Exposing the property tax myth

AACI | Vice President, The Regional Group of Companies Inc.
  • Jan. 7, 2015

Let’s be clear here: Property tax doesn’t make city hall money.

John Clark“Whoa!” you say. “How does that make sense, John? Tax is government’s source of revenue.”

That is true. But, from the perspective of a municipality, let’s put that in perspective with one statement of fact, the ramifications of which are often lost – government is a not-for-profit entity.

Government is not in the business of making a profit, or paying dividends to shareholders. Instead of profit, it may occasionally have budget surpluses. In keeping with the public trust, these must be used to provide tax cuts, pay down debt, or banked against future operating costs by being put into reserve funds.

Which is why, when we look at big infrastructure project, such as Ottawa’s new light rail transit (LRT) system, the land speculation and new development that may follow does not result in a net increase in property tax revenue for the city even though the tax base may increase in size.

How do we budget to fix the broken bits?

This is problematic, considering infrastructure costs money to build, maintain and repair.

All too often, the big photo op and the headline news coverage are on the initial cost and construction of new infrastructure. The discourse invariably revolves around who is going to pay for it — how much is the province or the feds going to chip in on top of the municipality’s investment?

It doesn’t matter which level of government is paying which portion. You, the taxpayer, are the one ultimately footing the bill.

And once that shiny new thing is built, who pays for its repair and maintenance? As taxpayers, we cry and moan over anything more than an incremental increase to our property taxes year-to-year, and yet, someone has to shoulder the costs of maintaining the infrastructure we too often take for granted.

As I have written before, eventually all infrastructure wears out and we either abandon it or fix it. (In fact, check out this segment from earlier this week by CTV Ottawa.)

Government bears the burden of responsibility. It’s a form of institutionalized myopia in this country that government rarely exercises the discipline and foresight to ensure any new infrastructure investment has, from the get-go, a reserve fund building against its eventual repair or refit.

But what about new development?

Which brings me back to where I began – why new development doesn’t solve the problem.

I wrote recently about how proposed LRT stations will be magnets for land acquisition for future development. New condo towers or commercial development are the driving factors. These buildings can substantially add to the assessment base in their neighbourhoods.

But because assessment just divides the tax burden and a municipality is a not-for-profit organization, this doesn’t result in additional revenue for the city. Instead, it serves to reduce the property taxes paid by the rest of the property owners in the city.  I’ve laid this out in my white paper “Stop Your CFO From Paying Your Neighbour’s Property Taxes.” Here, the converse is the case.

Why? Because the city sets a budget, which may increase year to year as its operating costs increase. It funds that budget through property tax revenue, and divides the amount it must collect between property owners. How much of the total each property owner is required to pay is determined by the total assessment in the city, taking into account the assessed value of a given property, its type and its class.

It’s a carefully balanced system. When a new building comes on the scene, it means the system has to reset itself.

So let’s use the example of a condo tower built adjacent to a new LRT station.

When this condo comes online, it likely has to retroactively catch up on its taxes by the time the city delivers its first tax bill. This will provide a one-time boost to city revenues. But the following year, the condo is  assessed as part of the whole property tax base. The taxes that must be collected are now spread among more properties – a larger assessment base. This reduces tax rates, and the impact is a reduction of the tax burden charged to previously existing buildings and their owners.

Because city operating costs tend to rise faster than changes to the assessment base, most property owners likely won’t see their taxes go down. What they may not realize is that thanks to that new condo down the street, their taxes will not have gone up as much as they would have, had the new tower not been built.

In short, new development and added assessment simply spreads the existing tax burden further over a larger number of taxpayers. There is no mechanism by which the city can capture value and revenue from public infrastructure projects through the property tax system.

Municipalities have limited revenue options: property taxes, transfers from other governments, user fees, or direct non-assessment based charges. Property taxes based on market value assessment result in tax shifts between ratepayers as new properties are built, but don’t generate new revenue. If a city wants to capture a portion of the value from public infrastructure projects, property taxes will not accomplish this.

The answer may be in land value capture charges

Without public infrastructure, land is almost useless. Great infrastructure can make poor property great, and the question that needs settling is the allocation of the cost of paying for infrastructure.

Using the property tax base is not the answer as it is revenue-neutral and only by increasing taxes for everyone can it be used to pay for projects like an LRT system. 

With an infill project, such as an infill condo project in the city core adjacent to a new LRT station, a city usually does not have to incur significant costs to provide services to the new building. Utilities are already passing by that location, so this type of development is very efficient and in fact will increase the assessment base and as a result, lower everyone’s tax bill. Existing services have already been paid for, but the challenge is how to pay for the big-ticket LRT system.

Bearing in mind new construction already is subject to development charges of which a considerable portion is directed toward transit infrastructure, the only option cities have is this type of land value capture (LVC) mechanism that focuses charges to development land that benefits from a value lift via projects like an LRT. 

LVCs can provide city hall a vehicle through which to capture value from LRT-adjacent development. But this is a one-shot deal. City hall has one chance to get it right. In the end, whether it’s you or your neighbour, infrastructure has to be paid for – the only question is how to allocate its cost.

To discuss this or any other valuation topic in the context of your property, please contact me at [email protected]. I am also interested in your feedback and suggestions for future articles.

John Clark is Vice President with The Regional Group of Companies Inc. He has more than 33 years of experience in the real estate appraisal field, is a fully accredited…

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John Clark is Vice President with The Regional Group of Companies Inc. He has more than 33 years of experience in the real estate appraisal field, is a fully accredited…

Read more

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