Can a Circuit Breaker Ever Really Work?
Submission to Chairman, Commission on Property Tax Relief
H. William Batt, Ph.D., April 23, 2008

Wednesday, April 23, was the final testimony hearing for the Suozzi Commission in Albany,1 and I stayed throughout the session not just to testify myself in favor of the deferral option but also to listen to what others had to say about possible property tax relief. I was astonished to see how much support there was for the property tax "circuit breaker" option.

1 New York State Governor's Commission on Property Tax Relief www.cptr.state.ny.us.

The "circuit breaker", for those who don't know, is a provision whereby a household's property tax liability would be automatically limited (i.e., capped) by formula if it exceeded a stipulated proportion of its income2 — hence application of this electrical metaphor. Assemblywoman Sandy Galef and Senator Betty Little have collaborated to sponsor a bill that would offer relief in accordance with both variables in any given year.3 It has been endorsed by the Fiscal Policy Institute (FPI) which has provided considerable analysis of its distributive impacts.4 At least so far as that is possible!

2 Presumably this would be applied to either one's federal or state adjusted gross income.
3 A. 1575A and S. 1073A For more description, see http://assembly.state.ny.us/mem/?ad=090&sh=story&story=25874
4 http://www.fiscalpolicy.org/propertytaxresources.html

It is that which I doubt. The whole scheme so ignores several critical variables and confuses concepts5 that it can never hope to achieve its goals, however noble the attempt. No matter that many other states have adopted the "circuit breaker" idea, its problems are so basic, at least as now conceived, that it can never be more than a poor solution to what is essentially a conceptual problem. That other states have adopted this program is no reason for believing that it is sound policy; rather, there is every reason to believe that it has been adopted more by default for reasons that its impacts and implications have not been thoroughly scrutinized.

5 I have addressed much of this confusion in other papers, see www.wealthandwant.com.

At its sponsors see things, the fundamental challenge is to find equity in taxation by linking income with wealth. But the correlation between income and wealth is very problematic, especially as people enter their advanced years. A home may have radically appreciated in value, while the owner's income, perhaps only a pension and Social Security, has precipitously dropped. Sometimes also households have temporary exigencies — losing a job, for example — that lead to inconsistencies between incomes and home values. Efforts to solve such incongruities by the "circuit breaker" can never properly assess these real world situations. Moreover, because the data used to calculate the tax burden will always be incomplete and problematic, one must always doubt how fairly the tax design plays out in practice. The property tax as now understood is a wealth tax, a poor one at that.6

6 Plausibly the property tax, particularly the portion that falls on land value, could be seen as a user fee, as payment for use of sites according to their market value. In some localities the lion's share of residential parcel values is in land, particularly for older homes. But there has been little discussion of it in this vein. Were this logic to be employed, there would be little likelihood that relief measures would be offered, any more than for parking charges.

Moreover, one could argue in passing that it misconstrues the nature of wealth. Accepting natural resource as wealth through capture of property titles leads down a path of windfall gains that are not only unearned but frequently ephemeral. We are seeing this now particularly in what may be the biggest real estate bubble since the 1930s.

It is the focus upon equity concerns that are the root of the problem. If it were clear that the equity problems were really solved by the "circuit breaker" provisions, argument for their adoption might be persuasive. But that can't be shown. All that its proponents can do is offer models or sample cases, none of which adequately justify the imposition of a scheme which, in consideration of its other limitations, hardly warrants further defense. FPI has been able to show distributions and benefits in the aggregate, but would be hard put to show the validity of its claims if variances were taken into account. Still, while the equity claims are problematic and never conclusive, other liabilities the "circuit breaker" solution faces are massive.

Any tax regime needs to be judged according to a number of criteria, the tenets of which have been enumerated and refined since the work of Adam Smith. I have chosen in my writing to break them down into six because it offers the best explanatory refinement. They are neutrality, efficiency, equity, stability, administrability, and simplicity. The "circuit breaker" tries to meet the principle of equity, or fairness, but at such a huge cost in compromises to other principles as to be not worth the candle.

The first problem it faces is in its compromise of tax neutrality as it attempts to achieve equity. A neutral tax is one in which decisions about the use of a tax base are unaffected by the application of the tax. It is obvious that a "circuit breaker" will typically alter a household's choice of options when it is applied; indeed that is its intent. Whether such intents should be fostered as a matter of policy ought to be openly discussed, not hidden in agendas that are only partially explicated. For example, any tax relief granted by a "circuit breaker" will be capitalized in part in a parcel's market value, thereby altering the considerations applied to it for alternate use. Other public considerations should play a part in such choices; for example, preferential tax relief may compromise efforts to foster the "highest and best use" of locations. Issues of generational equity are raised by institution of "circuit breaker" relief. The policy can even influence the choices beyond public view faced by families alone.

A second concern is raised by the impact of a "circuit breaker" upon the performance efficiencies of the economy. As noted above, the policy may compromise land use considerations of highest and best use, so that patterns of sprawl and urban blight are engendered. The distributional impacts of the policy will likely create considerable deadweight loss, not just by the spatial configurations fostered but also by resource allocation among households and commercial interests. These are harder to identify and measure, but they are nonetheless real, especially in view of scarce resource allocation that necessarily obtains in the real world.

The matter of fairness, the one that the "circuit breaker" is intended to address first and foremost, after all is said and done leaves out of the equation several other parties to claims on distributive justice. Among them are not just those in different income and age groups that are typically excluded, but those who are not homeowners at all — renters, non-residential titleholders, and so on. Deliberately or not, studies of property tax incidence often fail to take into account these other titleholders, especially with respect to claims about progressivity. Their self-serving nature is often explained by their sponsorship, those done by AARP, for example.

The "circuit breaker" is not likely to have any significant impact upon the stability of a revenue stream, unless, as in California, tax obligations are linked to assessment practices which only occur with a title transfer. In those cases, the forgone tax revenue is reflected in the market value of parcels. There the ripple effects wrought by the wholesale corruption of the property tax regime has affected not just stability but every other principle as well.

It is the administrability and the simplicity of the property tax that are most compromised by the "circuit breaker." Take first of all the simplicity concerns. The formula as it stands incorporates factors of household income, of property tax burden, and both are adjusted to accommodate the regional differentials that are so profoundly evident in New York State. Those regional differentials are extremely broadly drawn, and palpably invite compromise in equity concerns they hope to address. Those differentials take no account of the tax rates that obtain regionally. In downstate areas, they are in the neighborhood of 1 percent; upstate, as high as 3 percent in some places.

A still further consideration involves the wider economic and public policy forces at work influencing property values inter-regionally. Transportation costs have an enormous influence upon the market value of sites — consider the projected real estate growth in anticipation of improved rail service in the Hudson River Valley. One need also only recall the projected impact two decades ago of the removal of tolls on the NYS Thruway as an illustration of such factors.

Consider further the changes in the IRS code regarding the write-off of capital gains on the rise of second homes which in fact are often claimed as primary homes. Innumerable factors have had an impact on property values beyond what any simple relief formula is able to address.

An analogy can be drawn with the experience of the federal government decades ago where a growing number of exemptions, deductions, credits, and other modifications were made to the personal income tax. The growing complexity and confusion surrounding such designs culminated in 1986, when agreement was finally reached to broaden the base and lower the rates. This was an effort to bring simplicity to the system once more. The property tax faces a similar experience now in growing complexity, all of which threatens the integrity and legitimacy of the design. A good part of the antipathy toward the property tax is due to suspicion and antagonism of its administration, but an equal measure of blame should be directed toward its design. The "circuit breaker" would compound this sentiment.

One needs to look at how the property tax base itself is managed to see how vulnerable any formulas are to distortion, obsolescence and abuse. As noted elsewhere, the real property tax from an economic perspective is really two separate taxes, each with its own peculiar dynamic.7 It is a tax on land values and a tax on improvements (buildings or structures). A Federal Reserve Board study discerned that improvements typically depreciate at 1.5 percent per annum.8 This means that over a relatively short period of time a building will have a much lower market value. Land values, in contrast, appreciate, these typically far faster than the cost of labor and goods or the rate of inflation generally. Much of this is influenced by factors such as the health of the local economy. But a significant influence also is the attraction of real estate as an investment venue, precisely because it has been so favored by public policies. Assessments quickly become dated unless they are revised regularly, and too much reliance upon their validity simply invites challenge to their soundness. Given that assessments are so problematic, why should political leaders adopt a tax design that rests upon such questionable data variables? Ample evidence exists, much that I can provide, that demonstrates how poor the assessments presently are, and not just in New York State.

7 Several of my other papers speak to this matter. See, for example, Explaining the Virtues of a Land Value Tax for Those Who Never Had Economics 101, at http://www.wealthandwant.com/docs/Batt_Virtues_LVT_101.htm and Property Tax Relief Measures: Answers to the "Poor Widow" Argument at http://www.wealthandwant.com/docs/unindexed/Batt_poor_widow_solution.htm
8 Morris A. Davis and Michael G. Palumbo, “The Price of Residential Land in Large U.S. Cities,” Finance and Economics Discussion Series, Washington: DC: Federal Reserve Board, 2006.

The last consideration prompts questions about whether the "circuit breaker" is indeed administrable at all. To be sure, public officials are imbued with a "can do" spirit and a service orientation that leads them to accept and respect whatever laws are enacted by legislative bodies. But surely they have an obligation to speak to questions about the administrability of laws they are expected to carry out. Testimony before the Assembly Property Tax Committee elicited assurances from its spokesperson last year that difficult provisions relating to the STAR program were finally being dealt with. But this was years after the program was initiated. The confusion and misunderstandings concerning its administration were costly not only in time and resources but also in loss of public trust. It is this very sentiment that is now prompting calls for a redesign in the property tax regime: the old system isn't working.

But will the new one work? Can it work? Of course, it will likely hobble along if it is enacted. And the public will likely comply with the same level of resentment and suspicion that leaders are taking as a benchmark of all tax regimes. Every indication suggests, however, that, if the "circuit breaker" is adopted, it will have as many problems as earlier designs, suggesting that a more concerted and deeper analysis of applicable principles of taxation is called for. This I have addressed in other submissions to the Commission. A far more palatable, politically salable, and administrably feasible alternative is the deferral option.9 It involves far fewer people and parcels, far easier and quicker to institute, and a better way to encourage the economic vitality of New York State's suffering towns and cities.

9 Property Tax Relief Measures: Answers to the "Poor Widow" Argument at http://www.wealthandwant.com/docs/unindexed/Batt_poor_widow_solution.htm