by Robert J. Kleine, Vice President and Senior Economist
|This report, the seventh in a series on school finance reform, discusses the effects of the ballot and statutory proposals on local property taxes.|
There are four key reasons for changing Michigan’s school finance system. First, the distribution of resources among school districts is unequal. Second, schools are too dependent on the property tax, with nearly two-thirds of their revenue generated by the tax, one of the highest local shares in the nation. Third, Michigan property taxes are among the highest in the nation. Fourth, the property tax generates more dissatisfaction and controversy than any other tax; public opinion surveys find it to be the least popular of all state and local taxes. This is largely because of the size and visibility of the tax and the perception by many people that it is unfair.
For these reasons the legislature and the governor elected to eliminate school property taxes last August (Public Act 145). Some of the school property tax has been restored, but dependence on the tax to finance schools has been reduced sharply.
In Michigan, property taxes are levied by local units of government (including school districts) and generate more revenue than any other tax at any level of government. In FY 1990–91 (the latest year for which full data are available for all states) property taxes generated $8 billion for local governments across Michigan, about 63.1 percent of their own-source revenue (excludes funds received from other levels of government) and 28.4 percent of combined state and local own-source revenue. (Nationwide, the respective figures are 47.6 percent and 21.6 percent.) Local governments in Michigan rely more on property taxes than do those in any other Great Lakes state.
All Michigan property not specifically exempt is assessed at its state equalized valuation (SEV), one-half its true market value. This value then is multiplied by the local millage rate to determine the property tax due. One mill represents one dollar due on $1,000 of SEV. To illustrate, if a house has a market value of $100,000, its SEV is $50,000. If the rate is 50 mills, the total property tax due is $2,500.
The SEV of property more than tripled (335 percent) between 1970 and 1993. The other side of the equation, the average state millage rate, rose 10.8 percent from 1970 to 1977, then declined each year through 1983. The decline was due mainly to large assessment increases and the millage rollbacks required by the 1978 tax limitation amendment. From 1983 to 1989 there were small increases in the millage rate, with a total increase of 4.7 mills. In 1990 the millage rate averaged 57.17 mills, down from 57.4 mills in 1989. The rate increased moderately to 58.09 mills in 1992. (See Exhibit 1.)
The largest share of total property tax revenues, 71.7 percent, goes to school districts. The second largest share, 13.8 percent, goes to cities. Exhibit 2 illustrates the distribution of property tax revenue in Michigan and the average millage rates levied. The distribution of school operating mills is shown in Exhibit 3. The average is about 34 mills, and nearly three-quarters of all districts levy more than 30 mills.
Description of Reform Proposals
A number of the provisions in both school finance plans affect property taxes. Most important are the provisions that reduce school operating property taxes on homesteads from an average of about 34 mills to 12 mills under the statutory proposal and 6 mills under the ballot proposal and on nonhomestead property to 24 mills under both plans.
Because of the provision that allows districts with resources of more than $6,500 per pupil to levy “hold harmless” mills, some districts will levy a higher number of mills. Under the statutory proposal 35 districts will need to levy additional mills to maintain the current level of resources (plus an additional $160 per pupil guarantee), under the ballot proposal 38 will have to do so. More than half (19) of these districts are in Oakland and Wayne counties.
Under the ballot proposal, two districts will need to levy a higher millage rate than they now do to maintain current resources. These are Jefferson in Monroe County, which currently levies 21.75 mills and will need 28.81 mills, and Lamphere in Oakland County, which currently levies 28 mills and will need 28.85 mills.
To maintain their 1993–94 level of spending 33 districts will need to levy more than 24 mills on nonhomestead property under the statutory proposal, and 5 will have to do so under the ballot proposal. There are so few under the ballot plan because it includes a provision that “hold harmless” mills can only be levied on homestead property until the number of mills reaches 18; mills over 18 would be levied uniformly on all property.
There are 43 districts under the statutory proposal and 36 under the ballot proposal in which millages on nonhomesteads will be higher than they are currently, mostly in the rural areas of the state. The exceptions are the Jefferson, Birmingham, South-field, Bloomfield Hills, Lamphere, and Gross Pointe school districts.
The “hold harmless” mills can be levied without voter approval if the districts currently have authorization to levy the required number of mills. In those districts discussed above, where millage rates will have to be higher than currently, voter approval will be required (except in cases where authorized mills equal the number of mills needed). When voter authorization for school millage expires, the districts will have to go back to the voters for approval of these mills (those in excess of county-allocated school mills in 1993–94).
School districts should have an easier time winning voter approval of local mills under the ballot proposal because of the difference in the allocation of state and local mills under the two proposals. Under the statutory plan there is a state property tax of 12 mills on nonhomestead property and a local property tax of 12 mills on all property. Under the ballot plan there is a state property tax of 6 mills on all property and a local property tax of 18 mills on nonhomesteads.
As a result, under the ballot plan voters will be voting to levy mills on nonhomesteads only, while under the statutory plan the vote will be to levy mills on all property. Therefore, under the ballot plan most voters will be voting to levy taxes on businesses, not their own homes. However, under the statutory proposal the school board could establish the district as a charter authority, eliminating the need to keep going back to voters when millage authorization expires.
Property Transfer Tax/Assessment Limit
Both plans also give school districts the right to levy “enrichment” mills with voter approval. Under the ballot proposal school districts could levy up to 3 mills from 1994 to 1996. Beginning in 1997 these mills must be levied by the Intermediate School District (ISD). Under the statutory plan, ISDs would be allowed, with voter approval, to levy from 2 to 7.75 mills, depending on the property wealth of the ISD. In addition, school districts could ask voters for additional millage, not to exceed the maximum rate for the ISD less any mill levied by the ISD. If more than one district in the ISD levied additional mills, the districts would have to share the revenue.
Both plans originally included a property transfer tax, 2 percent under the ballot plan and one percent under the statutory plan. The legislature recently approved legislation to reduce the rate under both plans to 0.75 percent. (See discussion below.)
A key provision in the ballot plan is a limit on assessment increases on each parcel of property to 5 percent or the rate of inflation, whichever is lower.1 The provision should be popular with property owners but unpopular with local governments. This is one reason why the Michigan Municipal League is opposing the ballot proposal.
TIFAs and Tax Abatements
The two proposals also differ in their treatment of Tax Increment Finance Authorities (TIFAs) and property tax abatements.2 Under the ballot plan there is no guarantee to replace lost TIFA revenues and no future capture of school taxes is allowed. The statutory plan provides more generous treatment, guaranteeing replacement of lost revenues and allowing future capture of the 12-mill state education tax levied on nonhomestead property, local school property taxes (a minimum of 12 mills for most districts), ISD property taxes, and specific taxes paid in lieu of these taxes.
Although the ballot plan does not guarantee reimbursement, the school aid bill includes $40 million for this purpose in FY 1993–94 under either plan, and in FY 1994–95 the school aid bill includes $22 million for reimbursement under the ballot plan and $12 million under the statutory plan.
Property tax abatements would be largely eliminated under the statutory plan. Under both plans the calculation of an existing abatement would be the same. Businesses with existing tax abatements would pay the new 1994 state and local school taxes or 50 percent of the 1993 school taxes, whichever is less.
Under the statutory plan local units would not be able to grant future tax abatements on state or local school taxes, and other taxing units could choose not to have their taxes abated. For example, if a city voted to grant an abatement, the county and the community college could opt out. Under the ballot plan school millages could be abated as under current law and all or half of the 6-mill state tax on all property could be abated by the state treasurer.
Homestead Vs. Nonhomestead Property
An important feature in both proposals is the distinction between homestead and nonhomestead property, because of the difference in millage rates discussed above. A homestead is defined in both plans as a dwelling or unit in a multiple-unit dwelling subject to ad valorem taxes that is owned and occupied as a principal residence by the owner of the dwelling or unit.
Agricultural property is treated differently from other property. Under the statutory proposal all property adjacent and contiguous to the home of the owner is considered part of the homestead if the gross receipts from agriculture exceed the household income of the owner. If this is not the case, the homestead includes the home and only 5 acres adjacent and contiguous to the home of the owner. Under the ballot plan, if the home is located on or adjacent to the farm, all agricultural land owned by the homeowner is included. All homeowners will be required to file a form with their local government for their home to be classified as a homestead.
School Millage Rate Reductions by County
Exhibit 4 provides data on current school operating millage rates by county and the average reduction in millage rates for homesteads and nonhomesteads under the two plans. The unweighted average millage reduction for homesteads is 18.7 mills under the statutory plan and 24.3 mills under the ballot plan. For nonhomesteads the average millage reduction is 6.6 mills under the statutory plan and 6.9 mills under the ballot plan.
Property Tax Burden
Michigan’s high property taxes relative to other states is one of the factors behind the reduction in school property taxes. In FY 1990–91, property taxes in Michigan were 4.9 percent of personal income, 35.9 percent above the national average, and ninth highest among all states. Property taxes in Michigan are the highest in the Great Lakes region and 57.9 percent higher than in Ohio, which has the lowest property taxes in the region. Keep in mind, however, that these numbers do not reflect the Michigan homestead credit program, the most generous in the nation. The homestead credit program annually rebates more than $900 million to homeowners and renters, which amounts to 15–16 percent of total residential and agricultural property taxes levied in the state.
No data are available comparing states on their actual tax burden (levy minus rebate), but if there were, Michigan’s rank would likely improve, although the state would still rank among the 20 highest. It should also be noted that in the past few years the property tax burden in Michigan has fallen relative to that in other states, although there was a small increase in FY 1990–91. In FY 1985–86, property taxes in Michigan (as a percentage of income) were 42.5 percent above the national average (see Exhibit 5).
Both the ballot and the statutory plan reduce the property tax burden to a more reasonable level. Michigan property taxes will be about 33 percent lower under the ballot plan and 28 percent lower under the statutory plan (see Exhibit 6).3
If these reductions had been in effect in FY 1990–91 Michigan property taxes would have declined from 4.9 percent of personal income to 3.3 percent under the ballot plan and 3.5 percent under the statutory plan. Michigan property taxes would have been about 9 percent below the national average under the ballot plan and about 2 percent below the national average under the statutory plan. As mentioned above, Michigan’s property taxes were about 36 percent above the national average in FY 1990–91. Michigan’s rank would have dropped from 9th among the 50 states to 27th under the ballot plan and 24th under the statutory plan.
Michigan property taxes were 42.4 percent of total taxes in FY 1990–91, ranking the state 6th among the 50 states. (The next highest ranking state in the Great Lakes region is Illinois, which ranks 14th and raises 36.8 percent of total taxes from the property tax.) Under the ballot plan this share would fall to about 28 percent, ranking Michigan around 30th. Under the statutory plan the share would fall to about 31 percent, ranking Michigan 25th.4
Business pays about 34 percent of local property taxes and therefore received 34 percent of the gross reduction in these taxes under Public Act 145. Because of the loss of state tax credits by homeowners, however, business received about 41 percent of the net tax cut.
Under the ballot plan business pays 53 percent of the restored property taxes, while under the statutory plan business pays only 44 percent. The net property tax cut for business is about 20 percent under both proposals. This compares with a 42-percent reduction for homeowners before and 32 percent after loss of state tax credits under the ballot plan and a 33-percent reduction before and 25 percent after loss of credits under the statutory plan.
Property Transfer Tax
One of the most controversial revenue sources under both reform plans is the property transfer tax, which was originally set at 2 percent (effective January 1, 1995) under the ballot plan and one percent under the statutory plan. The legislature voted to reduce the rate to 0.75 percent under both plans but did not give the bill immediate effect. This means that the rate will not be reduced until April 1995, although this issue may be revisited. There are a number of problems with the transfer tax, but they become much less important at the lower rate.
Our view is that the property transfer tax is an unstable, inequitable tax. The tax will hit low-income taxpayers much harder than high-income taxpayers, and this regressiveness will not be offset by tax credits, as has been the case with the property tax. In addition, the transfer tax will impose a larger burden on homeowners whose homes do not increase in value than on homeowners with large capital gains. Although the tax will go up as home value increases, it will only reduce the profits of those whose homes increase in value, while possibly resulting in a loss for those homeowners living in areas where housing values are stagnant.
Another major problem is that this tax is very unstable. For example, a property transfer tax would have declined an estimated 53 percent from 1978 to 1982, and then increased about 143 percent from 1982 to 1986. From 1989 to 1991 the tax would have increased only 6.1 percent, with a decline of about 6.5 percent in 1990. At a higher rate it would make sense to tie the tax to a stabilization fund so that money is put away in good years to be used when revenues decline sharply. This is probably not necessary at a rate of 0.75 percent, however, as the tax accounts for less than 2 percent of total school aid fund revenue.
Neither the ballot or the statutory plan will satisfy everyone. Whether taxpayers are happy with the replacement taxes, however, is not an issue discussed here. Most homeowners concerned about high property taxes should be satisfied, however, particularly if the ballot plan passes.
Both the ballot and the statu-tory plans will provide most homeowners with substantial property tax relief, but the ballot plan provides more property tax relief and also limits future assess-ment increases. Homeowners living in high tax school districts and with high value homes will receive the largest amount of property tax relief. Net tax relief will be highest for those taxpayers not eligible to receive state home-stead tax credits.
There will be a wide disparity in property tax relief depending on a homeowner’s circumstances. For example, a home-owner living in a low-millage district (50 total mills/28 school mills) in a $50,000 home and earning $25,000 will receive net property tax relief of $250 under the ballot plan (20 percent of property taxes paid) and $130 under the statutory plan (10.4 percent of property taxes paid).
A homeowner living in a high-millage district (70 total mills/43 school mills) in a $300,000 house and earning $200,000 will receive net tax relief (before federal deductibility) of $5,100 under the ballot plan (48.6 percent of property taxes paid) and $4,200 under the statutory plan (40 percent of property taxes paid). However, the high-income taxpayer will lose 36 percent of the net property tax cut due to federal deductibility. (See School Finance Reform: Effect on Taxpayers, Public Sector Consultants, Inc., January 14, 1994, for other taxpayer examples.)
In addition to lower property taxes for homeowners and most businesses, school districts will no longer be as dependent on local property taxes, with the state picking up almost 80 percent of the cost of K–12 education under the ballot plan and more than 70 percent under the statutory plan. This moves Michigan from 42d in the nation in state support (35.5 percent in FY 1991–92) to 2d under the ballot proposal and 4th under the statutory proposal.
School districts will still be in the millage election business, but except for high spending districts, millage votes will be less frequent and less important than they are now. Some school officials may be nervous, however, about placing such great reliance on the state for funding.
The reduction in property taxes is not likely to have much effect on the state economy, as most of the revenues will be replaced with other taxes. The real estate sector should receive a major benefit, however. Lower property taxes will increase the number of families able to afford homes, which will increase the demand for homes and drive up home prices. This will particularly benefit current homeowners. The rise in home prices, however, will not fully offset the reduction in property taxes. Therefore, home ownership should rise and more homes should be built, providing a significant benefit to the housing industry.
Our view is that property tax relief and school finance reform have been long overdue. Although neither plan is perfect, on balance the schools, most taxpayers, the tax system, and the state should be better off. Most important, after 25 years, the state can move on to other important issues.