of these fees (see U.S. Bureau of the Census 2006). The purpose is not to illuminate the circumstances of community associations in the United States, but to enable the Census Bureau to estimate levels of total housing costs by categories of owner occupants. Thus, the survey is a partial sample of American housing units in community associations, limited to owner occupants and excluding the significant number of association units that are rented. Nevertheless, it is the best that the Census Bureau has to offer.

According to the American Housing Survey, the median assessment in 2005 per owner-occupied unit in a condominium or cooperative was $196 per month, or $2,352 per year--hardly a trivial amount (U.S. Census Bureau 2006, 9). By comparison, the median real-estate tax paid in 2005 by an owner occupant of a housing unit in the United States was $127 per month, or $1,524 per year (of course, the geographic distribution of all housing units in the United States differs greatly from that of condominium and cooperative units alone). According to the Community Associations Institute (CAI), condominiums represent about 40 percent and cooperatives about 5 percent of all private community associations in the United States. The largest category, about 55 percent, is homeowners associations. (Although these three forms of collective ownership of housing have many similarities in their day-today operation, each rests on a different legal basis.)

Unfortunately, the census data on homeowners associations is even more compromised. In asking questions of owner occupants, the Census Bureau does not distinguish between voluntary associations of neighbors that have few powers and collect little revenue (typically organized after the neighborhood has been developed) and mandatory homeowner associations in which the home buyers are required to agree to the terms of a powerful private government as an initial condition of purchase. The latter sort is the one spreading rapidly across the United States today, and it typically involves much higher private assessments. Perhaps the best indicator of such mandatory homeowner association "taxes" is the average assessment for townhouses (or owner-occupied "attached housing" in the Census Bureau's language), which typically consists of newer housing that is more likely to be part of a mandatory homeowners association. In 2005, according to the American Housing Survey, the median private assessment for a townhouse unit in a homeowners association was $105 per month, or $1,260 per year. (1)

Because the census data are so flawed, most researchers have relied heavily on estimates developed by the CAI, which is an unusual combination of a trade association and a research and educational institute. According to the 1999 Community Associations Factbook (the most recent such general compilation available from the CAI), the average homeowners association assessment was $90 per month per unit, the average condominium assessment was $152, and the average cooperative assessment was $440 per month (Treese 1999, 19). Weighted by the shares of each type of community association, the average assessment per housing unit for all community associations in the United States in 1999 was $132 per month, or $1,584 per year. The CAI estimated more recently that the 300,800 private community associations in the United States in 2008 will have a total annual operating revenue of $41 billion. Spread over the 24.1 million housing units in these current community associations, this total comes to a nationwide annual average of $1,701 in association service costs per unit owner--an amount that must be covered in one way or another by assessments (CAI 2008).

Further confirmation of the significant magnitude of assessments appears in the available data (again rather limited) on the actual services community associations provide, overlapping in many cases with public services provided to other people in the same jurisdiction. According to the 1999 CAI Factbook, 77 percent of all community associations provided snow removal, 64 percent garbage collection, 54 percent street cleaning and lighting, and 12 percent supplemental police patrols of the streets (Treese 1999, 13). A survey by Barbara McCabe and Jill Tao in 2006 focused on "large scale HOA [homeowner association] communities," those with at least 1,200 housing units, 1,000 acres, and $1.5 million per year in service expenditures (2006, 1144-45). Among these larger homeowner associations, more than 95 percent cut the grass and otherwise provided landscaping services in their common areas, 82 percent operated a swimming pool, 62 percent undertook street repairs, 48 percent had a security guard, 41 percent collected the trash, and 33 percent had their own golf course, among other service responsibilities (1154-55).

Thus, the added financial burdens of paying both for their own private services through community association assessments and at the same time for public services through local public taxes are significant for many associations. As...