Property tax -- maligned and misunderstood

Tax reform is in the air in Minnesota. And the tax everyone loves to hate -- the local property tax -- is again a prime target.

Officials in Gov. Mark Dayton's administration have heard loud and clear that Minnesotans want lower property taxes. It's an idea that the new Legislature seems eager to support.

Although the specifics of Gov. Dayton's tax reform proposal remain a mystery, all indications are that reducing local reliance on property taxation and providing property tax relief will be high priorities. But are these reform goals really justified?

A closer look at the main arguments offered in their favor suggests that concerns about property taxation are significantly overstated.

Argument 1: Minnesota's revenue system is unbalanced and too dependent on property taxes.

In 2010, the property tax's share of the "big three" state-local revenue sources (income tax, sales tax and property tax) was the highest it had been in more than a decade -- 39.8 percent. The resulting tax system has been compared by critics to an off-kilter three-legged stool that can no longer stand up.

But a rise in the property tax's share of revenue is exactly what you should expect at the end of a major recession. Since volatile income and sales tax revenues fell by $1.35 billion between 2008 and 2010, the inherently more stable property tax was predestined to pick up tax share.

For perspective, consider that in 1973, after major tax reform to buy down local property taxes (the much-touted "Minnesota Miracle"), property taxes raised 46.9 percent of the "big three" taxes. Our three-legged stool was a unicycle.

Rather than throwing the system out of balance, property taxes by their very nature provide the fiscal system with sorely needed stability exactly when it's needed most. The property tax should not be criticized for the very characteristic that causes public-finance experts to find it indispensable.

Argument 2: The property tax is highly regressive.A regressive tax is one that burdens the less-affluent more than the more-affluent. But according to the Department of Revenue, Minnesota's property tax on homes is actually one of the least regressive taxes in the state. It's less regressive than the sales tax, which is the most commonly sought substitute revenue for local governments. When combined with the state's property tax refund program, homeowner property taxes are less regressive than -- among others -- corporate income taxes, gambling taxes, gas taxes or tobacco taxes.

Argument 3: The property tax is poorly aligned with taxpayers' "ability to pay."Not really -- not according to a Revenue Department report that matches homeowners' incomes to their actual property tax bills. This report finds that homeowners' property tax bills are quite affordable across most of the state, both in total dollars and relative to incomes. They are most affordable in Greater Minnesota, where complaints about property tax burdens are especially strong.

Some affordability problems will always exist, which is why it's vital to also recognize Minnesota's generous, broadly accessible property tax-refund programs. Over the last two years, the state spent $627 million to deliver direct, income-tested property tax relief to homeowners whose tax relative to their incomes exceeded statewide standards. Renters received an additional $388 million based on an estimate of the property taxes they paid as part of their rent. Importantly, these refund programs are more than three times as progressive -- favoring the less-well-off -- as Minnesota's income tax.

Bad reform habits die hard

Despite being unpopular, the property tax is regarded by experts as the best way for local governments to raise money. It provides a stable stream of revenue that ensures funding for local services. It can't be evaded. It's simple to pay -- no accountants needed. Countless studies have shown that high-quality property-tax-funded services lead to higher property values -- you economically benefit from what you pay for. And the visibility of the property tax allows and encourages taxpayers to compare the benefits and costs of local services they receive.

In this sense, the perceived "problem" of property tax increases actually represents a crucial accountability link between citizens and their governments.

Yet, none of these arguments can diminish citizen frustration with a tax that is often unpredictable, frequently paid in big semiannual chunks and very difficult to understand. Possession may be nine-tenths of the law, but perception and politics is 99.9 percent of property tax policy.

If reform only addresses the perception and politics problems by pacifying local governments and taxpayers with levy buy-downs -- that is, sending more state aid to local governments so they can reduce or hold down property taxes -- we won't accomplish anything. Forty years of experience demonstrates the futility of this approach and what we can expect in the future if we try it again.

Local officials will then cut services, because they do not have the political support to continue raising the necessary property taxes to pay for them. Ironically, the evidence often shows that the additional property taxes needed would still be affordable by any objective measure. But local taxpayers for decades have been taught to expect local services at a discount price.

So the call for higher state taxes to fund local property tax relief will begin anew.

We've seen this movie many times. But this time the ending will be different. Once we had excess capacity in our tax system and tax rates to perpetuate this cycle of fiscal illusion. Current budget and demographic trends say that those days are over.

Real reform basics

This type of "reform" does nothing to improve the incentives and disincentives surrounding property taxation. Real property tax reform should focus instead on respecting the essential role the tax has, and will continue to have, in local government finance.

Currently, the state subsidizes cost structures created by local governments at the same time that local property taxes are required to pay for state mandates and programs over which local officials have no control.

One of the smartest things we could do is sort out these lines of accountability based on this general principle: If you have no say on what gets done or how it gets done, you shouldn't be paying for it. This is especially relevant to improving the design of state aids to cities and counties.

Simplifying the property tax system and improving its transparency are two more worthy reform objectives. Local government finance has a lot of moving parts -- any of which can affect an individual's property tax. To restore trust in the tax, we must make it simpler to understand. And we must make it much easier for taxpayers to accurately determine what and who is causing their taxes to rise.

Real reform, leading to a stronger and more accountable revenue system, is unlikely to pay big political dividends. But it will preserve what is most important about the property tax -- its ability to balance citizens' expectations of government with their willingness to pay for it.

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