Public Finance

By now, the story is well known. The housing market booms, property taxes rise, and taxpayers demand relief.

In the story’s original version in the late 1970s, inflation in California’s home prices skyrocketed from 5 percent per year to 5 percent per month, setting off a tax revolt that culminated in Proposition 13, a strict set of property tax limits that inspired copycat laws across the United States.

Now, after years of rising home prices fueled by new jobs and migration, Texas faces similar pressure. From 2013 to 2017, property tax collections increased by about a third in major cities like Houston, San Antonio, Dallas, and Austin, and by much more in some neighborhoods.

“Texas is experiencing what California experienced in the 1970s,” said Debbie Cartwright, an attorney for the Texas Taxpayers and Research Association. “People who have owned their properties for a while are feeling the pinch.”

The situation in Texas is just the latest sign of the great property tax conundrum. Favored by many economists for being stable, efficient, and transparent, the property tax is also unpopular because it is so visible, and because it’s not tied directly to people’s ability to pay. Even now that the housing market is cooling, property tax bills are unlikely to decline much in the near future because assessors take a while to catch up to market values.

Texas policy makers are considering a host of measures designed to reduce property taxes, chief among them a proposal to limit the annual growth in local property taxes—the “levy”—to 2.5 percent. Anything greater would require voter approval.

Mayors of 24 of the largest Texas cities have called the proposal unworkable, citing the need to provide basic public services, absorb higher health insurance rates and other costs beyond their control, and invest in public health, safety, transportation, and economic development.

Texas, which already restricts property tax levy growth to 8 percent per year, is not the only state considering new or tighter levy limits. Policy makers have introduced similar proposals in New York, Iowa, and Nebraska, although Texas faces the additional challenge of being one of only seven states without an income tax.

The levy limit, used in about 35 states, is actually an improvement over the Proposition 13 model, which reduces property taxes in a fundamentally different way, by artificially keeping assessed values of long-owned properties far below market value. The result is that owners of identical homes can have vastly different property tax bills. As detailed in a Lincoln Institute report, assessment limits have had many bad side effects, including major inequities and perverse incentives that distort the real estate market.

Levy limits, by contrast, preserve market-rate assessments, but they share some of the other negative consequences of assessment limits—a reduction in local governments’ autonomy, and sometimes a greater reliance on state aid, which can be more volatile. In the end, no property tax limit can defy the basic math of government budgets, and the need for revenue to fund education, infrastructure, public safety, and other priorities.

“Public services cost money,” said Adam Langley, associate director of tax policy and data initiatives for the Lincoln Institute. “If taxpayers want lower property taxes, then governments either need to cut services or fund them through some type of tax—a tax limit does not eliminate this basic trade-off.”

Langley is studying other tools that preserve local governments’ taxing authority but still provide property tax relief to those who need it most. These include “circuit breakers,” which offer relief to lower income and elderly residents if their property tax bills reach a certain percentage of their income—in the same way a circuit breaker protects a home from excess electrical current—and deferrals, which defer collection of property taxes until a property is sold or the owner dies. A more widely used tool, the homestead exemption, spares a certain amount of home value from taxation.

Another option is for states to provide more aid to local governments or to take responsibility for more services. In Texas, lawmakers are exploring options to increase the state’s contribution to public schools, which has declined under a complex funding formula from 46 percent of all education funding in 2011 to 36 percent in 2018 (read more in the Lincoln Institute’s policy brief on school funding). And where possible, local governments should lower their property tax rates to compensate for higher property values.

“The property tax is a critical source of revenue for local governments,” Langley said. “When real estate prices rise, policy makers need to protect residents and businesses from unreasonable burdens while maintaining the integrity of the tax system overall. Research shows that with enough autonomy and the right tools, governments can do just that.”

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