You asked us to analyze Section 1 of SB 701 (LCO 3540), AAC Property Tax Assessments for Residential Property and for Solar Voltaic Systems, and Instituting an Incentive Program for the Provision of Regional Services, and describe how it could affect taxpayers and municipal officials.

SUMMARY

SB 701

SB 701 changes when and how towns must revalue property. Currently, towns must tax property based on its value, which tends to change over time. Tax assessors estimate that value by inspecting properties every five years and comparing the sales of comparable properties or, in some cases, determining the income a property generates or the cost to replace it.

SB 701 eliminates the requirement to revalue property every five years. It freezes each property's value as of July 1, 2006 until it is sold or improved. If the property is sold, the town must change its tax valuation to its sales price. If the property is improved, it must add the improvement cost to the old value. But the town cannot change the value when the owner sells the property to family members or repairs it after a natural disaster.

Effects on Tax Payers

Research on assessment freezes in California and Georgia suggest how a freeze could affect property owners and municipal officials in Connecticut. But these findings must be used cautiously since these freezes operate in a different context. For example, California froze assessments at 1975 values, but allows towns to increase assessments by 2% per year and caps the tax rate at 1% per year. Georgia's freeze applies only to homes where a portion of the fair market value is exempt from taxation (i. e. , homestead property).

Given these caveats, freezing property values could create disparities between new and existing owners. A freeze requires new owners to pay taxes based on current values and existing owners on older, outdated values. Consequently, existing owners would pay less tax if their property's current value is more than the frozen one and more tax if that value is less than the frozen one.

But some researchers contend that regular revaluations do not produce accurate, uniform assessments. Tax freezes correct this problem by revaluing property only when it sells and basing the new assessment on the property's actual sales price.

Housing market dynamics could ultimately determine if a town's tax burden (1) is evenly distributed among property owners regardless of when they bought or improved their property or (2) varies between new and existing owners. When sales are up, the freeze affects both parties less since each sale changes the property's assessment to the sales price.

The freeze could also redistribute the tax burden on residential and commercial property. The assessment on residential property as a class is more likely to reflect fair market value since homes tend to sell more frequently than stores and factories. When property values are increasing and sales are up, residential property may bear a greater share of the tax burden.

It is not clear how the freeze might affect real estate sales. Some researchers found that California's freeze has little effect on sales volume, but others found that owners are less likely to sell when the fair market value of their properties begin to exceed the assessed values.

Effects on Towns

The way a freeze affects property owners and real estate sales could affect towns' fiscal policies. California's freeze has reduced property tax revenue growth rates but caused towns to depend more on state and federal funds. Consequently, they depend more on funds over which they have less control and become more vulnerable to fluctuations in state and federal aid.

California's freeze appears to have had other effects. Towns have created new fees and increased existing ones, including the fees they charge developers to cover infrastructure costs (i. e. , development impact fees). They have also sought to increase local sales tax revenue by promoting commercial development, a trend some researchers refer to as the fiscalization of land use.

Connecticut towns cannot impose development impact fees or levy sales tax, a fact that could put more pressure on the tax rate if a tax freeze reduces property tax revenue. If this happens, they might have to cut services or increase the tax rate to maintain current ones. The pressure to maintain services without increasing tax rates could cause them to promote more development or redouble efforts to find and assess personal property, or ask for authority to impose other fees and taxes.

CURRENT REVALUATION REQUIREMENT

Fair Market Value

SB 701 changes when and how tax assessors must determine a property's value. Current law requires them to estimate how much a property will sell for if neither the seller nor the buyer is under pressure to complete the sale (i. e. , fair market value). Towns assess and tax the property at 70% of this estimated value (CGS § 12-63(a)). Several factors affect fair market value, including the property's location; surroundings; and proximity to parks, schools, and other amenities. Demographic trends, interest rates, and other factors affect the demand for property and, consequently, its fair market value.

Periodic Revaluations

Since the factors that affect fair market value change over time, the law requires assessors to determine each property's value at least once

every five years (CGS § 12-63(a)). They must do this even if the owner did not sell the property. In this case, assessors must estimate the value using methods based on how the property is used.

SB 701

Revaluation Rule

Instead of revaluing all property every five years, the bill requires assessors to revalue property only when it is sold or improved and base the new assessment on the sales price or improvement cost, respectively. They must implement this change by freezing the assessment on each property as of July 1, 2006, after which they must:

1. assess newly constructed property based on its sales price,

2. reassess improved property based on its frozen value plus the improvement cost and,

3. reassess any property when it is sold based on its sales price.

It appears that assessors must base all assessments on a property's full value, not 70% of it, as current law requires.

Exceptions

Under the bill, a property's current assessment does not change when:

1. a party purchases the property to replace one the government took by eminent domain,

2. the owner sells or transfers the property to his spouse, or

3. the owner sells or transfers his principal residence to his child or grandchild.

Nor does the assessment change when an owner sells or transfers property other than his principal residence to a child or grandchild for less than $ 1 million. For sales or transfers above this amount, it appears that the assessor must reassess the property for the amount over $ 1 million. For this reason, the new assessment could be lower than the original one even if the property's value increased.

The bill also exempts improvements made to:

1. restore property damaged by a natural disaster to its original condition without significantly increasing its value,

2. give people with disabilities better access to the property, or

3. install fire extinguishing or detection systems for improved fire-related egress.

POTENTIAL EFFECTS ON TAXPAYERS

Disparities between Existing and Recent Owners

Under a tax freeze, new owners pay taxes based on the price they paid for their property while existing owners pay taxes on a frozen value, which could be more or less than their property's current value. For example, a new owner who bought a house for $ 200,000 pays taxes on that amount. But an existing owner who bought an identical house under the freeze 10 years earlier for $ 150,000 pays taxes on that lower, frozen amount. Consequently, the existing owner pays less tax than the new owner.

But the opposite happens when the value of the identical houses fall and the new owner pays less than $ 150,000 for his. In this case, the freeze hurts the existing owner because he must continue paying taxes on a house assessed for $ 150,000 while the new owner pays taxes on a lower amount.

Research on California's tax freeze found that the disparities between new and existing owners depended on increases in property values, real estate sales, and new construction (Sjoquist and Pandey, Limitations on Increases in Property Tax Assessed Value, Georgia State University, Fiscal Research Program, 1999). As Table 1 shows how these trends could affect the disparities between these owners and the extent to which they bear a disproportionate share of the tax burden.

Table 1: How Property Value and Real Estate Sales Trends could affect New and Existing Property Owners when Towns Freeze Assessments

When property values are rising, an assessment freeze favors owners who hold on to their properties. The freeze locks in their assessments even though the value of their properties could increase over time (when it will be reflected in the sales price). But it does not freeze their tax bill, which will go up if town increases the mill rate. A higher mill rate requires everyone to pay more taxes. But those who kept their properties would still pay less tax than if the town periodically revalued their property. Consequently, they, as a group, bear a disproportionately smaller share of the tax burden than new owners.

While changes in property values signal whether the burden will shift to new or existing owners, changes in sales volume signal how many owners in either group will bear the tax burden. When sales are up, more properties are taxed based on their actual fair market value. Consequently, more owners pay tax based on their property's fair market value. But the opposite occurs when sales drop because more properties are taxed based on frozen, outdated assessments. In this case, the burden falls on the relatively few new owners when property values are rising and the relatively more long-time owners when values are dropping.

Claims that tax freezes led to disparities between new and existing owners assume that the methods used to revalue property yield accurate and uniform assessments. A tax freeze takes the guess work out of revaluation by reassessing property based on its actual resale price, proponents claim. The California Taxpayers Association found that disparities were greater in California before it imposed the freeze (Cal-Tax Digest, Proposition 13: Its Benefits are Real, May 1998). Eliminating the guesswork that accompanies regular revaluations also makes it easier for property owners to predict their tax bills (assuming, as in California, they know how much the mill rate can increase).

The association claimed that real estate trends corrected the disparities between new and existing owners. Those who purchased property in the mid-1990s received lower assessments reflecting declining property values.

Business Versus Residential Property Owners

The freeze could redistribute the tax burden between residential and business property. This could happen because residential property tends to resell more frequently than business property. Consequently, residential property could bear disproportionately more or less of the tax burden depending on trends in property values.

For example, business property will generate disproportionately less tax than its residential counterpart when residential property values are high and the volume of business property sales is low. But the burden will fall more on business property when residential values drop faster than business values and the volume of business property sales remains low.

Assessment Freeze and Real Estate Sales

Some observers contend that an assessment freeze should discourage owners from selling their existing property and buying new ones. But research in California found that it did not significantly discourage them from doing so. It seemed to cause seniors and low-income families to delay moving by only a year and upper-income families by only a few months. These findings suggest that other factors besides the freeze influence owners' decisions about whether to move (O'Sullivan et. al. , Property Taxes & Tax Revolts: the Legacy of Proposition 13, Cambridge University Press, 1995, cited in Sjoquist and Pandey).

But a different study found that a freeze was more likely to discourage owners from moving if it produced substantial tax benefits. The researchers measured the benefits based on the difference between a property's assessed and fair market value and found that it was generally greater in California's coastal cities. “From 1970 to 2000, the average tenure length increased by less than one year in inland California cities, but by more than two years in the Los Angles area and by three years in the Bay area” ( Wasi and White, The Lock in Effects of California's Proposition 13, National Bureau of Economic Research, 2006).

An owner could reap substantial tax benefits when his property's fair market value is substantially greater than the assessed value. But, as Table 2 shows, other factors besides the freeze's benefits could determine if the owner keeps or sells his property.

Table 2: Affects of Assessment Freeze on Real Estate Sales

As the table suggests, the freeze could weaken markets and discourage sales in weak and depressed markets. In a weak market, the demand for property drops and the magnitude of a higher assessment could further discourage potential buyers from shopping for property. The higher assessment that comes when a prospective purchaser buys a new property could encourage him to keep his current one.

The relatively few owners who want to sell their property might have to reduce their asking price, which could affect the asking price of comparable properties. If the asking price falls below the frozen assessed value, then buyers would likely pay less tax than existing owners. This condition could stimulate real estate sales and, depending on demographic and economic trends and the property supply, increase property values.

EFFECTS ON MUNICIPALITIES

Fiscal Autonomy

California towns have become more dependent on state and federal aid as the growth in property tax revenue declines (Shires, Patterns in California Government Revenues Since Proposition 13, Public Policy Institute of California, 1999). This trend could stem from the fact that California freezes assessments and caps the annual increase in property tax rates.

SB 701 does not prevent a town from increasing the tax rate and deriving more revenue from property tax base if it wants to maintain or increase services. The town's other choice would be to minimize or avoid a tax increase by seeking more state and federal aid. But doing so could make it vulnerable to changes in state and federal budget and subject more of its budget to state or federal control.

Basing Land Use Decisions on Fiscal Considerations

Freezing assessments could put more pressure on towns to stimulate new development when real estate sales are down and few new properties are coming onto the tax roll. Adding more property to the tax roll lessens the need for tax increases, reduces the tax burden on individual taxpayers, and generates the revenue needed to maintain or increase services.

New Local Revenue Sources

While the assessment freeze and the tax rate cap reduced the growth of property tax revenue, California towns turned to other revenue sources. Since that state's law allows them to levy local sales taxes, many towns sought to increase revenue from that source by stimulating commercial development (Chapman, Proposition 13: Some Unintended Consequences, Public Policy Institute of California, undated). They also

began to charge people for using more types of municipal services and developers for building the roads, sewers, and other infrastructure needed to serve new development.

Connecticut towns can only charge fees for municipal services, but the legislature has considered bills authorizing local sales taxes and development impact fees. The pressure to enact such legislation could increase if assessment freezes significantly reduce property tax revenues.

Property Tax Assessment

Freezing the assessment on real estate eliminates the need for and the cost of periodic revaluations. It could also give tax assessors more time to discover motor vehicles and business equipment and add them to the tax rolls. The new law phasing out the tax on manufacturing machinery and equipment could increase the burden even more on the other types of business personal property.

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