Homestead Credit: Old Versus New
During the 2011 special legislative session, Minnesota conservatives insisted on and—after a 20 day state government shutdown—succeeded in eliminating the homestead credit. The property tax increases resulting from the elimination of the homestead credit became a key talking point during 2013 legislative campaigns. As a result, in 2013 a progressive majority in the Legislature enacted the “homestead credit refund.”
The new homestead credit refund is significantly different from the old homestead credit—known officially as the market value homestead credit. Today’s article is the first of a three part series that will explore the relative merits of these two distinct forms of property tax relief, beginning today with the old market value homestead credit, which was used to reduce homeowner taxes from 2002 to 2011.
The old homestead credit was based on the taxable value of the homestead. The credit equaled 0.4 percent of the taxable value of the home up to $76,000; the credit was reduced by 0.09 percent for each dollar of taxable value in excess of $76,000. Thus, the credit peaked at $304 for a home with a value of $76,000 and gradually declined as the value exceeded $76,000 until hitting zero at a value of $413,778. (The credit cannot be less than zero.)
The old market value homestead credit was subtracted from the gross homestead property tax. For example, the credit for a home with a taxable value of $200,000 was $192.40; this $192.40 was subtracted from the gross property tax on the homestead. Thus, if the gross tax on the $200,000 home was $3,000, the net tax on the home after subtracting the homestead credit would be $2,807.60. The state would then distribute $192.40 to local governments to replace the amount of revenue lost to the local governments through the property tax reduction.
There were three significant problems with the old market value homestead credit. First, credit payments generally shrank during periods when gross homestead property taxes were increasing and grew during periods when homestead property taxes decreasing. In other words, during periods when the need for homestead property tax relief was growing, the credit was declining and vice versa.
This paradoxical outcome was the result of the structure of the old homestead credit. During the period from 2002 to 2008, the statewide taxable value of homesteads was increasing. As noted above, as homestead values grew beyond $76,000, the amount of the homestead credit payment declined; because the value of the overwhelming majority of Minnesota homesteads was above $76,000 throughout the era of the market value homestead credit, the growth in values led to a statewide decline in credit payments. To further compound the problem, the growth in homestead taxable value from 2002 to 2008 exceeded the value growth of other types of property, leading to an increase in the share of total statewide property taxes borne by homeowners.
As a result of these convergent trends, real (i.e., inflation-adjusted) statewide market value homestead credit payments declined by 40 percent from 2002 to 2008, while real statewide gross homestead property taxes (i.e., before subtracting the credit) increased by 23 percent. The fact that homestead credit payments were falling at the same time that gross homestead property taxes were increasing caused real net homestead property taxes (i.e., after subtracting the credit) to increase by 34 percent—significantly greater than the increase in the gross tax. In this way, the structure of the old market value homestead credit exacerbated the growth in homestead property taxes during the period when homestead values were increasing.
The reverse situation occurred from 2008 to 2011 in the aftermath of the bursting of the housing bubble. During this period, housing values dropped abruptly and, as a result, market value homestead credit payments increased. Thus, during a period of a modest drop in real statewide gross homestead property taxes (1.5 percent from 2008 to 2011), real market value homestead credit payments increased by four percent. The fact that the credit tended to increase when homestead property tax relief was least needed and decrease during periods when homestead tax relief was most needed was a serious flaw of the old market value homestead credit.
The second major problem with the old market value homestead credit is related to the indirect manner in which the property tax relief was delivered. In every year that the market value homestead credit was in effect, homestead property taxes were reduced in method described above. However, the payment from the state to local governments was not always made.* Using the example of the $200,000 homestead, during each year from 2002 to 2011 the gross property tax on the homestead was reduced by $192.40, but the full $192.40 payment from state government to local governments was not always delivered, thereby leaving some local governments with less revenue than they budgeted for.
The failure of state policymakers to deliver the homestead credit reimbursement to local governments created uncertainty within the budgets of the affected jurisdictions, some of which responded by increasing their levies in anticipation of future state failure to deliver credit reimbursements. The regular cuts to the market value homestead credit was another unfortunate byproduct of the “no new tax” mentality, whereby “fiscally conservative” state leaders would pass the burden of perennial state budget deficits on to local governments and local property taxpayers rather than increase state taxes. However, the indirect manner in which property tax relief was delivered under the old credit made it relatively easy for state policymakers to engage in this fiscal chicanery.
Third problem with the old market value homestead credit is that property tax relief was delivered with no direct consideration of the taxpayer’s ability to pay. Again returning to the example of the $200,000 homestead, the property tax paid by the owner of the home was reduced by the $192.40, regardless of the total property tax payment that was due or the income of the homeowner. Regardless of whether the total tax bill was high and the homeowner income was low or vice versa, the same $192.40 payment would be made. In short, the old market value homestead credit did not do a good job of targeting the relief to the homeowners who needed it most.
The problems with the old market value homestead credit made it ripe for replacement. However, the mechanism used by the 2011 Legislature to replace the old credit—the homestead market value exclusion—was flawed, resulting in property tax increases impacting approximately 84 percent of Minnesota homesteads† and an estimated statewide net homestead property tax increase of $112 million or 3.4 percent.‡
The solution devised by the 2013 Legislature and incorporated into the new omnibus tax act—the new homestead credit refund—is a more effective way of providing homestead property tax relief that avoids the problems resulting from the old market value homestead credit. More on this next week in part two of this series.
*Some reductions were made to local government reimbursements during eight of the ten years that the market value homestead credit was in effect. During most of these years, the majority of local governments received the full amount of the credit reimbursement that they were entitled to. The jurisdictions affected by credit reimbursement reductions included counties, cities, and townships; school district and special tax district reimbursements were never reduced. In some years, the magnitude of the credit reduction was quite large and impacted a large number of jurisdictions. For example, during the final year of the market value homestead credit (2011), total reimbursements to local government were reduced by over $130 million.
†This estimate is based on a Minnesota 2020 analysis using the Department of Revenue’s statewide parcel specific database.
‡This estimate is based on House Research simulation #11F1. This estimate of the property tax increase resulting from the old homestead credit elimination and the new homestead market value exclusion does not include the estimated $160 million increase in non-homestead property taxes produced by the shift of taxes from homestead to non-homestead properties resulting from the reduction in taxable homestead value.