Death and Bad Tax Policy

 Actually, not at all. (bizarrocartoons)

Actually, not at all. (bizarrocartoons)

NYC Housing Policy Tools Series

Over the next few weeks, as we prepare for the Trump Era, I will spend time on various housing policies in NYC in order to help frame the the affordable housing crisis.  I have picked four topics related to NYC housing laws: rent regulation, zoning, occupancy, and property taxes.  I concede that there are other policy tools that could be included (particularly around financing) but these four tend to have an immediate impact on the most people.  The hope for this blog series is to explain the current policy tool kit in New York, but also to show why questioning the underlying assumptions about housing policy might be able to expand it. 

Part 4 of 4: Death and Bad Tax Policy

For my final post about NYC policy tools, I come to perhaps the most opaque and the most frustrating topic: property taxes.  I can honesty say that after years of studying housing issues, I think the property tax system is the single biggest source of injustice in housing. The incentives are warped, the metrics are arbitrary, and the goals are backwards.

That last point is an important place to start.  What is the goal of tax policy? It is simply to allow a government to provide a baseline of services – police, fire, water, etc? Is it to encourage or discourage a particular type of activity or behavior? Is it to promote social cohesion through income distribution? Depending on your political ideology and personal experience, you probably have a clear idea of what you think it is supposed to do and not to do.

But if you think tax policy shouldn’t be designed to impact behavior or social outcomes, you might be disappointed to find out that all tax policy does that. All tax policy ever.  Anything that a government chooses to tax or not to tax obviously has social and economic consequences. Any federalist or anti-federalist can wrap their rhetoric on taxes around liberty, strong governance, and whatever they want, but they are attempting to codify subjective values. 

(There are also inherent problems with relying on property taxes to pay for things like public education that impact behavior and social outcomes, but I’ll address that at another time.)

This is what is so confounding about NYC property taxes.  What values are being projected? Nominally, it is designed to provide tax relief for homeowners but it doesn’t exactly do that. It is sort of designed to give tax benefits to condo/co-op owners, but it in fact gives huge benefits to speculators.  It isn’t expressly designed to screw renters, but it absolutely does.  For a city that is two-thirds renters, that is ass backwards.

Since 1981, NYC has split property into four classes with varying tax rates – Class 1: single-family homes (19.991%), Class 2: multiple-dwelling buildings (rentals, condos, co-ops) (12.892%), Class 3: utilities (10.934%) and Class 4: commercial (10.574%).  For this blog, I am only focusing on Class 1 and Class 2.

On the surface, it looks like homeowners get screwed comparatively.  But below the surface, these numbers are almost meaningless to compare.  How the value of each property class gets assessed, what portion of a given property can be taxed, and how often a property tax assessment can change all vary dramatically. 

There are two big differences between how this system works for Class 1 and Class 2.  In Class 1, the Dept. of Finance measures the market value of a property by matching it to comparable real estate sales in the surrounding neighborhood. This gives as close-to-market value for the land as possible.  In Class 2, instead, the DOF measures property income – ie the rent roll – rather than property value. (If you wonder why certain ground-floor retail space remains empty in buildings for a long time, here’s your answer. Unless a landlord can get exactly what they want in rent from a retail space, they have an incentive just to write it off.) 

Second, for Class 1 and Class 2, there are limits to what percentage of the market value the DOF can tax.  Instead of applying the 19.991% or 12.892% to 100% of the property value in each Class, Class 1 has a limit of 6% of a property's market value, while Class 2 has a 45% limit.  

There is also a 20% cap on how much a tax burden can go up over 5 years in Class 1. In other words, a homeowner is only getting taxed on 6% of the market value of their property and pays the 19.991% tax on that number.  And even if the neighborhood has exploded in value, there is a limit to how much the property tax can go up. These factors mean there is an effective tax rate (ETR) much lower than the stated rates.

A few years ago, City Limits showed a stark example of this inequality. Mayor de Blasio’s Park Slop home was valued at $1.4m but assessed $2,894 in property tax. A similarly valued home in Borough Park was assessed $15,000 in property taxes. The difference is how fast the value of Park Slope homes have changed compared to Borough Park.  This means that the biggest tax savings inevitably go to homeowners who live in highly valued neighborhoods. 

Owners of co-ops and condos, particularly in Manhattan, are the biggest beneficiaries in the current system. As I mentioned earlier, because Class 2 combines these with rental buildings, the DOF draws their assessment from the income streams of these buildings even though they are dramatically different enterprises.  (There is also a large tax abatement on the books since 1996 that gives back as much as 25% of property taxes for co-ops and condos.)

In some cases this means that an individual unit in a co-op can sell for more than the entire measured property value of the building.  According to the same City Limit report, a couple of years ago a co-op unit in the UES sold for $54m while the entire building was valued at $41m. That co-op owner’s property tax was on 45% of $41m divided by how many other units there are in the building, minus whatever further tax abatement they were qualified for.

This means speculators can make a killing in this market segment.  It’s why so many foreign interests buy this type of asset (see my blog on the Panama Papers.) I’ve already spent a lot of blog space talking about how 421a distorts the real estate market by giving away tax benefits to high-end developers and their buyers.  You can see how that policy on top of this tax system effectively erases any tax liability for these high-end buildings, which lends itself to favoring speculation.

Let’s talk about why renters get screwed in this system. To begin with, based on the way the Class designation works, renters live in buildings with a higher tax burden than single-family homes and condos/co-ops.  Renters ($41, 262) also have less than half the household income of homeowners ($86,468) in NYC.  As a result, you have a higher tax burden getting passed to individual households with lower incomes, causing a higher relative tax burden on renters.

Renters also don’t internalize the property tax system as much as homeowners do, even though their rent does.  This leaves renters without any political power to change the tax system. Just as I discussed how market-rate tenants don’t organize with rent-regulated tenants, very few tenants organize around property tax reform – they don’t think it applies to them.  This allows a deeply unfair system to remain in place and it robs the city of much-needed and rightfully deserved revenue.

Beginning shortly after the system came into place in the 1980s, there have been efforts by mayors, the city council, and other advocates to reform the system. The problem here is that Albany controls the tax policy.  Specifically, it controls how the classifications are defined, what % of an assessment counts towards billable tax, what the caps are, and how any corresponding abatements apply. NYC can set the specific rates in each classification, but that’s it. 

There isn’t much political will to change this system currently because it means upsetting the powerful developer interests in NYC (who benefit from the high-end speculative market segment) or upsetting homeowner groups.  Without a unified renter effort, it is difficult to change the status quo.

What would a fair property tax system look like in NYC? A good place to start would be reclassification.  Homeowners should be in one class whether they own a single-family home or a condo. This would remove the grave disparities between single-family home and condo/co-op assessments as well as separating owners from renters altogether.  In a city that is majority renter, many of which are poorer, having a system that burdens renters unfairly is self-defeating.  

Second, matching the billable percentages in each class somewhere in the middle would bring an effective tax rate in line to remove differences between owners and renters.  Additionally, this could remove the tax advantages that fuel speculation on the high-end ownership market. This distorts land-use and prevents more productive and equitable development.

Finally, removing the caps on increasing property taxes in popular neighborhoods would allow the city to capture the proportional value increase that a homeowner garners.  Given that the city is providing the same, if not better services to warrant that increase, it is entirely reasonable to do so. If there is concern that a dramatic increase in property tax might be too much for a poorer resident, institute a case-specific means-testing increase rather than a blanket cap.

These are just some of the ideas that have been floated, but there needs to be political action taken to organize renters on this matter. If there is one commonality between all four of these sections it is that point.  Renters are a sleeping giant in New York politics.  If awoken and organized, they can reframe the economic and political policy discussions in the city and create an unprecedented period of innovation and reform that could benefit all parties in the city.