Imagine, if you will, Tinyville, a community of only ten houses. The ten houses were of the same size and style, built at the same time on similar-sized lots, using similar architectural drawings and building materials, each with comparable views and amenities, and each sold to its original owner for the same price, $250,000. Assuming that the fair market value of each of these homes was $250,000 (because after a reasonable time that is the price at which sellers and buyers met, without being under duress), the Tinyville tax assessor assessed each property at $250,000, resulting in an underlying total property value of $2.5M for all of Tinyville.
Like any municipality, Tinyville has expenses: police and fire departments, schools and libraries, water and sewer, sanitation workers, judges and clerks, engineers and inspectors, tax assessors and collectors, civil servants and clerks. To keep the math simple, let’s assume that Tinyville’s annual budget is only $100,000 and that it has no other sources of income (such as parking meters, local sales or income taxes, or hunting/fishing permits). To cover your annual expenses, Tinyville’s tax assessor divides your $100,000 of budgeted expenses (known as total taxes) by each property’s proportional share of the community’s $2.5 million total assessed value. Dividing $250,000 by $2.5 million means each home is responsible for 10% of Tinyville’s property tax. Each homeowner (or their mortgage banker) receives a $10,000 tax bill.
For years, everyone is happy in Tinyville. Each of the families have children in Tinyville schools, march in Tinyville parades, and compete in Tinyville pie-eating contests. In the natural course of events, two of the original families were more prosperous than others and moved to better housing in Mediumville, one retired to Southville, another was transferred to his company’s Westville office, and one died in a tragic accident. car accident, but his heirs in Bigville did not want to return to the family home. Anyway, five of the houses came on the market and since the market had been doing well for the past few years, four sold for $300,000… except the one owned by the deceased couple’s heirs, they let the house fall apart. in disrepair, stopped mowing, and eventually the squatters moved in and started trashing the place. When they finally sold it as a “maintenance special,” they got $150,000 for it.
Before any year’s tax assessment is “final,” it is sent to each owner for review. Each owner has the opportunity to dispute the assessment. The five original owners continued to be assessed at a rate commensurate with their property value of $250,000, and knowing that many of their neighbors sold their comparable homes for $300,000, they quietly accepted this assessment. The four new owners who paid $300,000 each are also appraised at $250,000. Strangely, it is illegal for a municipality to do a “spot appraisal” on individual properties, so even though the “fair market value” of those four houses has increased 20% since the last appraisal, they are still appraised at $250,000 each. The tenth house, purchased by the handyman for $150,000, is also assessed at $250,000, but he questions his assessment. He argues that the fair market value of his home should be based on its recent purchase price, and through the various legal methods at his disposal, he has the home revalued for $150,000.
Assuming the total tax lien does not change by $100,000, what happens to each owner’s property taxes? Nine of the ten houses are still appraised at $250,000 each, but the last one is now appraised at just $150,000. One might quickly (and incorrectly) guess that homes with unchanged appraisal values would have no change on their $10,000 property tax bill, and that the 10th home would pay only $6,000, but that doesn’t add up correctly; Tinyville needs to collect $100,000 in taxes to break even, and this formula only adds up to $96,000. What actually happens is that the denominator also changes. Tinyville’s total assessed property value is recalculated based on each property’s assessed value and now adds up to just $2.4 million. That means each of the $250,000 homes now represents a little more than 10.4% of the total, and is now responsible for that percentage of the $100,000 lien, increasing each of their appraisals to $10,417. The handyman’s $150,000 assessed value represents 6.25% of the total, so he is now responsible for just $6,250 of Tinyville’s tax collection.
Some (including handymen) would argue that the handyman’s house is worth less and should therefore pay less in taxes than its neighbors. Others (including your neighbors) would argue that your house is the same size and shape, occupies the same amount of land, and requires the same of Tinyville police, fire, schools, libraries, sewer, and other services, and that you must pay the same amount as the other houses. Some (including the original five families) would argue that resold homes should be assessed at their new, higher market values, with new owners paying proportionately more taxes. Others (including the four new owners) would argue that the fair market values of their homes (as evidenced by their sales prices) are indicative of the actual fair market value of the five unsold homes, even though those homes have not been sold. t changed hands recently. These are the kinds of issues that confound homeowners and plague tax assessors, appraisal review boards, and courts in every municipality, every year.
In a perfect world, when handymen apply for building permits to repair and restore value to your home, the new value they create from the work they do should bring your tax assessment back in line with other comparable homes. , thus reducing the percentage of its neighbors. of the total tax, as applicable. Unfortunately, not everyone applies for building permits, and not all projects require building permits. Upgrading your kitchen appliances improves the value of your home without the need for building permits. Many municipalities do not require a building permit to add a new layer to your roof or to re-tile your bathrooms. Of course, there are also homeowners who build attic rooms or lofts over their garages without permits, and not all new homebuyers are smart enough to realize they are paying for such unauthorized improvements. If you complain to the tax assessor that your neighbor has a finished basement without a permit, the tax assessor does not have the same authority as a building inspector to call and demand to see that basement to tax them properly…and not all of them. Building department inspector is willing to conduct inspections with an anonymous tip, so you may need to register as the guy who ratted on your neighbor. Consequently, many home improvements are not reflected on tax assessment rolls.
Since buying a home in a market downturn gives you the ability to lower your tax assessment based on its new apparent fair market value, other homeowners may use your new “fair market value” to argue that your home is comparable. to yours, and that their rating should also be lowered. This creates an additional burden for appraisers as they try to determine new values for homes that have not recently sold based on evidence created by comparable homes that have. As more and more homeowners file grievances against their assessments, the denominator in the municipality’s total assessed value is reduced, increasing the actual tax bills for homes for which assessments have not been grieved. Naturally, that reinforces the process, prompting more and more homeowners to pay their taxes, creating more and more work for appraisers. Taken to the unimaginable extreme, however, in a community where home values have gone down, it may take a few years before all homeowners realize they are being unfairly evaluated (compared to their neighbors), but ultimately In instance, when the last one finally gets taxed, everyone’s share with the new denominator should be comparable to their share with the original denominator, which means that everyone, on average, will eventually pay almost as much tax as before. In the intervening years, those who joined first and had the largest and earliest reductions in their home’s assessed value will reap the greatest short-term benefits. Some would go so far as to argue that this is fair, like so many other cases in life when the early bird gets the proverbial worm.
The chaos and disparity in between, however, causes more work, costing municipalities more in assessments, review boards, and grievance hearings. In the worst case, when complaint processes fail and the courts are left to decide, municipalities have to pay unanticipated rebates to vindicated homeowners, reducing their immediate coffers and further increasing tax collections. in subsequent years to offset those losses. For students of economic theory, Keynes would argue that these machinations are a necessary and productive part of the system, employing lawyers who would otherwise earn less; these lawyers rent offices, hire staff and buy office supplies, and actually keep the economy going. Hayek would counter that these legal costs do not so much enrich the system as they redirect capital that would have been spent elsewhere, such as the tax savings that allow homeowners to buy new furniture, hire a gardener, or take a vacation. He would view these inefficiencies in the tax determination process as an unnecessary cost that allocated resources in a less-than-optimal way…and would tend to agree with him. I don’t know what the solution is, but I know we should try to find a better one.