Wednesday, February 29, 2012

The Property-Revaluation Flap — 2012 Edition

Lately there has been much emotion exerted over the issue of the property revaluation that occurred last year. People whose property increased in value since 2006 are holding meetings with the mayor, demanding that their taxes not go up. My purpose here is to explain why all this agitation is basically wasted.

I live in a neighborhood called East Rock. The name was coined by the local real-estate tsarina, who thought that the previous name for the neighborhood, "Goatville," might, if advertised, decrease property values all by itself. (Maybe we should try that!) There really is an East Rock overlooking the 'hood, a big chunk of basalt that has eroded slower than the rocks that used to encrust it. There's a pleasant park surrounding our little mountain, and also bearing its name. There is also a West Rock, with a similar origin. New Haven is squeezed between the two, which may seem improbable given how isolated they are, but the city's street network is defined by the bottlenecks created by the Rocks and the Long Island Sound.

East Rock — the neighborhood — is a pleasant place to live, with many shops and restaurants within easy walking distance. It's not the richest neighborhood in town, but most of the town is poorer.

Like many cities, New Haven collects taxes from its citizens based on the dollar value of the property they own. "Property" means houses and cars. To estimate the value of the cars, they look the values up in the same books car dealers use. To estimate the value of the houses, they send people around every five years to look at each house and estimate its market value.

The last 3 revaluations were done in 2001, 2006, and 2011. We all know what happened to real estate prices in the last ten years. Sure enough, the assessed values went way up in 2006, and then went down in 2011. Right? Not quite. Whenever property values shoot up, people get worried their taxes are going to go way up. The City agrees to do a "phase-in," where the house assessments rise gradually from their previous value to the new values. How gradually? Just fast enough so that, about the time the next evaluation is done, they will have reached their new value. This is to give people time to prepare … — Really? Prepare by putting their house on the market? Or what?

Never mind; that's not the main thing I want to make fun of. This year things are complicated by the fact that because everyone knew property values had tanked in 2009, the City agreed to freeze the ongoing phase-in from 2001 values to 2006 values. So the assessed values were stuck somewhere in 2003 when the 2011 evalution occurred. Nonetheless, property values in most of the city had gone down; most people's houses have an assessed value less than that somewhat arbitrary partially-phased-in value from the past. There are, of course, exceptions, neighborhoods where the average house value is higher now than it was in (hypothetical) 2003. One of them is East Rock. This has everyone in East Rock terrified that their tax bills are going to shoot up this year.

Confused yet? Well, don't bother to review the story so far too carefully, because

None of the stuff above has much impact on whether taxes go up.

To explain, let me simplify by portraying a simpler city than New Haven, so simple that it has just two houses. I'll call it Twoville. One house is owned by Mr. A, the other by Ms. B. Let's also assume that Twoville's entire budget is a mere $1000 per year. If the two houses have the same assessed value, then A will pay $500 in taxes and B will pay $500. For concreteness, let's assume both houses are initially assessed at $400,000.

Now suppose there's a revaluation, and because of a real-estate bubble (these have been known to happen), both A and B see their assessed house values go up by 50%, to $600,000. Oh my! Does this mean that Twoville gets a windfall 50% increase in revenue at the expense of the taxpayers? No. The town still spends $1000/year, and collects the same amount in taxes. The "mil rate," i.e., the tax expressed as a fraction of the property value, goes down by exactly the amount required to keep the revenue the same. To collect $1000 when the houses were worth $300,000 each, the rate had to be 0.00166. After they double, it must go down to 0.000083. (The decimal point is usually put somewhere else, for reasons I never quite get.) Contrariwise, if there is a real-estate crash and both Mr. A's and Ms. B's houses decline in value, the mil rate goes up. Unless the citizens can figure out how to impose massive cuts on the city budget, the taxes just gotta be collected.

Now suppose that A's house is on one side of town, B's on the other. (Twoville has a low population density.) The town bordering Twoville on A's side of town decides to put a toxic waste dump right across the street from A. His property value plummets. On B's side, the neighboring town tears down a blockful of abandoned factories and puts in a beautiful park. Her property value zooms up.

Now for the scenario we care about: In the latest revaluation, B's house appreciates in value by 40%, and A's declines in value by 30%, so that A's house is worth $420,000 and B's is worth $840,000. In other words, A's house is now worth half as much as B's (ratio: 0.7 compared to 1.4). If everything else stays the same, B will pay twice as much in taxes as A, meaning that she pays $667 and A pays $333 (rounding a bit). (We don't have to know how much their houses are actually assessed at to figure this out; all you need to know is the ratio of house values. But it helps to see concrete house prices.) Now B is politically savvy; she organizes her friends (or perhaps her many tenants) to lobby the Twoville city government to do something about her plight. A is oblivious or doesn't know how to work the levers of politics; he sits on his hands. The mayor agrees to help B by phasing in any assessment increases over 5 years. However, anyone who gets a decrease gets it immediately.

What a great compromise! It's good for A and B, right? Well, a moment's reflection will convince you that that just can't be correct. Assuming the city budget remains at $1000 next year, not everybody's taxes can go down! We have a zero-sum game here.

B's house is now assessed at a value 1.08 times last year's value instead of 1.4, because 0.08 is 20% of the distance between 1 and 1.4. A's is still assessed at 0.7 of what it was. The ratio between 1.08 and 0.7 is 1.54. (If you want real prices, it's the ratio between $648,000 and $420,000.) So we need to find two numbers in the ratio of 1.54 to 1.0 that add up to $1000. The answer is $606 and $394 (rounding a bit). Next year the ratio will be 1.16 to 0.7 (= 1.66), and so forth, until after five years the ratio gets to the ratio of actual assessed values, 2 to 1.Ratios

Is that fair? Well, it certainly may seem fair to Ms. B! Instead of her taxes going up 33%, they go up 21%. But Mr. A's taxes, instead of falling by 34%, fall by only 21%. (Over the next few years, of course, as they "prepare" for the changes, perhaps by investing in shares of a fracking company, the taxes glide to the 2-to-1 ratio.)

The case is often made by people in East Rock that, just because someone's house goes up X% in value, that doesn't mean they've actually gotten X% wealthier, or that their ability to pay has gone up that amount, or at all. True enough. But it applies just as much to people whose houses have gone down in assessed value, maybe more so. Suppose Mr. A's mortgage is large enough that the decline in his property values due to the toxic waste dump puts him "underwater"; he owes more than the house is worth. (Turns out he's not the original owner; that would be Mr. A'. This Mr. A borrowed $500,000 to buy the house from A' for $600,000; big mistake.) A is essentially bankrupt, and could do nothing to fight the bank if they decided to foreclose. He could really use a 33% decrease in taxes, which he will now have to wait years for in order to help out his friend Ms. B.

In fact, the whole idea of measuring wealth by house prices is obsolete, for two reasons:

  1. Until the late twentieth century, the only wealth that a person couldn't hide was their house. But nowadays the state government knows about every bank account you have. The banks have to transmit this information to the federal and state governments in connection with income taxes. The state could perfectly well share it with the towns. Twoville could take into account all of the assets of Mr. A and Ms. B.All
  2. Why in the world should taxes be based on wealth anyway? The original rationale was that, in many jurisdictions, you had to own property in order to vote. The idea was that the government was to be run by people with a stake in the community, people with a proven track record of wisdom and maturity. These were the people who owned property. They were wise enough to keep, manage, and grow their wealth, and they had a lot to lose if the community went downhill. In return for the privilege of running the town, they paid for the town's upkeep. It was sort of like condo fees.

    Hey, this system makes a lot of sense! Unfortunately, it hasn't been the way things actually work for a hundred years. The tide of history has been running strongly toward letting everybody over the age of 18 vote, except maybe convicted felons. And everybody pays the fees, in the form of sales and income taxes. Only the town budgets are funded in this weird anachronistic way.

The whole brouhaha over property-value assessments seems so misguided that a cynic might propose that it's meant as a distraction from the real isssue, which is keeping Twoville's budget at $1000. Note that an increase in one's assessed value can't by itself raise your taxes. But if Twoville decides to hire more police, that will raise taxes. Unless the citizens decide that the pension system obtained by the city workers' unions is just too expensive in these tough times, and they cut back on it to pay for the extra cops.

Well, that might happen in Twoville. But don't count on it happening in New Haven. The unions got all their candidates elected to the Board of Alderman last year. If you hear those new alderman wringing their hands about the plight of East Rock, perhaps it's because they figure that by solving this nonproblem at the expense of the people in poor neighborhoods, who aren't paying attention anyway, they can get the people of East Rock in such a grateful state of mind that we will agree to increasing the city budget just a tiny bit. After all, we can afford it; we got our phase-in, and time to "prepare" for higher property taxes.


Note Ratios
When thinking about phase-ins, it matters exactly what the property values are, not just their ratio. In an extreme case, suppose we reach a ratio of 2:1 between B's and A's property value by having A's house decline by 50% while B's changes in value not one bit! A phase-in will not help B at all. B would be reduced to lobbying to delay A's decline. In fact, B's assessment could fall and she could still reach that 2-to-1 ratio. Suppose A's house declines by 60% (to 0.4 of its former value) while B's declines by 20% (to 0.8 of its former value). The ratio of 0.8 to 0.4 is 2. A phase-in would hurt B, but of course under the compromise decreases take effect immediately. [Back]

Note All
In the real world, including New Haven, the people whose property values have gone down are disproportionately black, of course, and those whose values have gone up are disproportionately white. Nationally, according to this article in the current New Republic, the median wealth of white families is 18 times the median wealth of black families, the highest ratio since the Pew Research Center started keeping track thirty years ago. In 1995 the ratio was 7 to 1. (The actual median wealth numbers are $92,000 for white families and $4,900 for black families.) [Back]

1 comment:

John McDermott said...

Excellent analysis of property tax policy. It is a constant source of difficulty for politicians.

You ask: why not tax all wealth and not just property? I think it is because most wealth is highly mobile and would flee the local jurisdiction. Very few entities can tolerate a wealth tax (New York can; Philly and Detroit not so much) before the tax base erodes disastrously.

As for why not just use sales and income? They tend to decline much more in recessions, leading to crises and higher tax rates, which often stay high.