The second main feature of Cut and Cap is a limit on assessment increases for individual parcels. The Headlee amendment currently limits tax increases caused by assessment growth to the rate of inflation, but applies the limit to all existing property, taken as a group.Cut and Cap would place a limit of 3% or the rate of inflation, whichever is less, and apply it to individual parcels. This limit on assessment growth would add to the tax savings created by the exemption, although it could be offset by millage rate increases.
In addition, the cap on assessment increases would result in less "Headlee" rollbacks in millage rates, since SEV would not grow as fast as actual values. Thus, millage rates would be higher under Cut and Cap than under current law, although property tax burdens would be significantly lower because of the 30% exemption for school operating millage.
Market Value Versus Acquisition Value Assessment
The cap on individual parcel assessment growth would change the current assessment scheme from a market-value system to an acquisition-value system. Rather that attempting to estimate the current market value of all parcels, assessors would rely on the cost of acquiring the property, even if it was years ago, in determining the current assessment. Since the annual adjustment is capped at 3%, which is less than the average inflation rate of the past couple decades, the acquisition-value system would almost certainly result in systematic under-valuation of most properties.
An acquisition-value assessment system creates disparities in effective tax rates, because most assessments do not reflect true market values. Those parcels that have been recently purchased are assessed based on full market value, while those purchased years ago are often significantly underassessed. This has raised the question of whether such a system violates the U. S. Constitution's guarantee of equal protection under the laws. This question was answered conclusively in a case involving a provision similar to Cut and Cap in the California constitution.
The U.S. Supreme Court, in Nordlinger v Hahn ruled that the California Constitution's "Proposition 13" assessment growth cap does not violate the equal protection clause of the U. S. Constitution. The court ruled that the legitimate interests of preserving neighborhoods and maintaining predictable and affordable property taxes gave an acquisition-value assessment system a rational basis, and that it did not violate the U.S. Constitution. Cut and Cap would almost certainly pass federal constitutional muster under the Nordlinger decision.
Cut and Cap vs. RJR H: Assessment Growth Caps
The assessment growth cap in Cut and Cap is different from that contained in HJR H. Cut and Cap applies a 3% limit on all parcels, while HJR H applies a 5% limit on homestead parcels only. While any assessment growth cap introduces disparities in effective tax rates, Cut and Cap uniformly applies the cap, while HJR H applies it to only certain parcels. Furthermore, HJR H allows different millage rates to emerge, partially because of the limited scope of its assessment growth cap. Thus, while Cut and Cap would cause some disparities, they would not be as severe or as explicit as those in HIR H.
Appendix I outlines the reasons why the disparities created by HJR H might result in it eventually being ruled contrary to the equal protection clause of the U.S. Constitution.
Pros and Cons of an Assessment Growth Cap
An assessment growth cap has both advantages and disadvantages.
Predictability in Taxation
With an assessment growth cap, taxpayers can better predict the future burden of taxation on their property. Although millage rates still could increase, assessment shock would be eliminated. This is especially important given the sad history of widespread abuses and inequities in assessing practices, vividly recounted each spring in angry meetings of taxpayers and local Boards of Review.
Property buyers normally go through a rigorous screening to ensure that, barring unforeseen financial setbacks, they will be able to support the payments of mortgage principal and interest, property taxes, and insurance within a reasonable share of their income. Banks and other lending institutions, federally-chartered institutions supporting secondary markets in mortgages, and purchasers of mortgage-backed securities all support these standards. However, while mortgage payments are normally fixed, or at least limited in amount, no such limit exists for property taxes. It is not unusual in this state for monthly property tax burdens to exceed the mortgage payments on a home purchased some years ago.
An assessment growth cap limits the annual increase in property taxes due to assessment growth. This is particularly important to senior citizens, retirees, and others on fixed incomes.
A limit on annual assessment growth helps preserve neighborhoods, by allowing long-time residents to remain even if their property taxes, if based on market value, would be prohibitively expensive. Again, senior citizens and retirees are especially vulnerable to being "taxed out of their homes."
No Taxation of Unrealized Gains
While an increase in the market value of a home is a real increase in wealth, it is typically an "unrealized gain," meaning an increase in value that has not been converted to cash. Unrealized gains on other assets, for example stocks and bonds, are not subject to federal or state income taxation. Proponents of assessment growth caps, such as Hillsdale College economics professor and Mackinac Center analyst Gary Wolfram, have argued that property, taxation should not be based on unrealized gain.
Reduction of Assessment Abuses
Under an acquisition-value assessment system, assessments are made when there is strong, solid evidence of true market value: when a parcel is sold. At other times, when the current assessment system is rife with inequities, it does not attempt to estimate true market value.
Reduction of Assessment Administrative Burden
By eliminating the need to assess the market value of every parcel of property each year, an assessment growth cap also eliminates much of the need for the expensive, time consuming, and frustrating assessment bureaucracy and appeals system.
The obvious drawback is the creation of disparities in effective tax rates, as discussed previously. An example is presented on page 28.
An assessment growth cap also creates an incentive to remain in a house long after it serves an efficient function, since the sale of an existing home and purchase of a new one carries an implicit penalty of increased taxation. This is the downside of the "neighborhood preservation" argument.
No Taxation of Unrealized Gains
The argument that unrealized gains should not be taxed has strong appeal, when discussing income taxes, since "gains" are income. The argument does not have the same weight when discussing asset or wealth taxes, such as property taxes. All asset taxes require payment of money that cannot be made out of the value of the asset, unless it is sold. To a great extent, the argument that unrealized gains in assets should not be taxed is an argument against any tax on assets, especially the property tax. Of course, given the high property tax burden in Michigan, an assessment cap can be seen as a reduction in the high rate of asset taxation.
The benefits of an assessment growth cap accrue mostly to stable property owners in desirable areas. Renters, transient movers, younger people, and owners of property in less desirable areas receive less of a benefit. However, that is not to say they receive no benefit. Furthermore, the overall economic benefits of a tax cut are likely to help exactly this latter group of people the most, since they have the most to gain from a more vibrant Michigan economy.
What is a "Sale?"
Over time, an assessment cap creates a strong incentive not to sell a current property. Individuals who nonetheless wish to move will create imaginative financial arrangements designed to give almost all the benefits of a sale, without being a sale for tax purposes. Long-term leasebacks, leases-to-purchase, land contracts, intra-family transfers, and other arrangements blur the distinction between sold and owned, and would be used to give physical possession to one individual, while retaining an assessment growth cap based on the purchase long ago of another.
This incentive to avoid a "sale" would create a new legal and administrative burden. On the other hand, the cap would also eliminate much of the large existing burden of annual assessment and review. The addition of new burdens must be weighed against the reduction in old ones.