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Tax Caps Unbudged After 10 Years Baffling Policy Conceals Entrenched Inequity
March, 2008
By Barbara Carss
Property tax caps first introduced in 1998 to help ease the tax shifts caused by current value assessment (CVA) continue to reward tens of thousands of Ontario's commercial/industrial/multi-residential ratepayers with artificially low taxes. The caps have also become something of an inadvertent obstacle to the provincial government's urban intensification goals since vacant land and surface parking lots are among the major beneficiaries of the policy.
Rising property values could take the owners of some protected properties farther away from carrying their true allotment of the tax burden following the impending reassessment based on January 1, 2008 market values. Critics of the incremental phase-in of CVA-related tax shifts are concerned that reassessment could undo some of the recent progress toward harmonized CVA-level taxes.
Chief among those critics are the property owners who have not received the full benefit of tax decreases attributable to CVA. Instead, municipal governments have had to appropriate those tax savings to balance the shortfall that occurs when capped properties contribute less than their share.
"They work out how much revenue they've lost as a result of the caps and then they claw it back from the properties where taxes would otherwise go down. It's an administrative nightmare. It's difficult for municipalities to explain and they get a lot of backlash from angry taxpayers," observes Peter Tomlinson, an economist, consultant and author of the Toronto Office Coalition's 2006 study and recommendations on ways to achieve better property tax parity.
MOVING TARGET FOR PHASE-IN
Reassessment reshuffles the tax apportionment within a property class because individual properties gain (or lose) value to differing degrees. The variance from the average increase determines whether taxes go up or down.
Properties protected with caps throw off the calculations, however. Taxes can only increase a specified percentage above the previous year's level even though the property's assessed value may have increased more than the average. In such cases, the capped taxes would actually move farther away from the intended CVA destination.
"We take two steps forward and then we have a reassessment and it's two steps back," says Edward Hankins, Director of Policy, Risk & Treasury in York Region, where Regional Council recently adopted a motion calling for the phased elimination of the property tax caps and clawbacks by 2012. "If every property goes up 5% then the tax rate would be such that everyone would pay the same [proportionately], but that's not what happens."
York Council's stance is far from unprecedented. The Municipal Finance Officers Association (MFOA) of Ontario made a similar submission to the then Minister of Finance, Greg Sorbara, in 2003 and most Ontario municipalities have consistently expressed dissatisfaction with the practice.
"Capping was meant to be a transition tool, but it's 10 years later and where are we? In order to sustain and maintain this regime there is a significant amount of cost both provincially and municipally, but even more fundamentally it is an equity issue." Hankins says.
"Equity, from our members' point of view, generally means that people with the same CVA in the same property class should pay the same tax," concurs Dan Cowin, Executive Director of the Municipal Finance Officers Association.
TORONTO'S EXTENDED TIMETABLE
Meanwhile, the City of Toronto is taking a more long-term approach. In 2006, Council implemented a 15-year plan to equalize and reduce the commercial, industrial and multi-residential tax rates down to 2.5 times the residential rate, while also phasing out capping. "Within 15 years we estimate that most of our properties will be at CVA," says Adir Gupta, Manager of Corporate Finance for the City of Toronto.
He argues that the extra time - 23 years, factoring in eight years of capping leading up to 2006 - is necessary because Toronto had not undergone a comprehensive reassessment since the 1940s prior to the introduction of CVA.
"York had a more up-to-date assessment base so the assessed values prior to current value assessment were not as far out of date. The distribution in values between similar properties and between property classes is significantly greater in Toronto. Our starting point is much worse," Gupta stresses. "Those distortions occurred over 60 years and they are not going to be solved in the City of Toronto overnight."
A recent report from a special taskforce appointed to study Toronto's fiscal outlook (see story, page ?) makes no direct reference to the issue of tax caps and clawbacks, but its recommendation to shift more taxes onto the residential tax base could reduce the magnitude of revenue that has to be clawed back from other taxpayers to protect the capped properties.
"As soon as you can lower the commercial tax rate, it reduces the costs of capping," Tomlinson notes.
Nor is Toronto necessarily the only municipality where that strategy could apply. "We have 4.2 million properties in the province of Ontario. About 33% of the taxes generated should be coming from residential, but we're only getting 22% from residential," reports David Gibson, Executive Vice President with Altus Group Limited, one of Canada's largest tax consultancies. "That tells us, in reality, that taxes for residential are not high enough."
UNINTENDED CONSEQUENCES & BENEFICIARIES
Policies allowed through 2005 provincial legislation have accelerated progress to unified CVA-level taxes to some extent. Previously, allowable yearly tax increases for protected properties were restricted to no more than 5% above the 1997-level taxes.
"Under that formula, there were 108 properties in Durham that would have taken more than 100 years get to CVA and one property that would taken 3,000 years," notes Dana Howes, Senior Economic Analyst in Durham Region.
Since 2005, municipalities can choose one of two options for imposing gradual tax increases - either 10% of the previous year's taxes, or 5% of the CVA-level taxes for the property. Most municipalities have adopted the 10% option, with Toronto choosing to increase taxes each year by 5% of the CVA-level taxes.
"We were very careful in moderating our shifts, but it helps move those properties that were the most farthest away from CVA," Gupta says.
In York Region, approximately 16% of commercial/industrial/multi-residential properties are still capped. In 2007 that translated into $14.5 million that had to be clawed back from other property taxpayers - many who were owners of small to medium-sized businesses.
In contrast, regional analysis shows that commercial condominiums, railway buildings and lands, and vacant commercial and industrial lands number predominantly among capped properties. "For a lot of municipalities, it's not the smaller owners who are getting the big protection," Hankins says.
"Vacant land, historically, is the big winner in capping," Howes agrees. "If the original argument for capping was that it was meant to protect businesses and jobs, vacant land isn't really an economic driver."
Of the approximately 3,600 protected properties within York Region, 935 are currently paying less than 50% of CVA-level taxes. "It's a relatively small number of properties that are really going to be impacted on if the caps were eliminated," Hankins maintains.
The Region has called on the provincial government to make other potential relief mechanisms available, such as giving municipalities the ability to defer assessment increases for small businesses in special cases. "We think this should be a deferral versus a phase-in because a phase-in would require that we fund this probably from some other taxpayers. Deferral will mean that the municipality will finance it, and then we'll get our money back at some point in the future," Hankins says.
Beginning in 2005, the Ontario government gave municipalities leeway to bring newly constructed
commercial/industrial/multi-residential properties onto the tax roll at CVA values. Such structures were previously taxed at the lower of CVA or the average of six comparable properties - a practice believed to increase the number of appeals to Ontario's Assessment Review Board (ARB) as property owners disputed the legitimacy of the six comparable properties the Municipal Property Assessment Corporation (MPAC) identified.
"It was really open to abuse. People would try to come in with the lowest assessed value that was comparable. We have a lot of properties that have been brought in [to the assessment base] in the last four or five years that are way below their true assessments," Hankins maintains.
"Using comparables would give an artificial value that the property would have [theoretically] had in the old days, which was also an inequitable value. It was unfair, and it was administratively burdensome," Cowin says. At the same time, provincial legislation exempts new construction from the pool of properties from which clawbacks can be obtained.
After a four-year phase-in, the 2008 tax year marks the first year that new construction will automatically be taxed at 100% of CVA. Nevertheless, as the provincial legislation now stands, any property is potentially eligible to fall back into the capped property pool following a reassessment.
DISCORDANT APPROACHES FOR RESIDENITAL AND NON-RESIDENTIAL
Other changes to be introduced in tandem with the upcoming reassessment are creating more uncertainty. Notably, the Provincial government has pledged to phase in assessment increases on residential properties over the four years of the assessment cycle.
Since assessment decreases will flow to homeowners immediately, municipalities could potentially face revenue shortfalls, but analysts predict most will simply raise residential tax rates. "There was no clawback put into the residential tax system. If you need to get 'x' amount of dollars and you don't have as much assessment, then you need a higher tax rate," Tomlinson explains.
Provincial legislation prevents municipalities from shifting taxes from the residential to non-residential property tax classes if commercial/industrial/multi-residential property tax classes are taxed at more than 1.1 times the residential tax rate. York Region is one of the few Ontario municipalities that is anywhere close to that target.
Even so, analysts have some concerns about the possible fallout of non-residential properties jumping to full CVA-level assessment in the first year following reassessment, while residential properties take four years to reach the same target. They also wonder about the ever-increasing complexity of the tax system.
"There are going to be some interesting implications from running two different tax mitigation systems for different types of properties - residential and non-residential," Cowin predicts. "The interaction between the two and how they can affect each other, we don't really know yet."
Alternatively, York Region Council's recent motion proposes that the Province provide the same four-year phase-in schedule of assessment increases for non-residential properties in lieu of caps. The 2007 Ontario budget left the door open for such a move with a promise to consult municipalities and other stakeholders and further study the issue.
The 2008 tax year also inaugurates business education tax relief promised in the 2007 Ontario budget. All residential taxpayers in the province have paid a harmonized education tax rate since the provincial government assumed responsibility for funding education in 1998, but commercial and industrial ratepayers still pay a patchwork of different rates that date back to the days when each school board levied taxes for its own needs.
The 2007 budget introduced a seven-year phased reduction of the business education tax rate, which will translate into a tax cut of $540 million per year by 2014. Corporate capital tax was also repealed to stimulate economic growth - a move Tomlinson sees as a breakthrough acknowledgement of the redundancy of the two tax streams. "This recognition of business property tax as akin to capital tax was the first time an Ontario government has ever made that link," he says.
"Even in 2014, the business education tax rate will still be five times the residential education rate. If the government could move the business rate down to that residential rate, the budget's predicted economic benefit would increase dramatically right across Ontario," Tomlinson adds. "A rate reduction that large is a long shot, but, if it happened, there would be a major side benefit. Clawbacks would painlessly go off into the sunset."
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