Budget Basics: Property Tax — Can It Realistically Be Reduced?
A series that details the fundamentals of New Jersey's budget, as well as its current budget woes
This is the sixth in a 10-part series outlining New Jersey’s fiscal fundamentals. The goal is to demystify some of the state’s financial challenges, and put them in context of the broader issues New Jersey faces. This series is also intended as a way to underscore the importance of state government in a year that will see a new governor and a new Legislature chosen by voters. Follow this link to see the.
Most people believe the property tax is the most onerous tax in New Jersey. The total property tax in 2016 was $28.4 billion — greater than the income, sales, and corporate taxes combined. Property taxes are collected and used at the local levels of government: It is not spent by the state government. It cannot be readily reduced and is very difficult to control.
A summary of where property taxes are expended is as follows:
Allocation of Property Taxes (billions of dollars) Schools $14.858 Municipalities $8.389 Counties $5.117 Total $28.364
Taxpayers receive a tax bill yearly from their municipality. The first reaction: Why is the bill so high? To answer properly one needs to understand all factors related to the computation and how and why it might change each year. Six factors determine the bill:
Market value of the property one owns
Annual budgets for municipal, county, and K-12 schools
Availability of other revenues
Value of the taxable property in the municipality
Tax-exempt property in the municipality
The value of property can increase due to structural additions to the home, but the principal way to determine the value of property is accomplished in one of three ways: (1) house value is based on “comparable sales” transacted during the past year; (2) commercial or industrial property is usually determined by “replacement value”; or (3) “income generated” — but also on a sales transaction — if one recently took place.
The challenge is to keep the assessment value current. If assessments are current the assessment ratio is 100 percent of true value. But for several reasons, the assessed value may be less than true value — in which case the ratio might be at 80 percent or lower (as we’ll see later).
How to Compute Your Tax Bill
Let’s look at a typical situation for an individual who lives in one of New Jersey’s 565 municipalities — and examine how a property tax bill is computed:
First: Let’s say the assessor determines the value of your home is $400,000.
Second: Governing bodies for the municipality, the county, and the school district approve budgets for the upcoming year.
Third: Let’s say that each local unit of the municipality (let’s keep it simple) receives $2.0 million in revenue from other sources. For example, every school district receives state aid based on formula. The total budget of each governmental unit less other revenues is the amount that must come from the property tax.
Fourth: Let’s say the assessor determines the value of all property in the municipality is $4 billion. This includes homes, apartment complexes, industrial property, commercial property, and so on.
Fifth: Tax-exempt property is determined —for example, churches, nonprofit organizations, and the like.
+Sixth: Tax rate is determined. In New Jersey, the tax rate must be a single rate for every property in that municipality — whether a home or a major pharmaceutical company.
We are now ready to do the computation. For example:
Entity Budget Other Revenues Property Tax Needed Municipality $12,500,000 ($2,000,000) $10,500,000 County $15,000,000 ($2,000,000) $13,000,000 School District $60,500,000 ($2,000,000) $58,500,000 TOTAL NEEDED FROM PROPERTY TAX $82,000,000
The tax rate for the municipality is: total money needed divided by assessed value
$82,000,000 divided by $4,000,000,000 = 0.0205
This rate is often expressed as $2.05 cents
The rate is applied to the home’s assessed value of $400,000; the tax bill for the year is $8,200
Thus, there are five moving parts: 1)total assessed value in the community; 2) assessed value of your home; 3) size of each budget; 4) other revenues available, 5) the tax rate. A change in any of these components will result in a tax bill change. A change in more than one component might offset another in terms of the effect on the taxpayer.
Equalization Process and Coefficient of Deviation
There are two terms one should know: “equalization” and “coefficient of deviation.” Both are complicated, but essential to understanding property taxes. The first process allows comparisons among municipalities; the second process identifies fairness within a municipality. The process of equalization ensures that each municipality in the county pays its fair share of county taxes, and most important, each school district receives its fair share of state aid. Let’s consider the issue of school-aid allocations to each school district.
A major component of the school formula is property value: the lower the property value the more state aid. Let’s say there are two municipalities, one whose ratio of true value to assessed value is 70 percent. Another municipality in the same county is assessed at a ratio of 98 percent of true value. If money was distributed based on assessed value, the school district in that municipality with the lower value would receive more. But that would not be fair.
To correct this situation the County Board of Taxation reviews the records of all property that has been sold and compares it in the aggregate to the assessed value of each town in the county and brings all property up to true value — this in effect “equalizes” the aggregate value in each municipality. This is basically an artificial number and is used only for the purpose of distributing state aid. The underlying assessed value is not changed; hopefully, the assessor would take future action to be at 100 percent. Now school aid is distributed on an equal basis.
A coefficient of deviation is also critical, and is done so everyone in the same municipality is paying one’s fair share of taxes vis-a-vis other taxpayers. Complicated – yes! But suffice it to say if the variation in the assessed value among homes is in excess of 10 percent of a “mean value calculation,” one would be pretty sure that there is an unfair assessment among the properties — and people with basically the same property are paying more or less than their fair share. A computation greater than 10 percent might lead the state to direct the municipality to initiate a reevaluation of all property in the community to make tax allocation fair.
In summary equalization ensures that each municipality in the aggregate is paying its fair share of taxes to the county and the school district is receiving its fair share of state aid. A computation of coefficient of deviation is a check to make sure everyone in the municipality is paying their fair share of taxes compared with other taxpayers in the municipality.
New Jersey has the highest property taxes in the nation. Our average is $8,500; the national average is $3,296. Fifty-two percent of all property taxes are used to support K-12 education. Some argue it is the reason people are leaving the state; however, there is little evidence that homes are sitting unsold and vacant — so somebody must be replacing these movers. Others argue it is not a fair tax as it has no direct relationship to income. In short, it is regressive.
Some argue that property taxes should be reduced and the gap filled by increasing the income tax, particularly on the wealthy. Others simply say we spend too much on K-12 education as it is 100 percent more than the average in the country — for whatever reason.
Let me observe good things about the property tax. Unlike the income tax, which is highly volatile and decreases when the economy sinks (aka fiscal 2008), the property tax is dependable and relatively stable. There has been no recent dramatic fluctuation in the property tax. Last year the property tax increased 2.5 perent — and over the past five years has averaged 2.1 percent. The tax reaches nonresidents (think shore communities); it is very difficult to evade; and one might argue it promotes local autonomy. Finally, from a tax administration viewpoint, most people pay their property taxes. The collection rate in NJ last year was 95 percent.
The relatively modest percentage increase in property taxes during the past five years (2.1 percent) is principally a function of two laws that were enacted in 2010: a 2 percent cap on property tax increases and and a 2 percent limit on arbitration awards applicable to police and fire personnel. The law on arbitration expires on January 1, 2018 unless extended by the Legislature. The cap on property-tax growth is permanent. Both laws are needed to limit increases. Before these laws the average property-tax increase was 6.8 percent — almost three times the current increases.
The property tax is a problem. Many people look to state government for solutions: more state aid, a circuit-breaker concept, more homestead rebates, an expanded property tax “freeze” for seniors, different and higher tax rates for commercial and industrial property, and so forth. But, I observe that these actions require increased taxes at the state level or other unpleasant actions, and as I have noted in a previous article the state budget is already stressed.
The obvious and logical way to reduce property taxes is to reduce costs. Seventy-three percent of all statewide spending occurs at the local level.
Cost reductions might involve a combination of the following very difficult decisions: reduce the number of jurisdictions (do we need 21 county governments?); how about the number of school districts and municipalities (almost 1,200 of them — also another 215 local authorities and 185 fire districts); reduce employee benefits; constrain personnel costs at all levels of government (the average teacher’s salary is the fourth highest in the country and our public safety people make 50 percent more than officers elsewhere in the country); eliminate or limit retirement payments for unused sick and vacation time; increase class sizes in local school and reduce administrative overhead. I could go on, but you get what would need to be done. Superimposed on top of this recitation is the simple but real fact that New Jersey is a high-cost-of-living state.
These observations and facts generate another whole range of questions and consequences. Like many situations in public finance an action regarding reductions in the property tax — by, for example, any of the above actions — generates other reactions that may not be favorable or acceptable. Realistically, I see no significant relief in property taxes.