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MN2020 - Conservatives Provide Chance to Correct Poor Policy
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Conservatives Provide Chance to Correct Poor Policy

July 08, 2013 By Jeff Van Wychen, Fellow and Director of Tax Policy & Analysis

When conservatives eliminated a popular property tax relief program, know as the homestead credit, during the 2011 special legislative session, progressives were not happy. The mechanism used to replace the credit—the homestead value exclusion—was insufficient to prevent property tax increases that impacted approximately 84 percent of Minnesota homeowners. However, the elimination of the credit in 2011 created an opportunity for the 2013 Legislature to implement a new system that not only replaces the property tax relief lost two years earlier, but that also provides that relief in a more rational and targeted fashion.

The new homestead credit refund enacted as part of the 2013 omnibus tax act effectively replaces the old market value homestead credit. Part 1 of this series highlighted some of the problems with the old homestead credit. Part 2 highlighted the features of the new homestead credit refund. The final installment in this series examines how the new homestead credit refund resolves the problems resulting from the old market value homestead credit.

The first problem with the old market value homestead credit is that credit payments tended to decline as homestead property taxes increased and increase as homestead property taxes declined. Thus, when the need for property tax relief was growing, the old credit was shrinking and vice versa. The new homestead credit refund avoids this counter-intuitive outcome; for all qualifying homeowners, the refund will increase as property taxes increase, all other things being equal. The only exception to this rule is for homeowners who are already receiving the maximum allowable refund amount or for homeowners who do not qualify for a refund because their property tax bill is low relative to their income. Under no circumstance will property tax relief decline and property taxes increase, as was often the case under the old homestead credit.

The second problem with the old market value homestead credit was the indirect manner in which the tax relief was distributed. The old credit program included a reimbursement to local governments for the decline in revenue resulting from the homestead property tax reduction. However, in eight of the ten years that the old credit was in existence, the state failed to reimburse some local governments. Thus, while homeowners consistently received a property tax reduction through the credit, some local governments were left with a hole in their budget because the state failed to provide the reimbursement—a hole that they had to fill either through budget cuts or through property tax increases in a subsequent year.

This sort of fiscal chicanery is not possible under the new homestead credit refund because the property tax relief is provided directly to the homeowner, with no local government involvement. State leaders will be far more reluctant to cut funding for the homestead credit refund, because any reduction in the refund would translate directly and transparently into a net homeowner property tax increase—something that would be political poison for the typical public officeholder.

The third problem with the old market value homestead credit is that the tax relief it distributed was often not directed to those who needed it most. As noted in part 1 of this series, the old credit was based entirely on the value of the homestead and did not take into account the homeowner's income and thus could not target tax relief to homeowners that had high property taxes relative to their income. Contrast this with the new homestead credit refund, which explicitly targets tax relief to homeowners with high taxes in relation to their income.

The following graph shows the increase in net homeowner property tax relief—including the impact of refunds—relative to the old law (prior to passage of the 2013 tax act) under two scenarios:

  • Scenario #1: The old market value homestead credit is restored and the homestead market value exclusion (which was intended to partially offset homestead property tax increases resulting from the elimination of the credit) is eliminated. This is essentially the system that was in place prior to the 2011 special session changes.
  • Scenario #2: The new homestead credit refund is implemented; the homestead market value exclusion remains in place. This is essentially the system put in place by the new 2013 tax act.

The graph shows the increase in property tax relief (i.e., the reduction in property taxes) relative to the old law based on an average value Minnesota home (about $218,000) subject to statewide average tax rates for homeowners at four different household income levels: one-half the statewide median ($28,500), the statewide median ($57,000), 1.5 times the statewide median ($85,500), and double the statewide median ($114,000).* Gross tax amounts (i.e., prior to refunds) are based on House Research simulation #11F1. Because simulation #11F1 is based on data from tax payable year 2011, the income brackets for the new homestead credit refund are adjusted to the 2011 level in order to provide an apples-to-apples comparison to information from simulation #11F1.†

    

For homeowners within 50 percent of the median household income, the increase in property tax relief resulting from new homestead credit refund is far greater than the increase resulting from reverting to the old market value homestead credit, vis-à-vis the system in place prior to the 2011 special session changes. This is particularly true for homeowners with household income equal to the median and 1.5 times the median, who see increases in property tax relief in excess of $300—multiple times greater than the increase in relief that they would receive by reverting to the old homestead credit.‡ Of the four income levels examined, only the homeowner with an income double the statewide household median does better by reverting to the old homestead credit.

These outcomes are easily explainable in light of the rationale behind the new homestead credit refund versus the old market value homestead credit. The refund directs property tax relief to homeowners whose gross property tax is high relative to their income. In the above example, the three lowest income homeowners have relatively high taxes in relation to their income and thus have the greatest need for property tax relief and therefore receive increased relief under the new homestead credit refund. The highest income household has a relatively low tax in relation to income and thus receives no increase in property tax relief.

Contrast this with the old market value homestead credit, which simply distributes tax relief to homeowners based on the value of the homestead without regard to the ability to pay. By reverting to this system, the highest income homeowner in the above example would receive the largest increase in net property tax relief after taking interactions with the old refund program into account, even though property taxes for this homeowner comprise a smaller share of total household income. Such a system is obviously less well suited to providing tax relief to homeowners who need it most.

Some conservatives may fret that the new system is providing too much preferential treatment to low and moderate income Minnesotans relative to high income households. Such fears are without foundation. As noted in a recent Minnesota 2020 Hindsight post, the state and local effective tax rates of high income households is still less than those of middle income households, even after the provisions of the new tax act—including the new homestead credit refund—are taken into account.

Not only does the new homestead credit refund enacted as part of the 2013 tax act replace the homeowner property tax relief that was eviscerated when the old homestead credit was eliminated in 2011, but it does so in a way that better targets relief to homeowners who need it most while avoiding other pitfalls resulting from the old credit. All things considered, the new homestead credit refund marks a significant improvement in Minnesota’s property tax system.

 

*Median income based on the 2011 American Community Survey (ACS) estimate for Minnesota ($56,954). Please note that the ACS definition of household income does not precisely conform to the definition of household income used to determine property tax refund amounts. Furthermore, the 2011 ACS household income estimate used here includes both homeowners and renters.

†House Research simulation #11F1 is used for this analysis because it is the most current examination of the impact of the elimination of the old homestead credit and the imposition of the new homestead value exclusion, in isolation from all of the other changes made during the 2011 special session; that simulation, completed in September 2011, is based on data from tax payable year 2011. In 2014, Minnesota 2020 tentatively plans to update the analysis of the market value homestead credit elimination and the comparison to the new homestead credit refund based on data for tax payable year 2014.

‡ Under the assumptions used here, the largest increase in property tax relief would accrue to a homeowner with a household income of approximately $69,000; for this homeowner, the increase in property tax relief under the new homestead credit refund ($538) would dwarf the increased relief from reverting to the old homestead credit ($37).

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