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MN2020 - Declining Values and Rising Property Taxes
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Declining Values and Rising Property Taxes

December 29, 2008 By Jeff Van Wychen, Fellow and Director of Tax Policy & Analysis

Many Minnesota homeowners are a bit befuddled these days. Why, if the value of my house is declining, are my property taxes going up?

Of the approximately 200,000 Minnesota homesteads that saw a decline in their taxable market value from 2007 to 2008, about three-quarters saw a reduction in their property taxes.  The remaining one-quarter of homesteads with declining values experienced a growth in their property taxes.  (Final property tax data for 2009 is not yet available.)  How do we explain the growth in property taxes among homesteads with declining value?

There are, of course, the obvious reasons for property tax increases.  All other things being equal, property taxes will go up if local governments increase their levies either to replace state aid cuts, keep pace with inflation, or provide a real increase in public spending.  A sufficiently large increase in local levies can be enough to wipe out a tax reduction that could result from a decline in homestead value.

However, it is possible for the property tax on a homestead to increase even if (1) the value of homestead declines and (2) there is no increase in local levies.  To understand how this can occur, it is important to understand a fundamental difference between the property tax and the other two major Minnesota taxes, the sales and income taxes.

In general, the amount of revenue generated by a tax is equal to the tax rate multiplied by the tax base.  With the property tax, the tax base is the taxable value of all property within a jurisdiction.  With the sales and income taxes, the tax bases are taxable sales and taxable income, respectively.

With sales and income taxes, the tax rate is set first; the amount of revenue generated is then determined by the size of the tax base (i.e., the level of taxable sales or taxable income) multiplied by the tax rate.  If the tax base is greater than anticipated, a budget surplus results, all other things being equal; if the tax base is less than anticipated, a deficit (such as the one the state is currently experiencing) results.

With the property tax, the order is reversed.  The local government first determines how much revenue it needs to generate from the property tax; this amount is referred to as the "levy."  The rate is then determined by dividing the levy by the tax base (i.e., total taxable property value in the jurisdiction).  With the property tax, the amount of revenue needed-the levy-is determined first; the rate is then set so that the needed amount of revenue is generated.  For this reason, revenue generated by the property tax is generally more stable and predictable than revenue generated from sales and income taxes.

Unlike sales and income taxes, a decline in the tax base does not necessarily result in a decline in the revenue generated by the property tax.  Rather, the tax rate increases so that the same amount of revenue is generated.  For example, consider the hypothetical City of Smallville.*  The property tax base in Smallville consists of three homesteads: the Olson house, the Carlson house, and the Andersen house.  In year one, the value of each of the homesteads is $100,000, so the total size of the tax base is $300,000.  The year one levy in Smallville is $3,000.  The year one property tax rate in Smallville would be determined as follows:

The year one taxes on the Olson, Carlson, and Andersen homesteads would each be equal to the tax rate (1.0%) multiplied by the taxable value ($100,000 for each of the three homesteads).  Thus, each of the three homesteads would pay $1,000 in property taxes (1% X $100,000).  The total paid by all three homesteads would be $3,000, which is equal to the property tax levy of Smallville.

In year two, the values of the Olson and Carlson houses fall to $90,000, while the value of the Anderson house falls to $70,000.  The total tax base of Smallville would then be $250,000 ($90,000 + $90,000 + $70,000).  The year two levy in Smallville remains unchanged at $3,000.  Thus, the year two property tax rate in Smallville would be determined as follows:

While the values of all three homesteads have fallen, the tax rate has increased.  The final property tax paid by each of the three homesteads would then be determined as follows:

The decline in the value of the Andersen homestead was so large that it offset the impact of the tax rate increase, so the property tax on the Andersen homestead fell by 16 percent, from $1,000 to $840.  However, with the other two homesteads the value decline was not sufficient to offset the tax rate increase, so property tax increased by 8 percent, from $1,000 to $1,080.  All in all, the tax reduction on the Andersen homestead was offset by tax increases on the Olson and Carlson homesteads, so the total amount of property tax revenue received by the City of Smallville remained unchanged.

Simply because the value of a property declines does not necessarily mean that the property tax will decline.  The total property tax collected within a jurisdiction will still equal the amount of the levy, regardless of what happens to values.**  If the decline in value of a particular property is less than the decline in the entire tax base, the property tax on that property will generally increase even if the local levy remains the same.  In the hypothetical example from above, this is what happened to the Olson and Carlson homesteads.

Anti-tax groups will be eager to spin any increase in property taxes as entirely the result of local government spending increases.  However, this is not necessarily the case.  Property taxes can increase even in the absence of increases in local levies or local spending.  Progressives should arm themselves with a basic understanding of the property tax system in order to rebut propaganda from anti-government demagogues.


*In this example, various complicating factors-such as the property classification/class rate system and presence of multiple taxing jurisdictions (i.e., county, city, school district, etc.)-will be ignored so that a fundamental feature of the property tax can be more easily explained.

**This is a generalization to which there are exceptions.  On occasion, the revenue generated from the property tax can be less than the levy if taxpayers are unable to pay their property taxes.

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