May 21, 2008
HIDDEN CONSEQUENCES: LESSONS FROM MASSACHUSETTS FOR STATES CONSIDERING A PROPERTY TAX CAP
By Phil Oliff and Iris Lav
In 1980 Massachusetts voters approved Proposition 2 ½, which mandates that property tax revenues not exceed 2.5 percent of a community’s assessed value and that a community’s property tax revenue not grow by more than 2.5 percent a year. (See box below)
Over the two and a half decades Proposition 2 ½ has been in effect, Massachusetts’ level of property taxation has declined. Between 1980 and 1985, property taxes as a percentage of income fell from 76 percent above the national average to 13 percent above the national average, where it stands today.[i] (Massachusetts localities rely more on the property tax than localities in much of the rest of the country because they are not permitted to levy sales or income taxes or various other forms of taxes. (See Figure 1.)
Because Proposition 2 ½ lowered property taxation in Massachusetts, advocates of limited taxation often cite it as a model for reform. But the story is far more complicated than that. State aid has helped fill in some of the gaps in local funding the law created, but not all of them and not reliably over time. Furthermore, the local “overspending” that proponents claimed Proposition 2 ½ could curb did not exist in the imagined quantities, and necessary public services have been jeopardized.
By limiting Massachusetts localities’ only major source of revenue, Proposition 2 ½ has exacted a considerable cost — one that highlights the shortcomings of property tax revenue caps as a policy approach. The law has:
- arbitrarily constrained local governments’ ability to raise revenues without any consideration of the actual cost of providing services;
- made local governments heavily dependent on state aid, which tends to fluctuate with economic cycles and state policies (a particular problem in an economic downturn when state aid usually declines but the need for local services such as education and fire and police protection does not decline);
- exacerbated disparities between wealthier communities and poorer ones in access to quality local services, as many of the former have voted to override Proposition 2 ½’s revenue cap while the latter have generally had to adhere to it; and
- resulted in cuts to valued services rather than simply calling forth greater efficiency from local governments.
Across Massachusetts, a number of communities have been forced to lay off teachers, police officers, firefighters, and other public employees; close fire stations; shut libraries, senior centers, and recreation centers or sharply reduce their hours; and scale back public school programs. One town even turned off its street lights to save money.
The Massachusetts experience can provide lessons about the potential effects of a property tax cap for other states that are considering similar measures. This report looks at the Massachusetts experience and gleans the following lessons.
- A tax cap won’t make government services cost less. A cap does not prevent employee health insurance costs, special education costs, or other costs beyond localities’ control from rising much faster than the cap allows. Nor does it hold down the cost of heating buildings, buying gas for police and fire vehicles, and operating schools buses when the world price of oil is skyrocketing. When these things occur, as they have in Massachusetts, other services have to be cut to fit total expenditures under the cap.
- Claims that caps will produce large savings through “efficiencies” are overblown. There are fewer efficiencies to realize from squeezing down revenues than cap proponents generally suggest. One person’s “efficiency savings,” such as the elimination of a police or fire station, may represent the loss of a critical service for another person. Ultimately, a property tax cap is highly likely to lead to reductions in basic community services and a deterioration in the quality of life in many communities — particularly in communities that cannot routinely override it.
- Tax caps can be particularly harmful if adopted during a weak economy. Proposition 2 ½ took effect during a period of extraordinary economic growth — the “Massachusetts Miracle.” State revenues were rising, which allowed the state to boost aid to compensate for constrained property taxes, and construction was expanding, which allowed communities to raise their property tax revenue by more than 2.5 percent per year.
If a state were to adopt a property tax cap during an economic slowdown or a period of weak state revenue growth, a major sustained infusion of state aid would not be possible and property tax revenue growth would be more constrained. As a result, schools and other services dependent on the property tax would have to be cut much more severely than in Massachusetts.
- State aid can’t be relied upon to fill the gap. Even when state policymakers fully intend to expand state aid to fill local funding gaps created by a cap, a recession or fiscal crisis will usually derail this plan. State aid to localities in Massachusetts has fluctuated greatly with the business cycle and with state policy decisions. In any other state that might implement a cap, local government and school budgets are likely to become more volatile.
- Changes in school enrollment can have a big impact. The adoption of Proposition 2 ½ coincided with a decline in Massachusetts’ K-12 enrollment, allowing schools to operate with less revenue.
If another state adopted a property tax cap during a period of steady or rising enrollment, it would be forced to impose much more extensive cutbacks in teachers, classes, and programs than those seen in Massachusetts.
- Without effectively targeted state aid, low-income communities will fall even further behind. Massachusetts has a highly targeted system of aiding local governments. The influx of state aid seems to have shielded low-income communities somewhat from Proposition 2 ½’s tendency to exacerbate differences in services between high- and low-income communities. But when state aid has receded as a result of economic downturns or state policy decisions, the poorest communities have had to make the largest budget cuts.
In states that do not have a system of school aid that is targeted as effectively as Massachusetts’, students in low-income communities are likely to fall increasingly behind students in schools that have greater resources.
- Wealthier communities will override a tax cap more frequently than poorer ones. This has contributed to a growing spending gap between local governments in high-income communities and all other communities, despite Massachusetts’ progressive system of state aid. This is likely to occur in other states that implement a cap.
The Basics of Proposition 2 ½
Proposition 2 ½ sets two kinds of restrictions on the amount of property taxes that a local government can collect: a levy ceiling and a levy limit.
Levy Ceiling: The levy ceiling limits property tax collections to 2.5 percent of the assessed value of a community’s property.
Levy Limit: Proposition 2 ½ set a property tax limit for each community in fiscal year 1982 equal to the lesser of a community’s actual property taxes or 2.5 percent of the community’s assessed value. This “levy limit” grows by 2.5 percent per year.
Proposition 2 ½ allows communities to adjust their levy limit upward to account for “new growth”: increases in the tax base that are not the result of revaluation. Such increases can result from the development of new properties, changes in assessed value that result from the renovation or expansion of existing properties, reclassification of properties that were previously exempt from taxation, or the conversion of existing properties into condominiums or new subdivisions.
A community taxing below its levy limit can increase its property tax collections to the limit at any time. The levy limit cannot exceed the levy ceiling.
A community’s residents can chose to permanently increase, or override, their levy limit through a majority vote.
Capital Outlay and Debt Exclusions: A community may vote to temporarily exceed its levy limit or levy ceiling for the payment of certain capital expenditures or debt service costs.
“Levy Limits: A Primer on Proposition 2 ½,” Massachusetts Department of Revenue, Division of Local Services, Revised June 2005, p. 4.
David M. Cutler, Douglas W. Elmendorf, and Richard Zeckhauser, “Restraining the Leviathan: Property Tax Limitation in Massachusetts,” National Bureau of Economic Research Working Paper, August 1997, pp 4-5.
“Levy Limits: A Primer on Proposition 2 ½.”
- Middle-income communities might end up bearing the brunt of a cap. In Massachusetts, budgets in middle-income communities grew more slowly than budgets in either low-income or high-income communities because they did not receive as much state aid as the former or override Proposition 2 ½ as often as the latter.
Proposition 2 ½ is a structurally flawed policy that has significantly eroded local services in Massachusetts despite a number of factors that have mitigated its impact. Massachusetts had the benefit of an unusually strong economy, declining school enrollment, and a system of effectively targeted school aid. Proposition 2 ½ nevertheless has had negative results for the provision of quality public services in Massachusetts. Other states that attempt to impose a similar tax cap without the benefit of Massachusetts’ mitigating factors are likely to face even worse consequences.
Click here for the PDF of the full report (17pp.)
[i] State & Local Government Finance Data Query System, Urban Institute-Brookings Institution Tax Policy Center; data from U.S. Census Bureau, Annual Survey of State and Local Government Finances, Government Finances (Volume 4) and Census of Governments (1977-2005), http://www.taxpolicycenter.org/slf-dqs/pages.cfm, accessed 23-Apr-08 02:38 PM.