Iowa's largest property tax cut in history fails to deliver, Register investigation finds

Copyright 2017, Des Moines Register and Tribune Co.

When Iowa passed sweeping property tax reform four years ago, state officials projected commercial taxpayers would save $218 million this year. Lawmakers also promised to fully reimburse local governments for the revenues they stood to lose.

The law has failed to deliver on both counts, a Des Moines Register review of state data shows.

In three years, the state has paid $391 million to Iowa's cities, counties and school districts. But that money has not kept pace with the reduction in property tax revenue brought on by the changes, and local governments have missed out on a combined $107.2 million.

Meanwhile, businesses that were expected to benefit the most through lower taxes have saved about half as much as the state projected in 2013, according to the nonpartisan Legislative Services Agency.

Now, city officials fear they could lose millions more.

DATABASE: Find out how much your city, school district and county has received from the state's backfill fund

With Iowa dipping into cash reserves to cover operating expenses, city leaders say legislators are telling them nothing is sacred — including the state's annual $152.1 million backfill payments.

"If this is one of the things that gets looked at and seriously considered, it creates literally thousands of issues across every part of the state," said Ankeny City Manager David Jones. His city received $1 million in state backfill payments this year.

"It's not an insignificant amount of money, even for a successful, growing city like Ankeny," Jones said.

City leaders say that without the backfill, local governments and school districts across the state would be forced to make cuts in services and staff — or dramatically increase property taxes.

City property tax increases could range from 26 to 75 cents per $1,000 in valuation, finance directors from across the Des Moines metro said. And school districts and counties could follow suit.

"It would be a Legislature-imposed property tax increase on most everybody that owns a house in Iowa," Des Moines City Councilman Chris Coleman said.

Even if the backfill remains whole, cities will continue to lose money under a provision of the 2013 legislation that lowers property taxes on multi-family residential units like apartments and nursing homes.

In two years, cities and counties statewide have lost $14.9 million under that new classification. The Des Moines metro has lost a combined $4.5 million. And statewide losses could reach $31 million through fiscal year 2022, according to conservative estimates from the Iowa League of Cities.

Savings over-promised, funds slashed

When passed, the bipartisan tax relief bill was lauded as a boon to Iowa's economic development. Giving financial breaks to commercial properties would "make it easier for Iowa businesses to invest and grow in our state," former Gov. Terry Branstad said at the bill's signing.

Sen. Charles Schneider, R-West Des Moines, said discussion in 2013 centered on lowering Iowa's high commercial property tax rate to make the state more competitive with its neighbors.

The Tax Foundation, a Washington, D.C.-based advocacy group, showed commercial property in Iowa was taxed at about 2.25 times the rate of residential property in fiscal year 2010, ranking the state 40th nationally in terms of that disproportion.

At the time, commercial, industrial and railroad properties were taxed at 100 percent of their valuation. Homes, on the other hand, were taxed at a rate nearly half of that.

The reforms lowered the level at which commercial, industrial and railroad properties were taxed to 90 percent over two years. From 2013 to 2017, residential levels increased from 54.40 to 56.94 percent.

"It makes us more competitive as a state with our neighboring states," Schneider said. "That in turn makes Iowa more attractive to do business in."

But Iowa still ranks 40th in the Tax Foundation's 2017 State Business Tax Climate Index, a score that hasn't budged since at least 2014. Missouri ranks 15th, Nebraska 25th and Wisconsin 39th.

Projections issued by the Legislative Services Agency in 2013 before the bill's passage showed tax savings for commercial, industrial and railroad properties statewide were expected to reach $254.4 million in fiscal year 2017. About $218 million of those savings were expected to benefit commercial properties alone.

But those projected savings have not been fully realized.

Tax savings in fiscal year 2017 were an estimated $157.6 million, according to an agency review released in January. Commercial properties accounted for about $125 million of that tax break.

Former Rep.Tom Sands, a Republican from Wapello who at the time was chairman of the House Ways and Means Committee, said the tax reform "did not do enough" for larger commercial property owners.

The 10 percent tax break "disappears" for bigger businesses due to rising property assessments, said Sands, who is now president of the Iowa Taxpayer Association.

Meanwhile, local government losses have been greater than projected. The Legislative Services Agency predicted in 2013 that cities and counties would lose a combined $17.1 million in fiscal year 2017. Schools would lose $8.8 million.

That's a loss even with the state paying governments back for some of the tax breaks to businesses.

In reality, cities and counties lost as much as $84.7 million last fiscal year, the agency said. Schools lost $22.5 million.

Several city officials surveyed by the Register say they've never talked to business owners who planned to expand or relocate to Iowa because of its property tax reform. Microsoft did not mention lower property taxes when deciding whether to add more data centers in West Des Moines, according to city Finance Director Tim Stiles.

Clive City Manager Dennis Henderson said city leaders regularly meet with business officials to discuss how services can be improved. He said "none of them have even mentioned" property tax reform during those visits.

"Yes, every single business is going to tell you they'd like to pay less," he said. "But as far as it entering into business decisions, I have not heard any impact at all."

The loss in revenue resulting from the state tax reforms has left cities weighing whether to cut services or raise property tax rates — something city leaders say was evident in 2013.

"The only solution was to pass taxes on to residential (properties), because if commercial (taxes go) down and services stay the same, what else can you do? You have to increase your overall rate or cut services," Stiles said. " ... That’s the only way it could have turned out."

Iowans could see tax bills go up

City leaders surveyed by the Register say conversations with state lawmakers indicate the Legislature plans to reduce or eliminate the backfill amid the state's budget shortfall.

That could be especially damaging for city budgets in rural Iowa, where population has been declining. It could also mean significant increases in residents' yearly tax bills.

Without the backfill, unless the city makes cuts to services, Des Moines could increase its property tax levy by 75 cents per $1,000 in valuation, said City Manager Scott Sanders.

"It's such a traumatic exercise," Sanders said. "It’s not healthy to go to department directors and say, 'What would you do with a 20 percent reduction of your budget?' Then doom and gloom starts to set in."

According to the cities' finance departments, without cuts to services, taxes could increase as much as 71 cents in West Des Moines, 63 cents in Altoona, 42 cents in Clive and 36 cents in Urbandale.

For an owner of a $200,000 home in Des Moines, that's an additional $85.42 a year. In West Des Moines, it's $80.85 a year. That does not include potential increases to school and county levy rates, which combined make up the bulk of a homeowner's property tax bill.

"The double whammy is the individual homeowner is going to get the tax increase, and he or she never got the benefit of the reduction to begin with," West Des Moines Mayor Steve Gaer said.

While losing the backfill may not halt city projects, it could stunt plans for things like quality-of-life initiatives used to attract new residents, Gaer said.

It would also limit local governments' ability to stay on top of infrastructure needs leading to deferred maintenance, a more costly way of doing business, he said.

Sands said local governments should "do what families and businesses do and look at more efficient ways to provide services" instead of making cuts or taxing citizens.

He pointed to rising property values.

Home values in Polk County dropped in both 2011 and 2013, but increased 4.15 percent in 2015, according to county assessment data. Residential property values have increased 8.3 percent on average over the past two years.

Some cities face unique challenges

It's likely Des Moines' suburbs could make up losses in short order due to explosive growth, city leaders say.

But that's not the case across Iowa.

Council Bluffs, for example, has reached its property tax levy limit, so a tax increase to make up a shortfall is not allowed under state law.

The loss of the state backfill would equate to across-the-board cuts in city staff, said Mayor Matt Walsh. He estimates the city would need to eliminate 25 to 30 jobs, or 4.5 percent of the city's workforce, to make up for the $2 million loss if the state reimbursement were eliminated.

Council Bluffs is already operating under stress, with a budget surplus of $64,000 that was created only "after multiple cuts to get there," he said.

Like Council Bluffs, 808 out of Iowa's 947 cities are at the general fund levy limit, according to the Department of Management. Of those, 426 are also using an emergency levy, and 367 have maxed out that allowance.

"I don't know that permanently damaging cities is an appropriate plan for the future of Iowa," Walsh said.

'It's a train wreck coming'

School districts across the state also rely on backfill revenue for operations.

The Waukee Community School District gets about $2.5 million annually. Its tax levy could rise by 20 cents if that funding goes away, said Chief Financial Officer Lora Appenzeller-Miller.

The district could also be forced to make "a pretty good cut of humans" to make up the loss, she said. Waukee directs $1.5 million of its backfill money to the general fund, which largely pays for teacher salaries.

That represents a cut of 23 teachers.

"We told (our legislators in 2013) 'it's a train wreck coming. You guys are going to be in trouble,'" Appenzeller-Miller said.

Losing the backfill would not be catastrophic for Des Moines Public Schools, said Chief Financial Officer Thomas Harper. The district received $5.46 million in fiscal 2017, just over 1 percent of its $475 million budget. Its tax levy could rise 1 to 2 cents to make up that loss, Harper said.

If the Legislature were to end the backfill this fiscal year — Gov. Kim Reynolds has said she will decide in September whether to call a special session to address the state's budget troubles — Des Moines Public Schools would be forced to dip into reserves to pay teachers, he said.

"That creates a bigger problem for the 2019 fiscal budget year," Harper said.

What will the Legislature, governor do?

Lawmakers have scrambled to shore up the state's finances, making $118 million in cuts to programs and services and pulling another $131 million out of the state's emergency cash reserve funds.

State lawmakers mulled cuts to the backfill earlier this year, but a proposal never went beyond committee discussions.

In a statement to the Register, the governor's spokeswoman pointed to Iowa's unemployment rate of 3.2 percent, three straight months of job growth and more than $14 billion in private capital investment since 2010 as successes related to the 2013 property tax reform.

"All point to Iowa creating a more competitive business climate," said Brenna Smith, spokeswoman for Reynolds.

She would "not speculate" if there may be changes to the backfill, saying it "was part of the compromise property tax reform bill, and it remains the law."

Schneider, the West Des Moines state senator who voted for the tax reforms, said city officials realize the state may "ween itself from the backfill," but he's not aware of any "immediate plans" to do so.

"But if it does come to that, we need to work with the cities to do it in a manner that it doesn’t impact the services they provide to their citizens," he said.

Rep. Dave Jacoby, D-Coralville, ranking member of the House Ways and Means Committee, called the reform the "worst tax policy bill of all time."

"Any time you're using one tax to backfill another tax, that’s not true tax relief," he said. "You’re just affecting one taxpayer more than another."

Jacoby, who voted against the 2013 bill, agrees that commercial properties should not be taxed at 100 percent. But he proposes a gradual approach — an annual 1 percent decrease over 20 years — to reduce the burden on local governments. That would in turn result in less of a financial commitment from the state to backfill lost revenues, he said.

He believes lawmakers should review all tax credit programs, as well as this reform, in the next general session as they deal with the state's budget shortfall.

In the meantime, he wants to see the backfill honored.

"It was a promise made to local governments. If we break that promise then that’s going to just send a jolt in the residential property tax owners’ pocketbooks," Jacoby said. "That's a tough call, and that’s what happens when we make stupid decisions."

Republicans hold majorities in both the Senate and the House. Several Des Moines metro GOP lawmakers did not respond to requests for comment. They include Sen. Jack Whitver in Ankeny, Rep. Peter Cownie in West Des Moines, Rep. Chris Hagenow in Windsor Heights, Sen. Brad Zaun in Urbandale and Rep. Zach Nunn in Bondurant.

Slow, steady drain of revenue

Meantime, a slow steady drain to city coffers is happening as a result of a new tax class for multi-residential properties.

That decline started last fiscal year when apartments were taxed at 86.25 percent of value, down from 100 percent in previous years, when they were classified as commercial properties. That level will continue to decline in 3.75 percent increments each year until apartments are taxed at the same level as residential properties in fiscal year 2022.

According to the Legislative Services Agency's latest review, local governments statewide lost $14.9 million in property tax revenue from multi-family units due to the change.

The Iowa League of Cities predicts the impact will reach at least $31 million statewide by the time the change is fully implemented in 2022. The Des Moines metro alone could lose $18 million over the next four years, the League said.

Alan Kempf, executive director of the Iowa League of Cities, cautioned that the League's model is based on assumptions, including new construction, rate of growth and a city's tax rate. Cities' actual losses could be higher, he said.

Des Moines has been hit hardest in the metro with a loss of $2.3 million over the past two years. West Des Moines follows close behind with a loss of $1.9 million.

The capital city is projected to lose another $9 million by 2022, according to the Iowa League of Cities' model.

West Des Moines could lose half that, representing about 2 percent of its operating budget each year, Stiles said.

None of that money is backfilled by the state.

"And it's a loss of revenue that grows over time," said Jones, the city manager in Ankeny. "To be frank, there's a number of people in local government who look at that particular part of the reform and are challenged as to what the overarching goal was."

According to Register archives, while the new property class lowers costs for landlords, they are not required to pass those savings on to tenants. Landlords statewide saved $24.7 million on property taxes in fiscal year 2017, the Legislative Services Agency said in its January review.

Rental rates in Des Moines have crept up 15 percent in the past five years, according to data collected this summer by Zillow.

Apartments are the fastest-growing property class in Des Moines, Sanders said. That puts more pressure on the city to raise its property tax rate, he said.

He estimates the city's tax rate would need to increase 18 cents to make up for the tax break given to landlords in just one fiscal year.

"I would feel better about the multi-family tax rollback if I had heard of even one landlord reducing the rent," Coleman said. "This was a handout to commercial property owners, not to residences."

In March, the Des Moines City Council approved a 12-cent property tax increase, the first in five years. That was enough to hire 16 new city staffers. Before this year, Des Moines had cut its workforce by more than 300 employees since 2005.

"I want lower taxes for our citizens, but I want a responsible and sustainable commitment from the state," Coleman said. "As they play pingpong with policies and tax rates, it creates real problems for the citizens of Des Moines and residents all over the state."

2017 backfill payments

The state provided $152.1 million in backfill payments to local governments in fiscal year 2017. Here is how much Des Moines metro cities, school districts and counties received:

CITIES

Des Moines: $5.3 million

West Des Moines: $3 million

Ankeny: $1 million

Urbandale: $977,000

Altoona: $615,000

Johnston: $570,000

Clive: $549,000

Grimes: $283,000

Waukee: $220,000

Pleasant Hill: $128,000

Windsor Heights: $120,000

SCHOOL DISTRICTS

Des Moines: $5.5 million

Waukee: $2.5 million

West Des Moines: $2.5 million

Ankeny: $1.6 million

Johnston: $1.3 million

Urbandale: $695,000

Southeast Polk: $975,000

COUNTIES

Polk: $6.2 million

Dallas: $655,000

Warren: $125,000

Madison: $51,000

*Information from the Department of Management.

What did 2013 tax reform change?

The bipartisan property tax reform legislation approved in 2013 included changes intended to benefit both commercial and residential taxpayers.

Included in the reform was: