In a previous article I discussed the possibility that the economists at the Federal Reserve in Chicago proposed a new 1% property tax on homes so as to create initial outrage in their first proposal; thus making further proposal more palatable. The economists promised that they would later "explore additional options for spreading the pain, including expanding the base to cover rental and commercial properties, and options for making the tax progressive."
The collective outrage over this proposal is palpable throughout the entire state. Homeowners are upset because a new 1% property tax could lower home values by approximately 17%. The economists at the Federal Reserve wrote:
"Current homeowners would not be happy about this, but it would be a good result for the Illinois economy. That's because the new taxes wouldn't affect people thinking of moving to Illinois. While they would have to pay higher property taxes, that would be offset by not having to pay as much for their new homes. In addition, current homeowners would not be able to avoid the new tax by selling their homes and moving because home prices should reflect the new tax burden quickly."
I have suggested that perhaps their next proposal will be to only levy a new tax of 0.25% on owner-occupied homes instead of the current 1% proposal. Then, to make up the additional revenue, they could also propose a tax of 0.5% on rental properties and commercial properties. A 0.25% tax increase on homes would lower the value by approximately 4.4%. Homewowners will still be upset, but will feel like they dodged a bullet by not having to take the 17% hit to the value of their property.
How would a new tax impact commercial property? Assuming that most commercial properties are trading in a 6% to 8% capitalization rate range, then a new 0.50% tax on commercial property could reduce values by 6.25% to 8.33%. However, this impact could not be uniformly applied to all commercial real estate. Due to the various ownership and lease structures, some properties would experience a lessened impact on the real estate. For example, a retail property with a 20-year net lease (the tenant responsible for paying taxes) would see little impact in its real estate value from a new tax. In this situation the tax burden would be passed on to the retail consumers rather than to the buyers and sellers of the real estate.
The following graph indicates the potential decline in value that could be experienced with an increased tax. The smallest decline in value is 3.13% from a 0.25% tax on a property with an 8% capitalization rate. The largest decline in value is 16.67% from a 1.00% tax on a property with a 6% capitalization rate.
It will be interesting to see what new proposals do come from the Federal Reserve, and how those proposals will be received by Illinoisans and by Springfield.
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Jason King, MAI