Maxwell School, Syracuse University


SYRACUSE UNIVERSITY
The Maxwell School of Citizenship and Public Affairs


PAI 735/ECN 635
State and Local Government Finance

Professor Yinger

 

Case: The Homestead Option in Syracuse 

It is the Fall of 1995. The Common Council of Syracuse, New York faces a crucial vote on the future of property taxes in the city. In particular, the Council must decide whether to vote for the so-called Homestead Option, which would allow Syracuse to levy a higher effective property tax rate on commercial and industrial than on residential property. Traditionally, residential property in Syracuse was assessed at a lower percentage of market value, on average, than was commercial and industrial property. After years of delay, however, the City has finally finished revaluing all its property, and all assessments will be brought as close as possible to market value. Without the Homestead Option, therefore, residential property as a class will experience an increase in its effective tax rate and commercial and industrial property will experience an effective-rate cut. The Homestead Option is intended to prevent this tax shift.
 

Background on Revaluation

Until its recent revaluation, Syracuse provided a perfect example of how not to administer the property tax. Assessed values were virtually never updated, even upon resale, and average assessments were a small fraction (less than 10 percent on average) of sales prices. The resulting assessment/sales ratios varied widely across houses, from as low as 2 percent to as high as 50 percent.

To a large degree, the assessment disparities reflected differences in house-value growth across neighborhoods, so that assessment/sales ratios, and hence effective tax rates, were lower in high-income neighborhoods, where house values tend to grow, than in low-income neighborhoods, where they do not. One study found, for example, that the average assessment/sales ratio decreased from 10 percent in the poorest census tract, which had a household income of $7,000, to 8.1 percent in the richest census tract, which had a household income of $51,000. Poor, minority neighborhoods were particularly hard hit. The expected assessment/sales ratio increased from 8.4 percent in an all-white tract to 16.9 percent in the tract with the highest minority concentration, namely 91 percent.

However, large disparities also existed within neighborhoods, and it was not uncommon for one house to be assessed at three or four times as much as a very similar house next door. Putting on an addition, for example, could have devastating tax consequences; a $10,000 addition might be assessed at cost, thereby doubling the assessment of a $100,000 house that had previously been assessed at only $10,000.

This assessing situation was widely criticized, both in and out of government. A professor at Syracuse University wrote that the poor assessing methods "violated the widely accepted principle that any two taxpayers whose properties have the same market value should pay the same tax." He also pointed out that it was not fair for higher-income households to face lower effective tax rates, and that such poor assessing "undermines public faith in the property tax and in city government" and results in many costly lawsuits against the City.

Despite these problems, the Common Council resisted the obvious solution, namely a revaluation of all property in the city, for many years. This resistance had a political basis; the burden would fall mainly on the under-assessed, high-income neighborhoods, whose residents were politically influential. Nevertheless, the proponents of revaluation eventually won out and in the Fall of 1993 the City Council voted for revaluation. A private contractor was hired, property in the city was revalued, and tax bills based on the new valuations were sent out early in the Fall of 1995.

The key remaining problem concerns the tax treatment of residential versus commercial and industrial property. The old assessing system not only resulted in widely varying assessment/sales ratios, and hence effective tax rates, within each class of property, it also resulted in higher assessment/sales ratios, and hence effective tax rates, for commercial and industrial than for residential property. Thus, a revaluation that assessed all property at market value and applied the same nominal tax rate to every parcel would result, on average, in a tax increase for residential property and a tax decrease for commercial and industrial property. According to calculations by the Syracuse Commissioner of Assessing, revaluation alone would shift the residential share of taxes from 46.4 percent up to 54.5 percent. This shift away from commercial and industrial toward residential is what the Homestead Option is designed to prevent.

This shift is regarded as unfair by many observers. According to the best available evidence, unanticipated property tax rate changes are capitalized into property values. If the present value of the stream of property taxes on a house increases by $1, the market value of that house is likely to decrease by close to $1. Thus the increase in residential property taxes that will occur if the Homestead Option is not passed, will result in a capital loss for most of the homeowners in Syracuse. A typical $70,000 house will experience a tax increase of about $169 if the Homestead Option is not passed (see the attachments at the end of the October 18th memo). With a real discount rate of 5 percent, the present value of this tax increase is $3,380. Not passing the Homestead Option would result, therefore, in a $3,380 capital loss on this house. More expensive houses would experience larger losses. Although long-time homeowners may have benefited from past declines in the effective tax rates on residential property, more recent home buyers paid more for their houses because of the low effective rates and gained no benefit at all. Thus it is not fair to saddle recent home buyers with such significant capital losses.

Shifting taxes from commercial and industrial to residential property raises two additional issues. First, the flow of resources into a city, and hence ultimately its standard of living, depends in part on its ability to export some of its tax burden onto nonresidents. A city cannot export taxes on single-family, owner-occupied houses, which make up the majority of residential parcels, because the owners are, by definition, residents. A city may be able to export a small fraction of the tax burden on rental property, but most experts agree that export ratios for rental property are very low. In contrast, export ratios for commercial and industrial property can be quite high, especially if it includes property owned by national corporations. Taxes on commercial and industrial property are paid to a large degree, most experts argue, by the property owners. In the case of a national corporation, the owners are stockholders who probably live around the country. In fact, one study estimates that property taxes on commercial and industrial property allow the typical large city to collect $1.75 from nonresidents for every $1.00 it collects from residents. Thus the higher the share of the property tax burden on commercial and industrial property, the greater the ability of a city to export some of its tax burden onto nonresidents, all else equal.

Second, cutting taxes on business property might attract some businesses into the city or convince others to stay. The magnitude of this tax effect is a subject of great debate. Business groups insist that this effect is large, and that passing the Homestead Option (that is, passing up a chance to cut business taxes) would be devastating for business in Syracuse. According to Deborah Warner, program director at the Greater Syracuse Chamber of Commerce, "If a community is trying to grow more jobs, you won't get it with an anti-business tax system" With the Homestead Option, she continued, "It=s going to be that much harder to attract businesses and keep the businesses we've got."  Academic studies do not, for the most part, add weight to this view. Although some studies find a statistically significant impact of tax rates on business location decisions, virtually all of these studies conclude that the magnitude of this impact is quite small. 

The Homestead Option

The Homestead Option, which is described in detail in the attached pamphlet from the New York State Board of Equalization and Assessment, authorizes certain municipalities to levy a lower tax rate on residential than on other property. Cities with fewer than one million people, such as Syracuse, can take advantage of this option only if they revalue all the property within their boundaries and the state certifies that the resulting assessments are reasonably close to market values. Because of its recent revaluation, Syracuse has just been certified and is now eligible to implement the Homestead Option.

The Homestead Option has several strict rules

First, property must be divided into exactly two classes: homestead and non-homestead. Homestead property is any residential property with three or fewer units and non-homestead property is everything else. Mixed-use buildings with a store on the first floor and apartments upstairs are not classified as homestead property, even if they have three or fewer units, unless a majority of the floor space is devoted to residential use. Cities have no say in the way property is classified.

Second, all property must be assessed at market value (or as close to market value as current assessing methods permit.)

Third, the nominal property tax rate can be lower for homestead than for non-homestead property, but homestead property's share of total tax revenue must be at least equal to its share the year before revaluation took effect. As noted earlier, this pre-revaluation share in Syracuse was 46.4 percent, whereas homestead property's share of market value (which equals its share of tax revenue if the Homestead Option is not passed) is 54.5 percent. These numbers imply that the post-revaluation nominal tax rate for homestead property must be at least 72.3 percent of the post-revaluation nominal tax rate for non-homestead property.

Fourth, if the City does not pass the Homestead Option at the time of revaluation, it cannot decide to implement it later. If it does pass the Homestead Option at the time of revaluation, it can later rescind it or it can phase it out. A phase out would involve increasing homestead property's share of property revenue until it reached its share of market value. This increase could take place in one year or could be drawn out for many years.

Fifth, homestead property's effective tax rate must be adjusted to reflect new property in the city. This provision is very unusual. In most states, a classification law sets rules for the effective tax rates on different types of property. If, following the above calculation, the residential rate were set at 72.3 percent of the nonresidential rate, other states would use this same ratio as the limit on the residential rate in future years. Not so in New York. Instead, homestead property's share of total tax revenue must remain no lower than 46.4 percent (in the case of Syracuse), regardless of what happens to the market value of homestead property relative to non-homestead property. Thus if the value of homestead property grows more rapidly than the value of non-homestead property, the effective rate for homestead property must drop further relative to the non-homestead rate to prevent residential property's share of total revenue from rising. If homestead property's share of market value increased to 60 percent, for example, the residential rate would have to decline to 57.7 percent of the non-homestead rate to ensure that homestead property contributed only 64.4 percent of total revenue. If homestead property's share of market value decreased, the homestead tax rate would have to increase relative to the non-homestead rate.

Note that if homestead property's share of market value increased over time, the declines in the homestead tax rate mandated by rule five could be offset by rule four, that is, by phasing out the Homestead Option. This "Fix" may be politically difficult, however, because it requires the jurisdiction to explicitly repeal the property tax rate cut for homestead property that rule five requires. Not too many politicians want to vote against a scheduled tax cut.

Experience with the Homestead Option in Other Cities

About 20 municipalities in New York, a small fraction of those eligible, have adopted the Homestead Option. These places include Rochester, Buffalo, and Niagara Falls. In most of these places, homestead property's share of the total market value of property in the municipality has increased over time. As explained above, this leads to a decline over time in the homestead property tax rate relative to the non-homestead rate (unless the municipality votes to start phasing out the Homestead Option, which has not occurred in any of these places). The time trend in homestead and non-homestead tax rates is given in Table 6 of the attached memo for October 18, 1995.

These trends in homestead and non-homestead rates suggest to some people that the Homestead Option does indeed scare business away from a city. After the Homestead Option is passed, these people argue, the value of non-homestead property declines relative to the value of homestead property due to the negative impact of high non-homestead rates on business property. This is a somewhat curious argument given the fact that the Homestead Option does not increase taxes on business, it only preserves the pre-revaluation tax situation. Moreover, the value of commercial and industrial property in central cities has been declining for decades, even in places without the Homestead Option. Nevertheless, it might be true that municipalities selecting the Homestead Option have a greater rate of decline commercial and industrial property than do other municipalities. This argument has not yet been tested, however, by any academic study.

The Homestead Option also has had another, much clearer effect: It gives incentives for the owners of so-called "marginal" property to change the way their property is used. Because four-unit apartment buildings cannot be treated as homestead property, some of the owners of such buildings have taken one of their units off the market in order to face the lower homestead tax rate. This has resulted in a small loss of rental housing in cities with the Homestead Option. The likely magnitude of this effect n Syracuse is difficult to determine. Syracuse has about 690 four-unit buildings, but it is not clear how many of them would be converted. In addition, mixed-use property can only be classified as homestead if residential activities use a majority of its square footage. Thus some owners of mixed-use property may cut back on commercial space to qualify as homestead property. Finally, vacant land is classified as non-homestead property. The Homestead Option gives the owners of vacant land a strong incentive to merge that land with contiguous residential property and thereby qualify for the homestead tax rate. This innocuous type of merging has occurred in cities with the Homestead Option. 

 The Decision

You are the president of Public Finance Associates, a well known consulting firm that specializes in the affairs of state and local governments. The Syracuse Common Council has hired you to write a background memorandum on the Homestead Option, complete with a recommendation. The Council's vote on the Homestead Option raises many issues, both analytical and political. Some Council members may be reluctant to vote against the Homestead Option, for example, because such a vote would raise the tax bills of many if not most of their constituents. Nevertheless, the Council has asked you to focus on the analytical issues, that is, to base your analysis and recommendation on what would be best for the residents of Syracuse in the long run. In addition, you have been asked to focus exclusively on city property taxes and not to consider county or school property taxes.

Your assignment is to come to a public hearing where you will present your analysis and recommendations and answer questions from other interested parties.

 

Attachments

1. New York State Board of Equalization and Assessment, "Questions & Answers About the Homestead Option."

2. Memorandum from John C. Gamage, Commissioner of Assessing, to the Common Council, September 6, 1995.
    (In a separate file.)

3. Memorandum from John C. Gamage, Commissioner of Assessing, to the Common Council, October 18, 1995.
    (In a separate file.)

 

Q&A

The Homestead Tax Option

(A publication of the New York State Board of Equalization and Assessment)

Introduction: In a number of places in New York state, assessments of residential property frequently have been at a lower percentage of market (full) value than other types of property, such as commercial and industrial property. When a town or city with this situation decided to conduct a property revaluation to achieve correct and fair assessments, the residential properties, as a class, would bear a much larger share of the tax burden. This discouraged other municipalities with similar situations from conducting their own property revaluations. As a result of the concern for tax-burden shifts to homeowners, a State law was passed in 1981 establishing the Homestead Tax Option.

This local option prevents any large shift of the property tax burden to the residential class of property owners after a revaluation. In a revaluation, changes are made to individual property assessments so that they are correct and uniform C as the law requires. These changes result in increases to some individual residential property owners whose properties were under-assessed before the revaluation. However, the homestead tax option prevents any large shift to the residential class of properties.

Q. What is the homestead tax option?

A. It is a local option to establish two separate property tax rates: a lower tax rate for residential property owners (homestead tax), and a higher rate for all other property owners (non-homestead tax).

Q. Is this program mandated by New York State?

A. No. It is a local-option program.

Q. Is the homestead tax option available everywhere in the State?

A. No. It is available only to qualifying cities, towns, villages, counties, and school districts. It is not available in New York City, or in Nassau County except for villages and, for certain purposes, the cities.

Q. How does a municipality qualify to use the homestead tax option?

A. A city, town or village that is an assessing unit first must complete a property revaluation project that meets the State Board's regulations. That entitles the assessing unit to be certified by the State Board as an "approved assessing unit." Then the local governing body of the assessing unit can adopt a local law stating its intent to use a homestead tax and a non-homestead tax.

Q. How does the homestead tax option work?

A. The homestead tax is based on the share of property taxes paid by the residential class of property owners in the year before the new assessments from the revaluation project are used.

For example, assume that residential properties paid 40 percent of all town taxes in the Town of Smith in 1989 (the year before the revaluation project). Now, in 1990, as a result of the revaluation, the residential class represents 50 percent of the town's total taxes. As an "approved assessing unit." that has opted to use the "homestead tax option," the Town of Smith can "freeze" the residential class share of town taxes at the previous 40 percent. Thus, the town will have two tax rates: one for the residential class and another for all other property classes, such as commercial property and industrial property. The difference is that the tax rate for the residential class will be lower than the tax rate for all other property classes. For example, the town tax rate for the residential class might be something like $25 for each $1,000 of assessed valuation, while the tax rate for the non-residential class might be $30 for each $1,000 of assessed valuation.

Q. Once the percentage shares are determined (in our example, 40 percent for residential property and 60 percent for non-residential property), do they remain that way forever?

A. No. They can change based on the following adjustments:

1. Using the example for the Town of Smith, the town would have the option of adjusting the residential share at various points between 40 and 50 percent.

2. The municipality must make annual adjustments based on property that is added to the assessment role and property that is removed.

3. The municipality must make annual adjustment for different rates of appreciation in the two classes of property based on the changes in the current market value of the classes, subject to a 5 percent cap.

Q. What type of property qualifies as residential class property under the homestead tax option?

A. One-, two-, and three-family residential units; mobile homes that are owner-occupied and separately assessed, and condominium units that were built as condominiums and not converted from some other form, such as rental apartments, qualify as residential property.

Also qualifying for the residential class are vacant land parcels not larger than 10 acres that are located in zones that restrict residential use to one-, two-, or three-family residential dwellings.

Land included with homestead options is limited to 10 acres or less. The assessor determines how much of the parcel is used for residential purposes, up to 10 acres. Any additional land will be in the non-residential class.

Q. I understand how the homestead option could work in my town, but how would it work in my school district?

A. School districts that are wholly contained within the boundaries of a city or town that has the homestead tax must use the homestead tax unless they opt out of the program by passing a resolution.

There is a special requirement for school districts located in more than one city or town that want to use the homestead and non-homestead school tax rates. That requirement is that one-fifth or more of the properties in the school district must be located in cities or towns that use the homestead tax option.

In addition, for school districts that are in more than one city or town, the determination of class shares will be based on current market value, with adjustments at the discretion of the school district within limitations set by the law.

Q. How many places are using the homestead tax option?

A. At the time this pamphlet was revised, 14 towns, three villages and 75 school districts are using the homestead tax. About 10 percent of the cities and towns that are eligible to use the homestead tax have opted to do so.

Q. In addition to adopting the homestead tax option, can "approved assessing units" also phase-in the results of the revaluation?

A. Yes. By passing a local law, approved assessing units can phase in the new revaluation assessments over a five-year period.

This option sounds simple. In reality, however, most assessment officials believe it would be extremely difficult to administer. Maybe that is why no municipality to date has decided to use the transition-assessment option.

Q. Can a municipality that has adopted the homestead tax option revoke it later?

A. Yes, simply by adoption a local law, without referendum, to rescind it before the next levy of taxes.

 

Trustee Professor of Public Administration and Economics