Our Monstrous Path to Fiscal Insolvency and Skyrocketing Inequality: The History

In November 2013, the City Club of Portland issued an invaluable history as part of a study that is as fresh and current as the day it was printed. As the Oregon Legislature contemplates massive further digging as the solution to the hole in which we find ourselves (by squandering new billions on more sprawl and roadway spending), it’s worth revisiting the history of Oregon’s uniquely screwed-up property tax system, the underlying source of so many of our troubles.

This is worth a careful read, and the five comparisons of taxes paid under the laws explain why so much of the tax burden in Oregon has fallen on individuals rather than businesses.

Credit to City Club of Portland for this kind of careful citizen advocacy and participation, and for making their work available to all.

Executive Summary

Oregon’s more than 1,200 counties, municipalities, and special districts—including school districts and community colleges—rely upon property taxes to fund the public services their citizens enjoy. Ballot Measures 5, 47, and 50 define the State’s property tax system. The sponsors of these measures, along with the voting majorities who supported them, sought to do good: reduce taxes and increase the predictability of property taxes for owners of property. They succeeded at these goals. However, like the creature in Mary Shelley’s novel, Oregon’s property tax, a Frankentax, is slowly but surely wreaking havoc upon its creators and their communities in ways they might not yet realize

The City Club of Portland chartered your committee to research the evolution of the Oregon property tax system, to understand and explain it, to evaluate its pros and cons, and to recommend improvements. The committee adhered to the principles identified in the City Club’s 2002 comprehensive study, Tax Reform in Oregon. Those principles include fairness, sufficiency, certainty, clarity, efficiency and neutrality.

Your committee interviewed thirty-four witnesses, including tax assessors; current and former elected and appointed representatives from state and local government; lobbyists for services funded by property taxes; proponents of property tax limitations; proponents of changing the property tax system; and policy analysts. The committee surveyed assessors, receiving responses from throughout the State representing 20 of 36 counties. The committee also tracked news reports related to the property tax beginning in January 2013, and reviewed academic literature and policy analyses published by think tanks.

Your committee concludes that Oregon’s property tax system is deeply flawed. The flaws are statewide. Specifically, your committee has reached the following conclusions:

  1. Oregon’s property tax system is inequitable

Owners of properties with similar real market values pay different amounts of property tax. The burden of the tax on property owners falls more heavily on those with lower incomes. Residential property bears more of the tax burden than commercial property. The property tax is associated with gentrification. School districts that impose higher property taxes on themselves lose State distributions of school funding. Finally, jurisdictions with authority to levy property taxes do not bear proportionate shares of the costs of administering the tax.

  1. Oregon’s property tax system undermines local control

The primary responsibility for funding K-12 schools—the primary justification for property taxes—has transferred from local property owners to the State. That is obvious. What is less obvious and more insidious is that some voters have been approving new taxes to support services for which they will receive no bill. A tax newly approved by one jurisdiction might reduce revenues in overlapping jurisdictions. The caps on total tax rates protect property owners from changes in their tax burden; they also induce a confusing, uncoordinated proliferation of tax jurisdictions that cannibalize each other and make accountability more difficult.

  1. Oregon’s property tax system fails to sustain service levels approved by voters

During the past twenty-five years, increases in the cost of local government services, and in the demand for them because of the migration of residents and businesses, have run up against inflexible Constitutional limits on levy increases, on tax rates set in 1990, and on assessed values of property pegged to 1995. Mechanisms that introduce a degree of flexibility, such as local option levies, are administratively costly. Mechanisms designed to promote predictability in tax burdens, such as limits on tax rates, can induce reductions in service levels that voters have approved. While some school districts are better funded than they otherwise would be because of equalization, other government tax jurisdictions are trying to achieve sustainability by increasing revenues or decreasing services. Inevitably, the State will supplement some of the decreased services, albeit funded by income taxes.

  1. Exemptions from the property tax exacerbate inequities and financial unsustainability

Exempting a property from tax, more properly called a “tax expenditure,” means nonexempt properties bear a greater burden of the cost of funding government services. With a real market value of $98.3 billion, almost 200,000 properties in Oregon are exempt from paying some or all of their property taxes. Property tax exemptions are distributed unevenly across Oregon’s thirty-six counties. Eliminating exemptions would increase revenues or, alternatively, reduce property tax rates on all other properties.

  1. Oregon’s property tax system is difficult to comprehend undermining its legitimacy

Experts and members of your committee could not answer significant questions about Oregon’s property tax system. Moreover, the value of services funded through the tax system tend to be less visible than the tax bills, which arrive annually, leading property owners to question the system and to focus on reducing taxes. The mechanics of the system are so complex that voters may be unable to determine the long-term consequences of proposed tax measures.

  1. Oregon’s property tax system requires a bold¨ comprehensive overhaul

Recent proposals for reforming Oregon’s property tax system, however well intentioned, are likely to exacerbate other problems, generate new Frankenfees or Frankentaxes, or at most improve the system moderately. Limiting taxes to limit spending begs the important question: what services do voters want to purchase at what prices? The situation calls for a reasoned, evidence-based redesign that addresses the concerns motivating supporters of Measures 5 and 47/50 while reducing unintended consequences.

This report makes six recommendations to rebuild Oregon’s property tax system. Voters must act on the first, a ballot measure to be referred to the voters by the Legislature. It will take effect if passed and if the Legislature enacts the second, third and fourth. Recommendations five and six can be achieved by legislative action alone. We propose that the Legislature implement our recommendations in phases to avoid precipitous changes in tax bills or budgets

Recommendation 1: The Legislature should place a ballot measure before the citizens repealing Constitutional Measures 5 and 47/50.

Recommendation 2: The Legislature should by statute implement base levies¨ adjusted annually for inflation and population changes and subjected to periodic citizen review.

Recommendation 3: The Legislature should by statute apply property tax rates to a rolling average of real market values

Recommendation 4: The Legislature should create a task force to prepare recommendations for reestablishing local control over funding of K-12 while satisfying equalization

Recommendation 5: The Legislature should scrutinize and scrub exemptions of property from the tax base¨ which should be treated as tax expenditures. Subject them to a means test and review them periodically.

Recommendation 6: The Legislature should by statute improve the equity and efficiency of property tax administration.

Your committee makes two recommendations for further study:

City Club should study a phased process for replacing the tax on land and buildings with a land or split-value tax

City Club should study the use of performance management in local government to educate the public about the benefits they receive for the taxes they incur

Introduction and Charge to the Committee

Oregon’s more than 1,200 counties, municipalities, and special districts—including school districts and community colleges—rely upon property taxes to fund the public services their citizens enjoy. According to David Brunori, a student of the subject, the property tax has virtues that account for its widespread use and longevity throughout the world.[i] It is familiar and stable. It provides a reliable source of revenues. It connects local services to the value of the largest investment most people make: a home. It is equitable to the extent that the property owner pays in proportion to the value of the property, including the benefits received. The property tax system gives local jurisdictions significant control over their financial affairs. As a visible tax, it helps voters holding government officials accountable. Finally, it is relatively easy to administer, primarily because land and, to a degree the improvements upon it, are immobile.

Still, others have described the property tax system as “a structure designed by a mad architect, erected on a shaky foundation by an incompetent builder, and made worse by the well-intentioned repair work of hordes of amateur tinkerers.”[ii] The well-intentioned repairs to Oregon’s property tax system during the past quarter-century have reduced tax bills. They also have had consequences, largely unintended, that call into question the virtues of our property tax system.[iii]

Governor Kitzhaber in his 2012 State of the State address said that revenue reform was high on his agenda. Tax reform typically focuses on a state sales tax or changes to the Personal and Corporate Income Tax Kickers. Changing the property tax system has no political traction. But the property tax system and its impact on local governments, described by Lane Shetterly as “a crisis in slow motion,”[iv] demand attention. Because state government creates and empowers local jurisdictions—counties, municipalities, school and other special districts —to tax their constituents and to provide services, state government will have to restore the virtues of the property tax.

Charge to the Committee City Club’s Research Board charged the Property Tax Research Committee with:

  1. researching the evolution of the Oregon property tax system,
  2. understanding and explaining the implementation of the property tax system,
  3. evaluating its pros and cons, and
  4. recommending improvements.

The Board instructed the committee to consider the principles identified in the City Club’s 2002 comprehensive study, Tax Reform in Oregon. Those principles include fairness, sufficiency, certainty, clarity, efficiency and neutrality. The study assumes that property taxes will remain a significant component of funding for local governments. While the Research Board encouraged the committee to identify the merits and disadvantages of the property tax, the Board directed the committee to focus its recommendations on improving the property tax system rather than on alternative tax sources.

This report provides a primer on the property tax and its evolution in Oregon, explaining how the property tax works in theory and how it works in Oregon. In doing so, we exercise a degree of artistic license to dramatize an otherwise dry subject, not to make light of the situation or to criticize those who have invested in improving it during the past quarter century. After reviewing the process used to conduct its research, we present your committee’s conclusions and the evidence upon which they are based. Finally, we present the criteria committee members agreed upon as a basis for evaluating possible improvements, and close with recommendations.

[i] Brunori, D. (2007). Local tax policy: A federalist perspective. Urban Institute Press Ch. 4.

[ii] Stocker, Frederick C. (1991) Proposition 13: A ten-year retrospective. Lincoln Institute of Land Policy.

[iii] Brunori, D. (2007). Local tax policy: A federalist perspective. Urban Institute Press Ch.4.

[iv] Lane Shetterly, witness

Oregon’s property tax system as a Frankentax, a monster only a mother could love

Oliver Wendell Holmes said, “Taxes are what we pay for a civilized society.”

The Beatles [George Harrison] said in Taxman:

If you drive a car, I’ll tax the street,

If you try to sit, I’ll tax your seat.

If you get too cold, I’ll tax the heat,

If you take a walk, I’ll tax your feet.

The conflicts over Oregon’s property tax system derive from these contrasting sentiments.

Preliminaries

The concept of a property tax is simple. A tax is money paid to the government of a jurisdiction. Every tax system has four components, three of which comprise the formula for calculating taxes:

  1. Tax revenue is the quantity of money generated by the tax system. It is common to talk about the property tax levy, that is, the amount of money the tax generates to support government operations. We refer to it as L.
  2. A tax rate is the financial charge per unit of the tax base. For the property tax, the tax rate is typically dollars per thousand of the property’s taxable value, or millage. We refer to it as M.
  3. A tax base is the thing taxed. For the property tax, the thing taxed is property, measured typically in units such as acres of land or the dollar value of the property. We refer to it as B.
  4. Tax administration is the set of procedures a jurisdiction employs to define L, M, and B, and to collect and distribute funds. These include procedures to define the tax base, such as including or excluding properties subject to the tax; assigning taxable value to property; and enforcing collections, all of which influence the size of B.

The first three components relate to each other through an equation, tax revenue equals tax rate multiplied by the tax base:

Levy (that is, revenue)=Millage (that is, tax rate) times Tax Base

or L=MxB

Regardless of the complexity of the tax system, it works through this immutable equation, as implemented through tax administration. There’s nothing else to manipulate, nothing else to change.

To understand the history of the property tax, we look at how L, M, B, and tax administration have changed, who changed them, and why. The system we saw in Oregon until 1997 had its roots in ancient practices common throughout the world. After 1997, Oregon created a tax creature all its own.

The Ancients Created It

The earliest known tax records date from 6000 BCE in modern day Iraq. Assessors used a system with features similar to those we find today. To make tax administration feasible, they focused on one geographic area at a time within the city-state Lagash, assessing and taxing a different area each month. Through much of Oregon’s history, assessors have reviewed and updated assessed values periodically, one area at a time.

Property taxation in ancient times focused on land and what it produced.[1] In Egypt the tax base expanded to include grain, cattle, oil and beer. A typical tax rate was ten percent.[i] The items of property subject to the tax have changed in modern times (as have the rates).

When early tax authorities set a rate (M) to be applied on the right side of the property tax equation, the resulting revenues (L) changed. In modern parlance, this would be called a rate-based system. When taxing authorities set the amount of revenue (L) to be collected on the left side of the property tax equation, the resulting rate (M) changed. In modern parlance, this would be characterized as a levy-based system.

The Athenian General Aristides (530-468 B.C.) became known as Aristides the Just for his legendary impartiality and competence in administering the property tax system. Following his death, a precursor to modern day tax revolts took place. Citizens complained about the level of taxation, the size of government, and biased, inefficient tax administration. As a result, the Athenian council reduced taxes, ran out of money to fund the Peloponnesian War, and Athens lost.[ii]

Between 200-300 AD, Romans paid tax on the value of land, buildings, trees, livestock, vines and various personal properties. Augustus Caesar (27 BCE-14 CE) redesigned the tax base as a flat rate on land, basing the tax not on what farm land produced but on its capacity to produce. This provided economic incentives for putting land to its maximum use because a farmer who produced more paid no more tax than one who produced less.[iii] It was a precursor to “land value taxation,” which appeared most recently within the U.S. in Pennsylvania to promote more intensive use of urban land.

Medieval Aristocracy Nurtured It

Periodic tax protests inspired their own legend: Lady Godiva rode naked on a white horse through Coventry, England in the 11th Century to protest oppressive taxes imposed by the Lord of the town, her husband. The term “Domesday Book,” known colloquially today in England as the “Doomsday Book,” referred to each town’s book of assessment for every property and the property tax due for each person. King John signed the Magna Carta under pressure in 1215, partly because he raised taxes to a confiscatory level. By 1689, the King could not tax without the consent of the Parliament, as decision-making authority for regulating the tax system shifted from the executive to the legislature.[iv]

After 1290, personal property taxes appeared with precursors of today’s exemptions for the poorest and the church, as well as for selected items such as a knight’s armor and a merchant’s capital. Tax administration became increasingly difficult because wealthier taxpayers moved assets among multiple residences to avoid taxation. As with land value taxation, the tax system influenced taxpayer decisions about their use of their property.

Pilgrims Brought It Across the Pond

The property tax originated early in American history as a local tax, bringing from the mother country the importance of the sheriff, such as the Sheriff of Nottingham in the legend of Robin Hood. The sheriff enforced laws and assessed and collected taxes. Soon after landing in Plymouth, Pilgrims created taxes and assessments— assessing more productive land at a higher tax rate—to fund their common defense.

For over 100 years, Puritans in Boston mandated taxes on everyone to pay for the church and religious education of their children.[v] Today, we do not pay taxes to fund churches and religious education; instead, we exempt property owned by religious organizations, which benefit from police, fire and other public services funded by the property tax.

Early American communities taxed land and cattle with different rates for different categories of property. As greater varieties of property appeared in the 18th and 19th Centuries, complicating the tax base, administrative challenges led to a general and uniform tax rate on total property. ‘Total property,’ a measure of a taxpayer’s capacity to pay taxes, included personal property. By the late 1800’s, thirty-three states, including Oregon (1859) had constitutional provisions requiring that all property be taxed equally by value. As an embodiment of the Jacksonian ideal of equality, a uniform tax levied meant every taxpayer paid for government services in proportion to his or her wealth.[vi]

The property tax system worked as a revenue source for the elaborate system of local government developing in the United States. States divided themselves into counties, delegating to them the responsibility for administering state laws and authorizing citizens to organize municipalities and tax districts to perform specialized functions. So it was in Oregon.

Industrialists Refined It

The challenges of administering an inclusive base undermined the property tax. First, as the economy industrialized, intangible property, such as financial instruments (stocks, bonds, mortgages, notes) became significant and mobile sources of wealth. The coincidence between the location of wealth and the scope of government responsibilities broke down. State and federal responsibilities increased, accompanied by greater reliance on consumption and income taxes; these could tap into intangible and mobile assets more easily. Second, elected local assessors tended to value property below market. Third, wage earners and professionals had substantial incomes but little property, disconnecting property ownership from the ability to pay.

By the end of the 19th Century, our current system emerged: a tax on real estate and business equipment and inventory to support government services provided locally.[vii] Other than real estate, tangible property held by persons is not part of the base. In some states, including Oregon, the state assesses public utilities, railroads, and similar properties but otherwise, local jurisdictions set the rates (M) and administer the system. This creates challenges for achieving uniform assessments. The pattern in the U.S. is different from other large countries, where the national governments administer the land registration and assessment system, in some cases collecting property tax revenues (L) on behalf of local governments.

During the 20th Century, states began assigning property in the tax base (B) to different classifications with different rates. Assessing taxes became a profession. When the depression of the 1930’s produced tax delinquencies, which allowed the government to take ownership and sell the delinquent properties, the public resisted.

State governments began limiting the tax rates and some exempted owner-occupied residences from the tax base. Called “homestead exemptions,” these came under attack as inequitable for relieving the burden on wealthy homeowners and reducing the revenues of local governments whose tax base consisted largely of residential property. By the mid-20th Century, “circuit breakers,” which limit the tax when it exceeds a percentage of a taxpayer’s income, replaced homestead exemptions, focusing tax relief on lower and middle income, older, or disabled homeowners.[viii]

Meantime, special purpose districts proliferated, but statutes authorizing their creation often limited the tax rate (M) or the total amount of tax (L) each unit could impose. However, the post-war rise in value of the tax base (B) increased the amount of tax collected (L). Voters were displeased.[ix]

Californians Almost Killed It

This brings us to 1978 and the tax revolt in California that produced Proposition 13. It fixed the tax rate (M) and the value of property subject to the tax (B). The value of property to which the rate is applied, called its assessed value, can increase by 2 percent annually or the rate of inflation, whichever is lower, regardless of the change in its real market value. To increase or add new local taxes requires two-thirds of the local electorate to approve. Upon sale of a property, its value for tax purposes resets to its sale price. Taken together, these changes reduced property tax collections (L). The new system also proved difficult to administer, generated unintended consequences (burgeoning fees, user charges and business taxes) and weakened governments closest to local citizenry.

Oregon’s Clones

Proposition 13 inspired movements in other states.[x] The ballot measures in Oregon known as 5, 47 and 50 created a tax system unique in all the world and in recorded history. It limits all four components of the property tax system. Like Victor Frankenstein, who gave life to the creature in Mary Shelley’s novel, the sponsors of Measures 5, 47, and 50 and the voters who approved these measures were neither repulsed by their creation nor tried to escape from it.[2] They set out to do good: reduce taxes and make them more predictable.

Like the fictitious creature who wished to be loved, however, Oregon’s property tax system has evolved into a monster. It is misunderstood. As it has matured and dealt with reality, it has wreaked havoc. Reducing taxes by mandate has consequences negative as well as positive. Most likely the sponsors of Measures 5 and 47/50 neither intended nor anticipated its negative consequences, at least not their extent. Like Frankenstein’s creature, the Frankentax plagues those who breathed life into it.

The transformation of the property tax system began innocently enough. Before Measure 5, each jurisdiction decided upon the funds it required to provide services (L).[xi] In this levy-based system, county assessors estimated the real market values for all properties, meaning the prices at which they would sell, to define the tax base (B).[3] Dividing the total levy (L) by the total tax base (B: subtracting the value of exempt properties) yielded the tax rate (M). Multiplying M by the value of each property yielded its tax payable.[4] See Table 1.

Table 1: Pre-Measure 5 Tax Calculation

The system involved three sets of actors. Elected officials decided upon the size of the levy. The factors influencing their decisions included citizen expectations about the quantity and quality of government services; the cost of producing the services, including the rate of inflation; and the size of the population being served.

County assessors assessed the value of properties from the most current information available on sales of actual or comparable properties; hence the label: real market value. The factors influencing assessor decisions included the technology they used to estimate real market value and economic forces that determine the supply and demand for property.

Property owners within each jurisdiction paid their shares of the resulting levy and, coming full circle, decided who served as elected officials. If elected officials made decisions contrary to the preferences of a majority of the voters, the majority of voters could replace elected officials with people it believed would make decisions more to its liking.

This system was self-governing with one exception. A provision in Oregon’s constitution limits annual growth in the levy to six percent unless voters approved a larger levy.[5] This is a recurrent theme: attempts to control property taxes by making one or more components of the system inflexible. This removes control from decisionmakers, whether elected or citizens. Yet conditions in a jurisdiction can change unpredictably for reasons largely outside the control of decision-makers: citizens decide they want different service levels, state and federal governments mandate service provision, intergovernmental transfers of funds decline or increase, people migrate in or out, new technology appears, and the economy waxes and wanes.

Oregon’s property tax system made it difficult to respond. Under the constitutional limit, a jurisdiction that had reason to increase its levy by 2 percent one year but by 8 percent the next could not exceed 6 percent in the second year without a costly public vote. The public might not approve. This created incentives for officials to maximize the levy increases at 6% in every year, an unintended consequence of using a cap disconnected from reality that set the stage for imposing more caps and triggering more unintended consequences.

A taxpayer’s obligation under this system depended not only on the market value of the taxpayer’s land and buildings but also on property improvement and development within the taxing jurisdictions to which the taxpayer’s land belonged. If, for example, new construction within the jurisdiction increased the total value of taxable property (B) more than an increase in its levy (L) the tax rate (M) could decrease. The taxpayer’s payments, then, could decrease. With no construction and no change in the value of property values in the jurisdiction, the taxpayer’s obligation increased or decreased with the size of the levy.

The First Clone, Measure 5, Had No Teeth

Oregon’s legislature enacted property tax relief to deflate support for a “Proposition 13” but under increasing budget pressure during the 1980’s the amounts of relief declined. Tax bills increased even when taxpayers made no investments in their properties because economic forces drove property values higher. Citizens presumably perceived insufficient increased benefits in the value of government services. People on fixed incomes who had lived in their houses for a long time feared being “taxed out of their homes.”

After several failed efforts, in 1990 voters amended Oregon’s constitution through Measure 5. Without eliminating the constraint of 6 percent growth on the levy (L) Measure 5 imposed limits—again invariant—on tax rates (M):

  • $15 per $1000 of real market value to fund schools, declining each year for five years until it reached a cap of $5 per $1000;
  • $10 per $1000 of real market value to fund all other government operations.

MEASURE 5: STATE CONSTITUTIONAL LIMIT ON PROPERTY TAXES FOR SCHOOLS, GOVERNMENT OPERATIONS

Question: Shall constitution set limits on property taxes, and dedicate them to fund schools and non-school government operations?

Summary: Amends constitution. Limits 1991-1992 property taxes for public schools to $15, and property taxes for non-school government operations to $10 per $1000 of market value. Schools limit gradually decreases to $5 per $1000 in 1995-1996 and after. Government operations limit remains same. Limits do not apply to government assessments, service charges, taxes to pay certain government bonds. Assessments, service charges shall not exceed cost of making improvements, providing services. General Fund to replace, until 1996, school funds lost due to school limits. (Oregon Voters’ Pamphlet)

Bond levies to improve infrastructure add to the total tax rates but are not subject to Measure 5 limits. Rather than control operating expenses directly, Measure 5 limited property taxes to 1.5% of property values to be used for operating expenses. This made tax rates simple to understand for property owners. It also decoupled tax revenues from variations in operating expenses, which previously could have influenced the size of a jurisdiction’s levy.

Measure 5 required the State to replace revenue lost by K-12 school districts in aggregate, not in individual districts. At the time, some people thought approving Measure 5 would put such a burden on the State income tax system that citizens would adopt a sales tax. They did not.

To achieve its objective of lowering tax bills, Measure 5 created an unorthodox procedure in tax administration known as compression. See Table 2 for an illustration. Levies—including temporary ones—imposed on any property inside multiple tax jurisdictions may not generate tax rates whose sum exceeds mandated limits.[6][xii] Compression requires tax administrators to adjust the rates (M1, M2…) applied to each property. If the school district rate or the sum of other government—city, county, special district—operation tax rates exceed their limits, then tax assessors reduce the rates of each jurisdiction proportionate to its share of the total rate until reaching the mandated limit.

For example, consider property within a municipality within a county, where the municipality’s tax rate is $7 per $1000 of taxable value and the county’s is $5, totaling $12 or $2 more than the limit. The municipality’s share of the total tax rate would be 7/12=.583 (58.3%); the county’s would be 5/12=.417 (41.7%). By the inexorable laws of arithmetic: $5.83+$4.17= $10.00. Compression requires the two jurisdictions to share in eliminating the amount above the limit.

Table 2: Post Measure 5 Tax Calculation with Compression 1992

Where the school tax rate and the sum of other government tax rates fell below their limits, the system looked like the old system: levy-based because the size of the levy (L) the total tax base (B) and the value of an individual’s property determined the size of the individual’s tax bill. Where the school tax rate and the sum of other government rates exceeded their limits, the system became rate-based: the rate and the value of an individual property determined the size of the individual’s tax bill.

Previously, decisions by elected officials in jurisdictions that overlapped had been independent. Taxpayers were subject to the sum of the tax rates, whatever they were. After Measure 5, decisions by one jurisdiction could come into conflict with decisions by another, potentially to the detriment of both as they attempted to raise revenues within the fixed limits. Voters had given the first breath of life to the Frankentax.

Measure 5 left largely untouched the tax base (B) which could change with market demand. A rapid and continuing increase in property values during the 1990’s meant that tax rates (=L/B) fell below Measure 5 limits. Tax bills increased without citizen votes, regardless of limits on tax rates and levies, when the real market value of property increased by a greater percentage than the reduction of the tax rates. The owner of a house purchased for $100,000 paid $1000 if the general government rate reached its limit; if the value of the house increased to $120,000, the owner would pay $1200, or twenty percent more. If property values changed dramatically and differently from one year to the next, so did property tax bills, assuming the tax assessors kept their assessments up-to-date.[7] Property owners bore the risk of property values changing and, thereby, tax bills changing.

The Second Clone, Measures 47/50, Had Teeth and Lockjaw

The first clone proved to be unpopular with taxpayers. They disliked the volatility and unpredictability of their tax bills. They disliked paying taxes on the increasing value of their properties, gains they would not realize until selling. In 1996, the voters approved Measure 47, also an amendment to Oregon’s constitution, to reduce tax bills and control their growth. However, the legislature, tasked with implementing the constitutional amendment, could not make it work. Technical problems interfered. [xiii] To state it more aggressively, Measure 47 produced a property tax creature that was in effect disfigured, hobbled, and gagged, much to the consternation of the sponsors of Measure 5.

MEASURE 47: AMENDS CONSTITUTION: REDUCES AND LIMITS PROPERTY TAXES; LIMITS LOCAL REVENUES, REPLACEMENT FEES

SUMMARY: Amends constitution. Limits 1997-98 property taxes to lesser of: 1995-96 tax minus 10 percent, or 1994-95 tax. Limits future annual property tax increases to 3 percent, with exceptions. Limits revenue available for schools, other local services funded by property taxes. Local governments’ lost revenue may be replaced only with state income tax, unless voters approve replacement fees or charges. Provides no system for spreading revenue cuts among local governments. Restricts new bonds. Tax levy approvals in certain elections require 50 percent voter participation. Other changes. (Oregon Voters’ Pamphlet)

Oregon’s legislature, attentive to the public sentiment expressed through support for Measure 47, proposed a new clone capable of achieving the results sought by Measure 47. Legislators did this by proposing Measure 50. Voters approved it in 1997. [xiv]

In sum, Measure 50 operated on all four features of the tax system at once: L, M, B and tax administration. Because the primary levers influencing tax bills are the restrictions on rates, this looks more like a rate-based decision-making system than a levy-based decision-making system. The risk of changes in property values producing changes in tax bills no longer falls upon taxpayers because the changes are controlled. The risk of revenues no longer keeping up with the cost of government services now appears to taxpayers to fall upon government officials. However, when government officials reduce service levels or seek optional levies to increase revenues, the risk returns to taxpayers. Unintended consequences could include reduced transparency in decisionmaking and citizens holding government officials accountable for decisions outside the officials’ control.

MEASURE 50 AMENDS CONSTITUTION: LIMITS ASSESSED VALUE OF PROPERTY FOR TAX PURPOSES, LIMITS PROPERTY TAX RATES

SUMMARY: This measure changes current provisions relating to property taxation. The measure establishes the maximum assessed value of property in this state for the 1997-1998 tax year as 90 percent of the property’s real market value in the 1995-1996 tax year and then limits any increase in maximum assessed value for tax years following 1997-1998 to three percent per year. For the 1997-1998 tax year, the measure generally reduces the total of all taxing district levies in the state by 17 percent. This reduction will reflect Measure 47 cuts by basing the cuts on the lesser of the 1995-1996 tax minus 10 percent or the 1994-1995 tax, adjusted for voter-approved levies. For subsequent tax years, the measure permanently fixes the tax rates of each taxing district, based on each district’s 1997-1998 levy. The measure permits assessed values to be adjusted for new property or property improvements and certain other events, but limits the amount of the adjustment. The measure permits certain local option taxes, if approved by voters. The measure retains the existing total property tax rate for all property taxes, including local option taxes but excluding taxes for bonds, at $5 per $1,000 of value for schools and $10 per $1,000 of value for nonschool government. The measure repeals obsolete constitutional provisions. (Oregon Voters’ Pamphlet)

Measure 50:

  • assigned and made permanent (invariant) the tax rate (MP) in each jurisdiction, calculated by reducing the jurisdiction’s 1997 levy (L) by 17 percent and dividing the reduced figure by 90 percent of its 1995-96 real market value (B) so the district’s permanent rate became:

Permanent Millage=(Levy-.17xLevy)/(.9xBase)

Or

MP=(L-.17L)/(.9xB);[8]

  • allowed voters in each local jurisdiction to approve levies, LT, called local option levies, that, once divided by the district’s tax base (B) became temporary (five year) additions to its permanent rate (MP);
  • reset residential real market values of each property in 1997 to 90 percent of their values in 1995, establishing maximum assessed values (MAV) and restricted their increase to 3 percent per year, never exceeding their real market values (RMV).[9] See Table 3. Measures 47/50 did not splice into the DNA of the creature a provision included in California’s version, resetting the taxable assessed value to market value upon sale of the property. Every tax base (B) in Oregon’s tax jurisdictions became an artifact of property tax rates in 1997, not a reflection of current market values;
  • retained the invariant limits on increasing levies (L) at 6 percent unless citizens approved an optional levy; retained Measure 5’s invariant limits on tax rates, M ($5 and $10/$1000) as caps on the sum of all rates, permanent and local option, so that compression remained.

Table 3: Post Measure 50 Calculation of Assessed Value
with 3 percent Annual Increase

What about new construction? A new development comes onto each county’s Doomsday Book as a percentage of its real market value. This means: multiply the real market value of the new property by the ratio of total assessed value to total real market value for all properties (residential, commercial, or industrial) in the County, called the Changed Property Ratio (CPR). The Changed Property Ratio adds complexity to the tax system.

AV=CPR x RMV

where CPR=AVTotal/RMVTotal

How does compression affect the property tax paid on a given piece of property subject to a combination of permanent and local option rates? To get to the $10 per thousand rate for general government applied to that property, reduce the rate resulting from the local option levy first, even to zero. If more than one local option levy applies, reduce them in proportion to their contribution to the excess over $10. If compressing all local option levies to zero fails to bring the rate to $10, reduce permanent rates proportionately.

Assessors apply compression as required, property by property, because the boundaries of jurisdictions differ and overlap. Properties can be subject to taxes from different jurisdictions. Property within Multnomah County and subject to its tax, for example, might be outside the City of Portland and not subject to the City’s tax. A property within the City would be subject to both. In neither case can the consolidated tax rate for general government (other than schools) exceed $10.

A property owner might not be affected by a local option levy enacted within a given tax jurisdiction, regardless of how he or she voted. Voters can approve a local option levy to raise a specified amount of money but the jurisdiction might raise less if properties within it are subject to compression. Jurisdictions overlapping the one that enacted the local option levy or created a new permanent levy might lose revenues as well.

How does compression work in a world with both assessed and real market values? Rolling back real market values, Measure 50 created assessed values to which tax rates apply. But Measure 50 retained Measure 5’s caps on, for example, consolidated tax rates used to support government expenditures other than for education: $10/$1000 of real market value. To determine whether to compress tax rates, an assessor sums the uncompressed tax rates established by statutes in taxing jurisdictions applicable to a given property, then multiplies this sum times the property’s assessed value as established under Measure 50. If the result exceeds the result from multiplying $10 times the property’s real market value, which is the cap, the assessor compresses rates to eliminate the excess. If AV is sufficiently below RMV, the property owner will pay the real (that is, statutory) tax rates; otherwise, the property owner will pay compressed rates.

It’s Alive: Distorted, Contorted… and Growing!

Measure 50 exempted the property tax from the Constitutional requirement of uniformity. Assessed values across property owners and among various classes of property need no longer be uniform. The combination of Measures 5 and 47/50 made assuring uniformity unnecessary by mandating the calculation of assessed value from a base year with a fixed percentage annual growth limit. Indeed, of twenty states with limits on the assessed value of property, Oregon has gone farthest in breaking the link between property taxes and property values.[xv] Properties in Oregon with comparable real market values could have different taxable assessed values and, because of compression, different tax rates.
See Table 4.

Table 4: Post Measure 50 Calculation of Tax for Education
with Compression [10]

These Measures fixed features of the property tax system mechanically, like a spinal fusion repairs a disk problem, constraining or removing discretion from decision-makers, including voters. Elected officials may propose increases in levies (L) which implies increases in the rates (M) and voters may approve them, but only for five years.[11] See Table 5. No one can increase the tax base by more than 3 percent, short of adding to it by new construction, regardless of changes in economic and population conditions within the jurisdiction. Just as officials had an incentive to increase levies by 6 percent under the pre-Measure 5 system, officials have an incentive under the current system to increase tax assessments by 3 percent annually, except that the law constrains them from increasing the assessed value above a property’s real market value.

Table 5: Tax Calculation Example with Local Option Levy

When real market values decline, as they did during the economic recession that began in 2008, they can approach and depress assessed values, a phenomenon called convergence. If real market value keeps declining, then the assessed value equals real market value because, under the law, the lower of the two is the assessed value. The assessed value at which the two converged becomes, in effect, a placeholder for maximum assessed value.

If real market value keeps declining significantly but then stabilizes and the following year increases by, say, 7%, what happens to assessed value? Assessed value equals real market value until real market value reaches the placeholder, or maximum assessed value, at which point, if RMV increases more than 3%, maximum assessed value can only increase 3%. But until RMV reaches the place holder, if RMV increases more than 3%, assessed value goes with it. This can surprise property owners accustomed to assessed values that increase no more than 3%.

As if this didn’t make the system a marvel, consider an additional feature: tax increment financing. A municipality wishing to rejuvenate an area may designate it as an urban renewal district. Doing so freezes the assessed value of properties within it. The municipality makes capital investments—from sidewalks to sewers—within the district to encourage new private development. The value of property in the area increases. [12]

Why do property values increase when a municipality makes capital investments in an area? Capitalization. Investing in sidewalks, sewers, paved roads, streetlights, and so on creates a stream of benefits, year after year, that accrue to nearby properties. People will pay more for properties with sidewalks than for comparable properties without. The person who owns property when the municipality makes these investments will be able to sell it for more than he or she otherwise would because the stream of benefits has been “capitalized” into higher property values.

The revenues generated by applying the tax rate to the increase—the “increment” in tax increment financing— repays bonds sold by the municipality to fund the capital investments in the urban renewal district. However, the revenues are limited by the Changed Property Ratio for new properties and the 3 percent annual growth in assessed value for existing properties. For the time period that the urban renewal district exists, increases in property values are removed from the tax base that supports general government services. Even though revenues raised to repay bonds typically fall outside of Measure 5 limits, the Oregon Supreme Court ruled in 1992 and in effect again in 2002 that revenues collected by an urban renewal agency are subject to them. They fall under the $10 “general government” cap, contributing to compression.[xvi] In general, this means jurisdictions either 1) have lower revenues to fund services they supply, or, 2) if tax rates have not reached their Measure 5 limits, everyone else pays to recoup the loss of revenues from the tax increment.

This primer describes neither all of the manipulations of Oregon’s property tax system nor all of its features. The system is too complicated. Like the creature imagined by Mary Shelly, if the Frankentax could see its own reflection, it would recoil in horror. Because of its complexity and unintended consequences, it has become a creature only a mother could love.

Oregon’s property tax system, unlike Frankenstein, is real and has many mothers: the 575,000 (52%) who voted “yes” on Measure 5; the 705,000 (also 52%) who voted “yes” on Measure 47; and the 430,000 (56%) who voted “yes” on Measure 50. It reduces their taxes. That’s what they want. What of its other virtues, though? Is it equitable; familiar, stable and reliable; generating sufficient resources; and supportive of local control and accountability?

We are approaching the 17th anniversary of the adoption of Measure 50 and the 25th of Measure 5. Depending upon how we count, Oregon’s property tax system is between a teenager and a twenty-something. Inexorably, it is wreaking havoc upon its creators. The challenge for the City Club is to decide whether the time has come to recommend tough love.

[1] In economic theory, the value of property reflects its capacity to generate flows of benefits, such as income. For owner-occupied residential property, unlike commercial or industrial property, those flows are imputed and not subject to annual property taxes.

[2] Although the voters in Multnomah County voted against Measure 47

[3] Property subject to taxation in Oregon includes all privately owned real property (land, buildings, and improvements) and business personal property (machinery, office furniture, and equipment) unless otherwise exempt. Household furnishings, personal belongings, and automobiles are not subject to property tax. (A Brief History of Oregon Property Taxation, page 4.)

[4] Inserts are from Oregon Property Taxation Overview, Presentation to the City Club of Portland Research Committee, January 15, 2013 by Mary Macpherson, Vice-President, Seattle-Northwest Securities Corporation. While the tables represent actual buildings, the numbers, which are no longer current, have been modified and simplified to illustrate the mechanics of the property tax system.

[5] The 6% cap was on a permanent tax base that was not subject to repeated voter approval. Most permanent tax bases were too small to support basic services, so local government units also imposed operating levies. Those levies were limited duration (3-5 years) and had to be approved again by the voters when they expired. Measure 50 locked in these permanent levies when it converted the system to a rate-based system.

[6] Voter-approved bonds to fund capital projects are exempt from the caps.

[7] With rates capped, assessors had incentives to keep their assessments current.

[8] According to the Oregon Counties: 2012 Financial Condition Report issued by the Audit Division of the Secretary of State, permanent property tax rates vary between Oregon counties from a low of $0.59 per $1,000 in Josephine County to $8.71 in Sherman County, with an average permanent tax rate of $2.81 per $1,000. Multnomah County’s permanent rate is $4.34.

[9] So long as real market value exceeds maximum assessed value, the maximum assessed value can increase by 3% per year even if real market value declines, as happened after 2008. Real market value can depress assessed value, but if real market value turns around and increases, as has occurred more recently, a scenario arises in which assessed value can increase by considerably more than 3% until it reaches its previous maximum assessed value. For an excellent visual explanation, see the Property Tax Fairy.

[10] The retail store pays the lesser percentage of taxes on its property as it is the only example with a compression loss but it actually pays the highest percent of taxes against the real market value: .5% of RMV whereas House A and B pay .23% of RMV and .45%. Note that owners of commercial and industrial properties can depreciate the value of buildings, which is why real market and assessed values can be the same.

[11] Unless voting in a general election, approval required a double majority—a majority of voters when at least 50 percent of registered voters vote—but that requirement has been removed. By statute, the dollar value of proposed increases may not exceed twenty percent of the value of the jurisdiction’s tax base.

[12] This is called “capitalization,” where the property owner at the time of the investments captures the value of the stream of expected benefits. It is also why properties in school districts with reputations for excellent quality can sell for more than comparable properties in other school districts. Capitalization can occur when comparable properties are subject to different tax burdens, too. If you could choose between two houses identical except that one’s annual tax bill is $2000 and the other’s is $4000, wouldn’t the first be more attractive? You and others would be willing to pay more for it. If you owned the first house, wouldn’t your realtor advise you to ask a higher price and tell the owner of the other to reduce the asking price, given the competition? If a municipality designates a building as a historical treasure and encourages maintaining it by reducing either its assessed value or the tax rate applied to it, that will increase its sale price, again because of capitalization of the benefits of lower tax burden. The building still receives police, fire protection, and other government services, but everyone else in the jurisdiction bears just a bit more cost as a result of the designation. Indeed, if a jurisdiction exempts from taxation properties used by government agencies, not-for-profits, or religious organizations, the properties still receive public services. With a levy-based system everyone else pays just a bit more to sustain the level of service or, if they don’t, the level of service declines. With a rate-based system, the revenues decline, which can lead to reductions in service.

[i] Carlson, Richard Henry (2004) “A brief history of property tax,” Fair and Equitable February p. 3

[ii] Ibid. p. 3-4.

[iii] ibid. p. 4

[iv] ibid. p. 5

[v] ibid.

[vi] Fisher (2010) History of Property Taxes in the United States http://eh.net/encyclopedia/article/fisher.property.tax.history.us

[vii] ibid.

[viii] ibid.

[ix] ibid.

[x] ibid.

[xi] Oregon Department of Revenue (2009) A Brief History of Oregon Property Taxation 150-303-405-1 June p. 2.

[xii] Linhares, Tom (2011) Recent History of Oregon’s Property Tax System, December http://tsccmultco.com/graphics/Recent_History_jan_2012.pdf pp.14-15.

[xiii] Ibid. pp. 29-30.

[xiv] Oregon Department of Revenue (2009) A Brief History of Oregon Property Taxation 150-303-405-1 June

[xv] http://www.lincolninst.edu/pubs/1412_Property-Tax-Assessment-Limits Property Tax Assessment Limits (Policy Focus Report): Lessons from Thirty Years of Experience. Haveman¨ Mark¨ and Terri A Sexton¨ Lincoln Institute of Land Policy¨ 2008

[xvi] Oregon Department of Revenue 2009: 8-d Policy¨ 2008

 

[xvi] Oregon Department of Revenue 2009: 8-9