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Reform of Local Public Finance in Virginia – Part III

I propose a five percent real estate transfer tax (RETT) to fund comprehensive reform of the Composite Index (CI) and to provide an alternative source of local revenue. Twenty percent of the RETT revenues (one percent of Real Estate Transfers) are used to pay for the reform of the CI. This portion of the RETT is the Virginia Open Space Preservation Fund (VOSPF). The balance (four percent of Real Estate Transfers) remains in the locality as an alternative source of revenue to reduce the over dependence on the annual ad valorem real estate tax.

In 2006, 28 localities had a local real property tax rate in excess of 90 cents per hundred dollars of valuation. As real estate values decline, tax rates will increase, and more localities will exceed 90 cents. If real estate values decline to 70 percent of 2006 levels, 84 localities are likely to have tax rates above 90 cents. With so many local annualad valorem tax rates nearing or exceeding 1%, a ‘one time’ (or at least infrequent) tax of five percent does not seem unreasonable, especially when its purpose is to decrease the annual levy.

A RETT of this magnitude will probably place Virginia at or near the top of states imposing a RETT. To my fiscal hawk, anti-tax friends, I would urge the recognition that a RETT is not so much a new tax as the existing real estate tax imposed at a different time, the time of transfer. Moreover, there can be no gainsaying the tax basis of the RETT. There is no question of an invalid assessment. The amount of the tax is based on what is actually paid in the transfer. The purpose of the RETT is to reduce the existing annual real estate tax. My conservationist and environmentalist friends, who probably need less convincing, should remember that the motive of the reform is open space preservation.

Some of my fellow fiscal conservatives will object on principle to any ‘new’ tax. I reply that taxes must be examined in their context. Virginia’s local governments are over-reliant on the annual ad valorem real estate tax. At the same time unprecedented demands for services are placed on these same local governments. As stated in part I of this series, Virginia is attempting to provide 21st century services with 19th century revenues. This is simply unfair to all property owners, and destructive of open space. To ignore this context is not a matter of principle but of ideology.

The real estate industry will object that a declining real estate market is not the time to impose a tax on real estate sales – is there ever a good time? To the objection that the RETT will increase real estate prices (and thus decrease sales), I reply that the prospect of lower real estate taxes in the future will tend in the opposite direction. The effect on real estate prices is uncertain, but in all likelihood will be far less than an increase by the full amount of the tax.
One group will certainly be disadvantaged. Short-term real estate investment (the ‘flip’) will be more difficult. The reader may decide if that is a good or bad thing. As others have remarked ‘houses are for living, not flipping.’

I recognize that it might be useful to impose the tax in two stages – two percent initially followed a year later by the full five percent amount. This should have the effect of encouraging sales prior to the imposition of the full amount. As the passage of time demonstrates that the RETT results in lower annual ad valorem real estate taxes, real estate prices should stabilize and eventually increase.

There remains the determination of whether the RETT will raise sufficient funds to pay for reform of the CI. Government revenue projections are notoriously optimistic and inaccurate. It is prudent to be conservative and pessimistic. As this memo is written real estate prices continue to decline, and the open question is when the bottom will be reached. For various reasons, I have concluded that the real estate market will recover at something approximating the market in the year 2001. Using data from the 2001 Assessment Sales Ratio Study published by the Virginia Department of Taxation, it is possible to calculate expected revenues from a RETT in 2001.

To determine the value of the ‘average’ property I have multiplied the reported per capita real estate value by 2.5. I believe this to be conservative – that is, I believe that on average there are more than 2.5 persons per household in Virginia. One percent of the value of real estate sales thus calculated is approximately $250 million. I have arbitrarily reduced this to $200 million (a 20 percent reduction) which exceeds the $173 million projected cost of reform.
In the event the VOSPF requirement exceeds the revenues from the RETT (a hopefully unlikely event) funds will be distributed on a pro rata basis. Should the RETT receipts exceed the required funds (as is likely) a reserve will be established (perhaps one year of VOSPF). Once the reserve is established (I expect it will take several years), any excess will be distributed to localities according to the Open Space CI to pay for schools capital improvements or to pay down debt incurred for that purpose (which is the same thing).

Readers interested in detailed calculations, can obtain a copy of the author’s entire memo by contacting him at his email address.

Next: Impact Fees

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