Abstract
Scholars have consistently found that governments intentionally underforecast revenue, a practice often defended on the grounds that it is created as a hedge against unanticipated revenue losses. Other scholars, though, have noted that variances in the revenue forecast are impounded into future budget levels, a process known as ratcheting. If underforecasting is prudent but has pernicious side effects, it stands to reason that at some point underforecasting will be excessive to the median voter. If underforecasting is excessive and intentional, it would be an instance of fiscal obfuscation, a concept recently given a formal definition as a particular type of fiscal illusion. Because of fiscal obfuscation, the true cost of the forecast error (an increase in tax levels) is not observable to the median voter. This chapter explores the forecasting dynamics of New York City’s property tax in order to demonstrate the tax is excessively and intentionally underforecasted by the mayor’s budgeting agency.
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Notes
- 1.
While the public choice literature in particular imparts intentionality on budget-maximizing lawmakers, the existence of fiscal illusion does not imply anything about lawmakers’ mental states. Consider that revenue diversification and tax structure complexity can lead to fiscal illusion (Oates 1988), but lawmakers may select more complex tax systems for ostensibly benevolent reasons such as a revenue stabilization strategy, whether that happens in fact or not (Carroll 2009). Where we find fiscal obfuscation we will find fiscal illusion, but where there is illusion there may not be obfuscation.
- 2.
Class 1 also includes vacant land adjoining a Class 1 residences, bungalows, residential garages (if separately assessed), and other uncommon real property that ostensible would appear to fit the definition of Class 2 or Class property. For more details, see New York Real Property Tax Law §1802.
- 3.
New York Property Tax Law §305(2) allows New York City to assess different classes of property at different rates, determinable by local law.
- 4.
Fair market value for ad valorem purposes is determined through one of the three property valuation approaches: the comparable-sales approach, the income approach, or the cost approach. The comparable-sales approach assigns a value based on recent sales prices of similar properties in the area. It is appropriate when real estate transactions for that particular type of property are abundant. The income approach assigns a value according to the amount of net income a property generates. This process can be done using a rate of capitalization (direct capitalization approach) or discounting a stream of estimated net income over time (discounted cash flow approach). The income approach is appropriate when the property generates income but there are relatively few transactions of the property type. The cost approach assigns a value according to how much it would cost to replace (using contemporary building materials) or reproduce (using the original building materials) a property. It is appropriate when there is no income data available, such as brand-new buildings or improvements, or when a property is rare, such as stadiums and arenas. In New York City, generally speaking, Class 1 properties are valued using the comparable-sales approach, and Class 2 and Class 4 on the income approach. Class 3 are generally assessed by the state.
- 5.
The assessment caps do not apply to increases in assessed value resulting from physical improvements.
- 6.
An exception to this reasoning could be made for abatements, which in New York City are credits—reductions in tax liability after the class-specific tax rate has been applied to a parcel’s taxable assessed value. Abatements are most often awarded as incentives for undertaking property rehabilitations or to otherwise incent other behavior such as installing solar panels. Abatements are financed by all other taxpayers by increasing the levy, but whether abatements should be included in the reserve or not in the first place is controversial.
- 7.
For all other future years in the forecasting period, b is not known and thus variation in the forecasted levy will be due to variation in both the reserve and tax base.
- 8.
The city council’s finance division produces a revenue forecast, but for the property tax it largely borrows from OMB. There are some state agencies that produce forecasts of city revenue such as the New York State Comptroller and the Financial Control Board, an oversight committee formed following the city’s financial crisis in the 1970s. Since the focus of the article is on local politics, state agencies are ignored.
- 9.
Williams (2012) characterizes IBO and the Comptroller as revenue finders, and therefore their forecasts underestimate revenue less than OMB’s in order to fund expenditures. Since IBO and the Comptroller do not have budgeting authority, it seems remarkable that finding revenue is the correct explanation, particularly in the case of IBO where the agency executive lacks any political incentive to systematically create forecasting bias. It is far more likely that IBO and the Comptroller underestimate less than OMB, because they care about forecasting accurately whereas OMB’s incentive is otherwise.
- 10.
Importantly, both forecasting philosophies cannot be pursued jointly as a matter of logic; one cannot both underforecast and minimize forecast error as forecasting goals (Bretschneider et al. 1989). The latter implies an effort to minimize bias while the former implies that bias is desirable to a certain extent for prudent budgeting.
- 11.
OMB forecasts particular items in the reserve separately and the overall reserve forecast equals the sum of the component forecasts. Across reserve components, though, there is great variation in the degree to which OMB overestimates uncollectibles. In recent history, the reserve component that is consistently overestimated the most is property tax refunds. From 2010 through 2016, refunds have been over forecasted by 40 percent compared to actuals on average (the median year was 43.6 percent). Moreover, despite actual refund levels never exceeding 2 percent of the levy from 2002 through 2009, refunds were forecasted to be more than 2 percent of the levy five out of the seven years from 2010 through 2016. Because the overforecast was built into the property tax levy as an uncollectible, if refunds alone were the only component forecasted perfectly and all other forecast variances were unchanged, the annual levy during the seven-year period would have been on average $170 million lesser than what it was in fact.
- 12.
The city council’s finance division generates a property tax forecast as well, but the vast majority of time the city council accepts OMB’s forecast rather than generating its own. An exception was in 1998 and 1999 when the council used its own forecast of the reserve to set the levy. There is good practical reason for the city council to accept OMB’s forecast. Doing so facilitates budgeting negotiations between the mayor and council members, allowing them to spend more of the budget season negotiating spending priorities rather than revenue. In addition, the city council benefits from access to more money than less, so it also has little incentive to go with a more accurate forecast.
- 13.
Annual increases in assessed value for Class 2 and Class 4 properties are phased-in over a five-year period, resulting in a pipeline of accumulated value waiting to be added to the tax roll.
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Propheter, G. (2019). Excessive Revenue Underforecasting: Evidence and Implications from New York City’s Property Tax. In: Williams, D., Calabrese, T. (eds) The Palgrave Handbook of Government Budget Forecasting. Palgrave Studies in Public Debt, Spending, and Revenue. Palgrave Macmillan, Cham. https://doi.org/10.1007/978-3-030-18195-6_11
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