Property taxes are weird. They don’t work like other taxes. I’ve been trying to get my head around them for a few years now.
In the run-up to this year’s operating budget, which is going to council next week, I thought I’d try to figure them out. I started researching a story for NOW magazine about how the city works out property taxes. My research confirmed that I was not the only one who had difficulty sorting them out — even the experts I talked to weren’t confident about all the details. The one person who was really on top of them was Councillor Shelley Carroll, chair of the city’s budget committee.
NOW found the details of how property taxes worked too dry for a magazine article, perhaps understandably. They did publish parts of what I wrote in yesterday’s issue, but unfortunately, in the search for an interesting headline and the need to keep things tight, what’s left of the article doesn’t really hang together.
I’m hoping that Spacing‘s readers may be more interested in the gory details of the workings of the property tax system and its implications, so here goes.
Property taxes basically work backwards, compared to other taxes.
For most taxes, like sales or income, the government sets a fixed percentage that it will collect, and then sees what revenue comes in.
For property taxes, on the other hand, the city government sets the exact revenue it wants to collect, and then works out what percentage to charge each existing property to get that revenue.
There are several important implications to this backwards system, all of which cause difficulties to the city.
First, city revenues don’t increase automatically with inflation and growth. The provincial and federal governments get more money automatically from the same taxation rates most years, because prices and incomes have gone up, and there are more jobs and more sales. That’s why they seem to be able to both increase spending and cut taxes at the same time.
The city, by contrast, will get exactly the same amount of money each year from existing properties. There is not even any increase to compensate for inflation.
The only way the city can increase its revenue from existing properties is by increasing its revenue target. The media generally describes this as “raising taxes”.
Here again, the city is a victim of the backwards property tax system. For other types of taxes, “raising taxes” refers to increasing the percentage that the government collects. If we judged the city by this standard, Toronto would in fact be a tax-cutting juggernaut. Between 2002 and 2007, Toronto’s residential property tax rate dropped from 0.73081% of a property’s value to 0.5888434% — a cut of about 19%. Commercial taxes dropped by slightly more.
(The drop is because property values have increased quite a lot, much more than municipal spending. Quite a lot of properties in Toronto, whose values have increased slowly, have enjoyed a small reduction in the amount of money they pay in tax in recent years).
If we were to judge other levels of government by the amount of extra revenue they raise, we would find that they usually increase their revenue in absolute terms by 5% or more each year — far more than the City of Toronto has been doing. Yet they give the appearance of keeping taxes steady or cutting them, while cities are presented as raising taxes every year. It makes city governments look less competent, despite the fact the City of Toronto, for one, has actually been operating under much tighter fiscal constraints than upper levels of government.
The one way that city governments can get more money from property taxes without “raising” taxes is if more units are built. Revenue from new units becomes an addition to the existing property tax base, expanding it. That creates a temptation to accept as much development as possible in order to raise revenues without a “tax increase.” Of course, more units means there are more people who need more services, but a council desperate for money could overlook that problem.
When I talked to Shelley Carroll, she agreed that this temptation was a danger, especially in smaller councils where greenfield developments could bring in lots of money, but she felt that most Toronto councillors understood that it wouldn’t actually improve Toronto’s situation, and would not fall into that trap. I’m not entirely sure myself — while I have no doubt that most councillors are consciously aware of the trade-offs, I think that the unconscious bias is powerful, especially given that many downtown developments are not accompanied by huge increases in service like new police stations, so that the costs are more hidden. Intensification is good, of course, but the danger is that the need for new revenues will lead to ignoring planning considerations in order to build as many new units as possible, without expanding services to match.
(Note that even when new units are built, a mature city like Toronto probably won’t get revenue expansion that is equivalent to economic growth, because the new units are still a small percentage of the overall size of the city. The new units factor makes a much bigger difference to a small municipality.)
The fixed property tax system also, to some extent, insulates the city government from the state of existing neighbourhoods. Upper levels of government suffer if the economy is declining, or are rewarded with more revenue if the economy is doing well. But the city gets the same revenue whether neighbourhoods are improving or declining. This situation reduces the fiscal incentive for the city to try to make existing neighbourhoods better, or to try to do something about the problems of declining neighbourhoods. Overall, the result is that the property tax system tends to push a city in the direction of seeking new development rather than nurturing existing properties.
The final big problem with the property tax system is rhetorical. It gives an in-built advantage to right-wing tax cutters in public debate. City politicians who simply want to maintain services at existing levels have to “raise taxes” every year. By contrast, anti-government politicians can call for a reasonable-sounding and attractive “tax freeze,” which actually means cutting city revenues in real terms (because of inflation).
Such a promise helped Mel Lastman get elected mayor of the newly amalgamated Toronto in 1997, and his three years of tax freeze in the midst of amalgamation caused problems for the city’s budget that still have repercussions. In Ottawa’s 2006 municipal election, the progressive candidate lost his lead in the polls and eventually the election to a right-wing candidate promising a tax freeze.
The property tax system has these peculiarities because it’s one of the oldest forms of taxation around. It developed at a time when growth and inflation were fairly slow, and when municipalities had fairly small populations and provided limited, predictable services.
Property taxes were also shaped by the subordination of municipal governments to the province. For a long time, the province has imposed a rule that municipal governments are not allowed to budget for either deficits or surpluses [clarification – in their operating budget. They can borrow for the capital budget]. (That’s another reason why local governments are required to set revenue targets for the tax, rather than seeing what the economy brings in — they need to be exact in their projections).
But, as Carroll says, “the original design doesn’t match up with today’s reality.”
Cities now have much greater responsibilities than they did in the past, including social services whose costs fluctuate with the economy, and large capital projects. And once a city gets to a certain size, these responsibilities begin to expand rapidly. Carroll explains that most cities start to look for new sources of revenue that grow with the economy as they approach a population of a million. By three million, cities cannot really function without alternative revenue sources. This need is why Toronto’s city council introduced the land transfer tax last year.
I have to wonder, though, if we shouldn’t also look at modernizing the property tax system itself so that property tax revenues grow with inflation and the economy. It’s tricky, but I think there are ways to do it. The second part of my NOW article deals with that, and, while there’s a section that doesn’t quite make sense because of cuts, I refer readers to it if they are interested. This post has gone on long enough for even the most patient Spacing reader.
photo by Trea Brown