Saturday, November 27, 2004

Incentives for Accurate Property Valuation

I had an unexpected visit home for Thanksgiving, thanks to inclement weather that diverted my plane from Dallas-Fort Worth (where I was supposed to have a layover) to Houston (where my folks live). Once it became apparent that I wouldn’t get back to L.A. in time to teach my Wednesday morning classes, I decided to extend my stay in Houston long enough to spend the holiday with my family.

While there, I had a conversation with my mom that reminded me of a policy idea I had a couple of years ago. My parents’ property taxes, like those of many homeowners, are constantly rising – not because the tax rates go up, but because the city keeps raising the assessed value of the property. The assessed value is almost certainly higher, probably a lot higher, than what the property could actually sell for on the open market. The government-employed assessors naturally have an incentive to overestimate the value of property, because doing so boosts revenues.

So here’s my proposal: Any property owner whose property is subject to a tax based on a government-assessed valuation should have the option to force the government to purchase the property at, say, 97% of the assessed value. This would give the state a strong incentive not to overvalue property, since whenever it did so, it could be faced with the losing proposition of buying at above-market value and then selling at actual-market value.

Why 97% instead of 100%? That was actually my original idea, but then I realized setting the buy-out value at 100% of the assessed value would give owners a poor incentive: they could avoid all marketing costs, realtor fees, etc., associated with selling a home simply by exercising their option of selling to the government. As a result, most property sales would end up going through the state, with all the poor consequences of a state-run real-estate market. So the buy-out percentage would need to be set low enough that if the state’s assessment were approximately correct, most property owners would still choose to sell in private markets. I don’t have any particular basis for choosing 97%; I just pulled that number out of my butt. If my proposal were taken seriously, a careful analysis of real estate markets would be required to find out the percentage of the market value owners actually receive on average; the buy-out percentage would be set somewhere below that figure. (To be more precise, we’d have to find out the variance in the percentages of market values received by owners, and then set the buy-out percentage low enough that only a specified fraction of sales would involve forced buy-outs.)

P.S. Thanks to co-blogger Tom for keeping this site active during my absence!


Tom W. Bell said...

The figure you "pulled out of [your] butt" has a certain logic, Glen, in that the standard real estate agent's fee is 6% of the sale price. When both buyers and sellers use agents, they typically split that fee 3%/3%. Since you essentially propose a system in which agents of the state would act as their purchasing agents (by assessing too high a value for a property and so triggering the automatic right of the owner to sell), only the seller would need an agent (so as to assist the homeowner with formalities and, no doubt, to make sure that the market does not make an even higher price possible). With only "half" an agent at work, only 3% need be taken out of the price. Voila 97%!

I'd have to say, therefore, that are a smart ass.

Anonymous said...

Hurray!! Glen's libertarian "cheeks" are back along with his head, feet, toes, etc. All in one piece, I presume. But yuck, the first thing you blogged about upon your return was your mom & dad's rising property tax bill. Guns, 4x4 Chevy trucks and good ol' boys but taxes in Texas? Who you kidding, boy! You might have at least waited until your second post before mentioning your plot to sell your parents house out from under them. In spite of your cheeky self, did you at least have a good time? I'll have to remember that inclement weather trick the next time I want to extend my vacation a few days. You don't know jack 'bout bad weather until you've been sucked into a tornado.

--Mr. Twister

TJIC said...

Heinlein had a pretty similar idea a few decades ago (exact cite not at hand, sorry):

Get rid of assessors, have everyone self-assess their property...but anyone else can purchase the property for 120% of the appraisal price.

Anonymous said...

My parents’ property taxes, like those of many homeowners, are constantly rising – not because the tax rates go up, but because the city keeps raising the assessed value of the property.This is a common misconception, but it's not true! A bad assessment can only raise your parent's taxes if their property is over-assesed relative to other taxpayers. This is a simple consequence of the way property tax rates are set--the city takes the amount it wants to raise and divides by the total assessed valuation for all taxpayers. That value is the rate, usually expressed as dollars per thousand or some such.
The tax bill is then the assesed value of your property multiplied times the rate.

The result of all this is that if everyone's valuation is off by the same factor, it has no effect at all. OTOH, if your house is assessed at over market value and everyone else's valuation is correct, then you end up paying too much.

So it is not the case that "government-employed assessors naturally have an incentive to overestimate the value of property, because doing so boosts revenues". The government decides what revenues it wants and sets the rate accordingly--the assessor couldn't care less.

So the reason your parents' taxes are going up is most likely because the city keeps spending more money.

Glen Whitman said...

Anon -- very interesting. Poking around on the web, I discovered you're correct that many jurisdiction calculate their tax rates in that fashion. But are you sure they *all* do it that way?

Anthony said...

So here in California, we do it differently.

You've all heard of Prop 13, right? I self-assessed. My house was worth $261,000 when I bought it this year,and that will be my property tax assessment this year. If I thought the house was worth less, I'd have offered less. (And someone else would have bought it, but the point remains.)

Oakland, CA, has a property tax rate of a small fraction over 1.3%, so my ad valorem property taxes will be $3393 per year. The tax rate only changes with a vote of the people. Here's where Prop 13 comes in: My assessed value goes up a maximum of 2% per year. (If I make major improvements to my house, the amount I pay for the improvements is how much my assessment is increased.) So I know what my property taxes will be from year to year. In ten years, assuming I still own the house, don't make any street-visible capital improvements, and my fellow citizens don't raise the ad valorem tax rate, I'll be paying $4136 per year. Of course, in ten years, I'll probably be able to sell the property for somewhere on the order of $522,000 (at a guess), and the new owner will be paying $6786 per year.

As you can guess, this has benefits and disadvantages. People living on fixed incomes (old folks, who vote) don't get taxed out of their homes. Tenants benefit a little, as landlords tend to keep buildings longer than homeowners. Cities have an incentive to promote gentrification, to induce high resale turnover. Cities have some incentive to promote housing, which turns over more quickly than commercial property. (This is more than counterbalanced by the mismatch between revenues from property taxes and the expenses of providing public services to residents versus commercial owners, however.)

Anonymous said...

I'm glad your back,too. In eminent domain cases, the government entity benefits from under or low assessments, but I guess this is an exception to your general point. For instance, the city can bide its time to purchase private property to widen a street until the property values have dropped like during an economic downturn. My friend hired an attorney who specializes in such things to get a better deal from the city. It worked because the city didn't want the legal headache. Although, I'm not quite sure how the assessor feels tempted to overassess a property and aren't there ways to protest the overvaluation anyway? During periods of rising property value, I suspect the assesor's office would be lagging behind because of bureaucratic delays and just the sheer volume of properties to deal with. Clearly, they may be even more lethargic during times of declining home prices.

That guy was right about the distortions and disincentives caused by proposition 13. My mother pays ridiculously low taxes on her triplex(income property) compared to new home buyers. She's lived there for about 40 years but she is far from poor and can easily afford to pay the going rate. She says that she "can't afford" to move because of the cheap taxes. If she had had to pay more maybe she would have sold the damn house and moved to a condo by the beach. In her case prop. 13 "tax fairness" means she gets a free ride. Please keep blogging about all different kinds of taxes and what you perceive as tax fairness; it's part of your job!

David Friedman said...

One problem with the proposal is that it provides an easy way for a corrupt local government to pay off citizens--including members of the government. Appraise a house for three times its value, then buy it for that.

Someone mentioned Heinlein's reference to the idea of a self-assessed property tax. That works the other way around. The taxpayer states a price at which he is willing to sell his house. His tax is based on that--and he is required to accept any offer at that price.

Spiney Widgmo said...

Too easy of a work around for the govt. Double (or more) the tax rate and assess at 50% of the house market value as a policy.

Also, under your proposal, you get the problem of people who find themselves in financial distress forcing a sale to the govt. Not to mention the problem of dealing with forced sales in a depressed housing market. IIRC Calif had almost a 20% decline in housing fairly rapidly in the early 90's. Its a nice option to force the local govt to purchase your home at last years price in a depressed housing market.