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Summer 1991
   
New York's Most Unjust Tax
Gerard Mildner
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Gerard C. S. Mildner is the coauthor (with Peter Salins) of the forthcoming book Scarcity By Design, an analysis of New York’s housing market. A research fellow of the Manhattan Institute, he was recently appointed an assistant professor of the Department of Urban Studies and Planning at Portland State University.

New York City needs a tax revolt, not despite the fiscal crisis but because of it. Although the Dinkins administration is planning to increase property taxes for the second time in two years, in order to raise revenue, that plan is likely to backfire, damaging an already fragile local economy and perhaps even losing revenue. A much surer way to narrow the fiscal gap would be to cut property taxes.

New York City’s property tax rates, which bring in more than 40 percent of all local tax revenue, are among the highest in the country, especially for apartments and commercial buildings. New York’s property taxes are overwhelmingly regressive, destructive of the housing stock, particularly in poor neighborhoods, and burdensome for businesses, especially new ones. Moreover, and perhaps most important in the current climate, New York’s high rates actually seem to be costing the city money. There is powerful evidence that New York City property taxes are so high—particularly in poor neighborhoods—that a correctly structured tax cut would increase property tax revenue and other tax receipts as well. In addition, such a tax cut would allow city hall to reduce its own expenditures on housing programs, narrowing the fiscal gap still further.

State law (and long-standing practice) divides all real estate in New York City into four categories—homeowner (one-, two-, and three-family homes), other residential, commercial, and utility—and permits the city to assess and tax each category at different rates. Effective tax rates on New York City’s private homes are quite reasonable by national standards. But the city’s apartment buildings, which house two-thirds of New York households, and commercial and utility properties are taxed at some of the highest rates in the country. Indeed, in a survey of property tax rates in 22 of the largest U.S. cities, New York had the highest rate on apartment buildings (see Figure 1).

Because renters do not see their property tax bills directly, most New Yorkers do not realize how high the city’s tax rates are. Figure 2 shows who pays what under the present tax code. The nominal tax rates on the four types of property appear to be roughly equal. But the effective tax rate is a product of the nominal tax rate and the assessment, i.e., the value imputed to the property being taxed. For homeowner properties, the average assessed value is only about 8 percent of official market value, while the assessment rate on all other properties is roughly 50 percent. As a result, the other property classes pay six times as much as homeowners. Suppose, for example, you owned a home worth $100,000 according to the city’s books. On average your assessed value in New York City would be $8,340. At your nominal tax rate of 9.43 percent you would owe the city $786. But if that same building were an apartment house, your assessed value would be $52,240, and your tax bill would come to $4,800. If your building were a commercial property, you would owe somewhat more. And these figures do not take into account Mayor Dinkins’s planned tax increases, which would raise effective tax rates even further.

Taxing the Poor

Even under well-designed systems, the property tax tends to take a greater share of the income of the poor than of the rich. New York, however, has pushed this tendency to such an extreme that the property tax loses money in poor neighborhoods.

The poor spend a greater proportion of their income on housing, so passed-along property taxes, usually in the form of higher rents, cut more deeply into their budgets. (Most economists agree that landlords pass most of the property tax along to their tenants.) New York’s system, however, is exceptionally regressive. We tax apartments much more stiffly than private homes, and the poor are almost all renters.

A detailed look at the data confirms that New York’s tax system punishes the renting poor. Economist Howard Chernick of Hunter College recently conducted a study matching New Yorkers’ household incomes to their property tax payments. In this study, published in the 1988 volume of Setting Municipal Priorities, Chernick found the property tax to be much more regressive than other local taxes, including the sales tax. In 1986, New York households with an income of $5,000 to $10,000 paid more than 8 percent of their income in property taxes, while those with an income of $75,000 to $100,000 paid just over 1 percent (see Figure 3). Chernick identified several causes of this extreme regressivity, but most important was the high effective tax rate on rental property.

Moreover New York, like many cities, seems to overestimate the market value of properties in poor neighborhoods, which in turn inflates the assessed value of a property (the product of the assessment rate and the estimated market value) and the final tax bill. Several nationwide studies confirm this tendency. A team of four economists who designed a study for the federal Department of Housing and Urban Development (HUD) found that overestimates of market value caused assessments in poor neighborhoods to be relatively higher than in richer neighborhoods in six of 10 selected U.S. cities, with only one city showing an opposite trend. A recent study of Class I property by the New York Public Interest Research Group found that three-family homes were overassessed by between 26 and 41 percent relative to one- and two-family homes, with particularly high assessments occurring in the poorer neighborhoods of the city.

This problem seems to be worse than average in New York. Assessments were dramatically skewed during the 1970s, when the city’s depressed economy and the combination of rising energy costs and the constraints of rent control depressed the value of many buildings in poorer neighborhoods. New York City landlords in poor and moderate-income neighborhoods were overwhelmed by the combination of rising costs, worsening social conditions among their tenants, and stagnant or falling rental income. Under these circumstances, assessments should have been cut dramatically, since the value of a building is a function of its posttax profits. A building that can only lose money is effectively worthless, and might as well be abandoned by its owner. That is just what happened. Thousands of landlords, faced with mounting tax bills they could not pay based on unreasonable and rarely adjusted assessments, cut back on maintenance and eventually just walked away from their buildings. From 1974 to 1984, more than 300,000 rental units were abandoned; some of the buildings were burned, apparently for the insurance money. Most of the rest fell into the hands of the city, which seized them for unpaid taxes.

As a result, the city government acquired a growing number of abandoned properties, under what came to be known as the in rem management program. The city currently has roughly eight thousand such buildings. Almost half are completely vacant. As city property they pay no taxes. Their operation and maintenance costs the city over $180 million each year. And though abandonment and in rem seizures slowed during the 1980s, in the current economic climate, with no tax relief in sight, abandonments are beginning to rise again.

Yet this very combination of tax delinquency, abandonment, and in rem seizure suggests that a tax cut could increase revenues and reduce costs, improve the housing stock, and help the poor. Reducing taxes would reduce abandonment and keep buildings on the tax rolls and out of the city’s expensive in rem program. Several studies, local and national, support this view. In the HUD study cited earlier, the authors concluded: “The higher rate of property taxation in blighted neighborhoods has done much to drive up operating costs and depress housing prices,” suggesting that taxation can be a major burden to landlords in poor neighborhoods. Similarly, Rutgers University economists George Sternlieb and Robert W. Lake, writing in the National Tax Journal, found in a study of Pittsburgh that severe property tax bias was a significant burden on the housing stock in poor neighborhoods.

Most important, in a detailed study of New York City’s property tax system and housing abandonment, University of Michigan economist Michelle J. White confirmed that a tax cut would reduce abandonment and raise revenues. Using data from 260 New York City neighborhoods in 1976 and 1978, White conducted a regression analysis to test a variety of possible explanations for high rates of tax delinquency. The variables, or possible explanations, that she tested included the age of buildings, the income of neighborhood residents, the percentage of residents on welfare, the percentage of single-family homes, and the percentage of tenement-type structures.

None of these variables, however, explained the rate of tax delinquency as well as a single other factor: effective tax rates. According to White, a 10 percent increase in the property tax bill was associated with a 21 percent rise in the rate of tax delinquency. Of course in prosperous or stable neighborhoods, where the delinquency rate is low, a 21 percent rise would have a minimal effect on city revenues. An increase in the delinquency rate from 1 percent to 1.21 percent would not mean much lost revenue. But in slum neighborhoods where a large percentage of buildings are already delinquent, the implications are more dramatic. If the delinquency rate is already 20 percent, the same 10 percent tax increase will increase the delinquency rate to 24.2 percent. That will cost the city treasury a lot of money. If the delinquent buildings are seized in rem, this cost will grow: The cost of subsidizing an in rem building was estimated at $13,900 in 1978, the year from which White drew her data. It has more than doubled since.

White then hypothesized a policy of reducing assessments by $1,000 per building in a typical poor, minority neighborhood: Brownsville, Brooklyn. Since assessments of all properties in the neighborhood at the time averaged about $17,000 per building, this amounted to a 6 percent reduction in the assessment. With a nominal tax rate of 9 percent, the city would lose $90 from each of the twelve hundred buildings in the neighborhood, or approximately $109,000 per year (in 1978).

As a result of this tax reduction, however, tax delinquency would fall by 12.6 percent. Sixty fewer properties would consequently go into delinquency, and the city would gain back some 80 percent of what it had “spent” on the tax cut. Furthermore, without the tax cut, roughly one-quarter of these sixty delinquent buildings would have ended up in the city’s in rem program at a cost of $208,000 per year for 15 buildings. So the tax cut, by keeping those properties out of in rem management, would save the city treasury an additional $208,000 per year.

Thus in 1978, the original $109,000 “spent” in tax cuts would have produced a total “payback” of $294,000, a benefit/cost ratio of 2.7 to 1, and a net gain to the treasury of $185,000. In 1991 dollars that figure would be far higher. Yet even these figures underestimate the ultimate savings. For when the city eventually does recycle seized properties back into the private sector, it almost always gives the new owners tax subsidies or even grants to rehabilitate these structures. The city’s current $5 billion, 10-year housing plan consists mostly of such rehab subsidies. A property tax cut that forestalled abandonment in the first place would render much of that spending unnecessary (much of the damage occurs after abandonment) saving the city hundreds of millions of dollars a year (see Figure 4).

Property taxes, thus, seem to be subject to a local “Laffer curve”: The city would gain more from having a larger property tax base and smaller in rem subsidies than it would lose by reducing property tax rates, at least in poor neighborhoods. There are, however, two big differences between this local Laffer curve and the national Laffer curve for income taxes, hypothesized by the “supply-side” economists: First, for New York City’s property tax, the mechanism by which the tax-cut payback is produced is clearer and easier to verify in advance. Second, the payback is much bigger. While the national income tax cuts of the 1980s produced a payback of only two-thirds, thus increasing the national deficit, a property tax cut in New York City, at least in poor neighborhoods, would produce a payback of almost 3 to 1.

Because White limited the latter part of her analysis to poor neighborhoods, we do not know without further study whether a general tax reduction on all residential apartment buildings, or indeed on all Class II, III, and IV properties, would produce a similar payback. The city, however, could immediately launch a targeted and highly profitable tax cut by reducing assessments in poor neighborhoods. Meanwhile, the city should study the revenue effects of a broader tax cut for Class II, III, and IV properties in all neighborhoods.

Even without such a study, however, there are a number of reasons to believe that a broad-based city-wide property tax reduction could boost the local economy at no cost to the treasury. To begin with, abandonments, which slowed during the 1980s, seem to be on the rise again. This stands to reason: The costs of operating an apartment building in New York have risen substantially in recent years, largely because of taxes. According to a study commissioned by the Rent Stabilization Association, but using techniques designed by the Bureau of Labor Statistics, real estate taxes now account for 23 percent of the operating costs of rent-stabilized apartment buildings, up from 18 percent in 1985. The real estate tax component of the price index for operating costs for such buildings has risen by double digits for three straight years. With abandonments and taxes rising, White’s scenario of increasing revenues by cutting taxes and forestalling abandonment seems especially likely to be valid today.

Moreover, a tax cut could justify the elimination of one of the most costly and least productive of city tax policies: the granting of special property tax reductions or “abatements” to keep businesses or developers here. In recent years such tax abatements have reduced property tax revenues by roughly 14 percent. Tax abatements make it easier for city officials to influence investment decisions (a job they are unlikely to do well) and encourage waste, favoritism, and even corruption. When tax subsidies are available, almost any business with sufficient clout can be expected to claim that it needs one to stay in town. Ultimately, the city is forced to grease all the squeaky wheels.

This problem is largely a function of the city’s high tax rates. Simple arithmetic suggests that eliminating abatements would enable the city to cut property taxes by 14 percent without harm to the treasury. In fact, eliminating abatements would leave room for an even larger tax cut. We know that there would be a very substantial “payback” in poor neighborhoods; it is reasonable to suppose that there would be at least a modest payback in other neighborhoods. Eliminating tax abatements might therefore allow a tax cut not of 14 percent but of 15 or even 20 percent. Of course since many existing abatements are guaranteed for a number of years the change would have to be gradual.

None of these calculations takes into account a property tax cut’s beneficial effect on the broader economy, which might be the most important result, even for the city treasury. New York has a broad array of taxes, many of which, like the income and sales taxes, are sensitive to the state of the economy. If a property tax cut should prompt a local recovery, revenues from those taxes would rise sharply.

Would a property tax cut help the local economy? There is every reason to think so, although such broader positive effects cannot be quantified with any precision.

Traditionally, of course, the property tax has not been regarded as an economically sensitive tax: That is, reductions and increases in the tax have not been seen as crucial factors in the state of the economy. Property—unlike a business or an individual—cannot leave town to escape high taxes. Thus, public finance economists long assumed that the owner of a property accepted his loss as unavoidable, paid his tax, and made the same marginal decisions as before.

In more recent years this consensus view has been challenged by economists. For instance, many now believe that developers do respond to high tax rates, locating new construction in neighboring towns or competing regions should local property taxes get too high. Certainly this is most likely to occur when property taxes have reached extremes as in New York.

Far more important, it is becoming clear that high property taxes harm not only new development but the entire economy. Writing in The Review of Economics and Statistics, Jay Helms, an economist at the University of California at Davis, found that the property tax had strong negative effects on a state’s growth in personal income. Or as Duke University economist David Davies reported in United Stated Taxed and Tax Policy, an important recent study: “High [property] taxes tend to increase the prices of goods and decrease real wages.” Thus, excessive property tax rates may harm living standards and job growth.

There have been two dramatic empirical tests of this proposition in recent years: the property tax revolts in California and Massachusetts, in 1978 and 1980 respectively, both of which were followed by economic booms. It is, unfortunately, impossible to determine precisely how much of that growth is attributable to the tax cuts. But the power of the post-tax-cut surge in both those states, and the growing belief among economists that property taxes are linked to economic growth, should give pause to high-tax states such as New York.

In Massachusetts, where the property tax rate previously averaged 4.4 percent, the passage of Proposition 2 1/2 in 1980 set a 2.5 percent maximum rate cap for any individual piece of property. California’s Proposition 13 reduced average property tax rates from 2.47 percent to 1.20 percent with strict ceilings on assessment increases.

In the four years before Proposition 13, California produced one-sixth of the new jobs in the United States. Yet in the two years following, the state produced one-third of the nation’s new jobs. From 1975 to 1984, the number of jobs increased by 25.5 percent in Massachusetts and by 34.5 percent in California, compared with gains of 22.5 percent in the rest of the country and only 10.6 percent in high-tax New York State. Compared with the rest of the nation, the much-vaunted New York recovery was little more than a return from the dead. Perhaps the time for a real New York recovery is now.

On the downside, in both California and Massachusetts local property tax revenues declined, taking several years to recover. Other tax receipts rose, of course. California and Massachusetts, however, cut property taxes for everyone, including homeowners. In New York City, a tax cut could be targeted to multifamily dwellings and commercial buildings, which are much more likely than homeowner properties to produce a revenue payback. Homeowners are not overtaxed in New York City.

New Yorkers might be surprised to hear that we already have a constitutional property tax limitation: The state constitution restricts New York City’s property tax levy to 2.5 percent of the “full value” of its property tax base. But constitutional loopholes and the division of property into four classes makes this provision completely ineffective.

The 2.5 percent limitation does not apply to individual properties but to the tax base as a whole: It is no barrier to effective tax rates of 4 to 5 percent on apartment buildings and business properties. Furthermore, the constitution exempts from this limitation whatever amount of revenue is needed to pay the city’s long-term debt: In order to raise taxes all the city need do is be fiscally irresponsible, a task it can certainly manage.

A major impediment to real tax reform is politics: renters do not see their tax bill so don’t care about it. Homeowners do, but they have a good deal. For this reason, any package of property tax reduction and reform must leave the present low tax rates on one-, two-, and three-family homes intact. The effective tax rate for homeowners here is quite low, but not much lower than the rates in Boston or Washington, D.C., or the major cities of California and Texas. Rates for other properties should be reduced by a more effective constitutional tax limitation on individual properties, not the tax base as a whole.

One way to do both these things would be to leave the class system intact, but apply the current constitutional limitation of 2.5 percent of full value to all properties individually. Because the 2.5 percent (or whatever figure were agreed on) would be a maximum, tax rates on homeowner properties could remain at their current low level. Establishing the correct maximum level would take a bit of study, since the city cannot afford a big revenue loss now. Of course the fiscal irresponsibility loophole, by which the city gets to raise taxes if it runs up enough debt, must be closed—especially since the city’s debt has risen in 11 of the last 12 years.

Correctly designed, such a reform would do little or no damage to the treasury in the short term, and pay dividends very soon: more housing with fewer city subsidies, especially in our poorer neighborhoods; a less regressive tax system with lower effective tax rates for the poor; lower rents for people and businesses; higher disposable incomes; more jobs; increased revenues from sales, income, and other taxes.

In the short term, of course, a more selective cut would certainly produce an immediate revenue payback. We need both short-term tax reduction, especially in poor neighborhoods, and long-term reform. No other major American city has property tax rates as high, as destructive, as inequitable, or as ill designed as New York’s. Few places have more to gain by change.

 

 

 
New York's property tax oppresses the poor, destroys housing stock, and discourages new business. Even worse, it costs the city money
City Journal Summer 1991.
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