House Legislative Study Committee
Income-Based Education Property Tax
Rep. Robert Rusten, Chair
(Member, House Committee on Ways and Means)
(General Counsel, Vermont Department of Taxes)
(Vermont Municipal Clerks and Treasurers Association)
Rep. Johannah Leddy Donovan
(Member, House Committee on Ways and Means)
(Executive Director, Vermont League of Cities and Towns)
Rep. Tim Jerman
(Member, House Committee on Education)
Rep. Richard Marron
(Vice-Chair, House Committee on Appropriations)
Rep. Harvey Otterman, Jr.
(Vice-Chair, House Committee on Ways and Means)
Rep. David Potter
(Member, House Committee on Education)
(Vermont Tax Preparers)
Report Filed December 15, 2005
Table of Contents
Appendices (available from the Council offices)
A. Committee Charge
B. Committee Agendas
C. List of Documents Distributed to Committee
D. Summary of the Income Sensitivity (Prebate and Rebate) Law
E. Summary of Committee Proposals
Act 38 of 2005 provided for a House Legislative Study Committee on Income-Based Education Property Tax for Vermonters. The committee’s charge was to analyze the prebate and rebate systems, and to propose a more understandable and efficient income‑based revenue system for education finance for Vermont residents. The committee’s charge, reprinted in Appendix A of this report, included several specific questions to guide the analysis.
The committee met eight times, including a public hearing. At its first meeting, the committee heard testimony on the costs and complexities of the current prebate and rebate system, and the effects of the volatile real estate market and rapid growth in education spending on education property tax liabilities. The committee agreed to work toward producing two proposals, one to address concerns in the current system, and one to create a new income-based system.
At the second meeting, the committee identified specific principles to guide its inquiry, and decided to prioritize a list of concerns to be addressed.
Applying its guiding principles and priorities, the committee drafted the broad outlines of six possible plans, and from these ultimately chose two plans, one to create a new system of income-based education finance, and one which simplifies the current system and addresses some of the issues raised during the study.
The study committee presented these two proposals at its public hearing on November 7, and addressed additional issues under these proposals in its final two meetings. While the committee supported the basic intent to simplify the current system and to try to craft an alternative income-based system as well, not every committee member could support all the components of each proposal. All agreed that the proposals merit further consideration by the legislature, and also that the proposals would require more detailed analysis than the committee could complete in its eight meetings.
The major features of the two proposals are:
(1) A new system which would
Significantly lower the base property tax rate (a rate of 30 cents was used for committee discussion) and adjust it by three times (also used for committee discussion) the percentage of the district’s education spending over the base education payment per pupil;
Impose an education income tax on the taxable income of residents (a rate of 1.5% was used for committee discussion); and
Repeal the prebate program and keep the rebate program.
(2) A simplification of the current system which would
Unify the prebate and rebate programs into one program with a two-step calculation;
Pay the adjustment amounts directly to the towns and reduce taxpayers’ property tax bills before they are issued; and
Allow taxpayers the option of also sending part or all of any refund (and to withhold for property taxes if they so choose) to the town for property tax payments. This feature preserves confidentiality.
Further details of the two proposals are presented in Appendix E. The study committee requests that the Ways and Means and Finance Committees obtain further fiscal analysis of these proposals, and the committee also recommends certain related issues for further analysis by the standing tax committees.
The committee was able, in its eight meetings, to address a large number of difficult issues. In designing its two proposals, the committee agreed to (1) preserve the current equity of the education finance system; (2) to the extent possible, not redistribute tax burdens; and (3) not change tax burdens for individuals who pay based on income. The committee was able to propose solutions to two perennial problems under the Act 60 system: (1) How to issue a property tax bill for the adjusted tax amount without introducing more complexity into the system and without violating taxpayer confidentiality; and (2) How to reduce the discomfort with volatility in common levels of appraisal without reverting to a tax system that would violate Brigham.
Report of the Committee’s Deliberations
I. Goal of Producing Two Proposals
At its first meeting, the committee heard an overview of the prebate and rebate programs and of the Ways and Means proposal from 2003 to simplify the education tax system.
Rebates are available to renters and homestead owners with household income of $47,000 or less. Prebates are available to homeowners with household income of less than $85,000 (less than $90,000 beginning in 2007); and homeowners with household income of $85,000 or more are eligible for prebates on the first $200,000 of housesite value. A detailed summary of the programs is attached as Appendix D.
Three major problems with the current education finance system appear to be:
(1) the inefficiency of collecting $400 million in homestead property tax and then using a complex system to refund $110 million of that revenue to approximately 70% of the homestead taxpayers;
(2) the increasing property tax burden resulting from rapid growth in both real estate values and education spending; and
(3) the lack of a clear connection between the prebate check and the taxpayer’s property tax bill.
The committee also heard from witnesses and from their own discussion about many less-sweeping problems with the current system.
In its discussions of how to proceed in future meetings, the committee agreed to try first to catalogue concerns with the current system and, in addressing those concerns, to focus on producing two proposals, one proposal for an entirely different system of taking into account the ability to pay, and one proposal to address problems in the current income-sensitivity system and to simplify it.
The committee then identified the information it would need to proceed in its analysis of the current system and how to improve it. Subcommittees were appointed to research and report back on the information needed.
II. Overview of Issues Considered
A. At its second meeting, the committee heard extensive reports from its subcommittees on a broad range of issues to be considered. The issues, with highlights from the committee discussion, follow.
1. Fiscal history of prebate program and school spending since Act 60.
Mark Perrault of the Joint Fiscal Office provided a chart of actual and estimated growth in the cost to the Education Fund of the rebate and prebate programs. The average annual growth rate over the ten years from 1999 to 2009 is 10.6 percent. That cost growth is due in large part to education spending and to property values growing faster than incomes.
First, school spending is growing (7.2% annual growth rate) twice as fast as non‑property-tax education revenue (3.7% annual growth rate). Since non-property-tax revenues are not growing as fast as education spending, the education property tax must make up the difference. Higher education property tax revenues mean larger property tax adjustment payouts.
Second, real estate values (and therefore, property tax bills) are growing faster than incomes. When incomes grow more slowly than property tax bills, the result is larger property tax adjustment payouts.
The result of these two factors is a fast-growing cost for the prebate and rebate programs and an increasing burden on taxpayers who are not eligible for an income‑based property tax adjustment.
One way in which property taxpayers have made some effort to control education spending has been to vote down school budgets, as evidenced by the fact that in 2005, twenty-seven school budget votes failed.
A third factor may contribute to greater costs for the prebate and rebate programs in the future. Rapidly rising real estate values meant that education property tax revenues grew in FY06 by 13.1%, even after accounting for the cost of the p/rebate payments. As the real estate market slows down or even declines in value, education property tax revenues influenced by that growth may be affected. If education spending still continues to rise, a larger percentage of Education Fund revenue would be needed to pay for p/rebates.
2. What are the causes of school spending increases, and would moving to an income tax system for school funding encourage spending?
There are many issues driving costs of education, and other legislative study committees have examined these factors. Some districts are not seeing as dramatic an increase in education spending as most other districts, but there is insufficient data to analyze why.
The committee was concerned that its proposal to use both a property tax and an income tax could create a misperception which could increase education spending. That is, if taxpayers only focus on the low property tax rate and ignore the education income tax, they might feel encouraged to increase education spending. To avoid this, it would be important to highlight for taxpayers, when they are voting on their school budgets, that the education income tax is part of the total education tax liability.
3. What is the historical basis for the prebate system and what other options were considered?
Initially, the House bill which became Act 60 used an income tax to raise education revenue. When that approach was rejected, a homestead exemption was considered. Ultimately, the prebate system was devised, based on the more familiar structure of the rebate system, and was proposed as a way to take “ability to pay” (an income tax notion) into the calculation for property taxes. In 1997, it appeared that the prebate system would apply to eighty percent of the population, and that this large participation would create the political will to maintain funding for the system. (A problem under the rebate system up to that time was the underfunding of that program.)
4. What is the administrative cost of the prebate system?
The original appropriation to the Tax Department for setting up the administration of the prebate program in 1997 was $500,000.00, for computer programming, forms development, and new personnel for taxpayer service and enforcement. It is difficult to break out the cost of administering the prebate and rebate programs from the general Tax Department budget. A number of related costs have grown over time. For example, a high percentage of taxpayer appeals in recent years have been p/rebate‑related. A best estimate of the current administrative cost of the prebate program is $1 million.
There is a significant cost to taxpayers, as well. For example, the forms are complex and time-consuming, and up to ninety percent of off-season questions to tax preparers are related to p/rebates.
Based on information from the Vermont Municipal Clerks and Treasurers Association, it is estimated that there is little or no administrative cost to local governments at this time for the prebate system. Town officials do, however, spend a significant amount of time explaining the prebate system to taxpayers.
5. What do other states’ circuit breaker programs look like?
Other states have property tax credits, reductions, exemptions, and deferred payment programs. Fifteen states have circuit breaker programs (rebates), but are more restrictive in eligibility and benefits. Vermont’s appears to be the most generous program.
6. What are current problems in the prebate system that need fixing?
a. The legislative charge to the committee noted several specific issues in the prebate and rebate programs to address:
i. whether prebates and rebates are the best method of taking income into account;
ii. how the administrative costs of that system compare to another option;
iii. issues in the definition of “household income”;
iv. housesite value limitation;
v. qualifying income thresholds and possible inflation index;
vi. inappropriate benefit amounts (is there a true need? income manipulation and averaging; balancing the cost to other taxpayers of paying out these extremely large benefit checks);
vii. how best to adjust the property tax bill or otherwise take income into account.
b. The committee discussed these and a large number of other issues within the prebate system, and at their third meeting, decided on the order of priority of these issues. The prioritized list is shown below in Section III.
7. What are problems in the definition of “household income”?
In this subset of issues within the prebate program, several more detailed problems highlighted were:
Gifts and inheritance are not included.
Reverse mortgages can create confusion as to whether loan proceeds constitute “income.” The committee determined, however, that true reverse mortgages are loans, and proceeds are not included in household income.
Some taxpayers are able to manipulate their income so that instead of never qualifying, they can at least qualify every other year, by moving income to an earlier or later tax year.
“Household income” doesn’t account for taxpayers who own a large amount of non- or low-income-producing assets and maintain a low income.
There is a $6,500 exemption for a dependent student-child’s earned income, but no similar exemption for the income of an adult child who remains dependent; also the $6,500 should probably be updated to nearer $10,000.
8. Estimated costs and other issues of State collection of property tax.
State-level collection of the education property tax would result in two parallel systems: one for State-level collection of the education tax and one for town-level collection of the municipal tax. This is expensive and cumbersome, as it would require two sets of tax bills, two checks for taxpayers to write, two levels of accounting and enforcement. In addition, towns objected to the loss of delinquency penalty revenue (which is often used to pay tax collectors) from the education tax, and objected to the loss of the “float,” which is generally equal to one cent on the tax rate.
9. Rebate issues for renters and landlords.
Statewide, twenty-nine percent of housing units are rental units, and according to U.S. Census data, it appears that eighty-four percent of renter units have household income qualified for renter rebates. The biggest issue is that there is no relief program for renters with household income above that level, and that problem is exacerbated by the current real estate market, which is making education property taxes rise on the buildings they rent. (That property tax is typically passed through in the form of higher rents.)
10. Ways and Means 2003 proposal in H.462 and other ideas.
One of the features of H.462 (the Ways and Means education finance reform bill from 2003) and earlier proposals was the inclusion of an education income tax. Many on the study committee felt that if the goal is to base revenue on the ability to pay, the income tax is a simpler system than a property tax which must then be adjusted by prebates and rebates.
B. After discussion of the foregoing issues, the committee turned to discussion of the broad outlines of proposals to simplify the current system or to add an education income tax component to the system.
III. Guiding Principles and Issue Priority
At its third meeting, the committee discussed the principles which should guide its study, and adopted fifteen criteria its proposals should meet. The committee also determined the priority of the issues it had identified.
A. Fifteen Principles
Under the fifteen criteria adopted, any income-based system proposed by the committee should:
· be more understandable than the current system
· be more efficient than the current system
· take into account taxpayer confidentiality
· comply with the Brigham decision’s holding that “children who live in property-poor districts and children who live in property-rich districts should be afforded a substantially equal opportunity to have access to similar revenues,” and that there be “substantial equality of educational opportunity throughout Vermont”
· be less costly for state and local governments to administer than the current system
· have lower compliance cost for taxpayers than the current system
· not need annual legislative action to “fix” problems or adjust rates
· provide local school districts with a stable source of revenue
· be responsive to differences and changes in taxpayers’ ability to pay
· have clearly-understood tax consequences on those who make spending decisions
· contain clear political accountability for changes in tax levels
· not be “economically inefficient” or cause undue harm to the state’s economy
· take into account not altering the balance of power between state and local governments or between voters and their government
· tax similarly-situated taxpayers equally
· not encourage more school spending
B. Priority List of Issues
The committee also published a list of issues and their priority for the committee, as follows.
1. Primary issues.
a. Taxpayers often don’t understand the connection between the prebate check and the property tax bill.
b. When real estate values do not rise as quickly, the cost of prebate system may outstrip the fund’s ability to pay out the benefits.
c. The current system is so complex and confusing that most people don’t understand it. Complexity adds to the cost of forms, cost of administration, number of errors made by taxpayers and the resulting number of assessments and penalties issued and cost of enforcement, further resulting in public resentment and frustration.
d. A successful tax system requires enough simplicity to encourage compliance and allow transparency.
2. Secondary issues.
a. Inefficiency of money going out versus money coming into the system.
· 70% of taxpayers are eligible for the prebate program
· 47% of the tax paid by claimants on average is then paid back to the claimants
· 25% of all money paid in education property tax is then paid back out in adjustment claims
It is more efficient to have a system which brings in the correct amount of money and does not overcollect taxes in order to repay 70% of residential property owners.
b. Mortgage escrow issues should be reviewed.
c. Since the prebate is based on prior-year value, a change in the assessed value of the housesite means that the owner is technically not receiving the property tax adjustment.
d. The prebate program has added pages to the income tax booklet, which is costly to the State and adds confusion for taxpayers.
e. Very large prebate checks are issued each year, some over $20,000.
f. Some people are “gaming the system,” that is, manipulating their income from year to year to qualify for prebates/rebates or to receive larger checks.
g. The rebate system caps a property owner’s tax liability for education and municipal taxes. This insulation from the tax impact of a vote for education spending can allow or encourage more spending.
h. The base (2%) prebate percentage should not be lowered each year when revenues are high enough to lower the education property tax rates, since prebate claimants do not contribute to the excess money coming into the Education Fund.
i. The way we calculate income for eligibility does not include assets, so people with substantial assets may be eligible. What are the plusses and minuses of an asset test?
j. Renters cannot take advantage of the system in the same way as homestead owners, since they are eligible for rebates only if household income is $47,000 or below.
3. May be issues but not of major concern.
a. There are costs of administration for the tax and education departments.
b. Some people who should take advantage of prebates don’t understand that they are still eligible even if, for example, a brother, child or parent is on the deed.
c. Even though a co-owner may be eligible for a prebate, the amount is reduced for the co-owner.
d. The definition of “household income” is inconsistent, because a dependent parent’s income of $6,500 is not counted, but there is no $6,500 exclusion for income of an adult dependent child.
e. Rebates and prebates use income from different years in determining the adjustment amount.
f. An honest mistake by the taxpayer or Tax Department can result in the taxpayer having to pay a large tax bill up front, then waiting for the p/rebate check.
g. If a town goes through a reappraisal, the prebate check is based on previous year’s value plus CLA, while the tax bill is based on new assessed value, resulting in taxpayers possibly paying more than they should.
h. Many people are now paying for accountants to do prebate forms, which costs them money.
i. Owners of residential property who are not eligible for income sensitivity are paying a significant percentage of their income on property taxes. The property tax adjustment system is no longer just for low-income Vermonters, so what is the rationale for an income cutoff?
j. The rebate system is more likely to help those in large towns versus those in more rural areas.
k. Timing issues regarding ownership of property can create problems.
l. With two separate programs for prebate and rebate, some people are confused and only apply for one program, and thus receive less assistance than they are entitled to.
IV. Initial Broad Proposals Considered
Also at its third meeting, the committee discussed the pros and cons of a number of broad proposals, in light of the committee’s guiding principles and list of priorities. The broad proposals reviewed follow.
A. Plans to Modify the Current Prebate/Rebate System
1. Eliminate the prebates, expand eligibility for rebate, and use saved money to lower residential tax rates.
2. Have Tax Department notify towns of each person’s property tax adjustment amount, and town then bills taxpayer for net amount.
3. Eliminate prebate, keep rebate, and give everyone a homestead reduction.
4. Eliminate prebate and have rebate based on current prebate formula.
5. Eliminate prebate, every homestead owner receives tax bill reduced by a flat amount; property tax bill will show the reduction amount.
Town bills state for lost education and municipal revenue; rebate the following spring for anyone with household income below $85,000 ($90,000 in FY 08).
Rebate uses same formula as current prebate system; spending above base payment will be the taxpayer’s education tax responsibility.
Rebate no longer capped, nor a combination of education and municipal tax; eliminates the slope for over $85,000, because homeowners would be receiving a direct tax bill reduction; eliminate $15,000 exemption option in current prebate system.
6. Any yet-to-be-identified ideas.
B. Plans to incorporate an income tax element as a direct measure of ability to pay.
1. Replace system with an education income tax.
2. Plan discussed at last meeting:
Reduce base homestead tax rate to $0.30 (for example) and increase that base rate by triple (for example) the percentage of education spending over the base per-pupil amount.
Eliminate the prebate system.
Create an education income tax.
Maybe keep the rebate program; and maybe create an adjustment for education income tax paid by renters.
V. Analysis of the Proposals
At its fourth meeting, the committee analyzed the major proposals in detail, identifying the pros and cons of each, as follows:
A. Proposals to Modify the Current System
1. Proposal 1 Eliminate the prebates, expand eligibility for rebate, and use saved money to lower residential tax rates.
If you raise the eligibility level to $60,000 household income, the number of people affected appears to be relatively low.
Simpler, less costly program.
Lowers property tax rate.
Exacerbates the eligibility cliff.
Does not address the problems with the definition of “household income.”
Removes cost containment feature of the prebate program. (But also creates more cost containment for those who were eligible for the prebate but would now not be eligible for the rebate.)
Doesn’t account for higher tax burden in high‑value towns.
Leaves in place the heavy reliance on property taxes.
2. Proposal 2 Have Tax Department notify towns of each person’s property tax adjustment amount, and town then bills taxpayer for net amount.
Taxpayers would not have to pay the taxes in and then receive money back; they would still have to fill out the prebate forms, however.
It is easier for taxpayers to talk to town officials (no travel time to Montpelier, smaller office to deal with).
Breach of confidentiality: town officials learn that taxpayer is income-eligible for a property tax adjustment, and may be able to calculate the taxpayer’s household income.
3. Proposal 3 Eliminate prebate, keep rebate, and give everyone a homestead tax reduction.
Cheaper to administer, simpler.
Is more progressive than the proposal to eliminate the prebate and lower the homestead tax rate.
May adversely affect most of those in the prebate system now.
Doesn’t account for higher tax burden in high-value towns.
Exacerbates the eligibility cliff.
May cause cash flow problems.
Removes any cost containment features that the prebate system provides.
4. Proposal 4 Eliminate prebate and have rebate based on current prebate formula.
Cheaper to administer, simpler.
May adversely affect most of those in the p/rebate system now.
Doesn’t account for higher tax burden in high‑value towns.
Exacerbates the eligibility cliff.
May cause cash flow problems.
Removes any cost containment features that the prebate system provides, except for taxpayers with household income below $47,000.
5. Proposal 5 Eliminate prebate, and instead, every homestead owner receives tax bill reduction of a determined dollar amount.
Property tax bill will state the tax reduction amount; town bills state for lost education and municipal revenue.
Rebate following spring for anyone with household income below $85,000 ($90,000 in FY 08); rebate uses same formula as current prebate system.
Spending above base payment will be the taxpayer’s education tax responsibility.
Rebate no longer capped, nor a combination of education and municipal tax.
Eliminates the slope for over $85,000 because homeowners would be receiving a direct tax bill reduction.
Eliminate $15,000 exemption option in current prebate system.
Too many changes and too complicated; people are just getting used to current system.
Is no simpler than current system, and the committee’s two goals are simplification and cost reduction.
The reduction in property tax is less specifically related to the taxpayer’s income or property tax burden.
Does not address extreme prebate check payments.
B. General Discussion of Issues in the Proposals to Modify the Current System
1. Transition costs of combining prebate and rebate programs.
The committee talked generally about the savings of combining the prebate and rebate systems in some way, and whether there would be a one-time transition cost for those who were covered by the discontinued system. In answer to that question, it appears there might be no such cost, because both the prebate and rebate amounts related to a single property tax year are paid within a single fiscal year. A combination of the programs would simply mean paying the benefits all at the same time within the fiscal year.
2. How to measure income for calculating prebates.
The committee also discussed whether household income eligibility should be changed to some other measure of income, such as the income tax concepts of taxable income, gross income, or adjusted gross income. The committee heard testimony on what items are included and excluded in each of these concepts, and testimony on what information would be needed to show the effects of a change. The committee decided that it would not be possible to obtain sufficient data to analyze fully how changing the measure of income might change those who were eligible for the benefits. The committee also agreed that the program was complex enough without adding confusion by changing a long-used income measure, and decided to keep the household income measure.
3. Large prebate checks.
All members of the committee were concerned about the fact that a few claimants receive excessively large checks. The committee discussed various solutions to the problem.
The committee discussed the possibility of using an annual $6,000 cap on adjustment payments. The amount of $6,000 was chosen for discussion purposes because it was a level which only a few people exceeded, and would bar the most excessive prebate check payments (only 460 claimants received checks in excess of that amount in FY06, but these checks ranged from $6,000 to over $20,000).
The committee also discussed whether a payment cap might be used as a threshold limit, which would trigger either an asset test or an investment income test. That is, if the claimant’s assets or investment income were below a certain level, then the cap could be exceeded. An alternative proposal was to allow a payment to exceed the cap if the claimant could show “true need” in some way.
Ultimately, a narrow majority of the committee endorsed the $6000 cap. A minority recommended that the standing tax committees also review the various solutions discussed, including (a) a cap on the combined prebate and rebate adjustment, but at a possibly higher amount; (b) exceptions to the p/rebate cap, including an exception for a showing of true need; (c) a limit on the value of the income-sensitized housesite, regardless of household income level; and (d) no eligibility if investment income exceeds a certain level.
4. Adjusting the 2% household income base for prebates.
Each year, if excess Education Fund revenue is available, the legislature is authorized to reduce the homestead and nonresidential education tax rates and also to reduce the two percent of household income base for the prebate calculation. The committee discussed whether the two percent should also be reduced, since those who receive the prebates are not contributing to the excess revenue generated. A majority endorsed not reducing the two percent base. A minority felt that the standing committees should look further at how to address this issue.
5. Loss of taxpayer confidentiality if town is notified of taxpayer’s p/rebate amount.
Notification to the town of the taxpayer’s prebate or rebate amount would alert town officials to the fact that the taxpayer met the income eligibility limit, and might even provide enough information for town officials to estimate the taxpayer’s amount of household income. In determining how to deal with this loss of tax confidentiality, the committee discussed using the approach that a person who claims a p/rebate would thereby waive confidentiality. This same approach was discussed during the Act 60 debates, and rejected because it was felt that no one should have to give up personal financial confidentiality in order to obtain the correct property tax liability or to obtain property tax help for lower-income taxpayers.
The committee discussed options for protecting the information once it is given to the town, such as making the property tax records non-public or making local officials subject to the Tax Department confidentiality laws and penalties.
The committee noted that it would take a fair amount of time for a town official to try to calculate a person’s income from the adjustment amount, and that town officials would have no desire to try to figure out incomes and would never have the time to do it in any case. As a result, the committee decided not to subject local officials to the confidentiality laws and penalties.
The committee also noted that town officials might not want even to be perceived as having access to this information.
Another possibility was to make the property tax records nonpublic documents. But this, it was felt, would only create bigger problems, because the public needs property tax information at real estate closings and at delinquent tax sales; and it might require that delinquent tax warrants also be made confidential (which might not even be possible).
When the committee ultimately chose a solution to this problem (see next paragraph), it decided that the options just discussed for protecting the information were unnecessary.
The committee ultimately resolved the entire confidentiality question, and the problem of taxpayers not understanding the connection between p/rebate checks and property tax bills, by proposing the following:
The Tax Department would notify the town of a certain amount by which to reduce the taxpayer’s property tax bill. The amount would be the taxpayer’s
(a) prebate amount, if any; plus
(b) rebate amount, if any; plus
(c) any portion of the income tax refund which the taxpayer chooses to have
(d) any additional amount the taxpayer chose to have withheld during the year for property tax purposes.
Under this proposal, the Tax Department will not send out prebate and rebate checks to the taxpayer, but will instead pay the adjustment to the town and notify the town to reduce the property tax bill by this amount. The proposal also allows the taxpayer to choose to send some or all of the income tax refund, and to choose to have additional withholding throughout the year, to avoid having to come up with a large lump sum to pay property taxes. The taxpayer might not even be eligible for a prebate or rebate, but have chosen to use withholding as a simpler method of property tax payment.
Since the property tax bill would show the reduction, and require payment only of the reduced amount, taxpayers would see clearly the connection between the p/rebate and the property tax bill. The committee felt that this approach would resolve a perennial problem under the Act 60 system, viz., how to issue a property tax bill for the adjusted tax amount without introducing more complexity into the system and without violating taxpayer confidentiality.
This approach solves the confidentiality problem, because town officials would have no idea which components (prebate, rebate, refund, withholding) make up the amount the Tax Department reports to the town for that taxpayer.
It was noted that if no one uses refunds or withholding for property taxes, then town officials would know that anyone with an adjustment amount was income-eligible for p/rebates. To prevent this problem, the new law could keep confidential any Tax Department information on how many people are using refunds or withholding to pay property tax.
The standing committees would need to look at how and when the Tax Department would pay adjustment amounts to the towns. Some of the issues involved would be how to net payments to the towns and how to allocate payments between education and municipal property taxes.
C. Preliminary Ideas to Replace the Current System with a New Income-Based System or to Incorporate an Income Tax Element
1. Proposal 1 Replace system with an education income tax.
2. Proposal 2 Reduce base homestead tax rate (to a rate of $.30, for example) and increase that base rate by triple (for example) the percentage of education spending over the base per-pupil amount. Eliminate the prebate system.
Create an education income tax (at a rate of approximately 1.0% or 1.5%, for example) of taxable income.
Maybe keep the rebate program; and maybe create an adjustment for education income tax paid by renters.
D. Committee Discussion of Issues Related to an Education Income Tax
1. Income tax rates and burden. The committee noted that the simplicity of an income tax (as opposed to trying to adjust the property tax for the taxpayer’s income level) has to be balanced against any problems which might arise from creating a higher marginal income tax rate. High marginal rates can affect decisions of higher-income taxpayers to migrate into the State or to leave the State. Tax preparers and others have anecdotal evidence of this happening now with the relatively high Vermont property and income tax rates, although some in-migration occurs because of our quality of life, in spite of our tax rates, and other causes may encourage out-migration, such as warmer weather.
2. Limit on amount of income subject to education income tax. The education income tax provision in H.462 (the Ways and Means proposal of 2003) had a limit of $150,000 on the amount of taxable income subject to the tax. There are several rationales for limiting the amount of income subject to an education income tax. First, a limit would maintain the tax burden at a level similar to the property tax burden, and not redistribute it. Second, limiting the amount of income subject to education income tax would be similar to the Federal limit on income subject to Social Security tax (applies only to a limit of about $90,000 of income). Third, an income tax limit would mirror the “natural” property tax limit which occurs at higher income levels. That “natural” property tax limit occurs because, with rare exceptions, the value of a house, expressed as a percentage of income, levels off and then declines as incomes reach extremely high levels.
3. Application of the tax to a specific group. The committee also discussed whether an education income tax would be imposed only on Vermont residents or also on nonresidents who have Vermont income. Since the proposal reduced the property tax rate only on homesteads, it was felt that the income tax might be imposed only on those same people. The tax might be on those who have their principal residence in Vermont; and a credit or other provision would need to be made for renters, who would continue to pay the nonresidential property tax rate indirectly through their rent.
VI. The Administration’s Position on Income Tax
A. Presentation by Secretary of Administration Charles Smith.
At its fifth meeting, Secretary of Administration Charles Smith presented the Administration’s position opposing an education income tax. An attempt to summarize this testimony is presented here, but for complete accuracy and more detail, the reader should consult the transcript of the Secretary’s remarks, available at the Legislative Council Office.
In brief, the Administration opposes shifting the education tax liability from the property tax to the income tax. Taxpayers feel stretched on all three of the major tax bases: property, income, and consumption taxes, and to the extent that this committee is responding to public stress from the education property tax, the Administration feels that a shift to the income tax would not really alleviate that stress. Moreover, the Administration does not support moving to an education income tax because it would lack sustainability, would not aid in cost control, and would lack fairness, all of which would have a negative impact on business development in the State.
Sustainability is questionable because of Vermont’s rate of growth in education spending. Education spending has been growing at more than double the growth rate for the rest of the economy, and no tax can rise fast enough to keep pace. The property tax, at least, does have a natural discipline built in, insofar as local school districts vote on their school budgets and see a real connection between their vote and their property tax burden. That connection provides a dampening effect on property tax rates. But that dampening effect is not present in an income tax. That is why an education income tax is less sustainable than an education property tax.
But sustainability is a problem to a greater or lesser extent with any tax we use to support education, because Vermont has an increasing problem with education cost containment. With education spending growing at about seven percent a year, while the rest of the state economy is growing at half that pace or less, cost containment is of paramount importance. Replacing the property tax with an education income tax would lessen the natural cost control discipline inherent in a property tax – and that natural discipline is the connection between the local vote and the property tax rate. Moving to an education income tax would just be one more legislative move away from that connection; it would remove the ability of taxpayers to affect tax rates based on what the taxpayers feel they can afford. So, while moving to an income tax might initially give some feeling of tax relief, that relief would just allow education costs to continue their unrealistic rise.
Fairness is lacking in an income tax approach because it would shift a larger portion of the cost of education to a smaller segment of the population; and that small segment of the population is already paying a very large share of the State tax burden. While progressivity in a tax system can be a desirable feature, there may be a point at which too much progressivity can have negative consequences in terms of tax fairness and negative consequence for a state’s economy. Vermont is third highest in the nation in income tax progressivity; and with income sensitivity taken into account, Vermont may be number one in the nation in progressivity. In approximate numbers, fifty percent of Vermonters pay five percent of Vermont’s income tax, while seven percent of Vermonters pay half of all Vermont income tax. And if income sensitivity is taken into account, seven percent of Vermonters pay almost seventy percent of our income tax revenues. If an education income tax is added to that, the tax burden will be tipped even more heavily toward a very small segment of the taxpayer population.
All of these negative features of moving from the property tax to an education income tax would have an adverse affect on business development in the state, as Vermont would increasingly seen as indifferent to wealth creation, which is a necessary component to business and job development.
B. Committee Questions and Comments for Secretary Smith.
One committee member remarked that with property values rising faster than incomes are rising in Vermont, the property tax is increasingly inequitable; whereas an income tax is inherently equitable since it is based specifically on the taxpayer’s income level.
The Secretary responded that a major concern, though, is lack of a cost control feature in an income tax, and that although school budget votes may be painful, it is part of the democratic process of working out how to deal with increasing costs. Local voters are making the tough decisions, and if we keep relieving the impetus (property tax rate pressure) for those decisions, we delay cost control.
Another committee member asked whether fairness and business issues are the main reasons the Governor objects to an income tax.
The Secretary responded that all the issues mentioned are important, but that fiscal sustainability and cost control are important, especially when expenditures are growing at three times the revenue growth rate.
A third member of the committee asked whether the Administration would still oppose an income tax if it included a cost control proposal, and noted that the committee’s proposal was not really to move away from a property tax to an income tax, but was instead to move away from an income-based property tax (a confusing and complex way to take income into account in the tax base), and move to a simpler and more direct way to take income into account, viz., an education income tax. The member noted that the income sensitivity program may lack sustainability, as well, and the committee is trying to address that in this proposal.
Another member asked whether the Governor would be more inclined to consider an income tax proposal if the committee could create a system in which a larger proportion of taxpayers paid the income tax revenues.
The Secretary responded that the Administration would certainly be willing to look at the committee’s proposals, but that it is clearly concerned with any move away from a property tax base to an income tax.
A subcommittee also drafted a written response to the Administration’s objections (See Appendix F), in which the fairness issue is addressed as follows:
Annual reappraisal of Vermonters’ home properties (which essentially occurs when Property Valuation and Review sets new Common Levels of Appraisals in every town each year) exacerbates the disconnect between property value and the ability of the owner to pay when values rise as fast as they have in the past few years. Even assuming that a Vermonter originally buys a property that roughly reflects his economic status, this connection evaporates as the Grand List value rises with the decreasing CLA percentages as comparable properties bring higher prices when purchased by more affluent individuals. Property tax does not necessarily reflect an individual’s ability to pay, and income tax generally reflects more clearly an individual’s ability to pay.
VII. Committee’s Further Discussion of its Two Proposals
The committee then continued its discussion of the details and remaining questions under each of the two proposals, and their presentation at its public hearing, scheduled for the following week.
1. Quarterly estimated tax payments.
The committee debated whether quarterly estimated payments should be required from taxpayers who do not have employer withholding. This was an issue in the drafting of H.462, as well, and in that bill, quarterly estimates were not required. Since Vermont has a large proportion of its taxpayer population which is self-employed, it was felt that quarterly estimates might be a good idea, and that it would be more fair to make the education income tax parallel the requirements of the personal income tax in that regard. The committee believes that quarterly estimates should be required, but no penalties should be imposed for failure to report in the first year, because there could be some confusion among taxpayers, which we would not want to penalize.
The committee also decided that due to first-year confusion, no penalties should be imposed on taxpayers who under-withhold in the first year. This approach for withholding might raise issues which are not raised by waiving the penalty for quarterly estimates. Any cash flow issues raised by the proposal would also need to be examined.
2. Renter relief from education income tax. The committee decided that the proposal should include some manner of credit for the education income tax paid by renters. A credit of this sort was a feature in H.462. The committee also decided to recommend that the standing tax committees review the costs and impact of providing this credit to renters, and whether and how to limit the credit, as necessary.
3. Administrative savings and cost control. The committee noted that education spending control would ease the property tax burden, but that cost control measures were outside the committee’s purview. In the proposal with the low education tax base rate of 30 cents and an income tax component, the prebate program could be discontinued at a savings to the Education Fund of about $1 million in administrative costs. Similar administrative savings would also be created by the proposal that combines the prebate and rebate programs into a single, two-step adjustment.
4. Additional savings of each proposal. In addition to any administrative savings, another $10 million would be saved annually under each proposal from combining the prebate and rebate programs or eliminating the prebate program. The Joint Fiscal Office estimated that $10 million would be saved by combining the prebate and rebate programs, because payments under both programs would be based on household income from the same year.
5. Proposal summaries. The committee then discussed the final draft of its summary of the proposals which were, as initially agreed, to create a new income-based system and to simplify the current system. The summary of the two proposals is attached to this report as Appendix E.
VIII. Public Hearing
A. The study committee held a public hearing on November 7, from four o’clock to seven o’clock. In advance of the hearing, the committee published, in a press release and on the Legislative Website, the summary of its two proposals for education finance reform, and invited public response at the hearing.
B. Fourteen people attended and seven people addressed the committee. A list of those who attended is attached as Appendix H. Most of the comments were generally about the current education finance system and were not direct responses to either of the proposals.
C. At the following meeting, the committee discussed comments, questions, and proposals from the public hearing which related to the committee’s charge, as follows.
1. Is there a revenue-neutral way to remove the cliff on prebate eligibility?
The committee felt that it would be difficult to maintain revenue neutrality if the income eligibility limit were changed to a graduated phase-out of the benefit. If “revenue neutral” means maintaining the same overall cost of the system, the change would be possible, but would reduce the benefits of those below the current income limit; whereas if “revenue neutral” means no change in the benefit currently available to claimants below $85,000, then the program would cost more, to cover the benefits (though phased‑down) provided to those over $85,000.
2. Can the homestead property tax rate be applied to rental buildings so that renters are not subject to the higher property tax rate on nonresidential property?
In an increasing number of towns (eighty-three this year), the homestead property tax rate is actually higher than the nonresidential rate. But even if an apartment building were allowed to have the lower of the two rates, there is no guarantee that this lower property tax would be passed along to renters in the form of lower rent. Renters eligible for a rebate are able to take into account in the benefit calculation the actual amount of property tax allocable to their rental unit. This feature does not help renters who have household income above $47,000, though, and are ineligible for a rebate.
3. Is there a way to eliminate the split grand list and return to a single statewide education property tax rate?
One member of the committee noted that the listers were “heard on this issue – loud and clear.” The committee agreed that the split grand list does create some difficult issues for local officials and requires some additional work, but that at this point, perhaps the bulk of the initial data gathering and setting-up of procedures has been accomplished, and that the work will lessen as the split list becomes a more-established practice.
With regard to returning to a single statewide rate, it was noted that, while it would resolve some issues, it would create others, including three significant problems: First, a single rate would not take into account local spending votes; second, it would not prevent fund raising by districts; and third, it would most likely not satisfy the requirements of the Brigham case.
IX. Final Report
At its final meeting, the committee reviewed the committee report prepared by staff and requested additions and amendments.
Issues Resolved by the Committee’s Proposals
Of the major issues analyzed by the committee, one or both proposals resolved the following:
A. The prebate program is an inefficient and complex way to try to take into account the ability to pay (i.e., income level).
Proposal 1 Resolves this issue by eliminating the prebate system, which the committee recommends only in conjunction with its proposal of an education income tax, which directly takes into account the ability to pay, and a low homestead property tax base rate, which dramatically lessens the disjunction between ability to pay and property tax liability.
Proposal 2 Does not reduce the complexity as fully as Proposal 1, but greatly reduces the inefficiency of the program by combining the prebate and rebate programs. Although both the prebate calculation and the rebate calculation are retained in the new two-step calculation, all of the application papers would be submitted at the same time, thereby lessening the current confusion of two separate programs. Since the Tax Department would make the property tax adjustment payments directly to the towns, with the towns then reducing the property tax bills directly, the proposal eliminates the inefficiency of collecting $400 million in property taxes and then refunding more than a quarter of that.
B. Some cost savings can be realized through changes to the income sensitivity system.
Cost containment and rising property values are two major causes of the increasing education tax burden, but the study committee’s purview does not cover education spending, and growth in real estate values obviously cannot be legislated. The committee did have the power, however, to try to reduce the cost of the education finance system itself, and both proposals are projected to save $11 million per year.
C. The prebate program is costly to administer and costly to the taxpayer in personal time or tax preparer fees required to fill out the forms.
Proposal 1 Eliminates the entire cost to the Tax Department and to the taxpayer by replacing the program with an education income tax and a reduced homestead property tax.
Proposal 2 Does not eliminate, but does reduce, the cost of the program by making it a single program with the rebates, and eliminating the need to send separate checks to each claimant.
D. The connection between the prebate payment and the adjustment to the education property tax is not evident enough.
Proposal 1 Resolves this issue by eliminating the prebate program.
Proposal 2 Resolves the issue by having the adjustment amount sent directly to the town and the town’s then adjusting the property tax bill accordingly. The tax bill will include a notice of the reduction amount, making the connection to the prebate adjustment very evident.
E. Significant annual drops in common levels of appraisal create increasing education tax liabilities and increasing dissatisfaction with the education property tax system.
Proposal 1 Resolves this problem to a great extent by reducing the homestead base tax rate to a very low level. With a much smaller education property tax, the effect of rapidly falling CLAs is greatly softened. The lost education property tax revenue is then raised from an income tax, which is not directly affected by property value increases.
F. Having two separate programs, prebate and rebate, confuses some taxpayers who, as a result, apply for and receive only the benefits from one program.
Proposal 1 and Proposal 2 Leave in place only one program, eliminating the possibility that a claimant could misunderstand that he is eligible for two programs.
G. The prebate program uses household income from the prior year to determine the property tax adjustment for the current year.
Proposal 1 Eliminates this problem by eliminating the prebate program altogether.
Proposal 2 Eliminates the problem by combining the two programs and matching household income and property tax from the same year for the adjustment calculations.
H. Some claimants receive excessively large prebate checks, and the need of those claimants should be balanced against the cost to other taxpayers for these large checks.
Proposal 1 Eliminates this phenomenon by eliminating the prebate program altogether.
Proposal 2 Eliminates the problem by capping the payment at $6,000 per year (or in the minority’s options to consider, either requiring the claimant to meet a needs test before a check over $6,000 may be issued, or making claimants ineligible for an adjustment check if their investment income exceeds a certain level).
I. The income used to measure eligibility for the prebate and rebate programs does not include gifts.
Proposal 1 Reduces the problem because it leaves in place only the rebate program. Under Proposal 1, however, gifts are still not included in the measure of eligibility for the rebate.
Proposal 2 Resolves the issue by proposing that gifts be included in some way in household income (with draft legislation on this issue to be presented by the Tax Department).
J. Some claimants can manipulate income eligibility for prebates. Some claimants, especially those who are either self-employed or whose income source is otherwise controllable (e.g., certain trust distributions), are able to control to some extent when their income is received. In such a case, even though the average annual income would be too high to qualify for a prebate or rebate, by delaying receipt of income from one year to the next, it is sometimes possible to reduce income in one year to a low-enough level to qualify for a prebate or rebate.
Proposal 1 Resolves this issue for prebates, but not for rebates, because it eliminates the prebate program. The issue is probably not as pronounced for the rebate program, however, because it is assumed (but not known) that fewer people at that income level have control over their income in this manner.
Proposal 2 Does not address this issue.
K. Current law allows the education property tax rates and the two percent income base for prebates to be adjusted each year in which the Education Fund receives excess revenue. The taxpayers who produce this excess revenue, though, are not those who receive the prebates; they are the taxpayers who must pay the rising education property tax without adjustment.
Proposal 1 Resolves this issue because the prebate system is eliminated.
Proposal 2 Resolves the issue by allowing the excess revenue to be used only to lower the rates on those who contribute to the revenue excess. (A minority of the committee recommends further study of the issue by the standing tax committees.)
Committee Recommendations for Legislative Consideration
I. Committee Proposals
While the committee as a whole did not support every component of the two proposals, it agreed that the proposals merit further consideration by the legislature. Details of the two proposals are contained in Appendix D.
II. Additional Issues for Analysis
In the course of its meetings over the Fall, the committee noted a number of issues which presented problems in the current system or in the two new proposals the committee was designing. The committee also noted proposal elements which some members could not support fully. The committee felt that these problems and controversial issues need to be analyzed further, but that further analysis would require more public testimony than the summer study committee could schedule in its limited time, and would also require the technical expertise of the standing committees. The committee agreed to recommend these issues to the Ways and Means and Finance Committees for further inquiry. Some of the following recommendations are from the full committee, and some are from a minority of the committee:
A. Proposal 1 Issues
1. The committee determined that there would no longer be a need for the prebate system only if the significant reduction in the homestead property tax rate and an education income tax are both implemented.
2. The committee notes the concerns which have been raised about problems which might arise from creating a higher marginal income tax rate, and the committee recommends that the Ways and Means and Senate Finance Committees analyze whether these concerns are justified, and if so, how most fairly to address them.
3. The committee recommends that the Ways and Means and Senate Finance Committees analyze ways to limit in some manner the effect of the education income tax on renters who are subject to that income tax.
4. The committee recommends that quarterly estimated payments should be required for the education income tax, but no penalties should be imposed for failure to report in the first year, because there could be some confusion among taxpayers, which we would not want to penalize.
The committee also recommends that due to first-year confusion, no penalties should be imposed on taxpayers who under-withhold in the first year, either. This approach, however, might raise issues which are not raised by waiving the penalty for quarterly estimates. The committee recommends that the Ways and Means and Senate Finance Committees analyze any issues created by waiving the first-year penalties, and also any cash flow issues raised by the proposal.
B. Proposal 2 Issue
The committee recommends that the Ways and Means and Senate Finance Committees identify problems which might arise from the proposal to pay property tax adjustment amounts directly to the towns for property taxes, and determine how best to resolve those problems. Those problems would include how to net payments to the towns, how to allocate payments to the towns between education and municipal property taxes, and how to allocate underpayments of tax by the taxpayer.
C. Issues Not Necessarily Related to Either Proposal
1. A majority of the committee recommends that excess Education Fund revenue should be used to lower rates only on those tax systems which generate the excess revenue to rates sufficient to eliminate the excess.
A minority of the committee recommends that the Ways and Means and Senate Finance Committees analyze this issue and weigh the majority recommendation against other options.
2. The committee recommends that the Ways and Means and Senate Finance Committees analyze a proposal from the Administration on how best to expand the definition of “household income” to include items such as “monetary gifts.”
3. A narrow majority of the committee supports an annual $6000 cap on property tax adjustment payments.
A minority of the committee would like the Ways and Means and Senate Finance Committees to analyze the proposed $6000 limit on property tax adjustment payments and also the following options:
a. a cap on the combined prebate and rebate adjustment, but at a possibly higher amount;
b. exceptions to the p/rebate cap, including an exception for a showing of true need;
c. a limit on the value of the income-sensitized housesite, regardless of household income level; and
d. no eligibility if investment income exceeds a certain level.