Policy Forum. Why is the Property Tax so Unpopular? By Nathan Anderson and Daniel McMillen. About the Authors

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1 Policy Forum Why is the Property Tax so Unpopular? By Nathan Anderson and Daniel McMillen Volume 22, Number 3 April 2010 About the Authors For local governments the property tax has long been a reliable source of significant levels of revenue. Yet, perhaps more than any other tax, the property tax has also long been the source of widespread discontent. In a recent paper, Anderson and Pape (2010) argue that uncertainty and confusion are the main sources of this antagonism toward the property tax. 1 Uncertainty arises in part because property taxes generally rise as property values increase, making it possible for a household s taxes to rise significantly even as its income holds steady or even falls. Uncertainty also arises because households find it difficult both to predict changes in their assessed values and to understand how assessment changes affect their tax bills. Moreover, the sheer complexity of the property tax system makes future tax bills hard for households to predict. A complicated property tax system is difficult for voters and policymakers to understand, let alone reform, and the lack of transparency in property tax bills makes the system appear unduly complicated. More transparency might go a long way toward increasing public understanding of the property tax. In turn, if better understood, these taxes might draw less of the public s ire. 1 Anderson, Nathan B. and Andrea D. Pape, Explaining the Tax Revolt: The Insurance Motivation for Property Tax Limits, manuscript, University of Illinois at Chicago, February The Property Tax in Illinois The starting point for the Illinois property tax system is the estimated market value of a property. We discuss below whether these estimates of how much each home could sell for in a given year are accurate. It is common in the United States for property taxes to be levied not on the full estimate of a home s market value, but on an assessed value, that is only a percentage the market value. The assessment level is 1/3 for all types of property in 101 of Illinois 102 counties. The exception, Cook County, has a classified system in which different types of property have different assessment levels. Prior to 2008, Cook County s assessment levels were 16 percent for small (six units or fewer) residential properties, 24 percent for large residential properties, 36 percent for industrial properties, 38 percent for commercial properties, and 22 percent for vacant land. Although the assessment levels were not formally changed in 2008, the Cook County Board of Commissioners established alternative market value percentages as the basis for assessment appeals. The market value percentages are 10 percent and 16 percent for small and large residential properties, respectively, 25 percent for commercial and industrial properties, and 10 percent for vacant land. The market value percentages serve the same function as the Nathan Anderson is jointly appointed the University of Illinois Institute of Government and Public Affairs and to the Department of Economics at the University of Illinois at Chicago. He earned a BA from Case Western Reserve University in 2000, then MA and PhD degrees from the University of Michigan in 2003 and 2005, all in Economics. Most of his research concerns taxation and public finance. Daniel McMillen holds appointments in the University of Illinois Institute of Government and Public Affairs and the Department of Economics at the University of Illinois at Urbana- Champaign. He earned BS and MA degrees from the University of Illinois at Chicago, and a PhD in Economics from Northwestern University in Much of his research focuses on land and home values. Policy Forum is an occasional publication of the Institute of Government and Public Affairs at the University of Illinois. It examines crucial issues facing the state of Illinois.

2 assessment level: they represent the proportion of the estimated market value serving as the basis for the tax. Once assessed values are determined, most states allow various exemptions before imposing the tax. Exemptions may include standard homeowner exemptions and special exemptions for favored groups such as senior citizens, long-time occupants, disabled persons, and veterans. Illinois has special exemptions for each of these groups, but most households qualify only for the general homestead exemption, currently $6,000. The assessed value less the exemptions is the basis for the tax. In Illinois, assessed values are also adjusted by an equalization factor. Outside of Cook County properties are required to be assessed at 1/3 of market value. If, for example, a county assesses properties at 1/6 of market value on average, the equalization factor would be 2 to ensure that the sum of all assessments is equal to 1/3 of market value. After a concerted effort in the 1990s to eliminate the widespread practice of under-assessment, nearly every county in Illinois now has an equalization factor of 1. A salient exception is Cook County, which continues to drastically under-assess most property, as is evident from the substantial differences between the market value percentages and the statutory assessment levels. The 2007 equalization factor for Cook County was , which indicates that the average property was assessed at approximately 35 percent (1/2.8439) of its statutory rate; much lower than the 50 percent rate (approximately 16 percent / 33 percent) implied by the Cook County classification system. Table 1 shows the progression from estimated market value to the tax bill for two $100,000 small residential properties, one in Cook County and the other elsewhere in the state. The final entry in the table is the tax rate. As is the case in most states, Illinois requires that the tax rate be the same for all properties within a taxing jurisdiction. However, tax rates can vary dramatically across jurisdictions and within jurisdictions over time. Indeed, myriad taxing units in Illinois school districts, municipalities, townships, counties, special districts can lead to significant variation in tax rates for properties that are quite Table 1. Examples of Property Tax Calculations for Cook County and Elsewhere in Illinois Cook County Other Counties Estimated Market Value (MV) $100,000 $100,000 Market Value Percentage /3 (Cook) or Assessment Level (AR) = Assessed Valuation $10,000 $33,333 Equalization Factor (EF) = Equalized Assessed value $28,439 $33,333 (EAV) - Homestead Exemption - $6,000 - $6,000 = Adjusted Equalized Value $22,439 $27,333 (Adj. EAV) Tax Rate (t) t t = Tax $22,439 t $27,333 t close to one another, but are located in different tax districts. In the example above, the final tax rate could end up being higher in Cook County than elsewhere. The final tax payment, in turn, depends on both the adjusted equalized value and the tax rate. A Simple Tax Structure? Although the tax structure appears quite complicated, it can be expressed as a simple linear function of the estimated market value. Using the notation shown in the table, the final tax is: Tax = (t)(ef)(ar)(mv exemption) The tax structure is far simpler than the federal income tax schedule, with its innumerable deductions and marginal rates that vary by income. The tax schedules implied by the table when t = 0.10 are simply MV in IGPA University of Illinois Urbana-Champaign Chicago Springfield 2

3 Cook County and MV in other counties. Since these taxes cannot be negative, these schedules imply that homeowner facing a 10 percent tax rate pays no tax when the home s estimated market value is below $21,126 in Cook County or below $18,018 elsewhere in the state. Above these thresholds, each additional $10,000 in estimated market value increases the tax payment by $284 in Cook County and by $333 in other counties when the tax rate is 10 percent far less than the $1,000 that may appear to be implied by a 10 percent tax rate. Taxes increase by much less than the proportion implied by the nominal tax rate primarily because the property tax is levied on a fraction of market value rather than the full estimated market price. Although a linear tax schedule is easy to understand in principle, each of the terms is cloaked in confusion in Illinois. Estimated Market Value Market values, by definition, fluctuate constantly. The official estimated market value used for tax purposes is updated every three years in Cook County and at least every four years in the rest of the state. These changes are often the subject of contentious dispute, leading to appeals to assessment offices and boards of review. Market values can be hard to estimate in areas with few comparable sales. When prices are appreciating rapidly, homeowners estimated market values can increase much more rapidly than their perceived ability to pay. Homeowners anxieties are exacerbated by the apparently widespread belief that increases in market value translate directly into increases in tax payments. Tax Rate The tax rate may well be the single most confusing aspect of the Illinois property tax system. We have arbitrarily set the tax rate at 0.10 in our examples above. In fact, tax rates vary substantially even within small geographic areas. A single property may be part of a school district, park district, a village or city, a community college district, a water district, and a township and county, all of which cover different areas and all of which set different tax rates. In the end, the homeowner pays one property tax bill covering the total charges levied by all the individual 3 taxing units. Showing the multiple components of the property tax individually on the tax bill is laudable from the point of view of transparency, but all of the detail might confuse some taxpayers. Moreover, the multiplicity of taxing authorities means that a household s property tax bill can easily end up increasing even when, for example, a highly publicized school district tax levy is defeated. In most states, including Illinois, jurisdictions request a level of property tax revenue. The tax rate faced by taxpayers falls out as the ratio of the requested revenue to the tax base. With income and sales taxes in mind, most people think of tax rates as being fixed, and amounts varying with changes in the bases (e.g. income, purchases). With property taxes, however, tax rates are computed based on revenue requirements and assessments levels. Moreover, the rates are often adjusted annually. Thus, when assessed value rises, tax rates often fall, resulting in only modest tax increases for some homeowners. When assessment values decline, however, tax rates often rise, resulting in tax increases for many homeowners. Assessment Timing The timing of the assessment cycle in Illinois also creates confusion. Assessments are officially put in place on January 1 at the start of an assessment cycle, after which they normally stay in place for three years or four years. If the assessment cycle begins on January 1, 2010, it would be natural to assume that assessments were determined during the latter part of 2009, and then announced on January 1. Instead, assessments tend to take place retroactively; assessments for January 1, 2010 are unlikely to be announced until mid This timing causes particular confusion and anxiety in declining markets in which homeowners know very well that they could not sell their house for the amount that they could have received a year and a half earlier. Do Assessment Increases Reflect Overall Price Trends? Although much of the antagonism toward the property tax may be a result of confusion over its details, it still is true that homeowners IGPA University of Illinois Urbana-Champaign Chicago Springfield

4 Figure 1. Distribution of Assessments Changes for Class 2 Properties in Chicago Percent Percentage Change in Assessment Percent Percentage Change in Assessment Red line = CPI; Blue line = repeat sales price index; Source: author s calculations IGPA University of Illinois Urbana-Champaign Chicago Springfield 4

5 tax bills sometimes increase significantly even while their incomes or wealth are not rising. Figure 1 shows the distribution of assessment changes for Class 2 properties in the City of Chicago for the and cycles. The first six years of the decade were a time of extraordinary increases in home prices. Whereas the consumer price index (CPI) for the Chicago metropolitan area indicated that overall prices rose by 6.2 percent and 7.5 percent between and , respectively, a repeat sales index of home prices indicates that the sales prices of Class 2 properties in the City of Chicago rose 28.9 percent and 36.1 percent during the same three-year intervals. The figure shows that more than half of the assessment increases exceeded the rate indicated by a repeat sales price index for both and , and the vast majority exceeded the relatively low rate of inflation indicated by the CPI. A tiny proportion of the assessments fell; a much larger proportion had new assessments that exceeded their old values by significantly more than the average rate of inflation of home values as revealed by the repeat sales price index. While many neighborhoods in Chicago had booming real estate markets during the period, others did not. Although the property tax rate in Chicago actually fell during this period, the tax rate reductions were not enough to shield homeowners with large increases in assessed value from significant tax increases. While homeowners housing prices were rising their incomes may not have been rising. Further, many of the housing price increases from 2000 to 2006 were the result of a rapid short-term increase in prices that was not accompanied by long-term increases in wealth. A Simple Policy Prescription: More Transparency Clearly, the property tax system could be simplified many ways. But much of the confusion over the property tax could be eliminated if tax bills indicated the reasons for all changes in tax liability. Taxpayers bills could indicate what portion of their tax bill change is due to assessed value changes and what portion is due to taxing jurisdictions revenue increases. 5 Without great difficulty, the counties could add this information for each jurisdiction, and for the grand total, clarifying which taxes are rising, and why. Greater transparency in property tax bills would help focus voters ire. What causes a tax bill to increase by, for instance, $500? Perhaps the household s relative assessed value increased, but the local taxing jurisdictions did not increase their total tax revenues. The tax bill would inform the household that the local government was not responsible for its tax increase. Without this information, homeowners could mistakenly believe that increases in local expenditures caused their taxes to increase. Showing the portion of any tax increase that is due to revenue increases would allow taxpayers to understand better the revenue decisions of their cities, counties, and school districts. The failure of the state s existing property tax relief efforts to temper voters frustration with the property tax will continue unless greater transparency demystifies the property tax system. IGPA University of Illinois Urbana-Champaign Chicago Springfield

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