Act 388: Its Impacts on South Carolina Schools and Communities

1. Act 388: Its Impacts on South Carolina Schools and Communities Dr. Laura Dawson Ullrich Winthrop University August 26, 2013

2. 2 Property tax revolts across the United States • The majority of states have undergone some form of property tax reform over the past 30 years. • Reforms come in many forms: tax rate caps, revenue caps, homestead exemptions, etc. • 75 percent of the property tax limits in the U.S. have income caps. In general, many of these caps are geared towards low income and elderly residents. • Many attribute property tax revolts to school finance reform (Fischel 1989, Downes and Shoeman 1998, Reschovsky 1999)‏

3. 3 South Carolina’s Property Tax Revolt • The property tax revolt in South Carolina initially gained steam in 1993. • Many believe this was a result of the Abbeville School District et al. v. South Carolina • First major property tax change was passed in 1995 • Exempted homeowners from paying school property taxes on the first $100,000 of the market value of their home • Law only applied only to owner-occupied houses • State did not fully reimburse school districts for lost revenue • Motor vehicle assessment rates were decreased in 2000 • Assessment rates were decreased from 10.5 percent to 6 percent • Represented an 8.3 percent decrease in property taxes

4. 4 South Carolina’s Property Tax Revolt • The anti-property tax movement gained steam again in 2005 as property values (especially on the coast) began to skyrocket • The South Carolina state legislature passed Act 388 on May 31, 2006 • Act 388 and related legislation contains several property tax related caps and exemptions • Tax Swap • Elimination of Sales Tax on Unprepared Food • Property Assessment Cap • Property Tax Rate Cap • Act 388 was phased in between 2006 and 2008

5. 5 The Tax Swap • Property tax values in South Carolina grew 16.02 percent between Q1 2004 and Q1 2006. Growth rates in the coastal counties were significantly higher. • Local governments were able to raise considerably more tax revenue while keeping property tax rates stable. • SC legislature decided to totally eliminate school taxes on the full value of owner-occupied homes in exchange for a one cent increase in the state sales tax from 5 to 6 cents. • Rental properties, vacation homes and businesses were not included in the property tax reduction.

6. 6 Potential Property Tax SavingsYork County, South Carolina

7. 7 Issues with the Property Tax Side of the Swap • The recession!!! • The housing crisis: • Homeowners whose homes were valued under $100,000 received no benefit from the legislation since they were already exempt from school taxes via the 1995 law.

8. 8 Issues with the Property Tax Side of the Swap • Renters and businesses received no property tax relief. In fact, many are now paying higher tax rates than they may have faced without passage of Act 388. • A significant shift in the property tax burden has occurred from homeowners to rental and commercial property. • The share of property tax revenue for schools obtained from commercial and rental property grew from 37.8 percent in 2006 to 47.1 percent in 2010. (Saltzman and Ulbrich, 2013)

9. 9 Issues with the Sales Tax Side of the Swap • Businesses and renters do not benefit from the property tax reduction at all, but still face increased sales tax liabilities. • South Carolina’s homeownership rate was 72 percent in 2000 and had decreased to around 70 percent as of 2009. • Businesses have been hit especially hard by the one cent sales tax increase because businesses pay just over 50 percent of all sales taxes in South Carolina. • Increased sales tax burden on businesses was estimated to be $250 million in 2008 and over $350 million in 2012.

10. 10 Issues with the Sales Tax Side of the Swap • Partially due to the economic downturn, the increase in sales tax revenues does not cover the revenues lost on the property tax side. • Original estimate, in 2006, anticipated an $84 million surplus for the 2008-2009 fiscal year. • Actual data show a $50 million deficit during the 2009 fiscal year. • The shortfall was $126 million for the 2011 fiscal year. • Overall shortfall due to the swap alone since the passage of Act 388 is estimated to be over $400 million. • The state’s official three year outlook (to 2015) shows continued shortfalls, even though steady economic growth is expected.

11. 11 Sales tax exemptions What is (and is not) included in the sales tax base: • South Carolina has an unusually high level of sales tax exemptions • SC exempts more in potential sales tax receipts than they collect • $2.7 billion in exemptions • $2.5 billion in sales tax collections • SC could lower the sales tax rate to 3% (from 6%) and collect the same amount of revenue if they eliminated the exemptions • Some exemptions are odd: train sets are taxed at 6%, but an actual locomotive is exempt • Other odd exemptions: portable toilets, zoo animals

12. 12 (Maybe) The Biggest Problem of All…. • Sales tax caps on some items are very low • $300 sales tax cap on ANY motor vehicle (including planes) • $5,000 used 2003 Toyota Camry • SC sales tax = $300 • $200,000 new 2013 Bentley Continental GT • SC sales tax = $300 ($11,700 exemption) • $1,000,000 new 2013 RV Bus • SC sales tax = $300 ($59,700 exemption) • Sales tax revenues are generally less stable than property tax revenues, but this may be especially true when so many exemptions exist.

13. 13 Elimination of Sales Tax on Food • Act 388 instituted a one year reduction in the sales tax on unprepared food from 5 to 3 percent and then eliminated it as of November 1, 2007. • The cost of the elimination of sales tax on food resulted in a revenue reduction of $375 million in 2008. • The elimination of the sales tax on food was responsible for 10 of the 10.8 percentage point decrease in sales tax revenues in 2008 (South Carolina BEA). • Additional problems with the tax cut: • Food stamp purchases of unprepared food were never taxed. • Boyd and Fox (2008): unprepared food would have to constitute 17 percent of taxable purchases for a household to receive a net-benefit in the sales tax post-388.

14. 14 Potential Sales Tax Increase Due to Swap • Regressivity of sales tax increases burden of low income households. • Since home ownership is positively related to income, those who are renters are more likely to have lower incomes.

15. 15 State Reimbursement • The state is required to reimburse local school districts for property tax revenues lost due to Act 388. • If the increase in sales tax revenues does not cover property tax losses, the money must be taken from the General Fund. • In the first year of implementation, 2008, reimbursement was guaranteed dollar-for-dollar. • In subsequent years, reimbursement is based on the number of “weighted students” in a district, and increases by an amount equal to state inflation plus population growth. • There is no guarantee that the state cannot cut state funds to local school districts outside of the Act 388 fund. • In fiscal year 2009-2010, the SC legislature cut K-12 funding by $365 million via the traditional funding formula. Cuts in 2011 will likely exceeded $500 million.

16. 16 Differential Treatment of Districts Property Value Growth Simulation • District 1: Property values grow at a rate equal to state inflation plus population growth • District 2: Property values grow at twice the rate of District 1

17. 17 Property Assessment Cap • A constitutional amendment was passed alongside Act 388 which limited property tax assessment growth rates to 15 percent over any 5 year period. • An exception is made for properties that are sold during that time period (point-of sale assessment). • Law also changed the way in which property value is assessed. Now properties are assessed at the sales price at the time of sale. • South Carolina also has assessment ratios that vary rather significantly across property classifications: • Owner-occupied homes: 4% • Rental and commercial: 6% • Manufacturing: 10.5% (highest in the nation) • Transportation-related assets: 9.5% • A 2011 amendment provides an exemption of up to 25% of the value of rental and commercial property subject to the point-of-sale assessment. It does not address other property classifications.

18. 18 Property Assessment Cap • The property assessment legislation can result in very different property tax liabilities for similar homes (horizontally inequitable). • Undervalued property is another very significant issue in many counties. • There was no “catch-up” period, so counties with historically undervalued properties couldn’t reassess the properties prior to the cap going into effect. • Property assessment caps can decrease mobility within the state and can reduce migration into the state. • Many previous studies have shown similar effects in California • O’Sullivan et al. (1994), Stohes et al. (2001), Wasi and White (2008)

19. 19 Property Assessment Cap • Simulation of differential property taxes on identical homes. • Assumes two identical homes were built and originally sold in 1999. • Home 1’s homeowner holds home long-term while Home 2 is sold in 2009 for $322,460. The value of Home 1 remains subject to the 15% cap for the entire period, while Home 2 is subject to point-of-sale reassessment.

20. 20 Property Assessment Cap • Simulation continued: • The homeowner of Home 2 must pay 22.9% more in property taxes than the homeowner of Home 1 due to the cap. • This differential grows exponentially with the number of years Home 1 has been held by the same homeowner.

21. 21 Property Tax Rate Cap • Act 388 also included a cap on property tax rate growth equal to inflation plus population growth. • Boyd and Fox (2008) estimate that the average school district increased property taxes by 46.5% between 1995 and 2005. • This is 22 percentage points higher than would be allowed under Act 388. • Property tax rates grew at a rate greater than the allowed amount under Act 388 in all but 4 districts.

22. 22 Property Tax Rate Cap • The cap constrains districts that have a higher taste for education and prefer to increase spending at a higher rate. • SC is behind the national average in educational attainment and GSP, so it makes sense that school districts may want to accelerate growth. • If school districts fail to raise rates in a given year they are not allowed to “catch-up” in future years. Therefore, districts have an incentive to raise rates each year due to fears of fiscal issues related to economic downturns, Act 388, and state budget cuts.

23. 23 Summary of Legislation • Property tax swap • Windfall gains for high income homeowners • Low income South Carolinians face losses due to little/no gain from the property tax reduction and an increase in sales tax liability • Narrower base and higher rates • 40 school districts have seen declines in combined state and local per pupil funding since Act 388 was enacted. This group includes 16 of the 26 districts classified as “poor”. (Saltzman and Ulbrich, 2013) • Sales tax exemption on unprepared food • Most families face an increased sales tax burden overall • State loses significant revenues (unprepared food is the most stable component of sales tax)

24. 24 Summary of Legislation • Property tax assessment cap • Decreases horizontal equity; identical homes may have significantly different tax treatment • Point-of-sale assessment policy has negative impact on the SC housing market as well as commercial activity and economic development • County assessors cannot ‘catch-up’ historically under-valued property • Decreased mobility and efficiency • Property tax rate cap • May actually cause rates to increase on other types of property • Limits the power of jurisdictions to pick their preferred level of spending

25. 25 Broad Impacts • Between 1996 and 2007, per pupil real funding for school district operations grew by an average of 3.4 percent a year. • After the implementation of Act 388, between 2007 and 2010, per pupil real funding for school district operations fell at an average of 1.5 percent a year. • But, all levels of government were suffering during this time period, right? • Remember, only school districts were impacted by Act 388. Source: Saltzman and Ulbrich (2013)

26. 26 Broad Impacts • The need for additional funding via the General Fund (due to the gap in funding created by the tax swap) has resulted in significant decreases in other funding categories as well. • Higher education, health and human services, and corrections have seen very significant cuts. • Current levels of state and • local support for higher education: • SC: $174.15 per student • GA: $297.03 per student • NC: $407.62 per student

27. 27 Overall Impacts • Impact on Higher education

28. 28 The Verdict Bad Timing? • Most definitely. Phasing in the program between 2006 and 2008 ended up being extremely detrimental to the revenue stream. • Relying on a less stable revenue source is especially difficult during economic downturns. Bad Policy? • Most South Carolinians have seen an overall tax rate increase due to Act 388. Relying on a narrower tax base with higher tax rates is generally considered to be bad tax policy. • Preliminary statistical analyses show that Act 388 has led to a significant decrease in state education support (independent of the recession). • A swap from the property tax to non-food sales tax benefits those who need the least help (high income homeowners) and harms those who need the most help (businesses and low income residents).