It's time for truth in property taxation

10/26/06

The tax on real estate that is used to pay for schools and other local government is a bad one for several reasons, but one flaw becomes particularly evident in an election year because the tax practically invites public misunderstanding and less-than-honest statements by politicians.

Public misunderstanding stems from how amounts of tax relate to values of taxed properties. Many people think that if the value of their home goes up, the amount of real-estate tax they owe somehow must go up, too. This isn't true, but some politicians are overly willing to perpetuate the misunderstanding.

Real estate or property taxes go back for centuries. The process is pretty straightforward. Officials decide what public needs are and how much money must be raised to meet those needs. They tabulate the value of taxable property. Then the total amount to be raised in taxes is divided by the total value of property. That calculation gives the percent of the value any real-estate owner must pay on his or her property.

If a village needs to raise $250,000 and it has $10 million worth of real estate, then each homeowner will have to pay 2.5 percent of the value of his or her house.

It is more complicated in practice because there are different classes of property owner-occupied, rental, commercial and industrial. There also may be laws that favor homeowners or limit the amount that the assessed value of any particular house can increase in a year.

The key question, however, is how much local government officials decide must be raised in taxes. Take the example above. If spending remains at $250,000, but property increases in value to $12.5 million, then the tax rate could drop to 2 percent of value. If officials leave the rate at 2.5 percent, taxes collected will increase to $312,500. But that increase results from a decision by officials to hike the amount raised in taxes. It is not the inevitable outcome of increasing property values.

Some officials understandably foster that misconception: "Gee, it's too bad. We kept tax rates the same, but your property rose in value so you had to pay more." Their implied explanation is "tough break." But no law says government cannot reduce the tax rate as property values climb.

This is a classic "fallacy of composition," in which people assume that what is true for one must be true for all. The homeowner opens her tax statements and sees that the assessed value has increased by 10 percent since the previous year. Tax owed is up by the same proportion. Therefore, the fault lies with rising home prices.

An increase in the value of one house obviously implies an increase in taxes due. But an increase in the value of all houses does not mean that all owners need to pay more. That only occurs when elected officials decide to spend more.

Some owners get all wrapped up in whether their houses are assessed correctly. If they can get their assessments down to a fair level, they reason, they will owe less in taxes.

That is true for each owner as an individual. It does not mean that if all owners could get their assessments reduced, then taxes would go down for all. That can happen only if government chooses to raise less in total tax.

All this is not intended as an anti-tax diatribe. My wife and I pay about $3,900 in taxes on our house in St. Paul. We get pretty good value for our money from our city, county and schools. People complain about government waste, but it seems pretty clear to me that there is more mismanagement in the private, for-profit company that built my pickup truck than in the public schools that educated my children.

But if we are going to finance local government by taxing real estate, let's be honest about what drives the level of taxation.

St. Paul economist and writer Edward Lotterman can be reached at elotterman@pioneerpress.com.


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