The School Property Tax and Homestead Credits: Accuracy, Equity, and Contribution to Overall Fiscal Relief

Transcription

1 The School Property Tax and Homestead Credits: Accuracy, Equity, and Contribution to Overall Fiscal Relief Presented by Vanessa Allen Danielle Fumia Kelly Krupa Rifelj Matthew Steinberg Prepared for the Wisconsin Department of Revenue May 4, 2007 Workshop in Public Affairs, Domestic Issues Public Affairs 869 Spring 2007 Robert M. La Follette School of Public Affairs University of Wisconsin-Madison

2 2007 Board of Regents of the University of Wisconsin System All rights reserved. Foreword revised May 11, 2007 For additional copies: Publications Office La Follette School of Public Affairs 1225 Observatory Drive, Madison, WI The Robert M. La Follette School of Public Affairs is a nonpartisan teaching and research department of the University of Wisconsin Madison. The school takes no stand on policy issues; opinions expressed in these pages reflect the views of the authors.

3 Table of Contents List of Figures... iv List of Tables... iv Foreword... v Acknowledgments... vii Key Terms... ix Executive Summary... xi I. Introduction... 1 II. Property Tax Relief in the United States... 3 Local Government Reliance on Property Taxes... 3 Property Tax Incidence... 3 Property Tax Relief Programs... 4 Individual Property Tax Relief in Wisconsin... 5 School Property Tax Credit... 5 Homestead Credit... 5 III. Accuracy of Credit Formulations... 7 Property Tax Equivalent... 7 Property Tax Equivalent Analysis... 8 Formulaic Heat Differential Formulaic Heat Differential Analysis IV. Analysis of Equity Analysis of the Distribution of Individual Property Tax Relief Distribution of the School Property Tax Credit Distribution of the Homestead Credit V. Contribution to Overall Fiscal Relief Assistance to Local Governments Composition of Fiscal Relief VI. Conclusion VII. Recommendations References Appendix A: Property Tax Relief: Circuit-Breaker Programs Appendix B: History and Development of the Homestead Credit Appendix C: Methodology for Estimating the Property Tax Equivalent Appendix D: The Assumption behind the Heat Differential Appendix E: Wisconsin Adjusted Gross Income Appendix F: Distribution of the School Property Tax Credit and Homestead Credit by Claimant Location Appendix G: Local Assistance Realized by a Median-Valued Home iii

4 List of Figures Figure 1: Distribution of Total Credit Dollars Claimed and Total Credit Dollars Used by Income, Figure 2: Total Amount of Used Credit as a Percentage of Property Taxes Paid or Property Tax Equivalent by Income, List of Tables Table 1: Estimate of the Property Tax Equivalent, Table 2: Cost of Heat Generated by 20/25 Percent Differential Table 3: Possible Outcomes of Analyzing the Cost of Heat Table 4: Distribution of Credit Claimants and Credits by Income, Table 5: Distribution of the School Property Tax Credit by Tenure and Income, Table 6: Homestead Credit Distribution by Tenure Status, Table 7: Local Assistance Realized by a Median-Valued Home Table 8: Total Individual Property Tax Relief for the Median-Valued Home Table 9: Annual Overall Fiscal Relief for Owner of Median-Valued Home Local Assistance and Individual Relief Combined Table 10: Local Assistance and Individual Property Tax Relief as Percentages of Overall Fiscal Relief for Medianand Low-Income Homeowners Table A-1: Property Tax Circuit-Breaker Programs in the United States (Tax Year 2005) Table F-1: Number of SPTC Claimants by Geographic Location Table F-2: Average SPTC Credit Claimed and Used by Geographic Location Table F-3: Average Homestead Credit and Number of Claimants by Geographic Location Table G-1: Local Assistance Provided to Counties, Municipalities, and School Districts from 1992 to Table G-2: Rate of Aid Calculation for All Taxable Real Estate Property Table G-3: Total Local Assistance Provided to Median-Valued Home iv

5 Foreword This report analyzing the accuracy of underlying assumptions and the equity in fiscal relief provided through the Wisconsin s School Property Tax Credit (SPTC) and Homestead Credits is the product of collaboration between the Robert M. La Follette School of Public Affairs at the University of Wisconsin Madison and the Wisconsin Department of Revenue (DOR). This partnership gives graduate students at La Follette the opportunity to practice their policy analysis skills while contributing to the capacity of the Department of Revenue to analyze and develop policies on issues of concern to the residents of the State. The La Follette School of Public Affairs offers a two-year graduate program leading to a master s degree in public affairs. Students study policy analysis and public management, and pursue a concentration in a public policy area of their choice. They spend the first year and a half taking courses that incorporate the tools needed to analyze public policies. The authors of this report are all enrolled in Public Affairs 869, Workshop in Public Affairs, Domestic Issues. Although acquiring a set of policy analysis skills is important, there is no substitute for doing policy analysis as a means of learning policy analysis. Public Affairs 869 provides graduate students that opportunity during the final semester in the program. The students were assigned to one of several project teams. One team worked on this project for the Department of Revenue, while the others worked with the Wisconsin Joint Legislative Council, and the Wisconsin Department of Health and Family Services. The topic of this report an investigation of the accuracy of the assumptions of the SPTC and the Homestead Credit about the share of rent that represents the property tax paid by owners but passed on to renters was chosen by the research staff of DOR. Wisconsin has a long history of providing its local governments with fiscal assistance. In collaboration with the Wisconsin DOR, the La Follette School s spring 2006 workshop class analyzed the state s Shared Revenue Program, which gives fiscal relief for municipalities, counties, and districts. The STPC and Homestead Credit are means of providing individual fiscal relief. These programs distribute assistance to people through the individual tax system. The first provides a nonrefundable credit; the latter is a refundable credit against property taxes paid. The mechanism for offsetting income taxes by a credit for property taxes paid is straightforward in the case of homeowners. It is not so clear in the case of renters who, of course, do not receive and directly pay property tax bills but do pay property taxes as part of their rent. The question of how to provide a credit to renters has been resolved by an assumption that 20 percent of rent represents property taxes if rent includes heat and 25 percent if heat is not included in the rent. The DOR asked for an investigation of how close these assumptions were to the percentage of rent that actually covers property taxes in Wisconsin. The authors of this report have compiled data that allowed them to address this question for Milwaukee and Madison, v

6 the state s two largest cities. They also analyzed the distribution of credits across income groups, and between renters and homeowners. The first distribution question is important on income distribution grounds. The latter is important in determining whether property tax credits are provided equally across taxpayers, including renters whose rents are determined in part by the property taxes landlords pay. Finally the authors examine the extent to which these credits provided relief during the last decade to a homeowner with the population s median income and, alternatively, with the median income among actual Homestead Credit claimers. The authors suggest further study and outline a methodology for doing so. This report cannot give the final word on the complex issues the authors address. The authors are graduate students constrained by the semester time frame, and the topic they have addressed is large and complex. Nevertheless, much has been accomplished, and I trust that the students have learned a great deal, and that the Secretary and staff of the Department of Revenue will profit from this analysis of the individual property tax credit programs. This report would not have been possible without the enthusiasm and continual support and encouragement of Paul Ziegler, leader of DOR s Sales and Property Tax Policy Team who first suggested the topic and wrote the draft project proposal. Additional advice and guidance were provided by Rebecca Boldt, leader of the Income Tax Policy and Economic Team; Brad Caruth, Division of Research and Policy; and Maureen Richards of the city of Madison s assessor s office. We are extremely grateful to DOR Secretary Robert Ervin for his support in allowing his staff to collaborate so fully and expertly with the La Follette School of Public Affairs. The report also benefited greatly from the support of faculty and the staff of the La Follette School of Public Affairs. Professor Andrew Reschovsky kindly helped in making contact with DOR, met with the authors several times to refine their research goals and methodology, and reviewed a draft of the report. Karen Faster, La Follette publications director, edited the report and shouldered the task of producing the final bound document. I am very grateful to Wilbur R. Voigt whose generous gift to the La Follette School supports our public affairs workshop projects. With his support, we are able to finance the production of the final reports, plus other expenses associated with the projects. By involving La Follette students in the tough issues that state government faces, I hope they not only have learned a great deal about doing policy analysis but have gained an appreciation of the complexities and challenges facing state and local governments in Wisconsin. I also hope that this report will contribute to the work of the Department of Revenue and to the ongoing public discussions of state policies to provide financial assistance to local governments and property tax relief to Wisconsin s residents. Karen Holden May 4, 2007 vi

7 Acknowledgments Many individuals provided guidance throughout the completion of our project. We would first like to thank the staff of the Wisconsin Department of Revenue, specifically Paul Ziegler, Rebecca Boldt, and Brad Caruth for providing helpful information and data for our analysis. We extend our gratitude to those individuals who took time out of their schedules to discuss ideas and clarify details in our draft reports. We would especially like to thank Professor Andrew Reschovsky for offering a wealth of knowledge, guidance, and motivation. We would also like to thank John Koskinen of the Wisconsin Department of Administration, Rick Olin and Al Runde of the Legislative Fiscal Bureau, and Maureen Richards at the Madison assessor s office for all their contributions along the way. We also would like to thank our student colleagues Samuel Hall, Patrick Mueller, Michael Pancook, and Carrie Schneck, who provided editorial feedback on earlier drafts. In addition, we thank Karen Faster for her patience and assistance in the production of our final report. Last, we extend a tremendous thank you to Professor Karen Holden of the Robert M. La Follette School of Public Affairs at the University of Wisconsin-Madison for her guidance and discussion throughout the progression of our work. vii

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9 Key Terms Contract rent Contract rent is the monthly rent agreed to or contracted for, excluding any furnishings, utilities, fees, meals, or services that may be included (U.S. Census Bureau, 2007a). Fiscal relief The combination of state aid provided to local governments and individual residents. This relief gives local governments the ability to finance public services and lowers their need to generate revenue through higher taxes. Fiscal relief also includes property tax relief the state directs to individuals, lessening their property tax burdens. (See definitions of local assistance and individual aid.) Gross rent Gross rent (total rent) is the contract rent (the monthly rent agreed to or contracted for with or without utilities or other services) plus the estimated average monthly cost of utilities (electricity, gas, water and sewer) and fuels (oil, coal, kerosene, wood, etc.) (U.S. Census Bureau, 2007a). Individual aid Aid provided directly to individual residents through the income tax system with the goal of reducing or compensating individuals for their property tax liability. In Wisconsin, individual aid (also referred to as individual property tax relief) is provided through the Homestead Credit and the School Property Tax Credit. Local assistance State aid provided directly to counties, municipalities, and districts that can be used in supporting local public services or in lieu of collecting property taxes (e.g. shared revenue, general school aid, school levy credit, lottery and gaming credit, etc.) Aid can also take the form of fiscal controls that restrict per-pupil revenue growth for school districts and limit the growth in which local governments (i.e. counties and municipalities) are able to tax property. Nonrefundable tax credit A nonrefundable tax credit is paid only to the degree that it offsets an individual s tax liability. If the credit amount exceeds the amount of tax liability, it generates a refund only up to the amount of tax liability. If the tax credit is an amount less than the tax liability, the individual receives the full credit amount. ix

10 Property tax equivalent The term property tax equivalent (PTE) is also referred to as the property tax rent equivalent or rent constituting property taxes. The PTE is the estimated amount of rent that constitutes property taxes for rental units. The PTE is estimated by multiplying the annual rent bill by the PTE percentage, which is the fraction of rent that goes to property taxes. The actual share of property tax that owners of real estate pass onto renters through higher rent is unknown. This property tax equivalent is usually expressed as the PTE percentage and ranges from 6 percent to 25 percent in states that provide property tax relief to renters (Lyons, et al., 2007). Refundable credit A tax credit whose award is not constrained by the amount of an individual s tax liability. A nonrefundable tax credit can reduce an individual s tax liability by no more than zero. Refundable credits award the full amount of the credit, regardless of income liability. If the refundable credit is larger than the individual s tax liability, the individual would receive a payment. The earned income credit is an example of a widely received refundable credit in the United States. Tenure status Refers to the distinction between owner-occupied and renter-occupied housing units (U.S. Census Bureau, 2007a). x

11 Executive Summary States provide fiscal relief to their residents to reduce or compensate them for their property tax liability. Wisconsin provides fiscal relief to residents using two approaches, assistance to local governments and direct property tax relief to individuals. At the request of the Wisconsin Department of Revenue (DOR), we have focused our analysis on individual relief provided through the School Property Tax Credit and the Homestead Credit. We analyze these credits with respect to accuracy, equity, and contribution to overall fiscal relief. We first analyze the accuracy of the credit calculation; we then look at the equity of the relief between renters and homeowners, among renters, and between income classes; and we conclude with an analysis of how the composition of overall fiscal relief has changed over the last 15 years. Both credits use a property tax equivalent percentage to estimate the amount renters pay in property taxes. This amount, referred to as the property tax equivalent (PTE), affects the credit amount a claimant can receive. Using data from Milwaukee and Madison, we estimate a PTE percentage of 22 percent for Milwaukee and 13 percent for Madison. The percentage for Milwaukee is similar to the 20 percent or 25 percent used statewide, depending on whether a renter pays for heat. For Madison, however, the PTE percentage we found is much lower. This indicates that there may be geographic variance in the PTE percentages. Verification of the accuracy of the current PTE percentages requires further analysis with more comprehensive data. We also suggest a framework that could be used to analyze the accuracy of the heat differential and determine the actual percentage of rent that represents the cost of heat. The distribution of the School Property Tax and Homestead credits to different groups allows us to examine the equity of relief allocation. We have found that the non-refundability of the SPTC creates some inequities, with higher-income individuals receiving greater benefit. When tenure status is considered, homeowners receive a greater benefit from the SPTC in comparison to renters. However, as a percentage of property taxes or PTE, renters benefit more than homeowners. The distribution of the Homestead Credit by tenure status resembles that of the SPTC in that homeowners, on average, receive larger credits than renters. Also, renters receive more relief on their PTEs paid than homeowners receive on their property taxes paid. Unlike the SPTC, however, more renters than homeowners claim the Homestead Credit. Finally, we explore the contribution of these credits to overall fiscal relief. We examine how the proportions of local assistance and individual aid have changed. For a median-income homeowner with a median-valued home, we find that the makeup of overall fiscal relief has remained consistent since 1991(92). 1 1 The notation 1991(92) indicates that tax was paid in 1991 and collected in xi

12 Local assistance made up 90 percent of overall fiscal relief while individual relief provided 10 percent. For a low-income homeowner with a median-valued home, however, the composition of overall fiscal relief has changed, with a decline in individual aid as a percentage of overall fiscal relief, from 34 percent in 1991(92) to 26 percent in 2005(06). Individual aid to low-income homeowners has become more similar to that provided to median-income homeowners. Our analysis has produced findings that serve as a base for further study and suggests the need for credit adjustments. We recommend that the Wisconsin DOR employ a more systematic approach to gathering data on rental properties used as residences. To calculate more accurately the PTE percentages statewide and across municipalities, the Wisconsin DOR should institute a comprehensive data system. We recommend that the Wisconsin DOR collect data on the number of rental units in properties classified as residential and commercial, the proportion of rental units with heat included in their contract rent, and the share of property taxes associated with rental units. We also recommend that the Wisconsin DOR support legislation that adjusts the Homestead Credit formula for inflation, which will help maintain the extent and composition of fiscal relief provided to low-income households. xii

13 I. Introduction Property taxes are the primary source of funding in many states for municipal services and public schools. In fiscal year 2004, property taxes constituted approximately 94 percent of total local government tax revenue in Wisconsin (U.S. Census Bureau, 2007b). They represented about 89 percent of local revenue for public elementary and secondary schools (U.S. Census Bureau, 2007c). Although vital to local governments and public schools, property taxes are burdensome to Wisconsin residents, taking up approximately 4.3 percent of total income in 2004, the eighth highest ratio of property taxes to income in the country (Norman, 2007). Property acts as a source of cash income to the owner only when the property is rented or sold. Most property tax revenue; however, comes from residential property. The net property taxes paid on residential property as a percentage of the total collected in Wisconsin has increased from 51 percent in 1970 to 71 percent in (Wisconsin Legislative Fiscal Bureau [WLFB], 2007). Therefore, property taxes are levied against mostly non-revenue generating residential property. Because property taxes depend on property value and not on income, they can impose a burden on taxpayers, particularly those at lower income levels. To reduce this property tax burden, states can provide relief in various forms. Local assistance provides relief by giving state money directly to municipalities to use in lieu of collecting property taxes or by limiting the rate at which municipalities can tax property. States can give property tax relief directly to individuals through the income tax system. In Wisconsin, individual property tax relief is provided through the Homestead Credit and the School Property Tax Credit (SPTC) through the income tax system. Both credits are available to homeowners and renters; however, they differ in significant ways. The Homestead Credit is a refundable credit targeted at Wisconsin s low-income residents. The SPTC is a nonrefundable credit that is universally available to residents at all income levels. On behalf of the Wisconsin Department of Revenue, we analyze these credits on the grounds of accuracy, equity, and their contribution to overall fiscal relief. An important aspect of individual property tax relief that we analyze involves the provision of relief through these credits to renters. Because renters do not pay property taxes directly, the legislature has estimated the property tax equivalent (PTE), which is the estimated amount of rent that constitutes property taxes paid by the rental property owners and shifted to their tenants through higher rents. The credit values are then calculated from this PTE amount in the same way they are calculated from the property tax bill paid by homeowners. The PTE is calculated similarly for the Homestead Credit and the SPTC. Wisconsin has structured credit formulas on the assumption that the PTE equals 20 percent of annual rent if heat is included in the rent and 25 percent if heat is not included. 1

14 Thus, the first piece of our analysis provides an estimate of whether the legislated percentages accurately reflect the fraction of rent that constitutes property taxes. Equity issues may occur between homeowners and renters, across renter groups, and across income levels. Horizontal equity refers to the equity between homeowners and renters in the same income category or with the same property value. Vertical equity, conversely, refers to groups at different income levels and holds that taxpayers with smaller disposable incomes should receive a larger credit. Horizontal equity depends on the accuracy of the current PTE percentages. If the percentages are inaccurate, claimants who pay similar property taxes may experience different levels of relief based solely on tenure status. The PTE percentage differential for those paying heat and those not paying heat may also affect horizontal equity if the heat differential inaccurately captures the cost of heat. Vertical equity concerns may arise among SPTC claimants across income levels, because the credit amounts depend on one s income or because credit characteristics, such as non-refundability, differ. To assess the performance of individual property tax relief from the perspectives of accuracy, equity, and contribution to overall fiscal relief, we focus on these four research questions: 1. Does Wisconsin accurately estimate the PTE for renters? In other words, on average does 20 percent of annual rent paid go toward property taxes if heat is included and 25 percent if heat is not included? 2. Does the percentage differential seen in the PTE estimate accurately measure the cost of heat? 3. How is individual property tax relief distributed across income levels and tenure statuses? 4. What is the composition of total fiscal relief local assistance plus individual relief for a median-valued home? By answering these four questions, we illustrate how well the SPTC and the Homestead Credit achieve their goals of relieving the property tax burden. This analysis demonstrates whether individual relief is provided accurately and fairly to all Wisconsin residents. Finally, we estimate how much of a role individual relief plays in the larger picture of overall fiscal relief to Wisconsin residents. 2

15 II. Property Tax Relief in the United States Local governments heavily rely on the property tax to function. States attempt to offset the burden that property taxes create through aid to jurisdictions with low revenue-raising capacity and through individual relief that lowers an individual s income tax liability or provides a cash transfer payment. Local Government Reliance on Property Taxes Property taxes are the principal funding source for local governments throughout the United States. These funds are used to provide many local public services, including street repair, police and fire protection, solid waste disposal, and public parks (Cico, et al., 2004). However, the most prominent use of local property taxes is the funding of K-12 education. The quality of a municipality s local school district is generally reflected not only in property values, but also in the total property taxes municipal residents pay. In 2005, tax revenue from property taxes totaled $352 billion nationally. This represents more than a 77 percent increase in property tax revenue from ten years prior, far outpacing the 28 percent inflation rate during the same time period. In 2004, property taxes constituted approximately 46 percent of all local government revenues in the United States; furthermore, property taxes represented more than 73 percent of all local government tax revenue (U.S. Census, 2007d). Compared to the national average, property taxes in Wisconsin make up a much larger share of local revenues. In 2004, property taxes represented approximately 66 percent of all local government revenue. 2 Moreover, property taxes represented approximately 94 percent of local government tax revenue (U.S. Census, 2007d). Property Tax Incidence Given the share of local revenues that property taxes make up, this tax has not been popular with the general public. From 1972 to 1994, the U.S. Advisory Committee on Intergovernmental Relations conducted an annual survey on public attitudes toward governments and taxes. For 20 of those years, the survey asked respondents to identify the least fair tax among four common taxes: the property tax, the federal income tax, the state income tax, and the state sales tax. In eight of those 20 years, the local property tax was ranked the least fair among all the state and local taxes (Baer, 1998). As a result, all 50 states have instituted individual property tax relief programs, including homestead tax exemptions or credits, circuit-breaker programs, 3 tax freezes for certain categories of taxpayers (such as senior citizens, war veterans, or disabled citizens), and deferral programs 2 Local government revenue also includes other sources of tax revenue, which include fees, fines, and intergovernmental aid. 3 Circuit-breaker programs include refunds, rebates, credits, or exemptions state governments give to reduce property tax liabilities for individuals whose property tax payments (or property tax equivalents, in the case of renters) are deemed too great. Several states offer these programs, which differ in scope and administration (Lyons, et al., 2007). 3

16 (such as those that allow senior citizens to defer paying taxes until their homes are sold or their estates are settled) (Mikhailov, 1998). While many taxpayers see the property tax as an unfair burden, the rationale for property tax relief extends beyond this perception to the relationships among property value, family income, and the generation of cash flow. Individual property, particularly an individual s residence, generates very little, if any, cash flow with which to pay property taxes (Cico, et al., 2004). High-income households have the financial solvency to pay the taxes to support the property they own. However, elderly residents and low-income families can face a disproportionately high property tax liability relative to their ability to pay. Therefore, property taxes are often considered regressive and can be the single most burdensome tax for many low-income and elder persons (Baer, 1998). Reschovsky (1994), for example, found that property tax liabilities for younger homeowners were essentially proportional across income classes but were regressive for older homeowners. Older homeowners had higher property tax liabilities than younger homeowners with identical average incomes. This is due to the fact that, on average, older homeowners live in higher-valued homes than younger homeowners with similar incomes. Property Tax Relief Programs Property tax relief programs can be divided into two broad categories: local assistance and individual property tax relief. Local assistance includes intergovernmental aid programs that aim to diversify local government revenue sources and reduce the need for higher property tax levies. Individual property tax relief is targeted to individual homeowners and renters with the intent to directly reduce the tax bills for individual properties (Mikhailov, 1998). Individual property tax relief programs also may be classified by the type of relief that they provide to taxpayers. These programs include (a) tax exemptions; (b) credits, rebates or refunds; (c) tax freezes for certain categories of taxpayers; and (d) deferral programs. 4 Property tax exemptions eliminate a portion of the tax liability prior to receipt of the tax bill. Programs that use state income tax credits, rebates or refunds require full payment of the tax liability but then return the amount of tax relief to the taxpayer. Property tax freezes require full payment of taxes but limit the growth of taxes through limiting the tax rate. Tax deferral programs eliminate part or all of the current tax liability of a qualified homeowner but attach a lien to the property and require repayment in full with interest when ownership changes hands (Cico, et al., 2004). If one objective of individual property tax relief is to reduce the burden on lowincome families, we must consider renters as a separate category. Renters are a special case when considering property tax relief, because they do not directly pay property taxes and because a larger proportion of renters are low-income than are 4 For more on other states individual property tax relief programs, see Appendix A. 4

17 homeowners. Although landlords receive property tax relief that could be passed on to their tenants through lower rents, they are slow to do so; one study has shown that individual property tax relief is realized three to five years later (Advisory Commission on Intergovernmental Relations, 1973). When landlords are not eligible for property tax relief, property taxes may be passed on to renters. If these renters are not eligible for property tax relief, they will likely pay more in property taxes than they would with relief. In this report, we focus on income-based property tax relief delivered to the individual in the form of a tax credit, refund, or rebate. A tax credit is subtracted from the tax bill after an individual s tax liability has been calculated. In this way, the tax credit is tied directly to individual income and not to the property value of a residence. According to Cico, et al. (2004), 19 states have a tax credit, refund, or rebate program in place. 5 All of these states have income eligibility requirements, while ten of them also have age requirements. Individual Property Tax Relief in Wisconsin Individual property tax relief programs in Wisconsin include income tax credits, classification laws (a different rate for taxing farmland), a freeze on local school property taxes, and deferral programs (Mikhailov, 1998, and Baer, 1998). Specifically, our analysis focuses on the School Property Tax Credit and the Homestead Credit. School Property Tax Credit The School Property Tax Credit (SPTC) is a non-refundable tax credit designed to offer relief to all homeowners and renters at all income levels. It was originally enacted in 1989 and has been modified over the years. Initially, the SPTC equaled 10 percent of the first $2,000 in property taxes, or the PTE for renters, with a maximum credit of $200. In tax year 1998, the credit increased to 14 percent of the first $2,500 in property taxes or the PTE with a maximum credit of $350. After a brief elimination of the credit in 1999, the legislature reinstated the SPTC in 2000 with the current rate of 12 percent for the first $2,500 in property taxes or the PTE with a maximum credit of $300 (Wisconsin Legislative Fiscal Bureau, 2007a). Homestead Credit Pioneered by Wisconsin in 1964, the Homestead Credit is a refundable tax credit targeted at low-income homeowners and renters who are 18 and older. 6 In the credit s current form, a claimant must have a household income below $24,500. A claimant with a household income at or below $8,000 receives a credit equal to 80 percent of the first $1,450 in property taxes or the PTE with a maximum credit of $1,160. For an individual with a household income between $8,000 and 5 These 19 states provide property tax relief in the form of a refund, similar to the manner in which Wisconsin provides individual property tax relief. For more information about such circuitbreaker property tax relief programs in particular, see Table A-1 in Appendix A for a comparison across states. This table provides information on circuit breakers in 17 states and the District of Columbia. 6 For information on the history of the Homestead Credit, see Appendix B. 5

18 $24,500, the credit is calculated differently (see below). All of a claimant s income above $8,000 is multiplied by percent, and the resulting amount is subtracted from the maximum allowed property taxes ($1,450). The final credit is 80 percent of this amount (WLFB, 2005). Credit = 80 percent x [Property Taxes (or PTE) {8.788 percent x (Household Income - $8,000)}] Source: WLFB, 2005 The formula is designed to limit the credit a claimant can receive. When a claimant s household income rises above $8,000, the credit phases out at a rate of percent until his or her income reaches $24,500 and the credit is zero. As a consequence, if the legislature does not change the formula s income limits, claimants will face a declining credit if their incomes are only rising with inflation. 6

19 III. Accuracy of Credit Formulations This section provides the analysis of the research questions pertinent to individual property tax relief. First, we estimate the property tax equivalent for renters. Then, we examine the accuracy of the different percentages used to calculate the PTE for renters who pay heat separately and for those who have heat included in their rent bills. Property Tax Equivalent The calculation of the Homestead Credit contains the assumption that the PTE percentage equals 25 percent of rent if a renter pays heat separately and 20 percent if heat is included in rent. Additionally, our analysis assumes (as do the 20 and 25 percent figures) that landlords are able to shift all of their property taxes (100 percent tax incidence) to their renters by charging enough to cover property taxes. In reality, landlords may not be able to shift their entire property tax bills, especially in communities where the supply of available rental units exceeds demand. The rationale for choosing the specific percentage of rent that is considered equal to property taxes most likely reflects the vision of University of Wisconsin- Madison professor Harold Groves. First, the authors of the tax study commission he co-chaired in 1959 concluded that 25 percent was a rough estimate of the share of property taxes on gross rents (University of Wisconsin Tax Study Commission, 1959). Second, two later reports on property tax relief say Groves was the likely author of the original proposal for the Homestead Credit, which was adopted in 1963 (Stark, , and Quindry & Cook, 1969). We examine whether the 20/25 differential accurately measures the PTE in Wisconsin. Our findings determine whether Wisconsin has chosen accurate PTE percentages for its Homestead Credit and SPTC calculations. Analyses of the PTE assumption are scarce; however, the Minnesota Department of Revenue s consideration of this issue in 2005 uses its own property tax data and rent data from the American Community Survey, a nationwide survey of housing and economic characteristics. Analysts found that on average across Minnesota municipalities, property taxes as a percentage of rent are 15 percent or less. Given that Minnesota uses 19 percent of rent as the PTE percentage, the authors of the report suggest changing the percentage to 15 or less. The authors further conclude that using 19 percent to estimate the PTE ends up subsidizing renters through Minnesota s version of the homestead credit (Minnesota Department of Revenue, 2005). Like Minnesota, if Wisconsin chose higher than necessary PTE percentages, then Wisconsin subsidizes rent through the property tax refund program. This is because renters receive higher refunds than they pay in property taxes. If these credits were intended, in part, to be redistributive in favor of those with lower incomes (renters typically being of lower incomes [Advisory Commission on Intergovernmental Relations, 1973]), the higher percentage could be justified as a subsidy to this group, though only for low-income renters but not low-income 7

20 homeowners. Additionally, because renters do not have the ability to rent their homestead (imputed rent 7 ) and they cannot take advantage of the federal mortgage interest deduction and other property-related income tax deductions, larger PTE percentages might be justified. Property Tax Equivalent Analysis To determine whether 20/25 percent of rent constitutes property taxes, we use data from Madison and Milwaukee, Wisconsin s two largest cities. 8 To estimate the accurate PTE percentage statewide, we obtained data on 2005 property values from Madison s and Milwaukee s assessor s offices and 2005 rent data from the American Community Survey. Using these data, we estimate the total property taxes paid on apartments and residential non-homestead properties. We divide this aggregate number by the estimated annual rent paid plus rent asked for vacant units to obtain the average PTE percentage for each city. Total Property Taxes Total Rent = PTE Percentage These data limit our analysis because we cannot observe the marginal effects on the PTE percentage for renters with and without heat included in their rent bills. Additionally, we cannot estimate the PTE percentages for those living in buildings with less than five units. These PTE percentages are not readily available and must be constructed from other data sources. First, the property value information we use to estimate total property taxes is limited to the rent data that are available from the American Community Survey. We use property values of buildings with five units or more. The American Community Survey breaks up the rent data based on buildings of one unit attached, one unit detached, two to four units, five to 19 units, 20 to 49 units, and 50 or more units. Because we could not obtain data on the property values for rental housing in Wisconsin for less than four units, we used rent data from the American Community Survey on buildings of five units or more. 7 Imputed rent refers to the possible revenue generated if a homeowner rents her or his property to another individual. This income is most often excluded from income measures and goes untaxed. 8 Our preference would have been to follow the 2005 Minnesota study and use data from the American Community Survey and the Wisconsin Department of Revenue (Wisconsin DOR); however, the manner in which Wisconsin classifies property considers some residential rental properties as residential property and others as commercial property. The Wisconsin DOR is unable to factor out residential rental properties from either classification to provide total property taxes paid on rental property in Wisconsin. Additionally, we considered obtaining addresses from the Wisconsin DOR for a sample of renters who claimed the SPTC and Homestead Credit. We would look up the property values for those properties and compute the property taxes paid on those buildings. We would also find the number of units within each building and divide property taxes by the number of units to obtain an average property tax amount per unit. However, addresses were not available due to confidentiality reasons. 8

21 To estimate the total property taxes we use property values from the Milwaukee and Madison assessors offices and add all the property values for buildings with five or more units to obtain total property values. Finally, we multiply the net mill rate 9 by the total property values to find total property taxes (Table 1). To obtain the estimate for the total rent we use American Community Survey data for rent for apartment buildings. This includes total rent paid by tenants and rent asked for on vacant units. The American Community Survey data includes total gross rent (rent plus utilities), total contract rent (rent without utilities), and rent asked for (rent on vacant units). To estimate the contract rent paid on buildings of five units or more we estimate the percentage of gross rent that is for buildings of five or more units by adding the gross rent for the buildings with five units or more and dividing that by total gross rent. For Milwaukee and Madison, we find that 37 and 61 percent of gross rent, respectively, comes from buildings with five or more units. We multiply that percentage by the contract rent to find the amount of contract rent collected on buildings with five or more units. We apply the percentage equivalently to the rent asked for on vacant units to arrive at the rent asked for on vacant units for buildings with five units or more. Finally, we add the amount of contract rent on to the rent asked for on units that are not rented for buildings of five units or more to obtain total rent asked for and paid on all units. For further clarification of the calculations, see Table 1 and Appendix C. We then divide the total property taxes by the total rent to estimate the accurate PTE percentage for Milwaukee and Madison. The percentage for Milwaukee is approximately 22 percent and 13 percent for Madison (Table 1). 9 The tax per dollar of assessed property value. The rate is expressed in mills, where one mill is one-tenth of a cent, $

22 Table 1: Estimate of the Property Tax Equivalent, 2005 Milwaukee Madison Total Property Value (commercial apartments, five or more units) $2,568,824,600 $1,676,845,400 Net Mill Rate per Thousand Total Property Taxes $66,429, $37,630, Percentage of Gross Rent from buildings with five or more units Estimated Contract Rent from buildings with five or more units $281,931, $263,176, Estimated Rent Asked from buildings with five or more units $24,905, $34,290, Total Estimated Rent Paid or Asked from buildings with five or more units $306,837, $297,467, Property Tax Equivalent Percentage Source: Created by authors using 2005 data from the Milwaukee and Madison assessors offices and the American Community Survey. See Appendix C for further clarification of these calculations. Note: We estimate the PTE percentage for all renters but are unable to estimate the percentage separately for tenants who pay heat and those who do not. 10

23 Formulaic Heat Differential Our analysis explores how to examine the extent to which the implied 20/25 percent differential (between renters) is an accurate estimate of the portion of rent representing the cost of heat. As noted, renters who pay heat as part of their monthly rent can claim only 20 percent of their rent as constituting property taxes, while renters who pay heat separately can claim 25 percent of their rent as constituting property taxes. The intent of this differential is to prevent the inclusion of heat in the estimation of property taxes paid by rental units. This differential attempts to correct for the fact that those who have heat included in their rent receive a credit based on their rent and heat payments. The differential attempts to prevent inequity by providing a larger credit to those who pay heat separately and thus do not receive a credit on their heat payments. Other states have found alternative mechanisms to correct for this. New York, for example, adjusts gross rent by subtracting out all utilities that claimants report as part of their rent (New York State Department of Taxation and Finance, 2003). When rent includes heat, New York assumes the cost of heat equals 15 percent of rent. Adjusted rent equals gross rent minus 15 percent of gross rent. This adjusted rent equals the rent paid by a renter of a similar unit who pays heat separately. Therefore, when New York applies its property tax equivalent of 25 percent of property taxes to the adjusted rent, the estimated property taxes paid are the same for both renters. The accuracy of Wisconsin s 20/25 percent differential has implications for the distributional equity of property tax relief that individual renters claim. Implicit in the differential is the assumption that heat makes up 20 percent of the annual rent bills for renters who have heat included in their rents and 25 percent of the annual rent bill for those without heat included. 10 Table 2 provides an example of how the 20/25 percent differential results in equivalent PTEs for those with and without heat included in their rent bills. Table 2: Cost of Heat Generated by 20/25 Percent Differential Renter A (heat included in rent) Renter B (heat paid separately) Rent Paid $14,250 $11,400 Cost of Heat 0 $2,850 Total Expenses (Rent Plus Heat) $14,250 $14,250 PTE Percentage 20% 25% Property Taxes Paid $2,850 $2,850 Source: Created by authors. 10 To see how we arrived at this implicit assumption, see Appendix D. 11

24 If the cost of heat deviates from the assumption that heat equals 20 percent of Renter A s rent, or 25 percent of Renter B s rent there is subsidization of one group over the other. Table 3 depicts the possible outcomes that may result from further analysis of the cost of heat as a percentage of rent. Table 3: Possible Outcomes of Analyzing the Cost of Heat Possibilities Beneficiary Adjustment Needed to 20/25 Percent PTE Combination A. Cost of Heat = 20% of X = 25% of Y Equitable None B. Cost of Heat > 20% of X; and > 25% of Y C. Cost of Heat < 20% of X; and Renters who have heat included benefit more Renters who pay heat separately benefit more < 25% of Y X = the amount of rent paid by renters with heat included Y = the amount of rent paid by renters who pay heat separately Source: Created by authors. Increase difference between property tax equivalents used Decrease difference between property tax equivalents used Formulaic Heat Differential Analysis To analyze the heat differential, we would need data that could not be obtained within the confines of this project. Instead we present a possible framework to analyze the differential: Estimate the average heat bill for renters who pay heat separately, and then Calculate heat as a percentage of rent paid for those who pay heat separately. o If the heat equals 25 percent, then estimate the heat paid by renters who have heat included in their bills. o If heat constitutes 20 percent of their bill, then it is clear the heat differential results in equal treatments of renters. In the event that heat does not equal 20 percent of the rent paid by renters with heat included or 25 percent of rent for those who pay heat separately, then there are three possible explanations: (1) the differential is inaccurate; (2) renters who pay heat separately live in properties that are systematically different from renters who have heat included; or (3) those who pay heat separately consume heat differently than those who have heat included in their rents and do not have to pay extra for additional heat usage. As noted earlier, this analysis rests on the assumption that the differential applies to renters in equivalent properties and the only difference is the inclusion (or exclusion) of heat from the rent bill. If no equivalent properties exist, then one cannot analyze the heat differential with the method discussed. 12

25 IV. Analysis of Equity 11 Our analysis assesses whether the benefits of the Homestead Credit and the SPTC are distributed equally to residents of Wisconsin. Because the Homestead Credit and the SPTC are based on property and income, equity concerns may arise due to income or tenure status. By closely examining the distributions of individual property tax relief, we hope to determine if certain groups receive a disparate amount of aid from the Homestead Credit and/or the SPTC. We illustrate how the SPTC is distributed by income and examine the distribution of the SPTC and the Homestead Credit by tenure status. The non-refundability of the SPTC may raise equity concerns because credit claimants do not always receive the entire credit for which they would be eligible if it were refundable. Indeed, non-refundability means that one can only receive a credit equal to or less than income tax liability. For example, if a claimant would be eligible for a full $300 SPTC based on property taxes paid but has an income tax liability of $200, he or she can only receive $200 of the SPTC. People with lower income tax liabilities, often those at lower income levels, will receive different amounts of relief even if they pay the same amount in property taxes as those with more income tax liability. While the Homestead Credit may equalize the impact of non-refundability because it is available only to those at lower income levels, our analysis examines the overall equity concerns raised by the non-refundability of the SPTC. Second, we examine the possibility that disparities exist due to tenure status for both the Homestead Credit and the SPTC. Specifically, does tenure status affect the likelihood that one will claim these credits? In addition, does the amount of the credit received have an association with tenure status? For this portion of the analysis, we study homeowners and renters with the same incomes to see if tenure status alone plays a role in how individual property tax relief gets distributed to Wisconsin residents. Finally, our analysis addresses the ability of these credits to relieve property tax liability. A person who pays $3,000 in property taxes and receives a credit of $300 sees 10 percent of his or her property tax bill relieved by the credit. A person with identical income who pays $1,000 in property taxes would also receive a credit of $300, realizing greater relief as a share of total property taxes paid. Thus, we address how well the SPTC and the Homestead Credit achieve their goals of lessening the property tax burden. We examine this by income and tenure status for the SPTC and by tenure status only for the Homestead Credit. By examining the distribution of the SPTC and Homestead Credit by income and/or tenure, we hope to illustrate to what extent, if any, disparities exist with respect to individual property tax relief amid different groups in Wisconsin. 11 We use Wisconsin adjusted gross income (WAGI), referred to as income, throughout Section IV as it is the only income data provided for SPTC claimants. Income sources that are included in and exempted from the WAGI are reported in Appendix E: Wisconsin Adjusted Gross Income. 13