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"The Quiet Indexing Victim": Homestead Property Tax Credit

Tax Indexing has been a major point of discussion during the current state budget process. Indexing prevents inflation from increasing tax rates, and helps maintain the progressivity of the income tax. The legislative Joint Finance Committee recently approved indexing the income tax in future years.
By comparison, little attention has been paid to the erosion of the homestead tax credit by inflation. This paper looks at the declining level of state support for this property tax relief program, which has been "decided" by inflation rather than a policy decision by lawmakers.

Declining State Support

The homestead credit was created in 1964 to ease the impact of rising property taxes upon senior citizens on fixed incomes. Since eligibility was expanded from seniors to the general population in 1974, the state's budgetary commitment to the program has fallen steadily when adjusted for inflation. (Seniors are still heavily affected, however--they filed for 53% of credits in 1997.)

Chart 1 shows that homestead credits have fallen 64% as a proportion of total residential taxes. In inflation-adjusted dollars, the state's commitment to low-income property tax relief has been cut in half since 1985, from $159.4 million to $79.8 million (Chart 2).

Budget Writers to the Rescue (Sort Of)

The legislative Joint Finance Committee recently approved Governor Thompson's proposal to raise the maximum eligible income for the homestead property tax credit by about 5 percent to $20,290, the first increase since 1991. Although a change in the right direction, the proposal does not begin to address the magnitude of the problem, for two main reasons:

• the number of families eligible for the credit has dropped steadily since its 1981 peak
• the value of the credit has fallen due to inflation.
  

The number of families claiming the credit has fallen by 44% since 1980. The primary reason is that the eligibility requirements for the homestead credit have not been adjusted for inflation. The approved budget proposal barely makes a dent in the problem. In fact, even with the higher income ceiling, the cost of the program will decline $3.4 million in fiscal year 2001 to $78.6 million, a 4% drop from 1999.

Declining Value of the Homestead Credit after Inflation

Not only are fewer families eligible for the credit, but the value of homestead credits is also not keeping up with growing property tax bills (or the property tax component of their rent) of low-income families. The average homestead credit claimed has fallen since 1985 by 20% in real terms, from $560 to $448. Meanwhile, the average property tax bill has climbed 21% to $2,055. The value of the credit relative to property taxes fell by more than a third from 1985 to 1998 (Chart 4).

Eligibility for Credit Declining as Families "Indexed Out" by Inflation

This falloff in property tax relief for low-income families was due primarily to the effects of inflation, a sort of "reverse bracket creep." Real incomes of the lowest two-fifths of families remained steady or fell throughout the 1970s into the 1990s, but inflation outstripped increases in the "eligibility parameters" for the homestead credit.

Chart 5 shows one example of these effects. The "full benefit threshold" is the level of family income at which the law begins to reduce benefits at a certain rate until the maximum income eligibility level is reached. Since 1990, this threshold level has been set at $8,000--benefits begin to drop off for anyone making more than $8,000. Plotting the threshold level against the federal poverty guideline effectively adjusts for inflation. The poverty guideline for a family of two in 1998 was $10,850.

The other parameters used to determine a family's credit have been similarly affected by inflation. The following table shows how the eligibility criteria have changed relative to inflation since the credit became generally available in 1974.

Conclusion

The effect of inflation on the credit parameters tells the story: all of the criteria have been negatively affected. By only addressing one of the four parameters, the budget proposal to increase the maximum eligible income will not go far to redress this erosion:

• In a state with a growing population, the number of claims has fallen 44% since 1980.
• Homestead credits equaled just 2.3% of the total residential property tax levy in 1998, compared to 8.2% in 1981, a 72% drop.
• The inflation-adjusted value of the average credit has fallen 32% over the past 20 years.