U.Va. Economist: Real Estate Tax Relief Would Only Shift Tax Burden; Localities Ought to Restrain Spending Instead

January 28, 2007 — A University of Virginia economist warns that Virginia's proposed "homestead" constitutional amendment, currently being considered in the General Assembly, will pose problems for local communities if it ultimately becomes part of the state constitution.

The legislation, which recently passed subcommittees in both the state Senate and House of Delegates, would allow localities the option to exempt up to 20 percent of a home's value from real estate taxes. If passed during this term, the amendment would be offered to Virginia's voters on the November 2008 ballot.

Writing in the current edition of The Virginia News Letter, a publication of U.Va.'s Cooper Center for Public Service, John L. Knapp, professor emeritus at U.Va. and senior economist at the center, argues that the proposed amendment would represent a major change in Virginia local government finance "since it is aimed at the real property tax, the most important single source of locally raised revenue."

The Virginia News Letter (pdf)

Knapp writes that the proposed amendment's impact on local governments is uncertain since local governing bodies have the option to adopt an exemption of up to 20 percent.

"The most probable outcome is that many local governments would provide an exemption, although not necessarily the full 20 percent," Knapp writes. "This would not occur immediately, but would be phased in over a number of years as governing bodies accede to homeowner pressure and emulate tax relief provided by neighboring jurisdictions. The form of exemption adopted by individual localities is unknowable."

Estimating local governments' foregone revenue is not possible unless one assumes that all local governments adopt the full 20 percent exemption, Knapp says. In the unlikely event that all adopted it as soon as permitted, the cost in foregone revenue, based on 2006 data, would be close to $1 billion. Moreover, Knapp observes that local governments would not be evenly affected by the homestead amendment if it were fully implemented because of the differences in the portion of taxable assessed value in homeowner property.

According to Knapp, if the amendment does result in the shifting of tax burden to business, it would convey an unwanted message about the tax friendliness of Virginia’s local tax system, especially if such differential treatment is supplemented with special surtaxes on commercial and industrial property for funding transportation projects.

Knapp says that homeowner taxpayer frustration is understandable because of increasing property taxes. But he contends that a simpler solution would be restraint on spending by local government instead of using market-driven increases in assessed values to bring in significant amounts of new revenue.

One alternative to the proposed amendment, writes Knapp, would be a device known as a “circuit breaker,” which provides state-financed relief for homeowners and renters whose property tax burden exceeds a prescribed portion of income.  A circuit breaker could be designed to aid renters, a group not included in the proposed amendment. He also suggests that the pressure to allow local governments to find new sources of revenue, such as local income taxes, may increase as the revenue-raising power of the property tax is diminished.

The earliest the amendment could be implemented would by 2009, Knapp notes. "Housing market turmoil, which is now having a very negative effect on property tax collections, is unlikely to be over at that time," he writes. "Thus, the amendment will exacerbate an already difficult time for local governments."