Beware of Fake Property Tax Reform

I have written previously about Governor Chris Christie's proposal for property tax reform in New Jersey, known as Cap 2.5. What I haven't discussed at length is New Jersey's storied history of failed property tax reforms. As Cap 2.5 is debated and possibly amended, what should New Jersey residents watch for to make sure the new reform doesn't repeat past mistakes?

There are two key features that set Cap 2.5 apart from past attempts at reform. One is that it seeks to firmly control the total amount of local tax revenues, instead of offering exceptions or exclusions that allow tax increases in excess of a stated cap. The other is that it would be accompanied by a set of reforms designed to reduce upward cost pressures on local governments, allowing them to respond to slower revenue growth with slower spending growth.

The modern history of New Jersey property tax relief begins in 1976, with the introduction of New Jersey's income tax under Governor Brendan Byrne. The tax, initially at a low rate of 2%, was intended to relieve property taxes. Indeed, income tax receipts are placed in a special fund called the Property Tax Relief Fund, and must be distributed to municipalities as local aid.

Today, after a series of tax increases (including one that funded a major expansion of local aid in 1991) New Jersey ranks eighth in income tax collections per capita. That should pay for a lot of property tax relief, right? Wrong -- New Jersey now tops the nation in property taxes per capita, or is number three for property taxes as a share of personal income. Seven of the ten counties with the highest average property taxes on owner-occupied homes are in New Jersey.

While Democratic governors have preferred raising income taxes to increase local aid for property tax "relief," Republicans have tended to prefer giving out property tax rebates. These, too, have failed to constrain taxes or spending overall. And when budgets get strained, the rebates tend to go away -- and taxpayers are left with high local property taxes and high statewide taxes.

Since the 1970s, New Jersey has had a number of caps on growth in local spending. But the caps included many exceptions that allowed spending to continue increasing rapidly. As a result, property taxes climbed by 102% per capita (adjusted for inflation) from 1980 to 2007, compared to 68% in the country as a whole. Real school spending per pupil grew 139%, compared to a national average of 95%, over the same period.

Most recently, in 2007, New Jersey enacted another cap, this time limiting property tax growth to 4% per year in any given municipality, county or school district. The trouble is that the cap includes sixteen exceptions, including for increases in teacher health care and pension costs. When a cap excludes the key cost drivers increasing local spending, it is not an effective cap.

Indeed, nearly one-third of the 566 municipalities in New Jersey raised taxes by more than the 4% cap in 2009 -- in a majority of cases without needing to seek a waiver, because the increase was driven by an exempted cost category. Again, New Jersey got fake property tax reform.

Christie likes to say that Cap 2.5 would be a "hard" cap, with only one exclusion -- for debt service. This exclusion can be justified for two reasons: debt issuances are already subject to voter approval, and including debt service costs in a revenue cap could negatively impact municipal credit ratings.

Christie's plan is extremely similar to Proposition 2.5, a property tax cap enacted in Massachusetts in 1980, limiting property tax levy growth to 2.5% per year. In New Jersey, as in Massachusetts, voters could approve faster increases. And like Christie's proposal, Proposition 2.5 is a hard cap, with exceptions only to cover debt service and for capital outlays -- and Massachusetts requires a separate vote on capital outlays. (In both states, property tax is essentially the sole tax source available to localities, and a property tax cap is tantamount to a local tax cap.)

In contrast to New Jersey's repeated failures, this reform succeeded in moderating property taxes in Massachusetts. From 1980 to 2007, property taxes per capita rose just 22% in Massachusetts, and total state and local taxes grew 58%, both significantly slower than in the country as a whole.

One key reason that Massachusetts' tax cap has succeeded is its lack of holes -- that's why property taxes actually grew slowly. But it is also important that the reform did not just lead to a tax shift, with slow property tax growth offset by other higher taxes. The most notorious example of this disease is in California, where 1978's "Proposition 13" tax cap has held down property taxes, but not overall taxes or spending.

In Massachusetts, overall tax and spending restraint has been achieved through a number of avenues. An education reform in the early 1990s gave school districts better tools to control spending, including a change in the state's special education funding formula. Perhaps most importantly, Massachusetts' constitutional requirement that the state's income tax be flat has provided a political barrier to raising new revenues at the state level, as income tax increases cannot be targeted.

Governor Christie has proposed his own "tool kit" to allow municipalities to respond to lower property tax growth with lower spending growth. Most notably, cities and towns could opt out of civil service rules that drive up employment costs, and binding arbitration would be reformed to require arbitrators to consider municipalities' revenue restraints when awarding new contracts. If the cap is to provide real overall tax relief, it must be accompanied by reforms like this.

New Jersey residents have good reason to be wary when politicians promise relief on property taxes. After all, they have been burned again and again. But Christie's proposals demonstrate a recognition of what has gone wrong with property tax reform in the past, and what can be done to make it work this time.