Is an Earlier School Tax Due-Date Really a Tax Increase?

To close a fiscal year 2002-03 deficit in the School Aid Fund, Gov. John Engler has proposed requiring all Michigan taxpayers to pay the 6-mill school property tax in July. The change would begin in 2003 and remain effective for all years thereafter. To compensate for the cost and inconvenience to taxpayers who currently pay all or part of the tax in December, in 2003-only the tax would be reduced to 5 mills. 

Engler's proposal would accelerate $490 million in tax revenue forward into the new fiscal year—but would it also result in a net tax increase for some Michiganians?  Let's look at the numbers.

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Owners of 24.1 percent of the total state taxable value now pay all the tax in July. Owners of 49.7 percent pay half in July and half in December. Taxes on the remaining 26.3 percent are paid in December only.  So here is the question: Are those who now pay all or part of the tax in December better or worse off under Engler's proposal? (Those who pay all the tax in July are pure winners, and can stop here.)

If you own a home with a market value of $150,000 and a taxable value of $75,000, you pay $450 in annual school property taxes ($375 in 2003). Let's say each year you salt away $450 for the tax between January and July, then invest it until December in a treasury bond yielding 5 percent a year. If you now pay all the tax in December, paying earlier will take away five months of interest you would have earned, or $9.36 ($450 multiplied by .05 multiplied by 5/12). For those who pay only half in December, the opportunity cost is $4.69.

It seems simple enough: A $75 tax cut costs just $9.36 (or $4.69), so you're ahead, right? Not quite. The lost interest doesn't stop there. Next year you also pay earlier, and lose the interest again. Plus, assuming 3-percent inflation, if your taxable value increases to $77,250, the tax will be $463.50, with a $9.65 (or $4.82) opportunity cost. This pattern continues forever.

The House Fiscal Agency has run the numbers using these assumptions.  Analysts figured in the fact that the present value of interest earned years from now is less than the nominal amount. Here are the results:

For those who now pay half in July and half in December, the 10-year opportunity cost is $54. For December payers it's $110. Subtracting  the one-time tax cut shows that this group has a net loss of $35 ($110 minus $75). The half-and-halfs are $21 winners after 10 years. However, these opportunity costs continue forever, and rise with inflation, so they too eventually lose.

This overstates the cost somewhat, because it leaves out the effects of reinvesting the one-time $75 tax cut. Assuming the same 5-percent return, this yields $3.75 every year, which can be used to pay an ever-shrinking proportion of the ever-rising property tax.

Does the opportunity cost really go on forever? You pay earlier, but after the first year, won't you once again have a full 12 months to earn the same interest? No, because the taxpayer in this model doesn't have the $450 until July—it's money saved between January and July. This is realistic, because it's how income actually flows through households, which do not begin life with mattresses full of cash for future taxes. An analogy is the federal income tax: You pay on April 15 using money earned last year. Paying on Jan. 15 would mean losing the use of your money for three months every year.

What if you don't save and invest that $450 each year? There is still an opportunity cost; it's just less visible. Investing is nothing more than deferring current purchases until later; interest is the reward for waiting. Paying the tax early makes you forgo purchases you could otherwise have made, whether now or later.

So, for most taxpayers the plan is a modest, slow-motion tax hike. Should you care? The state will use your money to raise the minimum per-pupil $6,500 grant to $6,700, and retain hundreds of millions in "categorical" spending on education-related programs. How you rate the plan depends on whether you think public schools deliver sufficient value for your money, when you now pay the tax, and how much you pay. You be the judge.