I am fortunate to be living in Lancaster, Pennsylvania’s renaissance. It’s been called the new Brooklyn and the new Portlandia, which is saying a lot for a small urban area of 60,000 people. Those who have been here long enough have seen Lancaster transform from a rundown city to a hotspot full of trendy stores, watering holes, and culinary delights.
From the Amish outskirts to the quaint city, Lancaster is a wonderful place to call home. However, there’s one blaring negative to living in Lancaster and Pennsylvania in general, and that is property taxes. If you’re from Pennsylvania, you know that there are three taxes levied on your property. The first is the county tax, then a municipal tax, but the real doozy is the school tax.
When it comes to state income taxes, Pennsylvania is one of the lowest in the Union. It makes up for it in property taxes; compared to other states, Pennsylvania has the 13th highest property taxes (an average of 1.54%). That’s a dream compared to many states.
It’s also misleading. What many tax analysis websites don’t take into account are school taxes, which are tied to home assessments and levied on property owners. The PA school tax is in essence a property tax, but because it’s called a school tax, it often slips under the radar. While most states collect taxes and distribute them to school districts, Pennsylvania makes the local school district collect their own funds. So instead of schools being able to draw from portions of sales, income, and other taxes, they are forced to pull from property owners.
How bad are the school taxes? In Pennsylvania, taxes are based on millage rates. A mill is equal to $1 in taxation for every $1,000 of assessed value of your property. Millage rates are arbitrary. Basically, the county, city, and school district will adjust the millage rate every year to meet the desired revenue. What’s important here is to look at the disproportion of values.
For 2017 property taxes in Lancaster, the millage rates are: Lancaster County – 3.735 mills, Lancaster City – 14.44 mills, School District of Lancaster – 27.7572 mills (2016-2017 School Year). When you add these percentages together, the property taxes aren’t 1.53%; they are really more like 4.6% (double the property taxes of New Jersey – the state with the highest property taxes).
One could make the argument that public schools should be well funded, and good schools bring up the value of properties in their district. However, levying additional hefty taxes on property owners (instead of using various tax resources to fund schools) has three enormous drawbacks: it dissuades home ownership, it stagnates home values, and it creates greater inequality between the upper and lower class.
Let’s say you had a budget of $300,000 and were going to buy a home assessed at that value, which would mean a very nice home in Lancaster. In this scenario, let’s say you put no money down, the interest rate is 4%, there’s no HOA fees, no PMI, and home insurance is $1,000/year. In California, your monthly mortgage would be $1,715.58. In Lancaster, Pennsylvania, it would be $2,665.58 – nearly $1,000 more each month. That equates to $13,800 per year just in property taxes! Over the course of a 30 year mortgage, you will have more than paid for the price of the home in taxes (see Figure 1).
Figure 1: Property taxes on a home assessed at $300,000
|Property Tax Rate||0.8%||4.6%|
|Monthly Mortgage w/ Escrow||$1,715.08||$2,790.58|
|Annual Property Taxes||$2,400||$13,800|
|Total Property Taxes over 30 Years||$72,000||$414,000|
|Total Payments on 30 Year Mortgage||$617,608.52||$959,608.52|
When it comes to purchasing a home, you can’t just consider the total amount you want to pay. Banks take into consideration what you can afford on a monthly basis. Let’s say as you’re looking for a home, your max budget is $2,000 per month for a mortgage. In California, that gives you wiggle room. It means you can offer $340,000 for a home. However, in Lancaster, that means you’re limited to about $211,000. When people spend more on homes, it drives up the value. When they’re inhibited on spending, it creates a flatter market (see figure 2).
Figure 2: What’s the max home price you can afford on a $2,000 monthly mortgage budget.
|Property Tax Rate||0.8%||1.9%||4.6%|
|Max Value of Home Price||$340,000||$304,000||$211,000|
Obviously, not everything is equal. A $300,000 home in California is not the same as in Lancaster. In some ways, we’re comparing apples to oranges. And when you consider the difference in income and sales taxes, many would argue that it all equals out in the end. However, there are much tax friendlier states than California. And if you’re someone like me who moved here to experience all the joy of Lancaster and now has the possibility to move out of the area, it’s hard to justify keeping a real estate investment here in Pennsylvania.
Many states have justified high property and income taxes because they are deductible on federal taxes. However, it’s important to keep in mind that if President Trump’s tax reform passes, that will no longer be the case. Should that plan pass, residents in states with high taxes will feel the full brunt of those taxes with no relief, most likely resulting in a massive increase of people seeking tax friendly states.
What should be particularly troubling for a good-willed city like Lancaster is that property taxes exacerbate income inequality and limit opportunities for the lower class. The median household income in Lancaster is just $35,000, which means that a family bringing in the average income should be able to afford a house that costs $140,000 (4 times the annual salary). With the median house in Lancaster valued at under $110,000, this means that buying a home in Lancaster should be feasible, even for people with below average income.
However, when you tack on a 4.6% tax onto a home valued at $110,000, it means someone is paying over $1,000 per month for their mortgage, which is about 40% of their income after federal taxes, exceeding the recommended debt to income ratio of 28% for mortgages. If we exclude the school tax and just calculate Pennsylvania’s average property tax of 1.54%, the monthly mortgage on a $110,000 home drops to under $750 – much closer to the recommended debt to income ratio for a family making $35,000.
Just like retirement, real estate is an investment. In fact, it is a very practical investment with relatively short term gains. Investing for retirement is important, but that is money that gets set aside until you are 65. Buying a home and paying a mortgage means consistently increasing equity into something that is also gaining value over time. For a city with 30% living in poverty and with the household median income 38% below the national average, it’s a no-brainer to make real estate investment more possible for households with lower income. A home would not only give lower income earners a place to live, it creates home ownership, and allows them to start investing in order to improve their economic situation. Unfortunately the school tax makes that impossible.
When home ownership becomes impossible, it increases rental markets. In many cases, that means subdividing homes into rental units in order to attract steady renters and turn a profit. However, an increased rental market takes a toll on property values. This is especially true in poorer neighborhoods, as areas of poverty typically see double the rate of violent, non-fatal crime. Instead of revitalization like we see in other parts of the city, the impoverished areas stay stagnant or decline. This is also due to the fact that people are renting rather than taking ownership over their property and ultimately their home’s value.
Renters are not immune from school taxes either. Landlords pass on those taxes to their tenants in the form of monthly rent, which make it more difficult for them to save money in order to buy a house of their own. While wealthier areas with higher home ownership enjoy the cycle of revitalization and increased home values, the poor experience a vicious cycle of decline and poverty.
There is a solution to this problem. Pennsylvania needs to eliminate the school tax, balance the tax rates, and use the additional revenue from other resources to fund schools. With low income and sales tax rates, it can stand to raise those taxes in order to pay for schools. With the school tax eliminated, Pennsylvania could also slightly increase the property tax. There are a variety of other ways the Commonwealth can add income as well. In Maryland for example, they legalized casinos and used the money for education. On toll roads, non-residents pay a higher rate than Maryland residents.
Whatever methods are chosen, the bottom line is that making homeownership affordable is beneficial for everyone. As many have noted about higher education, an educational institution aims at providing students with the opportunity to improve their skills and ultimately their economic situation. When that burden is placed solely on those seeking the education, it becomes counterproductive. The same is true with public school taxes. When levied solely on property values, schools unintentionally create despair in the lives and communities they seek to improve.