Michigan: Ending the Pop-Up Tax?

Michiganders call it the "pop-up tax." It's what happens when long-time Michigan residents sell their homes. A home that generates, say, $1,000 in property taxes under its current owner suddenly incurs a much bigger tax, say $1,500, after it is sold to a new owner. Michigan lawmakers think there is something unfair here-- and they're right. Unfortunately, they've identified the wrong culprit: it's not unfair that the new owner pays $500 more-- it's unfair that the old owner paid $500 less.

The problem is that Michigan's property tax laws cap the amount by which a home's taxable value can grow from year to year at 5 percent or the rate of inflation, whichever is less. This means that for many homeowners, there are two very different measures of what their home is worth: what the real estate market says (market value) and what the tax system says (taxable value). In a booming real estate market, the 5 percent cap makes taxable value smaller than market value, creating a gap between the (smaller) amount of value you're taxed on and the (bigger) amount your home is actually worth.

And the longer you own your home, the bigger that gap becomes.

Why does Michigan's tax system work this way? The idea with assessed value caps is generally to ensure that homeowners won't face an excessive property tax hike in any one year. When Michigan voters ratified Proposal A back in 1994, this property-tax-cutting proposal included an assessed value cap that basically said no Michigander, at any income level, should have to face more than a 5 percent increase in their property tax liability in any single year for as long as they own their house. And since inflation has been well under 5 percent in almost every year since then, Michigan homeowners at all income levels have seen across-the-board cuts in their property tax liability.

But the free ride ends when you sell your house. As in virtually any other state that imposes assessed value caps, the gap between taxable value and market value goes away when a Michigan house changes hands. This makes perfect sense: after all, the point of the cap is to prevent a homeowner from being taxed out of their home due to big year-to-year increases in property tax liability. But that rationale disappears when homes change hands. In the example I gave above, it's hard to see why a new homeowner should inherit the $500 tax break the previous homeowner received. And, more generally, the best way to ensure that a property tax system is fair is to ensure that what you pay depends on what your home is actually worth.

From the perspective of the new homebuyer, of course, something seems unfair. Why are they seeing a $500 property tax hike? And that's the way the Detroit Free Press article linked above generally frames this question (although the article is pleasantly neutral in its overall treatment of this topic). But the real question is not why the new homeowner sees a $500 tax hike-- it's why the previous homeowner was enjoying a $500 tax cut.

The answer one legislator, Andy Meisner, has come up with is to make the tax cut temporarily transferable. Under Meisner's bill, HB 4440, if the seller got a $500 tax break in his last year in a home, the buyer should get to keep that tax break for his first 18 months in the home. But as a representative of the home builders industry helpfully points out in the FreeP's article, this would create an artificial and totally unjustifiable gap between the tax on existing homes and on new homes. (In the example above, suppose that next door to the home that should be paying $1,500 in tax (but is paying $1,000 thanks to the transferable tax cap), a builder puts up an identical house and puts it up for sale. The two houses are worth the same amount, but the new home will pay $1,500 in tax, while the existing home will pay only $1,000. This means the home builder will have to sell the new home for less than it's really worth just to stay competitive.)

The source of the unfairness here is the 5 percent cap itself. The cap amounts to asserting that no one, at any income level, can afford to see a property tax increase higher than the rate of inflation. While this is certainly true for many fixed-income families, the idea that it's applicable to upper-income folks is simply absurd. But the Michigan system persists in doling out excessive tax breaks to every homeowner-- and efforts to expand the tax cap's benefits by making them transferable will do nothing to make these tax breaks more rational or fair. What some Michiganders are pejoratively calling the "pop-up tax" is, in fact, an entirely justified correction in the tax system-- making an unfair tax less unfair.

The Michigan House passed Meisner's plan earlier this month, and the Senate is now considering it.

Of course, an 18-month solution-- however wrongheaded-- has the virtue of only being wrong for 18 months. But even if lawmakers in the Senate approve the Meisner plan, at the end of the 18 months the "pop-up" problem will still exist. Sooner or later, Michigan lawmakers will have to confront the inherent unfairness of the tax cap approach.

If Meisner's plan is wrong, what's a better solution? One good approach would be to further strengthen the state's property tax circuit breaker credit, which (unlike the 5 percent cap) is explicitly designed to shelter Michigan homeowners and renters from excessive property taxes. The circuit breaker's design asserts that when low- and middle-income Michiganders (for a married couple, someone earning less than $80,000 or so) face property tax bills that exceed 3.5 percent of their income, those property tax bills should be thought of as excessive. The circuit breaker rebates property taxes over the 3.5 percent of income limit.

But the credit has limits. It's capped at $1,200, and it only rebates 60 percent of the "excessive" property tax. Expanding the credit so that it rebates 100 percent of the excess tax, and increasing the cap, would be a good, inexpensive and targeted way of ensuring that middle-income Michiganders won't get taxed out of their homes.