PROPERTY TAX EXPENDITURES:

CLASSIFIED PROPERTY TAX SYSTEMS

Terri A. Sexton
Department of Economics
California State University, Sacramento

ABSTRACT
This paper focuses on the tax expenditures arising from property tax policies that apply
different (non-zero) assessment ratios or tax rates to real property with the primary objective
of redistributing the tax burden by taxing different classes of real property at different effective rates. In addition to reducing the property tax burden on favored classes of property, such
classified property tax systems can result in reduced tax revenues. An overview of the various
property tax classification systems used in the United States is provided along with tax expenditure estimates reported by several states. In a case study of local governments in Tennessee we provide estimates of two different measures of tax expenditures: The revenue lost to
counties and municipalities resulting from a switch from a uniform to a classified property
tax, and the shift in tax burden that results from a revenue-neutral switch from uniform to
classified assessment.

1. INTRODUCTION
The property tax is an ad valorem tax but most states do not tax the full
market value of property. Instead, some states tax a uniform percentage or
fraction of actual market value. For example, Connecticut assesses all property
at 70% of market value, or uses an assessment ratio (ratio of assessed to market value) of 0.7. Similarly, the assessment ratio is 0.35 in Nevada, 1/3 in New
Mexico, and 0.20 in Arkansas.1 Many states specify different assessment ratios based on the use of the property (residential, agricultural, commercial, industrial) or type of property (land, improvements, personal property).
The application of different assessment ratios to different classes of property results in different effective tax rates, which express tax as a percentage of
market value. If the assessed value of all property is taxed at the same rate,
those with lower assessment ratios will pay a lower effective tax rate. Some
states achieve the same result by applying uniform assessment ratios to all
properties but taxing them at differential rates. Still others that assess property
1. Significant Features of the Property Tax, Lincoln Institute of Land Policy & George
Washington Institute of Public Policy, http://www.lincolninst.edu/subcenters/significantfeatures-property-tax/.
Public Finance and Management
Volume 14, Number 2, pp. 221-244
2014

ISSN 1523-9721

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uniformly and apply uniform tax rates achieve different effective tax rates by
providing tax relief that reduces the tax owed on some properties.
Any system that taxes different classes of property at different effective
rates is referred to as a classified property tax. According to this broad definition, every states property tax could be described as classified. Clearly the
partial or full exemption of certain types of property constitutes classification.
A full exemption or exclusion from the tax base is equivalent to a zero assessment ratio or a zero tax rate. Similarly, preferential assessment practices
frequently afforded agricultural properties, timber, and open space, are intended to lower the effective tax rate on these properties and hence constitute classification. Exemptions, preferential assessments, and other types of relief programs are considered separately in other papers in this volume. Here we focus
on property tax policies that apply different (non-zero) assessment ratios or tax
rates to real property with the primary objective of taxing different classes of
real property at different effective rates.2 Such systems are referred to here as
formally classified.
The objective of this paper is to examine the tax expenditures of classified
property tax systems. Two measures of tax expenditures are considered: The
revenue lost to counties and municipalities resulting from a switch from a uniform to a classified property tax, and the shift in tax burden that results from a
revenue neutral switch from uniform to classified assessments. We begin, in
the next section, with an overview of the various property tax classification
systems used in the United States. Section three summarizes existing research
on the impact of classification on the distribution of the tax burden. Section 4
defines tax expenditures for a classified property tax and describes the efforts
by various states to measure them. In section five we provide estimates of two
different measures of tax expenditures for several local governments in Tennessee. Finally section six concludes with a comparison of results and recommendations for further tax expenditure research.
2. AN OVERVIEW OF TAX CLASSIFICATION SYSTEMS IN THE
UNITED STATES
The first formally classified property tax system in the United States was
instituted in Minnesota in 1913. Today, 27 states and the District of Columbia
have formally classified real property tax systems or allow classification as a
local option. While there is considerable variation in these programs, most
give agricultural and residential properties favored or preferential treatment,
usually for the purpose of providing tax relief and/or to encourage these uses.
2. While there is considerable variation across the states in the treatment of personal property,
ranging from full taxation to full exclusion, the primary focus of this paper is on the treatment
of real property.

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Table 1 identifies the states with formal classified real property tax systems in 2012 and indicates the number of classes of real property included.
The range of assessment ratios for those states that apply different ratios to
different property classes are reported in column 3 and the range of statutory
tax rates for those states that tax different classes of property at different rates
are reported in column 4. In nineteen states different assessment ratios are applied to different classes of property and in ten states plus D.C. property is assessed uniformly but taxed at different rates. New York City does both while
Minnesota applies different assessment ratios for local taxes and different tax
rates for their state property tax.
Table 1. Overview of Property Tax Classification Systems in 2012
State
Alabama
Arizona
Colorado
District of Columbia
Georgia
Hawaii
Honolulu
Maui
Hawaii
Kauai
Iowa
Illinois (Cook County)
Kansas
Kentucky

Number of Real Property

Classes
3
8
5
4
2
4
10
4
4
3
3
6
3

Range of Assessment Ratios

(percent of MV)
10% - 30%
1% - 20%
8.75% - 75%

Range of Statutory Tax Rates

(percent of AV)

0.85% - 10%
30% - 40%
0.35% - 1.24%
0.25% - 1.5%
0.555% - 0.985%
0.344% - 0.79%
50.75% - 100%
10% - 25%
11.5% - 33%
Varies by jurisdiction
Avg. range: 0.015%-0.722%

Louisiana
Massachusetts

3
4

10% 25%

Minnesota

0.5% - 2%
10% - 30%
12% - 32%
0.32% - 18.41%
75% - 100%
6% - 45%

10.152% - 18.205%

North Dakota
Pennsylvania
Rhode Island

11(2 classes subject to

state tax rates)
3
3
9
2
2 assessment ratios classes and 4 tax rate classes
4
2
2

Varies by jurisdiction
Avg. range: 0% - 4.373%
20.75% - 51.1%

South Carolina
South Dakota
Tennessee
Utah
Vermont
West Virginia

4
3
3
2
2
3

4% - 10.5%

Wyoming

9.5% - 11.5%

Mississippi
Missouri
Montana
Nebraska
New York City

4.5% - 50%
Varies by city
Varies by county
Avg. range: 4.74% - 40.3%
0.2554% - 0.8491%
25% - 55%
55% - 100%
0.87% - 1.36%
Varies by jurisdiction
Avg. range: 0.118% - 0.287%

Source: Significant Features of the Property Tax, Lincoln Institute of Land Policy & George
Washington Institute of Public Policy at http://www.lincolninst.edu/subcenters/significantfeatures-property-tax/ and authors review of state statutes. More detailed tables are available
from the author.

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Minnesota defines the largest number of real property classes, 11, followed
by Maui with 10 classes, Montana with 9, Arizona with 8 and Kansas with 6.
At the other end of the spectrum, six states divide property into only two ratio
or rate classes. Georgia and Nebraska single out agricultural property to be
assessed at a lower fraction than other property while Utah, Vermont and
Rhode Island give residential property preferential treatment.
Among the states that apply different assessment ratios, agricultural and
residential properties are usually assessed at lower rates than other properties.
Georgia, Missouri and Nebraska all assess agricultural property at a lower rate
than residential while the reverse is true in Arizona, Colorado, Iowa, and Kansas. Two states distinguish between land and improvements. In Kansas, agricultural improvements are assessed at a lower rate than agricultural land while
Louisiana assesses commercial buildings at a higher rate than land. Although
all property is assessed uniformly on the island of Kauai, land is generally
taxed at a lower rate than improvements except for agricultural and owneroccupied residential properties for which improvements are taxed at a lower
rate than land. Several cities in Pennsylvania also treat land and improvements
differently, but they tax land at a higher rate than improvements.
Minnesota has one of the most complex classification systems. The assessment ratio varies according to not only the classification of the property
but also its estimated market value. For example, the assessed value of residential homesteads is 1.0% of the first $500,000 of market value and 1.25% of
value in excess of $500,000. Similar definitions apply to other classes of real
property. In contrast, Utahs classification system singles out only residential
property and assesses it at 55% of market value, while all other property is assessed at full market value.
In Illinois classified assessment ratios are an option for counties with populations greater than 200,000. Nine counties currently qualify but only Cook
County classifies. Cook County defines essentially two regular classes of
property, residential/farm and commercial/industrial and five incentive classes
including new development, redevelopment, and low-income housing. The
incentive classes benefit from lower assessment ratios that are of limited duration, usually 10 years, after which they gradually increase, over a three year
period, to the level for similarly classed property.
New York City is the only jurisdiction in New York that has a classified
property tax and it is unique in that it uses different assessment ratios and different tax rates. Homes are assessed at 6% of market value while all other
property is assessed at 45%. Then different tax rates apply to each of its four
classes of property.

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Among the states that apply different statutory tax rates to different property classes, residential property, especially owner-occupied, is usually taxed
at the lowest rate with agricultural property next, and commercial/industrial
property taxed at the highest rates. South Dakota taxes agricultural property at
the lowest rate but both residential and agricultural are taxed at much lower
rates than other property. New York City is the only place that taxes residential property at a higher rate (18.205%) than all other property. Here, commercial and industrial property is taxed at the lowest rate (10.152%). However,
since New York City also assesses residential property at a much lower percentage of market value (6%) than other property (45%), the effective tax rate
on residential property (1.09%) is much lower than that on commercial and
industrial property (4.57%).
In Hawaii, each island chooses its own classification and tax rates. Maui
has defined 10 classes of property and taxes them all at different rates ranging
from 0.25% for homeowner property to 1.5% on time-share properties. Honolulu taxes all residential property at 0.35%, less than a third of the 1.24% rate
on commercial, industrial, hotel and resort property. Kauai taxes the improvement portion of owner-occupied residential property at the rate of
0.344% and the land portion at the higher rate of 0.40% while for commercial,
industrial and resort property the improvement rate is 0.79% and higher than
the rate on similarly classed land, 0.69%. The island of Hawaii has the highest
tax rate on homeowner property of all of the islands, 0.555%, and taxes other
residential and apartment/resort property at even higher rates, 0.91% and
0.985% respectively.
Massachusetts, Rhode Island, and West Virginia also give local taxing jurisdictions varying degrees of discretion in classifying and taxing real property. In 1978, Massachusetts adopted a constitutional amendment authorizing
classification. The amendment enjoyed popular support as a means to prevent
the shifting of taxes from business property to residential property. Massachusetts defines four classes of real property and allows municipalities to tax them
at different rates. Several have chosen this option but generally only residential property is singled out and taxed at a lower rate than other property. There
is considerable variation in tax rates across jurisdictions, as the ranges in Table
1 indicate.
In Rhode Island there are two classes of real property and counties are allowed to vary their tax rates on each class. While again there is considerable
variation in tax rates across counties, residential real estate is taxed at lower
rates than commercial/industrial real property. In West Virginia the state constitution establishes three classes of property and the state establishes maximum state, county, school, and municipal rates for each class but allows each
jurisdiction to set its own rate subject to the maximums and the condition that

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the rate on other property must be twice that for residential and agricultural
properties.
Two states, Ohio and Indiana, tax different classes of real property at different effective rates though they have not been included in Table 1 because
they do so not by setting class specific assessment ratios or tax rates, but rather
by adjusting the final tax bill. In Ohio, property is reassessed every six years
and tax reduction factors are applied to prevent property taxes from increasing
because of appreciation in property values due to inflation. Separate tax reduction factors are applied to residential/agricultural property and industrial/commercial property to stop the shift in tax burden to agricultural and residential property due to greater appreciation. In addition, after the tax reduction
factors are applied, the property tax bill for non-business property is reduced
10% with an additional 2.5% reduction for owner-occupied residential property. This is commonly referred to as a rollback.3
In Indiana tax caps limit tax bills to a fixed percentage of a propertys assessed value and these caps vary across property classes. The cap is 1% for
owner-occupied housing, 2% for other residential property and farmland, and
3% for business property. The portion of the tax bill that exceeds the tax cap is
a credit to the taxpayer and lost revenue to local governments. Not all properties receive credits. The combined tax rate for all the overlapping taxing jurisdictions in which the property is situated (county, township, city or town,
school district, library district, etc.) determines whether a taxpayer receives a
tax cap credit, and thus a lower effective tax rate.
Most states without formal classified property tax systems provide for special taxation of some classes of real or personal property by offering full or
partial exemptions based on use, by using different assessment methods for
different types of property, or by providing differential credits or rebates for
different types of property. The classes of real property most frequently singled out for special taxation are forests, mines, and agricultural property. Infrequent reappraisals can also lead to differential effective tax rates when different classes of property experience different rates and directions of value
changes.
Agricultural land is usually assessed according to its current use in agriculture as opposed to its highest and best use. Such use-value assessment is
commonly based on the rental value as agricultural land or the capitalized income from agricultural use. Maryland was the first state to adopt an agricultural use assessment law in 1956 to help preserve the states agricultural land.4
3. http://tax.ohio.gov/divisions/tax_analysis/tax_data_series/all_property_taxes/pr5/PR5CY10.stm.
4. Hady and Sibold (1974), p. 37.

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In some states, such as California and Pennsylvania, the owners of agricultural

or open space lands must enter into contracts, which commit the land to its
current use for a specified period of time in order to receive the lower usevalue assessments.
3. CONSEQUENCES OF CLASSIFICATION
The intent of property tax classification systems is generally to provide
property tax relief to the owners of certain types of property, to redistribute the
property tax burden among different classes or types of property and/or to incentivize certain types of property uses. Relative to uniform assessment and
taxation of property, classification may result in a loss of tax revenue if the
overall tax base is reduced and tax rates are not adjusted to compensate for this
loss. But even if tax rates are adjusted to prevent a loss in revenue, a redistribution of the tax burden will occur. Also, the resulting differences in effective
tax rates will encourage an expansion of the favored uses and a different pattern of land use, which will in turn, impact future tax revenues and the distribution of tax burden.
Tax expenditures generally refer to provisions of the tax code that result
in reduced revenues. Calculating the cost of property tax expenditures is not as
straightforward as other tax expenditures. The most common system sets
statewide assessment ratios for each class of property and each local taxing
jurisdiction determines its own tax (millage) rate based on its budgetary needs
relative to its total assessed (taxable) value. If taxing jurisdictions are allowed
to raise tax rates to offset a reduction in the tax base, revenues will not be immediately affected but the burden of the tax will be redistributed.5 In general,
when the taxable value of a class of property is lowered, tax rates rise so property taxes are higher for all other classes of property in the taxing district. Although the total yield from the tax is not immediately affected, the tax is shifted from preferential to non-preferential property.
Consider the following simple example of a jurisdiction with property valued at $1,000,000 that has a budget of $20,000 to be funded by the property
tax. Suppose that the tax base is made up of two property classes, residential
(60%) and nonresidential (40%).

5. If the jurisdiction is subject to a tax rate limit that is binding then changing from uniform
assessment at 100% of market value to a classified system in which one or more classes of
property are assessed at less than 100% of market value, will result in a revenue loss since the
jurisdiction will not be able to raise the tax rate to collect the same revenue as before classification.

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Property tax expenditures

If all property in the jurisdiction is assessed uniformly at full market value,

a tax rate of 2% will raise the necessary $20,000 with residential property contributing 60% and non-residential property 40%. If the jurisdiction were to
implement classified assessment whereby residential property is assessed at
50% of market value while non-residential property is still assessed at full
market value, then either the jurisdiction will lose $6,000 in revenue or would
have to raise the tax rate to 2.86% to generate revenue of $20,000. In either
case, the share of the tax burden on residential property would fall from 60%
to 43% while that on non-residential property would increase from 40% to
57%. With classified assessment, the burden on residential property is reduced
while that on other property is increased. The effective tax rates on the two
types of property would be 1.43% on residential property and 2.86% on other
property.
As illustrated in this example classification results initially in a shift of tax
burden from one class of property to another, from the class(es) of property
with the lowest effective tax rate to those with the highest effective tax rates.
The long-run impact, however, could be quite different if property owners are
able to shift the tax burden and if the differential treatment affects land use and
location decisions of businesses and households.
Also, although the short-run impact of classification on revenues may be
mitigated by adjusting statutory tax rates to maintain revenues, in the long run
revenues may change as property values are impacted by classification. In
general, a decrease in the effective property tax rate on certain types of properties will increase the net benefits of owning those properties, thereby increasing the amount that potential buyers are willing to pay for them. Similarly, if
classification raises the effective property tax rate on certain properties, they
will experience a decrease in value. This is the capitalization process: A tax
cut is offset by an increase in the market price of the property while a tax increase is offset by a price reduction. So classification is likely to result in increases in the value of some properties and decreases in the value of others
and these changes may impact revenues in the long run.6
The consequences of classification, therefore, depend not only on how the
tax burden is redistributed initially but also on who ultimately bears the burden
of the property tax. Although many states have chosen, through classification,
to shift a greater share of the property tax burden to commercial and industrial
property, this burden may in turn be shifted forward in the form of higher
prices or shifted back to labor in the form of lower wages and employment. If
classification leads to inter-jurisdictional differences in effective tax rates that
6. The analysis that follows focuses on short-run changes in revenues and shifts in tax burden.
Measurement of the long-run impacts requires a dynamic analysis that is beyond the scope of
this paper.

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influence the location of business, higher tax jurisdictions will experience

slower economic growth.
The equity and efficiency consequences of classification also depend on
whether or not the system distinguishes between land and improvements.
Since land is in fixed supply, the economic incidence (or final distribution of
the tax burden) of the property tax on land falls entirely on landowners as the
tax is fully capitalized into lower land values and hence the burden of the tax
is distributed progressively. In contrast, the property tax on improvements
may, as discussed above, be shifted to consumers in the form of higher prices
or to labor in the form of lower wages and hence may be distributed regressively. Thus a classified system that taxes land at a higher effective rate than
improvements will result in a more progressive property tax. Taxes on land
and improvements also have significantly different impacts on incentives.
Since landowners cannot react to an increased tax burden by reducing the supply of land, the behavioral impacts, and consequently the excess burden of the
property tax, will be reduced by increasing the rate on land and lowering that
on improvements.
Hartzok (1997) concludes that the shift to a split rate tax on land and improvements discouraged land speculation and encouraged development and
more intensive land use in Pennsylvania cities. However, Oates and Schwab
(1997), focusing on Pittsburghs 1979-80 tax reform that raised the property
tax on land to more than five times the rate on structures, conclude that the
shift to more intensive land taxation cannot statistically be isolated as the direct cause of the subsequent dramatic increase in commercial construction.
Rather, they argue, land taxation is essentially neutral, as theory suggests, but
the increased tax on land did allow Pittsburgh to avoid other taxes that might
have discouraged development. Other studies simulating the redistribution of
the tax burden following a switch to a land value tax find that the distributional impacts depend critically on the composition of the tax base and the intensity of land development within the jurisdiction (England and Zhao 2005;
Bowman and Bell 2008).
Sonstelie (1979) examines the long-run incidence of a shift in relative tax
rates. In particular, he analyzes the impact of taxing commercial property at a
higher rate than residential property in a local jurisdiction in which the supply
of capital is assumed to be perfectly elastic in the long run. His main conclusion is that a higher tax rate on commercial property will shift the property tax
burden from local residents to customers of the local commercial businesses in
the form of higher prices and landowners in the jurisdiction in the form of
lower land prices. To the extent that customers of the local commercial businesses are not residents of the jurisdiction, the tax burden is exported.

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Property tax expenditures

Sonstelie shows that this effect will be larger if the demand for commercial
real estate in the jurisdiction is inelastic.
If, on the other hand, the demand for commercial real estate is not inelastic
and firms respond to higher taxes by leaving the jurisdiction, then the burden
will be shifted to workers in the form of fewer jobs and lower wages. Several
studies have found that local variations in taxes affect firm location decisions.
Higher commercial/industrial property tax rates are found to have deterred
firm location and new investment in Milwaukee from 1964 to 1974 (Wasylenko, 1980), in Cleveland in 1970 (Fox, 1981), in Detroit from 1970 to 1975
(Charney, 1983), and in Minneapolis-St. Paul from 1976 to 1979 (McGuire,
1985). In contrast, Mark, McGuire, and Papke (2000) examined nine jurisdictions in the Washington DC metropolitan area from 1969 to 1994 and found
that while the sales tax and personal property tax had a significant negative
impact on employment growth, the tax on real property did not.
Two studies have analyzed the impact of local-option property classification on economic activity. Lee and Wheaton (2010) examine towns in Massachusetts before and after the state approved the local option to classify property and find that towns with more commercial property are more likely to
choose to classify and tax this property at a higher effective rate and that over
time these higher rates tend to discourage business location resulting in job
loss or slower job growth. Furthermore, they find that smaller and wealthier
towns tend not to discriminate against business property via classification.
Dye, McGuire, and Merriman (2001) examine the effect of classification
in Cook County, Illinois on business activity in the Chicago metropolitan area
between 1990 and 1996. Cook County is the only county in Illinois that has
exercised the option to classify property and it assesses commercial/industrial
property at 25% of market value while most other property is assessed at 10%
of market value. In the surrounding counties of the Chicago metropolitan area
all property is assessed at 33.3% of market value. As a result the effective
property tax rate on commercial/industrial property in Cook County is twice
that of the surrounding counties and nearly three times that of residential property in Cook County. They find that the countywide variation in taxes due to
classification has a significant effect on the growth in market value of commercial property suggesting that the higher effective tax rates in Cook County
have slowed the growth of business activity.
The results of these two studies are consistent with other empirical evidence suggesting that state and local tax policies do influence business location decisions (Bartik 1991) and that taxes have a larger impact on intrametropolitan as opposed to inter-metropolitan or interstate location decisions.

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So differences in the treatment of business property across local jurisdictions

are more likely to affect economic growth than are differences across states.
4. ESTIMATING TAX EXPENDITURES FROM CLASSIFICATION:
STATE REPORTS
Of the 14 states that report property tax expenditures,7 only two provide
estimates of the tax expenditures due to classification, Kentucky and Minnesota. Minnesota varies assessment ratios across property classes while Kentucky
varies the tax rates for different classes or types of property. Colorado adjusts
the assessment ratio on residential property every two years so as to maintain a
constant burden distribution between residential and commercial/industrial
property. While they do not publish a tax expenditure report or budget, they do
provide estimates of the savings to residential property owners that result from
this adjustment. Ohio applies tax reduction factors to stop the shift in tax burden to agricultural and residential property due to greater appreciation. In addition, the tax bills of non-business property are reduced 10% with an additional 2.5% reduction for owner-occupied residential property. The Ohio Department of Taxation provides annual data on the impact of both programs on
property tax revenues. The Indiana Legislative Services Agency also reports
the annual losses due to their tax cap credits that vary by property class. The
most recent tax expenditure estimates from each of these states are provided
below.
Minnesota
Minnesota enacted the first property tax classification system in the U.S. in
1913 with four classes of property. In 1933 the number of classes was expanded to provide preferential treatment for homestead property (owner-occupied
residential property). Minnesotas local property tax currently identifies 5
classes of property with multiple subclasses and applies different assessment
ratios to each subclass. Minnesota also levies a state general property tax, enacted in 2001, on commercial-industrial and seasonal-recreational property, at
different tax rates for each.
Minnesota defines tax expenditures as statutory provisions which reduce
the amount of revenue that would otherwise be generated, including exemptions, deductions, credits, and lower tax rates. 8 They consider the classification system to be a tax expenditure because properties with the same market
value are not treated the same.

7. Connolly and Bell (2011)

8

Minnesota Department of Revenue, Tax Research Division, State of Minnesota Tax Expenditure Budget, Fiscal Years 2010-2013. http://www.taxes.state.mn.us/reports/reports.html.

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Property tax expenditures

In their 2010 tax expenditure budget, the Minnesota Department of Revenue provides estimates of the impact of classification but only as it pertains to
the local tax. In deriving their estimates it is assumed that the same assessment
ratio is applied to all types of property, rather than different ratios for different
property classes and subclasses. Then local tax rates are adjusted to generate
the same revenue and for each type of property, the difference in tax liability
that would result from uniform assessment is computed. Table 2 shows the
estimated fiscal year impacts for various types of property for fiscal 2010 and
for each of the following three years. Residential property classes would experience tax increases under uniform assessment while commercial & industrial
properties would experience tax cuts. These estimates measure the shift in tax
burden that would occur if the current classified system were replaced by a
revenue-neutral uniform assessment system. For 2010 this estimated shift totaled $534 million.
Table 2. Minnesota Estimated Tax Expenditures
Fiscal Year Impact
Type of Property
Residential Homestead
Farm Homestead
Farm Non-homestead

2010
$366,000,000
$124,000,000
($8,000,000)

2011 - 2013
$374,000,000
$136,000,000
($10,000,000)

Timber
Seasonal
Recreational
Commercial
Subsidized Housing
Seasonal
Recreational
Residential
Residential
Nonhomestead
Commercial/Industrial
Public Utility
Apartments
Railroad
Personal
Total9

$1,000,000
$1,000,000

$1,000,000
$1,000,000

$13,000,000
$3,000,000

$14,000,000
$3,000,000

$26,000,000

$27,000,000

($437,000,000)
($26,000,000)
($15,000,000)
($6,000,000)
($37,000,000)
$5,000,000

($460,000,000)
($24,000,000)
($17,000,000)
($6,000,000)
($35,000,000)
$4,000,000

Source:http://www.taxes.state.mn.us/reports/reports.htm

Kentucky
In Kentucky, all property is assessed at its fair market value but taxed at
varying rates depending upon the type of property. Property taxes are levied
by the state and local governments of Kentucky, and tax rates vary across all
levels of government. The 2010 state tax rate on most real property was

9. Although the sum of the increases and decreases should equal zero, they do not due to lower tax increment finance levies and differences in the computation of some credits.

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0.122% while the rate on most tangible personal property was 0.45%. There
are 16 classes of property that were taxed at preferential rates below these.
Table 3. Kentucky State Property Tax Expenditures Due to Classified Tax
Rates, 2010-2012
Property Class

Preferential
Tax
Rate
0.001%
(%)

FY2010
Tax
Expenditure
0

FY 2011 Tax
Expenditure
0

FY2012 Tax
Expenditure
0

0.015%

$2,000

$2,000

$2,000

Intrastate Railroads
& Railway Companies
Leaseholds in interest
in buildings financed
with industrial revenue
bonds products
Agricultural
Aircraft
Business inventories
Carlines, railroad cars
Federally documented vessels
Property in foreign
trade zone
Historic vehicles

0.10%

$22,000

$22,000

$22,000

$2,400,000

$2,400,000

Intrastate
railroads
and railway compaLeasehold
nies (tangibleinterests
person(tangible
personal)
al)
Farm machinery and
livestock
Manufacturing machinery,
pollution
Motor
with
control vehicles
equipment,
salvage
radio &title
TV equipTotal
ment

Alcohol production
facilities
Environmental Remediation Property

0.015%

$2,300,000

0.015%
0.015%
0.05%
0.2274%
0.015%

$4,000,000
$1,600,000
$72,900,000
$980,000
$460,000

$3,900,000
$1,600,000
$72,000,000
$980,000
$460,000

$3,800,000
$1,700,000
$68,800,000
$980,000
$460,000

0.001%

$20,400,000

$20,400,000

$20,400,000

0.25%

$188,000

$198,000

$208,000

0.10%

$175,000

$175,000

$175,000

0.015%

$3,900,000

$3,900,000

$3,900,000

0.001%

$5,500,000

$5,500,000

$5,500,000

0.15%

$66,000,000

$65,500,000

$64,900,000

0.05%

minimal

minimal

minimal

$178,427,000

$177,037,000

$173,247,000

Source: Governors Office for Economic Analysis, Office of State Budget Director, Tax Expenditure Analysis, Fiscal Years 2010-2012, Commonwealth of Kentucky,
http://www.osbd.ky.gov/NR/rdonlyres/DBC47EB8-FE21-4429-A2837357388BF39B/0/1012TEA_TaxExpenditureDoc.pdf.

Compared to taxing all real property and personal property at the common
state rates of 0.122% and 0.45%, respectively, the estimates above reflect actual losses in revenue from the preferential rates, averaging just over $176 million per year for the three-year period 2010-2012. Preferential treatment of
certain classes of personal property accounts for the largest share of these tax
expenditures. Reduced tax rates on business inventories and manufacturing

234

Property tax expenditures

machinery and equipment were responsible for almost 78% of the revenue
loss.
The Office of State Budget Director prepares a biennial tax expenditure
report that provides estimates of the impacts of state classified tax rates on
state revenues.10 Local tax expenditures are not included. Table 3 provides estimates of the additional state revenue that would have been raised from each
of these preferred classes had they been taxed at the common rates (0.122%
for real property and 0.45% for tangible personal property) for fiscal 2010,
2011 and 2012.
Colorado
In 1982, Colorado voters passed a constitutional amendment known as the
Gallagher Amendment. ( 3(1)(b), art. X, COLO. CONST.) The purpose of
this amendment is to prevent the increase in residential propertys share of the
property tax base that results when increases in the market value of residential
property exceed the increases in value of non-residential property. Between
1958 and 1982, the percentage of total assessed value consisting of residential
property increased from 29-44%.
The Gallagher Amendment requires an adjustment of the residential assessment ratio after every general reassessment (in odd numbered years) to
ensure that the rate of change in the assessed value of residential property is
the same as that for non-residential property, or in other words, to ensure that
the distribution of tax burden between residential and other property does not
change over time. The current residential assessment ratio is 7.96% of actual
value while that of non-residential property is fixed at 29%.
Table 4 shows what has happened to actual residential property values as a
percentage of total property values since 1987, the residential assessment ratio
for each year, and the resulting residential assessed values as a share of the tax
base. While residential property values actually increased from 61% of total
property value to 77%, the residential assessed value share changed very little
over this period, as was the intent of the Gallagher Amendment.11 The last
10. See for example, Governors Office for Economic Analysis, Office of State Budget Director, Tax Expenditure Analysis, Fiscal Years 2010-2012, Commonwealth of Kentucky,
http://www.osbd.ky.gov/NR/rdonlyres/DBC47EB8-FE21-4429-A2837357388BF39B/0/1012TEA_TaxExpenditureDoc.pdf.
11. The residential share of total assessed value varies from year to year because the residential assessment ratio is only adjusted in re-appraisal years yet residential appraisals change
from year-to-year due to new construction, destroyed property, and changes to a propertys
use that necessitates revaluation. Also, in 2005, 2007, and 2009, it was determined that the
residential assessment rate should be adjusted above the rate that had been enacted for the
previous two-year cycle. However, 20(4)(a), art. X, COLO. CONST. (TABOR), prohibits
the General Assembly from increasing an assessment rate without statewide voter approval.

Sexton

235

column provides an estimate of the savings to residential tax payers due to the
Gallagher Amendment, computed as the difference between an estimate of the
taxes they would have paid had the Gallagher Amendment not been enacted
and the taxes they actually paid. These tax savings constitute the tax expenditures due to preferential treatment of residential property.
Table 4.
Property Tax Burden Shift Due to Preferential Residential Assessment Rates
Tax
Year12

Actual Residential
Value as % of Total

1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
Total

60.83%
61.42%
62.48%
63.14%
63.75%
64.69%
67.05%
67.50%
71.83%
71.96%
72.35%
72.55%
72.58%
72.85%
74.80%
75.30%
77.51%
77.71%
77.78%
77.79%
77.58%
77.56%
76.09%
76.99%

Residential
Assessment
Rate
18.00%
16.00%
15.00%
15.00%
14.34%
14.34%
12.86%
12.86%
10.36%
10.36%
9.74%
9.74%
9.74%
9.74%
9.15%
9.15%
7.96%
7.96%
7.96%
7.96%
7.96%
7.96%
7.96%
7.96%

Assessed Residential
Value as % of Total
48.35%
46.01%
45.47%
46.05%
45.56%
46.53%
46.40%
46.83%
46.67%
46.98%
45.86%
45.94%
46.31%
46.62%
47.10%
47.70%
47.66%
47.15%
46.88%
46.08%
46.19%
46.16%
43.26%
46.11%

Savings to
Residential
Tax Payers
$79,064,785
$147,836,269
$187,262,167
$188,963,583
$222,648,266
$228,704,050
$294,643,464
$305,366,542
$460,958,707
$480,301,188
$568,826,762
$598,265,545
$653,172,356
$688,841,354
$823,345,112
$873,143,882
$1,053,722,569
$1,113,935,541
$1,190,706,817
$1,269,270,060
$1,436,467,739
$1,474,388,587
$1,603,527,584
$1,576,170,350
$17,519,533,277

Source: Colorado Department of Local Affairs, 2010 Annual Report, Section II, Tables 8 & 9.
http://dola.colorado.gov/dpt/publications/docs/2010_annual_report/SECII.pdf .

Ohio
Ohio reassesses real property every six years and applies tax reduction facFor these years, the General Assembly chose to reenact the same rate, 7.96%, that was effective during the prior two years.
12. The table begins with 1987, because the residential assessment rate remained at 21% until
1987.

236

Property tax expenditures

tors to prevent property taxes from increasing due to inflationary appreciation

in property values. Separate tax reduction factors are applied to residential/agricultural property and industrial/commercial property to stop the shift
in tax burden to agricultural and residential property due to greater appreciation. The Ohio Department of Taxation (ODT) provides annual data on tax
rates before and after the rate reduction factors are applied. Table 5 contains
statewide average rates for both cities and counties for taxes collected in 2010.
The gross rates are the actual tax rates applied to all taxable property and the
net rates are the rates on real property after application of the tax reduction.
The rates on all real property are reduced but those on residential/agricultural
property decrease by almost 34 mills for cities and 30 mills for counties while
the reduction is between 24 and 25 mills, on average, for commercial/industrial property. These rates, together with the taxable value of residential/agricultural and commercial/industrial real property allow us to compute
the revenue loss due to the tax reduction factors. These losses are reported in
Table 5 as change due to revenue reduction. The reductions, or revenue
losses from residential/agricultural property amount to a 34% reduction and
are roughly four times the value of those from commercial/industrial property
which amount to a 25% reduction.
Table 5. Ohio Estimated Tax Expenditures due to Classified Rate Reductions

Class I: Residential
and Agricultural

City

County

Statewide Average
Gross Millage Rate*
Statewide Average
Net Millage Rate*
Statewide
Gross
Taxes
Statewide Net Taxes

96.14

87.84

62.25

57.42

$9,052,713

$16,342,674

$5,959,731

$10,860,862

Change Due to Rate

Reductions
Statewide Average
Gross Millage Rate*
Statewide Average
Net Millage Rate*
Statewide
Gross
Taxes
Statewide Net Taxes

-$3,092,982

-$5,481,812

93.31

90.02

68.57

65.69

$3,611,855

$4,897,673

$2,695,513

$3,633,746

Change Due to Rate

Reductions

-$916,342

-$1,263,927

* Rates are expressed in mills with 1 mill equivalent to $1 per $1,000 of taxable value.
Source:
http://tax.ohio.gov/divisions/tax_analysis/tax_data_series/publications_tds_property.stm#Real
PropertyOnly
Tables PD23, PD27, PR5, PR6.

Sexton

237

In addition to the tax reduction factors designed to prevent inflationary increases in taxes and shifts in tax burdens, Ohio also reduces the tax bills on
non-business property13 by 10% and an additional 2.5% on owner-occupied
residential property. These reductions are referred to as rollbacks. Local
governments are fully reimbursed from the state general revenue fund for
these tax reductions. In 2010, local governments were reimbursed a total of
$1,061.9 million for the 10% rollback, and $206.7 million for the 2.5% rollback. Additionally, $4.1 million was paid to county auditors for administering
the 2.5% rollback.14
Indiana
Indianas tax caps limit tax bills to a fixed percentage of a propertys assessed value. The cap is 1% for owner-occupied housing, 2% for other residential property and farmland, and 3% for business property. In their 2011
Statewide Property Tax Report, the Indiana Legislative Services Agency reports that 9% of all tax levies of local governments were offset by tax cap
credits and hence were revenues not collected in 2011.15 The revenue loss totaled $616 million in 2011, up 32% from $467 million in 2010. Higher tax districts with more overlapping tax jurisdictions, usually districts where taxpayers
pay a city/town rate in addition to a county rate, experienced the greatest losses. Revenue losses were less than 3% in 40 counties but 21 counties lost more
than 9%. In terms of property classes, 27% of losses were attributed to credits
to owner-occupied residential properties, 30% were credits to business property, and 42% were credits to other residential and agricultural properties.
5. ESTIMATING TAX EXPENDITURES FROM CLASSIFICATION:
TENNESSEE CASE STUDY
Tax expenditures, both revenue losses and distributional shifts, resulting
from property tax classification will vary across jurisdictions depending on the
makeup of the tax base, namely the proportion of property in each property
class. In this section the tax expenditures due to classification are estimated for
a sample of four Tennessee counties and their cities.
For purposes of taxation, the Tennessee Constitution (Article II, Section
28) divides real property into three classes: commercial & industrial, residential, and farm. Fixed assessment ratios are set at 40% for commercial & indus13. Eligible property includes real property used for farming, single-family, two-family, or
three-family dwellings.
14.
http://tax.ohio.gov/divisions/tax_analysis/tax_data_series/real_estate_and_public_utility/pd1/d
ocuments/PD1CY10.pdf.
15. http://www.in.gov/legislative/pdf/STATEWIDE_2011.PDF.

238

Property tax expenditures

trial properties while residential and farm properties are assessed at 25% of
market value.16 Tax rates are uniform across property classes and are set by
the governing bodies of counties and municipalities or by the state legislature
in the case of special school district tax rates.
The 2010 Tax Aggregate Report of Tennessee published by the State
Board of Equalization provides data on the 2010 estimated market value and
assessed value (market value times the assessment ratio) for all classes of
property by county and municipality. Also reported are the actual tax rates in
2010 for each county, city and special school district.17
Table 6 identifies the four counties in our sample and indicates their 2010
population and estimated market value of all taxable property, as well as the
breakdown by real property class. 18 Davidson County and Shelby County
were selected because they contain the major metropolitan areas of Nashville
and Memphis, respectively. Rutherford County borders Davidson County to
the southeast and Greene County is a rural county on the eastern border with
North Carolina.
Our first measure of tax expenditures due to classification estimates the
revenue lost to counties and municipalities due to the classification of real
property. First we compute revenue neutral tax rates that would generate the
same 2010 tax revenues in each jurisdiction if all real property had been assessed uniformly at 40% of market value, the current assessment ratio for industrial & commercial property. These rates are then applied to classified assessed values with industrial & commercial assessments remaining at 40% but
residential and farm assessments decreasing to 25% of market value. The resulting revenue estimates minus the actual 2010 revenues measure the change
due to classification assuming no change in tax rates to compensate for the
loss. As reported in Table 6, the loss totals more than $506 million or 26% in
these four counties and their cities. The losses range from 17% to 37% across
our sample. As expected, the smallest percentage loss was in Goodlettsville
with the largest proportion of industrial & commercial property while the largest percentage loss was in Belle Meade with relatively little industrial & commercial property.

16. Other classes of property also subject to property taxation in Tennessee include public
utility property and personal property. The real property classes of industrial & commercial,
residential, and farm constituted over 91 % of the market value of real property in 2010 and
are the focus of this case study.
17. 2010 Tax Aggregate Report of Tennessee,
http://www.comptroller1.state.tn.us/pa/taxaggr.asp.
18. Ibid, Tables X and V.

Table

VI,

available

at

Sexton

239

Many states measure the revenue loss by comparing the current revenue
from their classified system to the revenue that could be raised at the current
tax rates under uniform assessment. This is an estimate of the gain from moving from a classified system to a uniform system and it will overestimate the
loss in revenue from moving from a uniform to a classified system. For example, if Tennessee had applied actual 2010 tax rates to property values uniformly assessed at 40% of market value, revenues would have been $2.617 billion,
more than $689 million higher than they were with classified assessments.
This method would overestimate the loss due to classifying by $183 million.
Table 6. Tax Expenditures of Property Tax Classification in Tennessee, Select Counties
2010 Estimated Market Value of Real Property

County Municipality

0.77%

-155,459,047

-25.08%

Belle
2,912
Meade
Good15,921
lettsville
Nashville 601,222

1,645,208,803

1.19%

97.84%

0.96%

-353,026

-37.05%

847,936,835

54.63%

45.16%

0.21%

-301,674

-17.01%

38,006,911,118 40.27%

59.67%

0.07%

-15,062,651

-22.40%

Ridgetop

N/A

2,380,308

3.34%

90.32%

6.34%

-1,914

-36.25%

68,831

4,431,650,200

15.38%

65.57%

19.05%

-5,561,682

-31.73%

15,062

1,201,783,200

40.33%

58.59%

1.08%

-1,552,988

-22.38%

262,604

18,818,102,938 27.21%

67.05%

5.74%

-36,897,172

-27.30%

Eagle604
ville
Lavergne 32,588

47,113,840

22.24%

68.04%

9.72%

-29,197

-29.16%

2,221,555,038

36.64%

62.50%

0.86%

-804,858

-23.76%

Murfrees
boro
Smyrna

108,755

8,177,843,088

36.98%

61.91%

1.11%

-7,497,921

-23.63%

39,974

2,893,477,208

38.77%

60.25%

0.99%

-1,555,997

-22.96%

927,644

57,229,135,760 25.48%

73.43%

1.09%

-186,056,471

-27.95%

Arlington 11,517

927,013,903

10.44%

86.99%

2.57%

-827,101

-33.59%

Bartlett

3,934,647,150

16.80%

82.93%

0.27%

-5,033,682

-31.20%

Collier43,965
ville
German- 38,844
town
Memphis 646,889

5,031,027,218

17.85%

81.24%

0.91%

-5,061,900

-30.81%

5,385,561,623

12.61%

86.97%

0.42%

-6,786,917

-32.77%

32,424,682,843 34.36%

65.51%

0.13%

-77,015,492

-24.62%

Millington

538,078,520

61.26%

3.33%

-485,925

-24.22%

-506,345,615

-26.26%

Greene
Greeneville
Rutherford

Shelby

Total

54,613

10,176

35.41%

Residen- Farm %
tial % of of Total
Total

66.11%

626,681

Total

Industrial
& Commercial %
of Total
58,101,649,067 33.12%

Davidson

2010
Population

Revenue Change Due to

Classification

240

Property tax expenditures

These tax expenditure estimates do not represent actual revenue losses,

however, since taxing jurisdictions set tax rates based on budgetary needs relative to their tax base. By raising the tax rate, each jurisdiction can collect the
same total revenue. Residential and farm property owners will pay less and
industrial & commercial property owners will pay more.
Our second measure of tax expenditures due to classification measures this
shift in tax burden that results from the revenue neutral change from uniform
to classified assessments. Industrial & commercial revenues increase since the
assessment ratio is the same in both the classified and uniform system but the
tax rate is higher in the classified case to compensate for the lower assessments of residential and farm property. Residential and farm property tax revenues decrease since these properties enjoy the reduction in assessments under
the classified system. In our sample, industrial & commercial property owners
pay almost $202 million or 35% more with classification while residential
property owners pay about $199 million or 15% less and farm property owners
pay $3.2 million or 13% less.
Table 7 summarizes the shift in tax burden due to classification. It shows
the share of total tax revenue contributed by the major real property classes
(industrial & commercial, residential, farm), with and without classification,
for each county and city in the sample. As expected, classification reduces the
burden on residential and farm property and increases the burden on commercial and industrial property in every location. The smallest shift in burden occurs in Belle Meade because the property tax base is predominantly residential
so there is nowhere for the burden to shift to. The largest shifts in burden occur in Nashville, Memphis, Murfreesboro, and Smyrna, locations where the
property tax base is more evenly split between residential and farm (the favored classes under classification) and commercial & industrial property.

Sexton

241

Table 7. Shares of Property Tax Revenue by Property Class

Share of Total Tax Revenue

County

Municipality

Industrial & Commercial

Without
With ClasClassificasification
tion

Davidson

Residential
With Classification

Farm
Without Classi- With Classi- Without Classification
fication
fication

44.21%

33.12%

55.15%

66.11%

0.64%

0.77%

Belle Meade

1.89%

1.19%

97.15%

97.84%

0.96%

0.96%

Goodlettsville

65.83%

54.63%

34.01%

45.16%

0.16%

0.21%

Nashville

51.89%

40.27%

48.06%

59.67%

0.05%

0.07%

Ridgetop

5.23%

3.34%

88.55%

90.32%

6.22%

6.34%

35.30%

25.48%

63.75%

73.43%

0.95%

1.09%

Arlington

15.72%

10.44%

81.86%

86.99%

2.42%

2.57%

Bartlett

24.42%

16.80%

75.33%

82.93%

0.24%

0.27%

Collierville

25.79%

17.85%

73.38%

81.24%

0.82%

0.91%

Germantown

18.76%

12.61%

80.86%

86.97%

0.39%

0.42%

Memphis

45.58%

34.36%

54.31%

65.51%

0.11%

0.13%

Millington

46.72%

35.41%

50.53%

61.26%

2.75%

3.33%

21.28%

15.38%

60.58%

65.57%

18.14%

19.05%

51.96%

40.33%

47.17%

58.59%

0.87%

1.08%

37.43%

27.21%

57.64%

67.05%

4.93%

5.74%

Eagleville

31.40%

22.24%

60.03%

68.04%

8.57%

9.72%

Lavergne

48.06%

36.64%

51.24%

62.50%

0.70%

0.86%

Murfreesboro

48.42%

36.98%

50.67%

61.91%

0.91%

1.11%

Smyrna

50.32%

38.77%

48.88%

60.25%

0.80%

0.99%

Shelby

Greene
Greeneville
Rutherford

6. CONCLUSION
Property tax classification systems are designed to alter the distribution of
the property tax burden from that which results from uniform assessment and
uniform tax rates. In the typical classification system a number of property
classes are defined based either on property use or type and each class is taxed
at a different effective tax rate through either varying the assessment ratio
and/or the nominal tax rate across these different classes. Most such programs
give agricultural and residential properties favored or preferential treatment,
usually for the purpose of providing tax relief and/or to encourage these uses.
In addition to reducing the property tax burden on favored classes of property, property tax classification can result in reduced tax revenues. In particular, the proceeds of the property tax will fall if tax rates are reduced on some
classes of property and not increased on other classes to compensate or, if the

242

Property tax expenditures

assessment ratio on some classes is reduced and the taxing jurisdiction is unable to increase the tax rate to compensate for the loss in tax base, as might be
the case if tax rate limits are binding. Those states that have attempted to
measure these consequences or tax expenditures have found that the shifts in
tax burden are significant and the potential losses in revenue large if compensating changes in tax rates are not undertaken.
The most common classification system sets statewide assessment ratios
for each class of property and each local taxing jurisdiction determines its own
tax (millage) rate based on its budgetary needs relative to its total assessed
(taxable) value. For such a system we propose two different measures of tax
expenditures. The first is the revenue that would be lost upon implementation
of the classification system assuming no change in tax rates. This requires calculating the revenue neutral tax rates that would generate the same revenue
when applied to a uniformly assessed tax base as the current classified system
generates. These rates when applied to classified assessments illustrate the
change in revenue due to classified assessments. As noted in our case study
the revenue loss that results from switching from a uniform to a classified assessment system is less than the revenue gain from moving from a classified to
a uniform assessment system. Kentucky and Colorado report the latter and
while it is easier to calculate, it overestimates the tax expenditure.
If taxing jurisdictions are allowed to raise tax rates to offset a reduction in
the tax base, due to classified assessments, revenues will not be immediately
affected but the burden of the tax will be redistributed. The taxes levied on the
favored classes of property, those whose assessment ratios are reduced, will
decrease and be offset by increases in the taxes levied on other property classes. Our second measure of tax expenditures estimates this shift in tax burden
from the revenue neutral change from uniform to classified assessments. Minnesota uses this method to estimate the tax expenditures of their classified assessments for local property taxes.
These initial or short-term impacts of property tax classification are only
the beginning, however. Further effects will occur as property owners adjust to
the new effective tax rates. In the long-run property owners will respond, tax
changes will be capitalized into property values, the pattern of land use will
change, and tax burdens will shift further. For example, if discriminatory
treatment of commercial/industrial property leads to less commercial/industrial development in the future, higher prices, and lower wages, as
several studies have found, the tax expenditures will be much larger than the
initial revenue losses or burden shifts.
Research on the consequences of property tax classification has focused on
the effects of differential tax treatment across local jurisdictions. In particular,

Sexton

243

local property tax classification that increases the effective tax rate on commercial and industrial property relative to surrounding jurisdictions is likely to
slow the rate of local economic growth. But most of the property tax classification systems are statewide programs and these same effects may not apply.
Both capital and labor are less mobile across state as compared to local jurisdiction boundaries and therefore state property tax differentials are likely to
have a smaller impact on business location decisions. When businesses and
households are choosing a state in which to locate, many other factors play a
role including other tax policies, as well as spending and regulatory policies.
Additional research is needed to determine the long-run tax expenditures of
statewide property tax classification systems.
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