City of Toronto property tax revenues do not rise with inflation.

I noted that simple fact in passing in a column this week, thinking it was uncontroversial. The response I got from readers showed that people don’t believe that’s true.

The apparently widespread misunderstanding of the system makes me think an explanation of the basics is in order.

The misunderstanding

I wrote that since property tax revenue doesn’t rise with inflation, the kind of “below the rate of inflation” increases promised by Mayor John Tory and some of his predecessors actually amount to a tax cut.

The gist of the overwhelming majority of the responses I got by email and social media is represented succinctly by one correspondent: “If house prices rise at the rate of inflation and property assessments keep up, doesn’t it follow that property taxes do rise with inflation?”

People pointed to the Municipal Property Assessment Corporation’s estimations of home values — which are used in calculating the rates homeowners pay — and quite reasonably asked how it was possible that rising assessments in a market that has seen home prices more than double since amalgamation haven’t led to big increases in revenue for the city.

How property tax “freezes” and “hikes” actually work

The key thing to understand is that property tax rates are determined by working backwards. City council does not set a rate and then see how much money comes in (as politicians do with sales taxes or income taxes). Instead, they set a revenue goal, and then bureaucrats use it to set rates for individual property owners. It’s almost like dividing up a restaurant bill: they start knowing the total they need to collect, then they determine how much each person at the table has to chip in to reach that total.

City council knows how much the city collected in property taxes last year. When they begin budgeting, they start with that number. If they say they are “freezing” property taxes, it means they will collect the exact same amount as last year. If they say they are “raising” taxes 2 per cent, it means they are planning to collect 2 per cent more than they did last year. So if they do not raise taxes, the number of dollars they collect stays the same, even if those dollars are worth less due to inflation.

How assessments factor in

Once the total amount to be collected is set, city staff set rates so as to determine what share of that amount each taxpayer will pay. This is enormously complicated. Different rates are charged to commercial, industrial, multi-residential (apartment building) owners and single-family homeowners. For the past several years, these rates in turn rise at different levels, due to a city economic development policy. Explaining all those fine nuances is beyond the scope of a short article like this.

But the key thing to understand is that the share of the total tax bill each homeowner pays is determined in large part by the value of their property relative to the value of everyone else’s property.

This is where assessments come in. Sometimes a homeowner’s taxes will go up dramatically because the price of the house has risen dramatically. But this will only be true if it has appreciated in price faster than the market as a whole.

For example, taxes on my home in a rapidly gentrifying area have gone up more than 50 per cent in the past five years due to MPAC assessments, because the market value of my home has gone up far faster than the value of average homes across the city. Meanwhile, I know a couple who own a home in Scarborough in a neighbourhood where home values have increased, but not nearly as much as the average house appreciation city-wide, and that couple has seen their property tax bill drop consistently for more than a decade.

A city report last year succinctly summed up the key to understanding how the assessments influence city revenue: “Reassessment is revenue-neutral to the city, meaning that increases in the values of properties do not provide the city with additional property tax revenues. Legislation requires municipalities to reduce their tax rates in proportion to the increase in total assessed value arising from reassessment, such that the reassessment by itself does not result in additional revenues to the municipality.”

The value of your home only determines what your share of the bill is. Property values do not determine the size of the bill. The average homeowner’s property tax bill does not rise with inflation, and neither does city revenue.

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This truth appears not to be widely understood. And if people already think their taxes are rising automatically with inflation, it may suggest a sneaky but relatively politically painless solution to some of the city’s budget problems: why not just change the system so it conforms with most people’s existing belief about how it works? Why not change the law so that property taxes work like income and sales taxes — so that the city does benefit from housing market inflation?

I’ll discuss that idea in a different column soon.