PROPERTY TAX;

TAXES - PROPERTY;

December 23, 2003	2003-R-0926
PROPERTY TAX CLASSIFICATION SYSTEMS AND THEIR IMPACT
By: Judith Lohman, Chief Analyst

You asked (1) for examples of states or localities that have property tax classification systems that require business taxpayers to pay higher taxes than residential taxpayers, (2) whether Hartford has a similar type of property tax system, and (3) what the effect of these classification systems has been.

SUMMARY

Connecticut law establishes a uniform tax assessment ratio of 70% of fair market value of all types of property and does not permit different assessments or tax rates according to property type. Unlike Connecticut, many other states have property tax classification systems established or authorized by state law. These systems establish different classes of taxable property with different assessment ratios or different tax rates. The number of property classes in those states ranges from two to 14.

Although Connecticut does not have property tax classification, state law allows Hartford to implement a program of residential tax relief that has some characteristics of a tax classification system. Hartford’s Tax Cap program gives owner-occupants of one- to three-family homes a tax credit equal to the amount by which their property tax exceeds 1. 5% of the property’s fair market value. Providing this credit requires the city to impose a 15% surcharge on all other property owners, thus in effect creating two property classes with different tax rates.

Assessments of tax classification or classification-type systems in Hartford; Cook County, Illinois; and Massachusetts agree that such systems increase taxes on business. Assessments of the Hartford and Massachusetts systems argue that the systems have a detrimental effect on business and harm economic growth in the localities where they apply. But a study of Cook County and its neighboring counties found only limited evidence to support the conclusion that Cook County’s relatively slower growth in the 1990s was the result of its higher property taxes on business. Instead, the Illinois study points out the difficulty of isolating the effect of property taxes from other factors influencing economic growth and business location decisions.

In addition to the information on tax classification in this report, we attach, for your further information, a recent OLR report on the “split-rate” property tax system used in Harrisburg, Pennsylvania (2003-R-0820).

TAX CLASSIFICATION IN OTHER STATES

A total of 26 states and the District of Columbia have property tax classification systems, according to information from the University of California at Davis’ Institute of Governmental Affairs and OLR’s research (see Table 1). Although five states have just two classifications, others have many more. Eighteen of the states have different assessment ratios for each class of property, seven have different tax rates, and two allow local taxing authorities to determine the type of tax classification system they will use.

TABLE 1: PROPERTY TAX CLASSIFICATION SYSTEMS

IN OTHER STATES

State	Number of Classes	Different Ratios	Different Rates
Alabama	7	X
Arizona	9	X
Colorado	3	X
D. C.	3		X
Georgia	2	X
Hawaii	7		X
Illinois	2 (Cook County 6)	X
Kansas	13	X
Kentucky	14		X (state rates)
Louisiana	5	X
Massachusetts	4		X
Minnesota	12	X
Mississippi	5	X
Missouri	8	X
Montana	11	X
Nebraska	2	X
New Hampshire	2		X

-Continued-

State	Number of Classes	Different Rates	Different Rates
New York	Local option
North Dakota	2	X
Oklahoma	4	X
Rhode Island	Local option
South Carolina	11	X
South Dakota	3		X
Tennessee	4	X
Utah	2	X
West Virginia	4		X
Wyoming	3	X

HARTFORD TAX CAP PROGRAM

Connecticut law authorizes certain cities tax with high tax rates to provide tax relief for owner-occupied, one- to three-family houses (CGS § 12-62d). Hartford is the only city that has used the law, instituting its “Tax Cap” program in 1990 after it revalued all properties.

Under the statute, towns must tax all properties at a uniform rate, but may credit residential property owners for a portion of their tax bill. A town can do this if its post-revaluation effective tax rate on residential properties exceeds 1. 5%. The credit continues for five years, including the year that the revaluation took effect. (Hartford has been providing credits since 1989. )

Towns can provide an equal flat credit to each residential property or link the size of the credit to the tax paid on the property. Under the first option, the maximum credit is $ 750. Under the second, which is the one Hartford uses, the credit is the amount by which the property tax exceeds 1. 5% of the property’s fair market value. The maximum credit under this option is 2½ times the average credit.

Towns must recover the cost of the credits by imposing a surcharge on nonresidential properties. The surcharge can be for up to 15% of the tax on those properties and, like the credits, must continue for five years. The surcharge applies to commercial, industrial, and public utility real and personal property. It does not apply to motor vehicles, lodging houses, or multifamily structures that are more than half residential and that contain more than three units.

EFFECTS OF TAX CLASSIFICATION

Hartford

A 1999 analysis of Hartford’s tax structure by the Connecticut Center for Economic Analysis (CCEA) at UConn found “the cap/surcharge structure seems to have damaged the City of Hartford economically, creating a hostile environment for businesses and apartments by distorting the tax burdens of different classes of property” (The Economic Effects of Revaluation and Tax Policy on the City of Hartford, December 1999).

The combination cap and surcharge structure does not necessarily increase tax revenue, but it shifts the tax burden placed on different types of properties. The effect is similar to tax classification systems with higher tax rates on business property. “Adding up to a 15% surcharge on top of the regularly calculated tax bill is the same as adding up to 15% of the mill rate onto the mill rate for specific categories of property owners,” the CCEA study notes.

CCEA stated that the cap and surcharge structure would distort the aggregate tax burden after Hartford’s 1999 revaluation. The distortion could encourage businesses to leave Hartford or discourage businesses from relocating there. CCEA found that Hartford “lost nearly 4% of its businesses, and nearly 10% of its apartments” between 1990 and 1998. “In addition, vacancies have increased by nearly 12%, and 158 properties have disappeared altogether,” according to the report.

Apparently, CCEA is the only group to have studied the impact of the cap and surcharge structure. But, when OLR consulted Hartford planning officials in 2000, they pointed to anecdotal evidence supporting CCEA’s findings. Merchants throughout the city consistently cite the property tax burden as their main concern, followed by a lack of affordable parking and crime or the perception of crime, city officials told us.

But the planning officials also suggested that other factors besides the property tax could have influenced business and residential property owners to close or abandon their properties since 1990, including people leaving the city for the suburbs during the economic recession of the early 1990s. The CCEA study does not discuss these or other factors that could have mitigated or reinforced the cap and surcharge structure’s impact.

Cook County, Illinois

In Illinois, by law, most counties require property to be assessed at one-third of its fair market value. But counties with populations greater than 200,000 may classify property and assess each class at different market ratios. Cook County, which includes Chicago, has adopted the authorized classification system. Although the county has six property classes, 90% of its taxable property falls within three classes: residential, commercial, and industrial. These classes are assessed at 16%, 38%, and 36% of fair market value, respectively.

In 1999, three researchers from the Lincoln Institute of Land Policy published a working paper on The Impact of Property Taxes and Property Tax Classification on Business Activity in the Chicago Metropolitan Area (Richard F. Dye, Therese J. McGuire, and David F. Merriman). The paper investigates the extent to which the classification and consequent higher taxes on commercial and industrial property contributed to a decline in business activity in Cook County compared to its five neighboring counties: DuPage, Kane, Lake, McHenry, and Will. None of the five has tax classification.

The authors note that Cook County taxes on commercial property are about triple those on similar commercial properties in the five neighboring counties. Industrial properties in the county are taxed at roughly twice the level of neighboring counties. Meanwhile, average Cook County residential property taxes are slightly lower than those in the neighboring counties. Cook County experienced lower relative economic growth in the 1990s compared to its neighbors.

Although Cook County’s slower growth is commonly attributed to the high business taxes produced by the classification system, the authors conclude that there is only limited evidence to support the connection. Their study shows that property taxes many Cook County businesses actually pay are mitigated by such things as lower property values; tax incentives and subsidies intended to reduce the effects of high taxes; and tax increment financing, which maintains the full tax rate but earmarks revenues for business subsidies. These tax mitigation strategies tend to be aimed at the most mobile businesses.

The authors hypothesize that “differences in growth rates may not be due to differences in property tax rates but may be attributable to other differences in municipalities. ” They cite other important determinants affecting business location decisions as having more impact. These include “residential share of property, population density, distance to a central business district, poverty rates, income per capita, and demographic differences. ” In addition, the study cites a national trend of central cities and inner suburbs growing more slowly than outlying areas. “This phenomenon is occurring in metropolitan areas with and without classification and in metropolitan areas with local government configurations and fiscal systems that differ greatly from those in the Chicago metropolitan area,” the authors note. Because of these other factors and trends, the Illinois study downplays the adverse role of property tax classification.

Massachusetts

Massachusetts law establishes four real property classifications:

• Class I – residential

• Class II – open space

• Class III – commercial

• Class IV – industrial

The law requires all property to be taxed at 100% of fair market value but allows communities to chose to tax property in the classes at different rates, with a maximum business rate cap of either 175% of the residential share or the highest share of the total levy businesses have paid since tax classification began, whichever is less.

According to a Tax Classification Overview, published by the West Springfield Chamber of Commerce (June 6, 2001), the tax classification system has led to a pronounced shift of the property tax burden to business. Table 2 shows the FY 1999-00 effective business and residential tax for each $ 1,000 of value for Boston and other communities in the state, according to the chamber.

Table 2: Effective FY 1999-00 Tax Rates in Massachusetts

(Tax per $ 1,000 Value)

	Business	Residential	All
All communities	$ 24. 34	$ 13. 00	$ 16. 19
Classified communities
• Boston	38. 21	11. 71	21. 68
• Other classified	25. 95	14. 03	16. 82
Not Classified	14. 81	14. 27	14. 34

The Massachusetts Taxpayers Foundation reported in 1998 that 102 communities used the classification system to shift an estimated $ 600 million of property taxes from residential to business taxpayers in FY 1998. The foundation also cited a “troubling trend” in the 200% growth of the disparity between the residential and business property tax burden between 1984 and 1998 (Unequal Burdens: Property Tax Classification in Massachusetts, November, 1998). The organization’s president remarked that the higher business tax burden “adds to the already high costs of doing business in the Commonwealth, placing many companies at a further competitive disadvantage. ”

Even with the shift to business, residential property taxes continue to rise, according to the Massachusetts Municipal Association (press release, December 2, 2003). As a result, a 2003 act requires a special five-member legislative commission to draft legislation to authorize municipalities to temporarily increase the limit on business’ share of a town’s total tax levy to 200% of the residential share, if the additional shift is needed to ensure that the 2004 residential share of total property taxes remains the same as it was in 2003. The commission must file legislation by January 12, 2004