Tuesday, September 15, 2009

The Tax Rate Is All That Matters

Whether it's sales tax or property tax, the only thing that matters is the tax rate. The tax rate tells you whether your taxes are high or low, increasing or decreasing, and by how much. This post explains property tax rate (for fire tax, school tax, town tax, county tax, etc.) by comparison with the more-familiar sales tax rate.

A Simple Sales Tax Example

Let's say you go into a used car lot, and a salesperson shows you a car for $10,000. If you buy the car at that price, your sales tax, using Dutchess County's 8.125 percent sales tax rate, will be $10,000 times 0.08125, or $812.50. But suppose you talk the salesperson down to $9,300, a 7 percent decrease. Then your sales tax will be only $9,300 times 0.08125, or $755.63. The sales tax amount is 7 percent less because the cost of the car is 7 percent less. Fair enough.

Now let's add a game-changing hypothesis: When you go back to the dealer the next day to buy the car for $9,300, suppose a new sales tax rate has just gone into effect: The 8.125 percent sales tax rate has been replaced by a 9 percent sales tax rate. So your sales tax becomes $9,300 times 0.09, or $837.

Your used car salesperson tries to mollify you, “That $837 is only $24.50 more sales tax than the $812.50 you would have paid yesterday — if you'd bought the car then for $10,000. That's only a 3 percent increase.”

You don't fall for this specious logic. Your plan was to buy the car for $9,300, not for $10,000. As far as sales tax is concerned, the only thing that really matters is the fact that the sales tax rate increased from 8.125 percent to 9 percent. So the $9,300 car is costing you $81.37 more in sales tax today than it would have cost you yesterday (a 10.8 percent increase), because the sales tax rate increased by 10.8 percent. The old price of $10,000 has nothing to do with the situation. It is the sales tax rate increase that's costing you more money than you would otherwise have had to pay.

Sales Tax Versus Property Tax

The main difference between sales tax and property tax is that you pay sales tax because you bought something (a car), but you pay property tax because you own something (your house). Sales tax is charged at the time you buy something, while property tax is charged every year that you own something. In both cases, the only thing that matters is the tax rate. The tax rate is used to compute the amount of your tax. The amount of your tax is simply the monetary value of the thing you bought or own times the tax rate.

Sales tax is usually expressed as a percent, like the 8.125 percent Dutchess County sales tax. Property tax could be expressed as a percent, but for historical reasons it's expressed as dollars per thousand dollars of market value. For example, a property tax rate of $10 per thousand dollars of market value could just as well be expressed as 1 percent. So a property tax rate of $10 per thousand dollars of market value means that 1 percent of your wealth (your property's market value) is paid to the government. Each year.

A Simple Property Tax Example

Unlike sales tax, property tax is paid every year. The amount of tax you pay each year is the product of your market value and the tax rate. Either or both the market value and the tax rate can change from year to year. Let's say your property had a market value of $200,000 last year, and that last year's school tax rate was $10 per thousand dollars of market value. Then last year's school tax would have been $200,000/$1,000 times $10, or $2,000. (I'm neglecting here the confounding effect of New York State's School TAx Relief (STAR) Program, which essentially subtracts a fixed dollar amount from school taxes for qualifying taxpayers.)

This year, because of declining real estate values, your property is only worth $186,000 on the open market, a 7 percent decrease. But this year's school tax rate has increased to $11.08 per thousand dollars of market value, a 10.8 percent increase. Therefore, your school tax this year is $186,000/$1,000 times $11.08, or $2,061. In summary, this year your property tax bill is $61 greater than last year, or about 3 percent greater. Now, here's your test: How much has your school tax rate increased this year?

If you answered “3 percent” you haven't been paying attention. Go back to the beginning of this post and read again. This time notice that in both the sales tax example and the school tax example, the value you're taxed on decreases by 7 percent, but the tax rate increases by 10.8 percent, resulting in a net increase in tax payments of about 3 percent.

The correct answer is that your school tax rate has increased by 10.8 percent, from $10 to $11.08 per thousand dollars of market value. Once again, the fact that you're only paying 3 percent more dollars is a reflection of the fact that you're paying taxes on a property that's worth 7 percent less.

Why does it matter? Why should you care?

This matters because politicians will try to fool you into thinking that somehow a 10.8 percent increase in property taxes is “really” only a 3 percent increase. Indeed, they already have. My next blog post will show how the Arlington School District is doing this.

Footnote on Measuring Property Tax Rate: Unfortunately, the property tax rate, measured in dollars per thousand dollars of market value, is generally not readily available. Instead, tax bills and public officials tend to talk about property tax rate measured in dollars per thousand dollars of assessed value. These two measures of property tax rate are not quite the same thing, and you may be in a world of trouble unless you understand the difference between the two. Short answer: They're related by the equalization rate. For a more detailed explanation, see pages 6—7 of Document #5 at my companion website.

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