Intelligent Investing Panel

Just Cut Property Taxes!
David
Serchuk, 03.05.09, 06:00 AM EST

Lowering property taxes would do more to keep people in their
homes than any government rescue plan.

There is an unpleasant surprise lurking in the mortgage meltdown for many
homeowners. Despite free-falling home values, property taxes and property
assessments remain stubbornly high. The problem is that though house prices are
falling, tax assessors are slow to acknowledge it. That means many homeowners
are paying taxes at homes with assessed values that they would never be able to
fetch in these markets. In some cases, property taxes are even rising.

Example A: Clark County, Wash. As reported by The Columbian
newspaper, $476.8 million in property taxes will be collected in 2009 on
properties with an assessed value of $47.8 billion. In 2008, those numbers were
$469.3 million on assessments of $48.3 billion. At the same time, home values
fell 6.2% from December 2007 through December 2008.

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Los Angeles County is in a similar boat. Taxable properties were assessed at
$1.1 trillion in fiscal year 2008, an increase of 6.9% over the prior year. In
that same time the S&P/Case-Shiller Home Price Index noted that home values
decreased by 25.3% in the L.A. metropolitan area. It should be noted that the
Los Angeles County assessor's office lowered assessments on 128,000 homes last
May, in the wake of the housing meltdown. But the average property tax rebate
after this reset was just $750.

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Feature: America's Highest Property Taxes

In New Jersey, high property taxes are a way of life. The Philadelphia
Inquirer reported last June that the Garden State has the highest property
taxes in the land at $6,796 per household, an increase of 50% in just five
years. The New Jersey League of Municipalities noted in 2005 that property taxes
represented 45% of all state and local revenue; the national average was 31%.

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On This Story

The problem is that, as noted above, municipalities have grown addicted to
the cash flowing from these taxes. As many homeowners saw their homes reassessed
upward during the housing bubble, town budgets swelled. But as these funds
threaten to dry up, towns across America are facing some pretty dire
circumstances.

Stockton, Calif., exemplifies this. Identified by Forbes as
America's most miserable city--courtesy of massive foreclosure rates, a
concomitant housing crash and 10.4% unemployment--it also draws its life blood
from property taxes. The Stockton Record notes that 43% of the city's
budget is drawn from property and sales tax; now that budget looks at an 11%
shortfall. With Stockton close to being Ground Zero of the housing meltdown,
it's hard to imagine how that shortfall will be made up.

While income taxes remain a hot-button issue--witness the hue and cry over
President Obama's most recent budget--property tax issues simmer in the
background, receiving relatively little coverage. One reason is because these
are local taxes, a stroke of the presidential pen can do little to alleviate
them. But an immediate and national resetting of overpriced properties would
almost certainly do more to keep homeowners at all income levels owning homes
than a few percentage points here or there off next year's tax return.

The Forbes.com Investor Team, homeowners all, certainly is on board with
lowering property taxes as a way of staving off a housing collapse.

Vahan Janjigian, chief investment strategist for Forbes, has been beating the
drum for lower property taxes since 2006. He notes that eager home buyers in the
Northeast and Midwest often pay little attention to their would-be tax burden,
but it can amount to a second mortgage.

Jeff Rubin, the director of research at Birinyi Associates, has a ground's
eye view for why property taxes are so hard to repeal, as he is a member of his
village's budget committee. In Rubin's affluent Westchester, N.Y., town, police
can earn in excess of $100,000 and teachers $120,000, both with full benefits
for life. And it's hard to imagine how much actual crime these cops actually
bust in lower Westchester.

Rubin says one problem is that many of the expenses are fixed by contracts
and therefore very hard to re-open. Another issue is that his town, for example,
has virtually no income streams other than property taxes.

Greg Ghodsi, the head of the 360 Wealth Management Group at Raymond James,
says his state has no income tax; therefore, the lion's share of services are
paid for by property and tourism, and both are looking relatively bleak. His
answer to this is a novel one, albeit one guaranteed to make most supply-siders
cringe: institute an income tax. "I can't believe I'm calling for it either!" he
says. "Since we are going to have taxes, why not structure them so they are
balanced?"

Ghodsi add that another reason property taxes are so hard to repeal is
because they are so intimate. "You must face the people you just cut at the
local diner," he says.

Property Tax Tango

Forbes: How come you don't hear anyone beating the drum all
that loudly about readjusting property taxes as a way of dealing with the
housing crisis?

Vahan Janjigian: You are absolutely right about this, and I
have been beating the drum about it since at least 2006. Here are several posts on my blog about this issue.

Jeff Rubin: I have somewhat of a unique point of view on
this subject as I am a member of my village's budget committee.

In my village, police make in excess of $100,000 with lifetime health and
pension and the possibility of retirement after 20 years. There are first
grade teachers in my village that make $120,000 a year ... after working
eight years ... again, with full benefits at retirement. Thank goodness we have
a volunteer fire department.

I wish it was so easy to just lower property taxes. In small towns and
villages, about 75% of the expenses are contractual, i.e., salaries, benefits,
longevity payments and cost of living adjustments. You cannot just lower taxes,
when most of these villages get 90% of the revenue from property taxes, it is
unlikely they will get other sources of income to offset a reduction in property
taxes.

So, in order to reduce the property taxes, the villages must reopen union
contracts, which they are generally against doing, or fire people. Most
contracts have stipulations against firing people. If you are to reduce property
taxes, you must reduce expenses, as it is mandated by state laws that towns and
villages have balanced budgets. As 75% of expenses are contractual, that leaves
very little wiggle room. Are you going to have the police drive less to save
gas? Or turn off the street lights? I agree that it is out of control, but most
small town trustees and mayors do not have the stomach for what is really
needed--reducing the work force and increasing productivity.

These are issues that my board is being confronted with now.

A real solution to making the intrinsic value of a house worth more would be
to raise the tax deductibility of mortgage interest expense. I would argue that
the Obama administration would have been better served if they, for the next
five years or 10 years, tripled the amount that can be deducted for interest
expense for the purchase of a one- to four-family house (either primary
residence or investment property). So, say you paid $10,000 a year in interest
expense, for the next five years you would be able to deduct $30,000 in interest
expense each year from your federal taxes. This would greatly increase the
intrinsic value of houses.

Do not get me wrong, I have called for a 10% reduction in the work force
except for police in my village but to no avail.

Janjigian: When foreclosures rise high enough, they will
listen to you.

Ghodsi: From a Florida perspective, things look bleak with
regard to property taxes. Our state economy was built on development and
tourists. As long as new homes were going up and people traded up, taxes were
generated. This only really bubbled up since 2000, so I am perplexed as to how a
state budget can grow so quickly. If we were able to manage before, why is it so
difficult today?

For example, I have lived in the same house since 1993 in Tampa. Because the
state has a program that caps your property tax increase every year, I pay half
of what some of my neighbors pay for a similar home. The situation in Florida is
much different for most of the country in that we don't have a state income tax.
We rely mainly on sales and property taxes to run the state. I hate to say it
because it will cost me more money, but the state needs to consider a state
income tax. We could then drop property taxes and create a more balanced way to
fund the state budget.

Lower property taxes, in theory, would make it easier to sell homes at more
attractive prices and then perhaps increase the state population again. Because
states run balanced budgets, that is one of the reasons why I like municipal
bonds so much. For the states to service their bond debt, the economics will
force the states to manage their workforce and the benefits the same as
corporate America. At this point in the argument, you ask what level of services
do I as a citizen expect from the state? When my house is on fire, I want the
fire department there quickly; when I am out in public, I would like to know
that police are on patrol.

Jeff's situation is faced by just about every municipality. What makes it so
difficult in small towns is you must face the people you just cut at the local
diner. Another way, if voters approve, is to float more municipal bonds and then
if the growth does not keep up you are forced to cut services to meet your bond
debt service. My example would push the hard decisions to the future.

Janjigian: Jeff, I suspect you live in my village. We have
very similar problems.

First of all, I am opposed to providing tax incentives to buy houses. I would
prefer to eliminate all deductions, including the mortgage interest deduction.
The government should not be in the business of favoring one industry over
another. Of course, this would be a terrible time to get rid of this deduction.
It is something that should have been done long ago. Second, even though
property taxes are tax-deductible, the AMT [alternative minimum tax] prevents a
growing number of people from benefiting from this deduction. As a result,
homeowners are getting crushed. They face falling property values and rising
property taxes at the same time. Governments are great at finding ways to spend
money. We need to restrict the flow of cash to governments. Municipalities will
just have to bite the bullet like the rest of us. If they have to, they must
renegotiate these union contracts. In many cases, the biggest portion of
property taxes goes to schools--another reason why we should eliminate direct
funding of schools entirely and go to a voucher program.

Also, Greg, I can't believe you are calling for a state income tax. Your
politicians would be happy to introduce one I'm sure, but there is no way they
would eliminate property taxes in return. In New York, we have income taxes,
property taxes and sales taxes, yet that does not seem to be enough to satisfy
our politicians. No matter how much money they collect from you, they will
always find something else to spend money on. The last thing you want to do is
give them additional sources of revenue.

Ghodsi: I can't believe I am calling for it either! Since we
know we are going to have taxes, why not structure them so they are balanced. In
Florida, with the tax structure we have, we sink or swim with the housing
market. In return for state income tax cap, property taxes so they have to drop
immediately. In crisis, people are more receptive to change, so we should be
discussing how we should pay for government services. Also, at a federal level,
it is time to start the discussions again about our tax system. I would love to
hear more about the flat tax.

Rubin: Vahan, I live in lower Westchester County. Removing
all deductions for home ownership would create even worse conditions than exist
now. If you propose eliminating all subsides, does that also mean the $500,000
tax deductibility of capital gains on your primary residences if you are
married? Providing a deduction for mortgage interest is not favoring one
industry over another, that assumes that another industry suffered because that
deduction exists. I do not believe you have the evidence to support that
claim.

I am not sure we want to dive into the AMT, but every year there is a
stop-gap measure that is passed. ... So the middle class is not hit with it. And
to say the $787 billion stimulus was a stimulus is a joke because it contains
this year's stop-gap measure for the AMT, which would have been passed anyway.
... Sorry I digressed.

I agree there needs to be fiscal discipline, but unfortunately unions are too
strong and scare politicians too much for them to do it. A better solution would
be to force fiscal discipline on them by passing legislation, similar to
California and Massachusetts, that caps the increase in property taxes in a
given year.

The other issue that was not discussed is that the municipalities encourage,
especially in Westchester, their employees to live in the town they work. In my
town, the average home price is $750,000; someone making $60,000 a year cannot
afford to live there, so you need to pay them more, which raises the property
taxes etc. ... It is a vicious circle. Lastly, discussing property values in our
area--they are down 10% from their high, on average ... given that they were up
100%-plus from 2000 to 2005, a 10% decline is small. Anyone who thought prices
were going to continue up at the pace they went up from 2000 to 2005 deserves to
be under water on their mortgage or have negative equity in their house.

I bought my house in July 1999. ... I still have a 90% gain in the value of
the, house and, yes, I pay high taxes, and, yes, they should be brought down
significantly, but the taxes have always been high in this part of the U.S.; the
only difference this time is that prices are coming down. But remember, property
taxes have not doubled from 2000 to 2008 ... even though many houses are still
up 100% in value.

My view is that house prices will not rebound in value, but instead will stop
going down and then go sideways for 15 years or so and be depreciated by
inflation as it once again increases.

Ghodsi: Jeff, when someone buys a home today in New York,
how is the property tax calculated? In Florida, you pay the current assessment,
and then annual increases are capped. If you sell, then the next person pays the
new assessment rate. This structure has filled the state of Florida with money
over the past few years until 2007. Every home sale was appraised at the new
higher value and tax collections increased. Obvious today ... the incorrect
assumption was home prices always go up. The double whammy for Florida was the
hurricanes of a couple years ago. Insurance costs have skyrocketed to make
housing even more unaffordable.

Rubin: It depends on the town you live in. The vast majority
of the towns/villages have not had a reassessment in the last 45 years. My
parent's house is assessed at $20,000. ... They bought it for $50,000 in 1971,
and they pay taxes on it with a valuation of $20,000. But that does not matter
because everyone else's is assessed at such low rates. My village a few yeas
back did a reassessment to fair market value and readjusts yearly. ... In the
beginning, it hurt only because of the country tax, as it looked as if my house
went up 500% but other town's houses stayed the same so our portion of the taxes
went up. But now, it actually helps me, as my property value is falling and is
reassessed yearly. ...

So to your question, Greg, it depends on where you live, but the vast
majority of towns do not reassess when the house is bought or sold, but instead
rely on 45-year-old assessments with a given mil rate to calculate the tax.

Janjigian: We must be neighbors. I bought my house in 1997.
It is currently assessed for 118% more than I paid for it, but I am convinced
that it is really worth only about 80% of the assessed value. As for my taxes,
they have indeed doubled since we've moved in, and we have made no improvements.

As for the $500,000 tax deductibility, in my ideal world, that would not be
an issue because capital gains would not be taxed at all.

Furthermore, when mortgage interest is tax deductible, that indeed favors the
housing industry over other industries. Why can't I deduct interest on a loan to
buy a car? I used to be able to do that years ago. Why can't I deduct interest
on credit card loans? It's only because politicians have decided to favor the
housing industry. In some states (Massachusetts), you can't deduct the interest
on mortgage loans, but you can deduct rent payments. These tax rules are
haphazard. They occur primarily because one industry or another has done a
better job of lobbying the politicians. I agree that now is not the time to get
rid of the mortgage deduction, but it is a deduction we never should have
allowed to begin with.

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