Monday, November 26, 2012

Full Value versus Fractional Value Assessing — A Comparison

Property tax in New York State is fundamentally based on current market value. But this simple fact is obscured by New York’s convoluted municipal assessment system, in which some towns, cities, and villages are assessed at full market value, while others are assessed at a fraction of market value. Whether properties are assessed at full or fractional value has no effect on tax bills, though many taxpayers and even some government officials seem to think otherwise. This post attempts to demystify fractional value assessing from the viewpoint of the assessor’s job.

An assessing unit is a municipality which has the power under New York State law to estimate the value for taxing purposes of each parcel of real estate in its jurisdiction. The assessing units in Dutchess County are the 20 towns, the 2 cities, and some of the 8 villages. Each assessing unit has a government official called an assessor, whose job is to estimate the current market value of every property in her assessing unit, and to publish these determinations in a list of properties called the assessment roll. The reason for the focus on market value is that property tax is fundamentally based on market value. For each property in the yearly assessment roll, the assessor includes the assessment of that property for that year. The assessment is not necessarily the market value itself, but it is always a measure of the market value. The essential difference between assessments at full value and assessments at fractional value is the way the assessor expresses the assessments in the assessment roll.

Market Value Depends on Condition of the Property

The market value of a property is simply the amount a willing buyer would pay a willing seller for the property. It is obvious that the market value of a property depends on the unique characteristics of the property, including the condition of the property. If the condition of a property changes significantly from one year to the next, such as by major improvement or damage, it is obvious that the market value of the property will change to reflect this. Your decaying house built in 1910 might sell for only $100,000, but if you tear it down and build a McMansion, your property might sell for $1 million. If the McMansion burns down, your property might sell for only the value of the land, say $20,000.

The condition of most properties generally does not significantly change over relatively short periods of time. Most properties are not significantly improved nor suffer significant damage from one year to the next. So you might think that the market value of most properties does not change from one year to the next. Wrong! Market value of real estate also depends on forces unrelated to the condition of the property.

Economic Forces Cause Market Values to Trend Up or Down

The market values of properties often change over time for reasons unrelated to the condition of the properties. Large scale economic forces independent of the condition of individual properties affect real estate values. These forces generally affect all properties in a neighborhood or region in the same way.

Assessors employ “trend analysis” or trending to account for these forces. This means that for every property in a neighborhood, or even in her entire assessing unit, the assessor adjusts last year’s market value by a fixed percentage to account for these forces. For example, if real estate values decline 3.57 percent (as happened in the Town of Hyde Park this year), she would lower the market value of each property by 3.57 percent to indicate this.

What about Equalization Rate, Full Value, and Fractional Value?

Notice that we’ve come all this way in the discussion without mentioning the dreaded term “equalization rate”. We also haven’t yet mentioned the terms “full value” or “fractional value” that are the subject of this post. That’s because, as I cannot emphasize too strongly, none of these concepts plays a role in property tax. Property tax is fundamentally based on market value, and the essence of the assessor’s role is to estimate market value.

The only difference between assessing units which are assessed at full value and assessing units which are assessed at fractional value is the way in which the assessor expresses the market values of properties.

Assessing at Full Value

The term full value is just an assessor’s term for “market value”. In an assessing unit assessed at full value, the assessor expresses the market value of every property directly, by actually showing the market value for every property on the assessment roll. But for historical reasons, and perhaps to confuse the unwashed, she doesn’t actually call it “market value”; she calls it assessed value. So in an assessing unit assessed at full value, assessed value is market value.

Assessing at Fractional Value Was Illegal For Centuries

The land we now call New York State has had property tax for three and a half centuries (with some respites), beginning here more than a century before the birth of the nation. For at least the last two centuries, the real property tax laws provided that tax amounts be proportional to the current market value of properties. This concept provides a basic element of fairness: Two properties with the same market value should pay the same tax to a given taxing unit such as a school district, even if they are in different assessing units. So property taxes in New York have always been fair, right?

Well, no, not at all. What the law said was one thing, but what actually occurred was quite another. For two centuries, properties were routinely assessed well below market value, in successful attempts to gain tax advantages for constituents. Sometimes assessments were made at a uniform fraction of market value within an assessing unit, but apportionment of taxes among assessing units was haphazard at best. The result was widely differing taxes among similarly situated taxpayers. For most of our history, these illegal practices were ignored by both the legislative and judicial branches of government, which turned a blind eye to these flagrant violations of the law by the executive branch.

Requirements for Fair Fractional Value Assessing

New York’s property tax system was unfair for centuries, but not simply because we had fractional value assessing. It was unfair because we had fractional value assessing without acknowledging that we had fractional value assessing. Since fractional value assessing was not officially sanctioned, we didn’t compensate for it. But we could have. A system with fractional value assessing can be fair if the following two key requirements are met:

1. Within each assessing unit, all properties are assessed at a uniform percent of market value. The assessor must specify the percent of market value that is used.
2. For each taxing unit (such as a school district) comprising portions of multiple assessing units (such as Towns), the tax levy is apportioned among the Towns in proportion to the taxable market values of each Town or portion thereof in the District.

With fractional value assessing, the fraction of market value in an assessing unit is called the equalization rate or the level of assessment, depending on who’s specifying it.

Why Is Fractional Value Assessment Problematic?

Fractional value assessing is needlessly complex. It introduces gratuitous concepts like equalization rate and assessed value. Fractional value assessing makes it inconvenient to compare property values across assessing units, because two properties with the same assessed values in different assessing units can have completely different market values, depending on the equalization rates. Full value assessing is straightforward and intuitive. Property values are expressed the same way that buyers and sellers of property express them.

Assessing at Fractional Value Became Legal

For centuries, New York’s assessing system was characterized by fractional value assessing, which was technically illegal, but widely practiced, and by apportionment that was fair on paper, but poorly administered. This legacy system was reformed in 1981, but not in the way one might expect. The obvious way to fix the problem of inequitable property tax would have been to enforce the long-existing laws requiring all assessments to be at full value. This was the approach recommended by most legal scholars, by state bureaucrats, and even by then-Governor Hugh Cary. But apparently the voice of reason was no match for the entrenched practice of fractional value assessing, overwhelmingly supported by local government officials and taxpayers who really didn't understand (and still don't understand!) how property taxation works. Listening to its constituents rather than to the tax wonks, the New York State Legislature enacted a law — over Cary’s veto — essentially legalizing for the first time the long-existing practice of fractional value assessing. However, this time, the new law provided for controls at the state and local levels to assure equitable property taxes based on the two requirements for fair fractional value assessing listed above.

Fractional Value Assessing Is Still a Bad Idea

The current system, which uses a combination of full and fractional value assessing, is reasonably fair in distributing the tax burden equitably among taxpayers. However, the prediction of legal scholars that fractional value assessing would lead to confusion has surely come to pass. Many of my previous blog posts discuss misunderstandings of fractional value assessing by government officials and the Poughkeepsie Journal. Most of these misunderstandings do not result in unfair taxation, but in misleading descriptions of the taxation. See, for example, Hyde Park School District Promulgates Misleading Tax Information. New York State has been using financial incentives and other measures to encourage local assessing units to convert from fractional to full value assessing. This pressure seems to be working, though slowly. In 2000, all two dozen or so of Dutchess County’s assessing units used fractional value assessing. Now only 5 do: The Towns of Dover, Hyde Park, Pawling, Pine Plains and Stanford are still assessed at fractional value.

Currency Analogy

Fractional value assessing is analogous to the world’s money supply, with innumerable different currencies. An iPad may cost $500 in the U.S., €390 in Europe, or ¥40,195 in Japan. It does no good to know that an iPad costs 28,000, without knowing that the currency is Indian rupees. Similarly, it does no good to know the assessed value of a property, or even of an entire assessing unit, without knowing the equalization rate. If full value assessing is considered analogous to U.S. currency, then equalization rates are analogous to exchange rates from U.S. dollars to other currencies. Just as exchange rates change over time, so do equalization rates. Having all properties assessed at full value is analogous to having a global currency, a sort of super-Euro. With a super-Euro, prices could be compared world-wide without any conversions. Similarly, assessed values of properties could be compared directly, without the need for equalization rates. Assessed values would just be market values, as they were originally meant to be.

I’d like to thank three anonymous reviewers with knowledge of the assessing process for previewing this post.