First thoughts on 2014 property tax

Last week's property tax workshop was a good opportunity to learn about property taxation and hear some of the stories people had of excessive tax increases. There was lots of public testimony (available as video) at the recent tax workshop meeting, but while much of it was heart-rending, most folks described their own situation and the grief and hardship that the extra tax expense caused them personally. A few people made policy points that were generally applicable that I will cover later. This has turned into a long piece but the issue is hardly a simple one and there is much to comment on.

Here's my short summary from attending the tax workshop:

• Taxpayers expressed widespread anger and some citizens felt their very livelihood on the island threatened by this recent tax change. Nearly every speaker was a longtime resident who had owned their home for many years, all kupuna (seniors) or getting there.
• The administration (Steve Hunt) and council (Tim Bynum) presented their assumptions and estimates, and that the actual results of the change by and large matched prediction without reasonable margins of error. Basically they said they thoroughly researched this and the actual numbers matched so they were surprised at the negative response. 
• The tax cap going back to 1991 masked problems in the tax system by artificially keeping taxes from rising much any particular year for many homeowners. An important point was that the assessed valuations in 1991 were not particularly balanced and regularly updated: as a result, some homes were undervalued, and the cap effectively locked in those extra low taxes forever after.
• There was genuine sympathy from council in response to individuals adversely impacted and well-intentioned offers to help; however, the details are invariably complex enough that in no one case in that public forum was anyone's tax situation analyzed and resolved.
• Poor communication from the county to the citizens was acknowledged though it was unclear exactly what more the county could have done, how to avoid a repeat of the situation in the future.
• Some taxpayers reported unfriendly response when they called the county for help or with questions. Another common theme was by the time they inquired it was already too late to file forms for this tax year which they considered quite unfair.
• I did not hear anybody in the room stand up and say the recent tax code changes were all just and fair and should stand unchanged. Some council members suggested the problem was the taxpayer not filing the proper forms to get the best tax treatment.
• I did not hear anybody point to the smoking gun - what specifically had the unforeseen adverse impact and must be changed.

Just Poor Communication?

To virtually every citizen complaint the county always answered that the problem was that they did not understand the tax system and if they had filed the right forms all would be well. Council members were offering to personally assist filling out forms - though this is quite generous and compassionate, it hardly addresses the problem. Council members should be spending their time legislating which they are uniquely empowered to do; it's important that all taxpayers get a fair deal, not just those showing up at council chambers to speak.

How exactly should the county communicate to citizens when changes are enacted like this that will directly impact taxpayers? Some people read the newspaper but a public notice buried in the back of The Garden Island is hardly going to reach even a majority of people effected. On the web there is kauai.gov and the online newspaper has http://thegardenisland.com/ads/community/announcements/ for  public notices which I suspect few people even know exists. Of course many people are "offline" and for many reasons - language, culture, cost, lack of internet service, disability, technology skill level, etc.

The county web site certainly could be improved. One speaker even complained that it took "three clicks" to find helpful information (although three is not that bad if she got there directly). You have to know to look under Finance Department since the web site is organized mainly by org chart rather than by citizen needs. The "Taxpayer Information" page [link] is mainly about the board of appeals. The "Forms and Handouts" page [link] lists about thirty forms and is very formidable looking. The "Tax rates" page [link] is just a table of the current rates without even explanations of what each rate is exactly.

Finally, this page "Understanding Real Property Taxes" - the title could be improved and the page made more prominent I would suggest - has useful information but it is rather a lot of reading and not especially user friendly. The information is updated but nowhere do I see anything that says, "Big changes this tax year: here is what you need to know and may need to take action." There are over ten "important dates" - that seems a little too much to have to deal with to me.

Is taxation based on property value fair?

Carl Imparato [at 3h05m] eloquently made the case that ad valorum tax system is fundamentally unfair. For example, a retired couple on fixed income may see their the home they bought long ago appreciate to many times its original value yet they will never see this money so long as they continue living there and do not sell.

Since tax rates apply to assessed value it's important to keep both factors in mind to understand the bottom line for the taxpayer. For over twenty years the Homestead tax rate (see chart here) has been fairly steady, dropping about 20% from $3.61 in 1991 to $3.05 in 2014. Actual taxes paid depends on what the property value did and the homeowner exemption is the other major factor, very recently increasing from $48,000 to $160,000 (more if over sixty years old). To get an idea of how property values have changed I found a property in Kilauea that happened to have sold (which causes the market price to be made public) a few times.

• sold in 1989 for $25,265
• sold in 1994 for $35,000
• sold in 2000 for $175,000
• sold in 2010 for $375,000
• and assessed in 2014 for $385,000

If you lived next door in a similar home on a similar lot, having also bought in 1989 for $25,000, your assessed value will probably be similar but that $385,000 valuation is completely on paper. Back in 1989 the homeowner exemption was $20,000 (most of the value then) but now the much larger $160,000 exemption is a much smaller portion of the entire value. And even though tax rates have gone down, with property values increased twelve hundred percent taxes are considerably increased. In this example the total dollar values are not that big but it demonstrates how dramatically property values can raise which is precisely one of the biggest problems with assessed value as a basis for taxation. This is the standard argument in a nutshell as I understand it - I am holding off suggesting what to do but wanted to explain this point. Also note that part of why this system is so tricky to analyze is that each individual property will have its own particular assessed values, be influenced by nearby property sales, and so forth, making it extremely challenging to know how any of this will play out for everyone.

Most local government revenues come from property tax based on market value, but when property values fluctuate wildly a number of problems can arise with this basis of taxation. The separate Homestead rate, homeowner exemption, and so forth are departures from ad valorum that I think it is fair to say are instituted to mitigate some of those effects - as was the tax cap.

Is it fair to taxpayers to keep changing the tax code?

Toni Martin [3h46m] makes a good point that taking action like CPR to reduce taxes is costly and further that there is no guarantee that in the future the council will change the rules yet again. This is a really important point I believe. When a tax code that rewards taxpayers only if they take certain legal steps - partitioning property, set up long-term leases, give family members percentages of property, all in order to get a beneficial tax rate - this can have serious consequences. These moves can be costly, take a lot of time to arrange, and are usually irrevocable or have very long term consequences. Specifically, there are other consequences than taxation such as inheritance and estate settlement. With tax code changes virtually every year, there is no guarantee the rules won't change again next year.

Common refrains

Some broad themes from many different people who spoke were repeated:

• People expect taxes to be stable year to year and they plan their finances and make decisions based on the status quo.
• Families occupy residential homes in many different ways, it is not always a nuclear family, and the situation can be fluid, taking in people from time to time to help out in a pinch, or accommodating family and friends visiting from neighbor islands. People do not want a tax system that invasively examines all these arrangements and blesses some but not others with tax benefits.
• Many retired people have planned their financial future around renting out a room or an ohana unit; some have a second or third rental home they count in to provide income to live on. When the tax code designates their entire property in a higher tax class as a result, the potential extra income from renting is quickly reduced or many said it was not worth renting anymore.
• Having to file forms annually to get tax benefits was seen as burdensome, and undoubtedly many people not knowing what about the various forms they could use are silently overtaxed.
• Decisions like long-term leases, sharing ownership percentages, etc. are important and should not be forced upon homeowners in order to maximize their tax benefits. One fellow talked about bad experience with leases where tenants have too strong of a position in court so he prefers not to use leases now.

These points are fairly obvious and uncontroversial, but the current tax code - including how complex it is and how often it changes - does not really respect these principles at all.

Removing the cap

Capping taxes to 6% and then 2% and then CPI based limit since 1991 represents a large accumulation of artificially low taxes for over twenty years. Suddenly removing the cap means that to the extent property values rose faster than the cap permitted (Homestead tax rate has help relatively flat throughout) a large jump is quite possible. The homeowner exemption was raised considerably (up $112,000) which represents a flat $341.60 (again, Homestead tax rate) savings against potential tax increase that is proportional to the property value. I don't have data to confirm but as such I suggest that multiple home owners or relatively more expensive homes were hardest hit.

Even though the people most impacted by the loss of the cap would have saved much more money over the past twenty some years than the large increase removing it, humans are not adding machines. Consider if every day I slipped a few dollars of spare change into your wallet that you had no idea of. That could be $1000 a year you benefit from my generosity. After ten years if I ask you to give me, say, $5000 of that back because now I need the money, it's clear most people would not be happy at all. Even if you believed that I really gave you that money, since you had no idea you did not save it or register it as an obligation at all. Asking for it back suddenly isn't fair, even though you would still be thousands of dollars ahead. I think the cap beneficiaries are in this position now and feel entitled to the limited tax increases they have enjoyed for years - as longtime homeowners, they feel strongly that a pact has been made and violated I would think.

Fairness

Everybody was talking about fairness and it's a principle nobody would argue with, but I think I saw it being used in directly contradictory ways which is going to lead to people talking past each other.

• The cap is both fair and unfair:
• The cap unfairly held some taxpayer's tax obligation low so eliminating it is more fair.
• Taxpayers have budgeted for taxes they have been paying for years so removing the cap, resulting in a large jump in taxes, is unfair.
• Changing the requirements for the lower Homestead is both fair and unfair:
• Only single families living in their own home should get the most beneficial low tax rate.
• People on fixed income rely on renting out a room so shouldn't have to pay high taxes on the entire property.

The county budget is now approaching $200M annually (that it needs to be that much is another issue, but related and important) so somebody has to pay more taxes. In the end, the whole tax system is just a set of rules that seek to equitably spread out that obligation because everyone would rather pay less. To the extent that tax classifications are apples-to-apples (i.e. hotels pay one rate proportional to their size) it is straightforward.

However, residential property is particularly difficult because you can have families both in $500,000 homes (roughly median valuation) that have very different financial situations and ability to pay. To deal with this reality we have the morass of tax relief provisions that in turn have their respective rules but I think it would be helpful to spell out what situations deserve special dispensation from higher taxes. Here are some of the factors that came out in the tax workshop or are suggested by the tax code:

• high taxes should never force people out of their primary residence
• families who take in their own should not be penalized (i.e. lower rates than renting out)
• long-term affordable rentals should be encouraged by tax reduction
• tax breaks for Hawaiian people, the elderly, the disabled, and our veterans
• taxes should be progressive with low income discounts
• incoming-producing properties (rentals) and commercial use should pay higher taxes

In addition, people were voicing a few more important points:

• taxes should be fairly stable so homeowners can budget long-term with confidence
• property speculation resulting in big swings on paper should not impact my taxes
• taxpayers should not have to fill out forms (especially annually which is burdensome and easily forgotten) in order to get a fair deal
• taxpayers do not want to be forced to do elaborate legal moves (e.g. CPR, 15 year leases, etc.) solely for the purpose of getting beneficial tax treatment
• it is unfair that the tax code can change at any time and adversely impact taxpayers

Would anyone argue with any of these principles? The second group is more challenging as the current tax system does not satisfy many of those points. So I think the devil is in the details here. The administrative rules the county uses to ensure that the right people get the right tax treatment are complex, burdensome, and in some cases invasive. I question that a practical tax system will be able to fairly get all these adjustments exactly right in every case without a tremendous amount of overhead. It's even more doubtful that every taxpayer will see their own situation as fairly taxed. The more rules we need to adjust taxes, it seems to me the more likely we are to get it wrong some of the time. And when you have lots of complicated rules, invariably the rich who can hire experts and lawyers are going to get the best deals for sure; the less fortunate, less educated, less organized will get the short end of the stick.

At the foundation of this tax system there seems to be a principle never explicitly stated that taxes are paid as some combination of in proportion to benefit from county facilities and services and ability to pay. This seems obvious but in practice does the current ad valorem taxation do anything like this? And if not then what is the underlying principle? To be clear, I am not judging the status quo so much as asking what the basic principle behind tax policy might even be.

• A wealthy second home owner who spends a few months a year in a $3M home probably uses far fewer county services than a family of six in a modest $300K home yet pays over 10 times.
• The elderly and handicapped get tax breaks but get many special services the rest of us pay for.
• A huge tract of agricultural land unused ostensibly uses very little county resources at all yet even assessed low dollar value per acre would pay a high tax bill.
• When a child is born into an owner occupied home, no taxes are incurred yet undoubtedly the additional person will use county services.

Of course the list of cases is endless, but these obvious examples all seem to indicate that the idea is for the wealthy who have more and pricier real estate holdings to pay more and that there is little bearing on county service use. Yet land appreciating on paper and large vacant land holdings easily result in being "land poor" and there may not necessarily be liquid funds to pay taxes.

I don't know what the right answer is at all here. I suspect that up to, a generation ago property taxes were nominal enough that the system did not matter that much. Postage stamps rates go up shockingly fast (I bet most people no longer know how much letter rate is now) but with email and online bill pay so common, it isn't an important expense anymore worth worrying about. (First class mail is 49 cents as of January 2014.)

My Challenges to the county

So after spending several hours at the county and reviewing the presentation slides, researching the tax code online and with additional council documents provided by the county clerk, compiling some historical data on tax rates and revenues, and thinking through all this what do I think about this?

It seems there are some major problems here, but I am not even certain that is so. Possibly only a handful of taxpayers bills went up dramatically, and from what I heard, some of the people complaining (in particular the ones owning multiple properties) may have to contribute more taxes in the future.

I found it very curious that one taxpayer after another stated their unhappiness with the tax increase, followed by the finance director explaining how estimates of tax code change were fairly accurate, and council member Bynum presenting the thinking behind the changes without any of them suggesting that any missteps or miscalculations were made.

Find out what doesn't add up. Maybe taxpayers are confused or misinformed (as was suggested repeatedly). Certainly communication was not good, but I don't think that was it entirely, or if it was that needs to be demonstrated. Going forward I would liked to see the county do less explaining and more searching for what they might have gotten wrong. Undoubtedly a lot of good work went into the tax code change with good intentions, so it's natural to want to defend that, but justification only makes it harder to see what might have worked better.

I think we have to question if a tax system this complex can really be fair and effective. Taxes are based in an ad valorem system, yet for homeowners there are so many exemptions and rules it seems to have grown way beyond what most citizens can understand. And if you can't understand it, it won't seem fair.

I am not going to suggest a course of action yet but I do have some suggestions for next steps.

• First, it's critical to get a thorough accounting of impacts and if there is a problem here or not.
• Did all the disgruntled people who spoke at the tax workshop, by filing forms they were able to significantly reduce taxes, and most importantly, what they said after getting help as to if they were happy or not and if they thought the system was fair? (We can answer these questions by the September 10 meeting I would think.)
• Publish statistics detailing how many homeowner's taxes went up how much and why. It's important to know the extent of the impact, especially the people who did not attend.
• Report on how many taxpayer calls and letters are coming in to the tax collections office and how those are resolved, including a summary from the citizen as to satisfaction.
• Communicate loud and clear.
• Write up an informational booklet on residential taxes including the 2014 tax code changes and how they will effect taxpayers.
• Put the same information on kauai.gov web site and prominently make it easy to find.
• Mail out this information to the taxpayers who had over $100 tax increase this year.
• Make all the tax filing forms available on the web site and distribute to public libraries etc.
• Hold tax workshops with volunteers at desks ready to explain and help people do filings.
• Extend deadlines and waive penalties to accomodate late filings.
• Welcome taxpayer input - we might as well take advantage of the notoriety this issue has raised. Consider a survey, local meetings, or whatever gives people an opportunity to speak out.

Next we still need to figure out if some taxpayers were unfairly impacted or not. If not then a report demonstrating that and including taxpayer statements would help bring closure - "I spoke at the tax workshop, but later when they explained and I filed XYZ Form my taxes came down some. I paid very little tax for years, so the XX% increase this year only I can live with." I don't think everyone will or should be happy, but if the majority of people up in arms are reasonably accommodated that would be a good validation of the new tax code.

Analysis of tax code changes should focus on identifying worst-cases, not just average impacts. While it may be true that only a small percentage of taxpayers experience high impact we also need to look at how severe the most extreme impacts are. Identifying worst-cases as a "canary" helps to better evaluate potential impact on individuals.

Possibly the tax system is reasonably fair and working as it should, but some people still are unhappy. Many public issues run into "NIMBY" perspective complaints (Not In My Back Yard: in other words, thinking that "some other folks" should bear than burden, not me.) I think clarification of the intended principles behind our tax code (as I tried to tease out above at the end of the Fairness section, not very successfully) would help at least explain the intention behind all the rules and complexities. 

If some taxpayers did not get a fair shake then there is work to do. I won't speculate on that yet, especially ahead of any solid data. We have to identify the problem (or verify that there is none) first.

The worst outcome in the next few weeks would be to just forget about this and learn nothing from it. Most people are not up to sustained protest so it is critical to respond to this step and maintain attention, following up with a solid accounting of what did or did not happen that makes sense.

At the tax workshop we heard taxpayer voices and county responses for the first time. It was a valuable session and served to get things out in the open. Now we need to see how far those two positions can move closer toward an understanding and possibly common views, or if not to identify where gaps remain to be addressed.