Appraisal caps in Texas: A review of proposed property tax legislation

Compression of school tax rates is a significant and positive step, but a 5% annual appraisal cap could have a number of unintended consequences

Property tax rates in Texas are indisputably high. In the last two years, taxes have risen even further, with appraised values spiking for many properties. In some sectors property values have skyrocketed, and in others, values have returned to pre-pandemic levels.

House Bill 2 (HB2) proposes dramatic action to reduce property taxes, not only by using state funds to reduce the property tax levy, but also by imposing 5% limits on how much appraised values can increase annually, for tax purposes. While a 5% appraisal cap on all properties may sound like a good idea - one that is fair to all taxpayers and intended to provide stability- evidence shows that it may in fact result in higher tax rates and widespread inequity in taxation.

The property tax system in Texas is one of the best in the world. Annual reassessments are based on the market value of the real property. Legislated provisions mandating equity between similar properties, and a robust and expeditious appeal process means that taxpayers have the ability to take action to reduce an unfair assessment. Unfortunately, Texas also has high property tax rates, because local government and school districts are primarily funded by property tax, and Texas does not have a state income tax.

HB2, written by State Representative Morgan Meyer, takes significant action to reduce the amount of real property tax paid in Texas. The Bill proposes to reduce the school district maximum compressed rates by $0.15. Representative Meyer has stated that this measure will inject $11.2 billion dollars of state money into public education; and, with the rate reduction already included in the base budget, the total property tax levy is being reduced by $17 billion.

In addition to the rate reduction, the Bill provides taxpayers the option of requesting the appraisal district set up an escrow account for tax payments as opposed to making this at the discretion of the collector, which allows for monthly deposits toward year-end tax bills. This is another welcome and positive step to improve affordability for residential taxpayers. At the Ways and Means committee meeting on March 13, 2023, almost all witnesses spoke in support of both the rate reduction and escrow account options as positive and historic moves to improve property tax outcomes for Texas taxpayers.

However, the 5% appraisal cap received mixed reviews at the Committee meeting. Some business owners spoke in favor of the cap, citing the ever-increasing cost of doing business in this inflationary economic climate. An organization representing hotel owners provided evidence of a dramatic 100% spike in property taxes for one of their properties from one year to the next. Property tax is one of the largest single operating costs for businesses, and such dramatic increases are not sustainable.

A number of property tax experts addressed the Committee and were unanimous in their concerns about the unintended consequences of the cap. The Texas Association of Property Tax Professionals (TAPTP), identified numerous reasons why an appraisal cap may not provide the promised tax stability and savings for taxpayers.

In our review, we have focused on five of TAPTP’s reasons and analyzed the potential outcomes, as well as considered reported outcomes from other jurisdictions which have implemented similar appraisal cap protections.

Reason 1 – Reducing the appraised value of properties does not reduce the tax levy, it just redistributes it

The property tax levy is the money needed by the jurisdiction to fund its programs and services and it is divided among taxpayers based on assessed value. Limiting assessment increases doesn’t change the amount of money the jurisdiction needs, it just changes who pays it – resulting in tax savings for some and increases for others.

An appraisal cap ensures that until you sell your property, the value your property tax is based on will not increase by more than 5% per year. This means that the increase in value above the 5% limit is not included in the assessment base, reducing the denominator for calculating the tax rate. This results in a lower assessment base, which means that the tax rate must be increased to raise the same amount of taxes. If assessment increases are capped at 5%, the properties with increases below 5% pay more taxes than they would without the cap.

In this simplified example, an appraisal district has an annual budget i.e., the total tax levy, of $20,000. The district is made up of two properties, and each has a value of $500,000, resulting in a total appraised value of $1 million. Property A increases in value by a modest 2% and Property B increases by 25%.

The example illustrates how the appraisal cap impacts the tax rate:

Reason 2 – When a property’s value drops, the cap may delay the return to full value for several years

In the case of a property with a sudden value drop, as was seen during the pandemic, the 5% cap on subsequent increases may prevent the property from returning to its full share of taxes for several years, even when the property’s value rebounds.

In this example, the value of Property B drops by 30% in year 2, after the cap is implemented, but rebounds in year 3 to be the same as Property A. While both properties have the same value in year 3, and continue to appreciate in value by 2.5% per year in year 4 and beyond, Property B does not pay tax based on the full assessed value until year 18.

In summary, the cap reduces the assessment base, resulting in a higher tax rate. In this example, we see that the assessment loss and higher tax rates will be ongoing for several years.

Reason 3 - Identical properties may be taxed at vastly different rates

The 5% appraisal cap will continue to apply until a property is sold. New owners and new construction will pay taxes based on the full market value.

In this example, the values of multi-family properties have increased by 30%, but are protected by the 5% cap. Property A sells in year 2, and the appraisal is reset to full value. Property B sells in year 5. Although the properties both benefit from lower appraisals as a result of the cap, tax equity is lost. The two properties are identical, and worth exactly the same, but as a result of the sales, each is taxed on substantially different values.

One of the many merits of Texas’ current system of taxation is the constitutional provision that taxpayers are entitled to “equal and uniform” taxation. This provision currently protects taxpayers from paying more tax than the owner of a similar property. If appraisal caps are implemented, how will the “equal and uniform” provisions of the constitution be applied?

Reason 4 - Appraisal caps may create a disincentive to new development

As inflation continues around the globe, construction costs have skyrocketed. Rising interest rates continue to increase the cost of capital. Utilities and other operating costs are also up. All of these factors have dramatically reduced the ROI for commercial real estate and are depressing the rate of new development.

In this example, imagine the existing development is multi-family housing, which increased in value by 30%. With the appraisal cap, the assessed value increase is limited to 5%. If a new multi-family property is constructed it will pay taxes based on full value, resulting in taxes 24% higher than the existing property. Although the new construction is protected from future increases by the 5% appraisal cap, the tax differential will continue indefinitely, as both properties appreciate in value at the same rate.

In summary, if new construction is taxed at a higher rate than existing inventory (as illustrated above) this further diminishes the incentive to build. Developments may become financially unfeasible, and this could potentially drive investors to other states that do not put new construction at a competitive disadvantage.

New construction adds to the assessment base and reduces the rate of taxation for all properties in the appraisal district. Appraisal caps create disincentives for new construction and may result in higher property taxes.

Reason 5 - Appraisal caps in other jurisdictions have resulted in mixed outcomes

The appraisal cap proposed in HB2 is very similar to California’s Proposition 13, which was implemented in 1978, and remains in effect. Under Proposition 13, the purchase of a property sets the base value, which can only be increased by 2% per year. Many of the negative outcomes outlined above have already been witnessed in California, in addition to other unintended consequences.

Analysis by the National Bureau of Economic Research (NBER) found that California’s appraisal cap had most benefit for California’s coastal communities, where property values increased the most over time and there was limited benefit for inland communities with modest home prices.

In addition, to avoid incurring higher taxes, fewer properties were sold. This created housing shortages and increased prices due to lack of supply. California’s appraisal cap has made it more difficult for first-time buyers to enter the housing market. In addition, both commercial and residential taxpayers pay widely different tax rates for identical properties, based on the date of purchase. As California's tax rate is fixed at 1%, the 2% limit on increases in taxable value severely restricts the funds that can be raised from the property tax, forcing municipalities to find new sources of revenue. Similar impacts on residential taxpayers have been noted in Florida as a result of the Save our Homes Amendment, passed in 1992, which limited appraisal increases to 3% per year. This has benefited waterfront properties the most, while creating substantial inequities between properties.

As demonstrated in California and Florida, properties appreciating in value quickly benefit the most from the cap, and homes become more scarce and less affordable for first-time buyers. Appraisal caps disrupt market behavior and create significant inequity in taxation between identical properties.

Conclusion – appraisal caps are not the simple solution

Texas has a great property tax system but nonetheless is challenged by continuously increasing property taxes. The tax rate compression provided in HB2 will provide relief from those property taxes, while an appraisal cap would benefit some taxpayers at the expense of others.

Capping appraisal increases at 5% provides immediate relief from increases but raises the tax rate to compensate. Over time, properties with rapid increases in value benefit, but properties that appreciate more slowly, pay higher taxes. The policy results in increased taxes for new market participants and is a disincentive to new investment and development.

Although the message of a 5% limit on assessment increases is a compelling one, it has been demonstrated that such caps do not always provide the promised tax relief and may increase the burden for vulnerable taxpayers and challenged properties.

Disclaimer

This article has been prepared and is intended for general informational purposes only and does not constitute professional or legal advice. Altus Group does not accept or assume liability for any consequences in reliance on the information contained in this article or for any decision based on it.

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