How Does a Certified (Property) Tax Rate Work?
Author's Note: This article is a work in progress, which I hope to improve over time. Suggestions, questions, comments, and references are most welcome. Simply use the link on LocalCommentary.com's home page to "Contact Us," or one of the links at David's Blog to "Contact the Author."
Utah's Truth-in-Taxation laws are intended to insure that legislative bodies such as city councils can impose tax increases only in the open, through a public process including notices, hearings, and public votes. Moreover, there are so many ways to build tax increases into tax formulas without additional legislative action that the Utah Legislature has imposed some limitations to prevent such "stealth" tax increases, too. These intentions, mixed probably with a general hostility toward taxes that is particularly strong in the Western United States (except the Pacific Coast), have given birth to a concept that can be difficult to explain or understand: the certified tax rate (CTR), which is used in calculating property taxes.
Life in Utopia: An Example
Here is a somewhat simplified explanation of how the CTR works. The numbers here are not entirely realistic; they are chosen for ease of explanation, and my sample city, Utopia, doesn't exist at all -- which is part of the meaning of the word utopia. (My fictional city has no relation to the local entity, UTOPIA, which is an acronym.)
Let us suppose that the assessed value of all the taxable residential properties in Utopia in 2005 is an even billion dollars ($1,000,000,000). Last year's certified tax rate (CTR) was 0.1%, or 0.00100. (This is also know as "one mil" -- as in, one thousandth.) This means that Utopia's property tax revenues last year were one million dollars ($1,000,000), or one-tenth of one percent of the total value.
Let's pause for a moment to note four of the complexities we are avoiding:
None of these complexities changes the basic principles we are examining.
Let us suppose that in 2006 the value of the same properties that were taxed in 2005 has risen 10 percent, from an even billion dollars to $1.1 billion. There is also new development valued at $50,000,000.
When the county calculates the CTR for the next fiscal year, the new development doesn't count. The county will look at the number of dollars of revenue Utopia received last year and say (to themselves), "What rate on the new value of the properties taxed last year will yield $1 million in revenue this year? The arithmetic for this is simple: divide $1,000,000 (the revenue) by $1,100,000,000 (this year's total valuation of the set of properties taxed last year), and the result is 0.0909 percent, or 0.000909, which we'll round to 0.00091, or 0.091 percent.
So Utopia's property tax revenue without the growth would have been the same $1 million, but with the growth it will be the rate times the total valuation including growth, $1,150,000,000. The result of this multiplication is $1,046,500. Because of growth revenue increases -- though often not enough to offset the additional costs to the city of that growth.
To calculate the next year's CTR, the process repeats with last year's numbers. Let us suppose that now the total valuation of the properties that were taxed in 2006 is $1,250,000,000, and there has been another $50,000,000 of new development. What rate against $1.25 billion will yield the same dollar figure as last year's revenue, $1,046,500? Again we divide the total valuation, excluding new growth, into last year's revenue. This time we get a CTR (slightly rounded) of 0.000837, or 0.0837 percent, which will round to 0.00084.
Multiply the new CTR by the total valuation, including growth, and Utopia's 2007 property tax revenue will be $1,092,000.
Again, note that the only reason Utopia gets more dollars of property tax revenue is growth. The overall increase in the value of existing properties does not increase city revenues. This is because the CTR automatically decreases to match increases in property values. Note also that this is what happens if Utopia's City Council does not pass a tax rate increase (we'll look at that case a little later).
Two Important Complexities
At this point, there are two important complexities we cannot just mention and forget. One affects individual property owners, and the other affects Utopia's revenues.
If all the properties in Utopia increased in value from year to year by exactly the same percentage, then each property's owner would pay the same number of dollars in property tax each year in our scenario. But the odds of that are practically zero. Instead, some properties will appreciate (gain value) and some will depreciate (lose value). If mine appreciates, I will pay more tax. If it depreciates, I will pay less. So without there ever being a tax increase or decrease passed by the Utopia City Council, some people will get a tax cut, and some will see a tax increase. The latter may not think this is fair, since they have to pay more in taxes without actually having more money to pay it with, but the fact of the matter is that, if the value of their property increases, they actually do have more wealth, even if it is not liquid (easily spent).
It is the other complexity which slowly strangles Utopia and other municipalities and taxing entities: All of this works by law as if inflation did not exist. But inflation does exist; in recent decades it has been a few percent each year, as measured most commonly by the Consumer Price Index. If we assume that the cost of things Utopia buys, including labor, increases at exactly the inflation rate (not likely, but a reasonable approximation), then a four percent inflation rate means that this year Utopia would need four percent more dollars to do exactly what it did last year. (Again, growth is no salvation, because the new growth imposes new costs on the city.) Do the math (1.00 divided by 1.04), and you will see that in real (inflation-adjusted) dollars that is equivalent to a 3.85 percent decrease in revenue.
In other words, unless inflation is zero, which virtually never happens, in real dollars (the inflation-adjusted ones that matter) Utopia will experience an annual tax cut unless its city council passes a tax increase. Someone somewhere probably thinks this is a wonderful idea, but the tendency in cities is to avoid tax increases, because they are unpopular, until the situation becomes dire. Four percent does not sound like a lot, but in a $1 million budget it is most of the average worker's salary, if not more -- and that's in one year. In five years it compounds to a 17.8 percent cut. In ten years it compounds to a 32.4 percent cut. In twenty years it compounds to a 54.3 percent cut.
All of this would be sane and reasonable if one change were made in the calculation: Adjust the previous year's revenue for inflation before calculating the CTR. In other words, use real dollars for the revenue figure. If 2005's $1,046,500 would be worth four percent more dollars now, when adjusted for inflation, then adjust for inflation and calculate the CTR based on $1,088,360 instead, because that many dollars in 2006 are worth what the smaller amount was worth a year earlier.
A Bad Analogy (A Candidate for State Legislature Should Know Better)
A candidate for the state legislature recently insisted to me that indexing the CTR to the inflation rate would allow the government to impose tax increases without passing legislation to increase taxes. This is not true in any meaningful sense. He cited the example of federal income tax rates, which are not applicable to this discussion at all. In fact, what he said about inflation is true of a graduated tax scheme ("progressive," some like to call it) like the federal income tax. In such a scheme, a taxpayer pays a higher percentage of tax on dollar amounts above certain thresholds.
Here is a simplified example: Suppose that I make $50,000 per year of taxable income. Up to $50,000, I would pay ten percent as income tax, or $5000. But next year I get a cost of living increase (COLA) in my salary equivalent to the rate of inflation, which we'll say is 20 percent, because President Jimmy Carter has come back for a second term. If the government moves the threshold up 20 percent, to $60,000, then the $6000 I pay in income tax the next year has the same value as the $5000 I paid before -- in real, inflation-adjusted dollars. Then we're okay, at least in theory.
But if the feds don't move the threshold to compensate for inflation, and the rate for income above $50,000 is 30 percent, then I'll be in a higher tax bracket, paying $5000 (on the first 50K) plus $3000 (on the last 10K), a total of $8,000 next year. In real dollars, that is a 33% tax increase in one year, and the buying power of my salary didn't change at all. Through all of this, Congress hasn't had to pass a single bill increasing my taxes.
Historically, this is a powerful incentive to national governments to induce high inflation rates. One of President Reagan's most important tax reforms was to index those brackets to inflation, removing this incentive.
This is true of taxes with graduated brackets. Property tax in Utah is not such a tax, so the good candidate's argument is misguided and irrelevant.
Utopia's Tax Increase
Remember that certified tax rate (CTR) the county handed down for next year's property taxes? It might be lower or higher than the previous year's CTR, but that doesn't matter. If Utopia sticks to the CTR for the year, it's not a tax increase or decrease (though we have seen that in real dollars it is, in fact, a decrease). If they raise that rate at all, even if it is still lower than last year's, it must be passed by the city council as a tax increase. If they lower the rate at all -- I'd like to see that happen just once -- it's a tax decrease, even if the lowered rate is higher than last year's CTR.
For example, suppose that 2005's CTR was 0.00100 and 2006's was 0.00091, as in the example above. The county sends down a CTR for 2007 of 0.00084. But the city council wants or needs (who can tell which?) to increase that rate to 0.00089. This is a tax increase, even though 2007's new rate will still be lower than 2006's. The proposed increase will have to be noticed (announced in a public way), at least one public hearing will have to be held, and then the council will have to approve the increased rate, or the rate the county sent will apply instead.
Note that these increases are sticky, in the sense that the revenue obtained in 2007 at the increased rate is the figure that will be used to calculate the CTR for 2008.
An Attempted Summary
At this point, you're most likely scratching your head and thinking, "This is the simplified explanation?!?" -- if you're not actually catatonic by now.
In short, where the CTR is concerned, it doesn't matter what last year's rate was. Only the actual revenue it produced matters. The county calculated the rate for this year to produce the same revenue from the same properties as last year (not adjusted for inflation, and growth is outside the calculation). If the city increases that rate, that's a tax increase. If it doesn't, it's not.
In practice, the other essential point is this: The effect of Utah's non-inflation-adjusted CTR calculations is that a municipality automatically experiences an annual revenue decrease in real dollars at a rate which corresponds to the inflation rate. This compounds brutally, if the city leaders are not wise, courageous, and vigilant.
August 9, 2006
Revised September 2007
Copyright 2006 by David Rodeback.