Before the Assembly Committee on Real Property Taxation

April 17, 2007

In my testimony today, I will not attempt to delve into the many issues surrounding the administration of the real property tax in New York. As this committee’s other witnesses will attest, New York’s current patchwork approach is both unfair and inefficient. The reliance on numerous local assessment districts, and the lack of a single assessment standard linked to a regular reassessment cycle, are glaring shortcomings of the system as it now exists.

Requiring reassessment of all property on a three-year cycle, as outlined in the proposed constitutional amendment cited in your hearing notice (A. 1572), is perhaps the most important improvement you can consider. However, the Legislature also needs to maintain sufficient flexibility to approve local variations in property-tax policies. For example, land-value taxation (LVT) may represent a promising approach to encouraging redevelopment of our struggling upstate cities. Any change in constitutional language should be carefully drafted to avoid tying the hands of local officials who may wish to consider such approaches.

Even if you could wave a wand to instantly fix what’s broken about property tax assessment in New York, there would still be broad and intense unhappiness with the level of property tax bills in New York. That’s because the vast majority of New York State property owners, excluding only homeowners in New York City, would still be paying property taxes wildly in excess of national norms.

The solution is not a further escalation of temporary, state-financed property-tax stabilization. Nor should legislators succumb to the illusory appeal of a substitute income tax – which, at very best, would alleviate one problem only at the cost of creating another, far more serious one. As I will argue, the only proven route to lasting, long-term property-tax relief is property-tax limitation.

THE LESSON OF “STAR”

New York’s School Tax Relief program is now the most-extensive, heavily funded program of its type in any state. In 2006-07, STAR cost $3.4 billion — or roughly 10 percent of New York State’s net personal-income tax collections, which provide a dedicated revenue stream in support of the program. Under the state budget for 2007-08, the separate STAR “rebate” approved last year has been expanded to $1.3 billion in the year ahead and will nearly double again in size over the next three years. By 2009-10, the total cost of STAR exemptions and rebates will reach $6 billion.

But public unhappiness over mounting property taxes in New York has persisted and strengthened in the 10 years since STAR was first enacted. STAR has not solved the problem it was meant to address, because it treats the symptom and not the disease. The “relief” STAR provides is temporary, like a large dose of fiscal Novocain. The pain becomes all the greater when the Novocain wears off.

It did not have to be this way. Gov. Pataki’s original 1997 STAR proposal included a provision that would have capped the annual growth in school tax levies at 4 percent or the rate of inflation. Exceptions to the growth cap would have been made for increases in enrollment and for the assessed value created by new construction.

At that point, tax levy limits were hardly a novel concept — even in New York State. Just two years before Gov. Pataki unveiled STAR, Assembly Speaker Silver introduced the “Real Property Tax Limitation Act” (A.6171 of 1995-96), a bill designed to limit all local revenues to the rate of inflation. Exceptions to the cap would have been allowed only in “extraordinary” circumstances, requiring a well-advertised public hearing and vote of the local governing body. The state itself would have been subject to a maintenance-of-effort obligation designed to ensure a steady flow of aid to local governments affected by the limit.

Although the speaker’s bill easily passed the Assembly in 1995*, Gov. Pataki’s proposed cap on tax levies was never seriously considered during the budget process of 1997. Indeed, the original STAR cap provisions never came to an up-and-down vote in either house of the Legislature. They were stripped out of the STAR proposal in budget negotiations before the program was enacted, and the governor’s subsequent, frankly half-hearted, attempts to re-insert the cap in subsequent budgets were ignored.

The rest is history. During the years when STAR was being phased in, from 1998 to 2002, homeowners’ school tax bills did, in fact, temporarily subside. But the underlying growth rate in school property tax levies accelerated – an effect most fully reflected on the tax bills paid by owners of commercial, industrial property and multi-family residences. This trend is illustrated in the chart I have included with my testimony. “The STAR Bump,” as I call it, has also been noted by the state comptroller’s office and has been documented in at least two different academic studies.

The STAR experience confirms the wisdom of a long-standing axiom in public finance: when you subsidize something, you get more of it. With no tax levy limit in place, spending billions of state tax dollars to dull the pain of high local property taxes simply resulted in higher spending – and ultimately, even higher school property taxes. STAR provided temporary tax stabilization, not permanent tax relief. It was not a tax cut but a “tax shift,” as then-Comptroller Hevesi’s office pointed out in a report last year.

By decoupling the added tax “relief” from the tax bill, the new, enhanced “Middle-Class STAR” rebate is likely to produce a smaller bump-up effect. However, it will also weaken the perception among homeowners that you are actually “cutting” their property taxes — as opposed to cutting them checks.

IF STAR ISN’T THE ANSWER, WHAT IS?

STAR had no sooner been fully implemented in 2001-02 than a new real estate boom prompted complaints that rising assessments were pushing school taxes to unaffordable levels, especially for senior citizens. This gave rise in some quarters to proposals for supplementing or supplanting the school property tax with an income tax. These proposals usually are aimed at replacing solely the homeowners’ portion of the tax.

However, the income tax rate necessary to finance elimination of the school property tax on a county-by-county basis would have to be quite high, even in upper income areas of downstate New York. For example, based on 2002 data, I have calculated that in Nassau County, the shift would require an across-the-board income tax surcharge of 76 percent on all income tax filers. The resulting marginal rate of 12 percent would be the highest in the country — a full 1.5 percentage points higher than the combined rate in New York City. In Suffolk County, the current state income tax rate would have to be doubled — to 13.7 percent — in order to replace the homeowners’ school property tax.

Westchester, with its larger concentration of wealthy taxpayers, would require a lower surcharge to replace the income tax with a property tax. But less wealthy, less developed counties upstate would need to more than double the current state income tax rate. Such a proposal would also mean a substantial redistribution of the tax burden within the borders of a given county — assuming, of course, that the wealthiest taxpayers do not shift their primary residences to other states or counties in order to avoid the tax.

If the add-on income tax was imposed on a statewide basis, excluding only New York City, it appears a top rate of roughly 10 to 11 percent would be necessary, depending on whether the tax also applied to out-of-state workers employed largely in New York City.

How would the impact be distributed among homeowners? It’s difficult to generalize in a state as diverse as New York. But it seems safe to say the greatest net savings would accrue to people who earn less than the median income but live in expensive houses. Conversely, the shift would result in a very large net tax increase for the wealthiest one or two percent of taxpayers – on top of the disproportionately large share of income taxes already paid by these households.

Elimination of the school property tax might not necessarily result in more affordable housing. In most neighborhoods, prices are likely to rise to reflect the lower tax burden. And under the kind of more equitable and accurate property tax system envisioned by the proposed constitutional amendment, assessments would have to adjust relatively quickly to reflect these changes.

The most important question is this: how would the state’s economy be affected by a law that eliminated school taxes for one class of property owners while significantly increasing the income tax for all households — including the many business owners also covered by the tax? Assuming New York City is excluded from any such change, raising the income tax back to double-digit levels in the rest of the Empire State would dramatically reduce the incentive to work, save and invest in New York compared to other states with lower marginal rates. The negative consequences of a higher income tax rate are likely to easily outweigh any benefits realized from lowering or even eliminating the property tax for homeowners.

Proposals to shift a large part of the school tax base to the income tax also ignore the substantial volatility of the income tax base. Between fiscal years 2001 and 2003, New York State’s income tax collections dropped by 14 percent, with virtually all of the decrease concentrated among high-income taxpayers. The property tax, by contrast, is a far more stable and reliable revenue source.

TREATING THE ILLNESS

The real root cause of the problem — the source of high property taxes — is the high cost of local government and school districts in New York, which is the primary element in the “perfect storm of unaffordability” described by Gov. Spitzer. Calming that storm requires a concerted effort to attack the factors that drive costs, such as state mandates. But at the end of the day, experience indicates that significantly higher state aid will not produce lower property taxes — unless local governments and school districts feel some real pressure to restrain their overall costs.

For your consideration today, the example I’d like to point to is Massachusetts. Throughout the 1970s, the Bay State perennially rivaled New York in rankings of combined state and local tax burdens relative to income. As late as 1980, New York and Massachusetts were Numbers 1 and 2 on this list, respectively.

New York has continued to rank in the top three throughout the past 25 years. But as of the latest Tax Foundation rankings, Massachusetts had tumbled to 28th place, well-below average. In fact, it’s been more than 25years since Massachusetts was even in the top 10. No one calls its “Tax-a-chusetts” anymore.

What happened in the meantime? The answer: Proposition 2 ½. Passed by the voters of Massachusetts in 1980, Prop. 2 ½ limits annual increase in any municipality’s tax levies to 2 ½ percent, and also limits total property taxes to 2 ½ percent of market value.

Opponents predicted it would starve local governments, especially schools. But there is no evidence of this. In fact, per-pupil expenditures by Massachusetts public schools increased faster than the national average and faster than per-pupil expenditures in New York during the first 23 years after Prop. 2 ½ was enacted. To a degree that surprised both sides in the original Prop 2 ½ debate, voters in many municipalities took advantage of the loophole allowing overrides of the limit for specific spending purposes. And over time, the Commonwealth assumed a much larger share of local school expenditures. But the Massachusetts income tax rate did not go up. In fact, at 5.3 percent, it is now lower than it was for most of the 1980s and early 90s.

New York should revisit the kind of tax cap proposed by Gov. Pataki as part of the STAR program — limiting annual tax levy hikes to 4 percent or inflation — allowing overrides and making exceptions for growth in enrollment and the size of the property-tax base. If there has ever been a time to cap school tax levies, it is now – when you have just approved two record increases in school aid, and when the governor is committed to more large increases over the next three years as well.

Again, let me point out that the idea of limiting taxes is not an alien or ideologically extreme concept.

It was embraced not long ago by many members still serving in the New York State Assembly. And it appears we may soon be almost surrounded by states that have seen the wisdom of the Prop 2 ½ approach. Gov. Jon Corzine, a Democrat, recently signed into law a 4 percent annual cap on school tax levies in New Jersey. Gov. Rell, a Republican, has now proposed a 3 percent annual cap on tax levies in Connecticut.

During the few times when the possibility of a cap has been publicly raised in New York, the main objection has been that it is somehow undemocratic in that it would supposedly rob local governments or school districts of discretion in raising revenue. But the Massachusetts experience indicates this is a red herring. Given a chance to override limits, voters frequently do just that. Yet over time, the overall tax burden in that once heavily taxed state has fallen dramatically, compared to national and New York trends.

At a moment when the winds of change are blowing through the Capitol, when previously closed minds are at least temporarily open to new approaches, the clear consensus in favor of real property-tax reform presents an opportunity the Legislature shouldn’t miss.

Thank you.