Monday, January 14, 2019

The Highs and Lows of Local Fair Shares in New Jersey

What do you think should be a "fair" school tax rate for New Jersey school districts?  How about 0.7% of property value?  Or how about 2%?  How about 1.4%?

Well, if you are the School Funding Reform Act (SFRA) your answer is ALL OF THE ABOVE, because Local Fair Shares in New Jersey range from as low as 0.7% to as high as 2%, with a statewide median of 1.42%.

To demonstrate the variation in Local Fair Share another way, how about this real-world scenario?

Secaucus and Lawrence Township (Mercer) both have $4.8 billion in taxable property, so they should have the same ability to fund their schools, right?

Answer: NO.  SFRA assigns a Local Fair Share of $52 million to Secaucus, which would be a 1.1% tax rate, and a Local Fair Share of $69 million to Lawrence Township, which would be a 1.4% tax rate.

And Secaucus compared to Lawrence Township is not extreme either.  Avalon's taxable property is $8.42 billion and Cherry Hill's taxable property is $8.34 billion, but Avalon's Local Fair Share is only $60 million while Cherry Hill's is $136 million.


The reason SFRA creates such divergent tax rate targets is that the formula for Local Fair Share uses the Aggregate Income of a district's permanent residents in addition to the Equalized Valuation (ie, taxable property), so if a district has little income relative to its Equalized Valuation, it will end up with a Local Fair Share that is a low tax rate.  On the other hand, if a district has a high income relative to Equalized Valuation, it will have a high tax rate.

As for comparing Lawrence Township and Secaucus, Lawrence Township's residents make $1.5 billion, whereas Secaucus' make $808 million, hence Lawrence Township's Local Fair Share is higher despite the two towns having identical amounts of taxable property.  Likewise for Avalon and Cherry Hill.  Avalon's permanent residents only earn $75 million , while Cherry Hill's earn $3.4 billion.  Hence SFRA calculates a higher Local Fair Share for Cherry Hill.

So the divergence comes from the Local Fair Share formula itself!!

(Equalized Valuation x 0.013828828) / 2 + (Aggregate Income x 0.046200477) / 2

Which in simpler terms is:

0.7% of Equalized Valuation + 2.3% of Aggregate Income =

(If you're curious about what your district's Local Fair Share is as a tax rate, see this spreadsheet)

See note at the end of this post for where EV and Aggregate Income come from and what the state does for non-K-12 districts.

To see how the Local Fair Share formula gives divergent tax rates for towns with identical tax bases, consider the following:

If a district is perfectly average in terms of its Equalized Valuation:Income ratio, and has an Equalized Valuation of $1 billion and an Aggregate Income of $300 million (which is near NJ's average ratio of 28.5%), its Local Fair Share will be:

($1,000,000,000*0.013828828+$300,000,000*0.046200477) / 2 =  
$13.8 million per year, which would be a 1.38% school tax rate.  (eg, numerous from Mt Laurel to Paterson to Freehold Regional)

But if another district has an identical $1 billion Equalized Valuation but a lot more non-residential property or second-home property, so that its Aggregate Income is only $200 million, its Local Fair Share will be:

($1,000,000,000*0.013828828+$300,000,000*0.046200477) / 2 =  $11.5 million per year, which would be a 1.15% school tax rate.   (eg, East Hanover, Ocean Township,  Asbury Park, Englewood Cliffs)

On the other hand, if yet another district has the same $1 billion Equalized Valuation, but very little non-residential property and a lot of high-earners, so that its Aggregate Income is $400 million, its Local Fair Share would be $16.2 million, or a 1.62% school tax rate.   (eg, Kingsway Regional, Cherry Hill, Glen Ridge, South Orange-Maplewood)

Every school district in New Jersey must tax all taxable property at the same rate, so the regular homeowners are either hurt by or benefit from the incomes (or lack thereof) of their neighbors.

There are many unintended consequences of using Aggregate Income in the formula for Local Fair Share.  
  • If a district is economically diverse, the high-earners will skew Aggregate Income upwards and force middle-income and low-income property owners to have to pay a higher school tax rate.
  • If a district has a lot of non-residential property or second-home property, it is already advantaged, but then the SFRA formula adds further advantage to that since non-residential property has no income attached to it and hence a district with a lot of non-residential property will have a lower Local Fair Share.
  • Districts that have residents in tax-exempt property or PILOTed property will have higher Local Fair Shares.
  • Districts where people live below their means will have higher Local Fair Shares.
  • If a district happens to have high-income outliers, it would skew Local Fair Share to an amount unreflective of the average property owner's ability to pay.
  • If a district has many people working off-the-books who do not report their income, the Local Fair Share will be lower.
---- The Highest Local Fair Share Tax Targets 
Are Mostly in South Jersey ----

The clearest observation I have of New Jersey's highest Local Fair Share districts is that they are overwhelmingly in South Jersey due to property values there being lower there relative to income than in North Jersey.

Audobon Park and Winfield are owned by tax-exempt mutual housing corporations.
They are not normal towns from the perspective of taxation.

Of the districts in New Jersey whose Local Fair Shares are above the state median (1.42%) and whose Local Fair Share is below Adequacy (meaning that actually the district should pay its full Local Fair Share), there is an overwhelming skew towards South Jersey, specifically the suburbs of Philadelphia.

Lindenwold, Woodlynne, Wenonah, Hi Nella have Aggregate Incomes that are half of Equalized Valuation, and hence their Local Fair Shares are approximately 2%.

CountyNumber of Districts w/ Above Median Local Fair Shares (and LFSs under Adequacy)CountyNumber of Districts w/ Above Median Local Fair Shares (and LFSs under Adequacy)

Winfield and Audobon Park are outliers here, but that is because they are highly-unusual mutual housing co-ops that originated as housing for industrial workers in World War II.  Most property in both towns is tax exempt, hence their Equalized Valuations are artificially low.  I do not consider them to be treated unfairly by the Local Fair Share formula.  On the contrary, I think what they are doing is similar to PILOT exploitation and both towns underpay in county taxes.

Winfield, NJ has a 19% all-in tax rate, but
that is
due to it having an exceptional
amount of tax-exempt
property on which people live.

There are also affluent districts among those with the highest Local Fair Share tax rates like Essex Fells, Somerset Hills, and Mountain Lakes, but the full Local Fair Share of an affluent district or high-tax base district is irrelevant because their Local Fair Shares exceeds their Adequacy Budgets anyway.

For instance, Essex Fells' Local Fair Share is $9.2 million, which would be a 1.84% Equalized tax rate, but Essex Fells' Adequacy Budget is only $2.8 million, so Essex Fells would never have to have a $9.2 million tax levy.  Essex Fells' actual tax levy of $4.6 million is thus more than enough for Essex Fells' students and a low tax rate for its residents.

Likewise for Somerset Hills. Somerset Hills' Local Fair Share is legally $62,518,639, but its Adequacy Budget is only $27,095,338, so Somerset Hills' Actual $25.4 tax levy is more than plenty for the district while actually resulting in a low tax rate for Somerset Hills.

It is not only conventionally affluent districts that will never need to tax at full Local Fair Share.  Secaucus' has a lot of non-residential property. 

It is entirely possible that the affluent districts among the highest Local Fair Share tax rates, Saddle River, Essex Fells, Chester, Somerset Hills, and Mendham are on the list due to randomly having ultra-high income outliers living there.

----  The Lowest Local Fair Shares ----

The districts with the lowest Local Fair Share tax rates have an obvious thing in common, which is being at the Jersey Shore.

This tendency is from the fact that residential properties at the Jersey Shore tend to have extremely high valuations, but they are second homes with no permanent income attached to them.  Hence, they only contribute to a district's Local Fair Share through the real estate component of Local Fair Share, not the Aggregate Income component.

The only one of the lowest Local Fair Share tax rate districts that isn't at the Jersey Shore is Carlstadt, which is 74% non-residential.   However, like the Jersey Shore districts on this list, Carlstadt's Local Fair Share is well in excess of its Adequacy Budget and hence it will never need to tax at 100% of Local Fair Share.  Carlstadt's tax levy is only $10 million on a $19 million Local Fair Share.

And this brings me to Brick and Toms River...

Brick and Toms River have aggressively said that SFRA overcalcualtes their wealth and ability to pay
These waterfront
mansions in Brick are worth $2-$5 million,
but if they are second homes, they have no
income attached to them. Hence, Brick's Local Fair Share
is a lower tax rate than what the median town in
NJ's is.
taxes but the OPPOSITE IS TRUE because Brick  and Toms River have second home properties to which no income is attached.

Hence, Brick and Toms River have Local Fair Shares that are below the median.  Brick's Aggregate income is only 22% of its ualized Valuation, so its Local Fair Share tax rate is only a 1.22% tax rate.  Toms Rivers' income is 21% of its Equalized Valuation, so its Local Fair Share would be a 1.18% tax rate.

Neither Brick nor Toms River pays anything near its Local Fair Share anyway.  Both are at approximately 1%, not the 1.2% SFRA recommends.

---- The Income Crossover Point: Why Having Affluent or Frugal Neighbors Will Raise Your Taxes ----

I do not know why the School Funding Reform Act uses income to calculate Local Fair Share.  County taxes are apportioned strictly by Equalized Valuation.  Taxes in regional school districts are almost always apportioned strictly by Equalized Valuation as well. 

But if New Jersey is going to use income at all, it should use something based on median income, not Aggregate Income, because Aggregate Income is distorted by high-income outliers and there is the unintended consequence of using Aggregate Income is that the more money residents make relative to their housing values, the higher their property taxes are supposed to be.  

In fact, there is an Income Crossover Point where a frugal person or rich person will raise a district's Local Fair Share by an amount greater than his or her taxes.

Based on how Local Fair Share is computed by taking 2.3% of a district's income, the Income Crossover Point is the inverse of 2.3%, which is 43.5x.  

Whenever someone's income is 43.5 times his or her school taxes, he or she will RAISE Local
Note, this only applies if the district is eligible for
Equalization Aid and 240 districts in NJ are not
Fair Share by a greater amount than what he actually pays in school taxes.  Since Equalization Aid decreases as Local Fair Share increases, frugal and/or rich people can hurt a district financially. 
(43.5 = 1 / .023)

Imagine someone pays $10,000 a year in school property taxes and makes over $435,000.  2.3% of $435,000 = $10,000, so for every $1,000 over $435,000 that person earns, his district's state aid is reduced by $23!

Someone doesn't have to be rich to trigger a theoretical loss of state aid, but I'll use Phil Murphy as an example since he is a public figure with a known income and known property taxes, even though Phil Murphy's town of Middletown doesn't receive Equalization Aid.

Phil and Tammy Murphy pay $204,360 in property taxes on their Middletown compound, of which $130,381 is for the schools.  Phil and Tammy Murphy made $7.3 million in tax year 2015, which would increase Middletown's Local Fair Share by $167,900!

Livingston provides the supreme example of Equalization Aid loss since Livingston was the home of David Tepper, New Jersey's richest person whose taxable income was $800 million to $1 billion, which would be 28-34% of Livingston's total.   Although Tepper's house was spacious, it was not extravagant and only had an assessment of $2,155,900, or 0.03% of Livingston's total.

In Tax Year 2014/School Year 2016-17 David Tepper was a New Jersey resident and Livington's Aggregate Income was $3,809,964,019. That $3.8 billion number was used to calculate a Local Fair Share of $139,074,977.

Yet, in 2015 David Tepper moved to Florida and so in 2015/School Year 2017-18 Livingston's Aggregate Income fell to $2,943,567,080, which is actually less income than Livingston had in Tax Year 2013/School Year 2016-17. The departure of one ultra-high-wealth person, David Tepper, thus caused Livingston's Local Fair Share to fall to $123,636,221.

The fall in Livingston's Aggregate Income and Local Fair Share is totally anomalous.  All of the other affluent towns in NJ saw their Aggregate Incomes increase from 2014 to 2015.  We can thus conclude that the fall is entirely attributable to Tepper's departure.

$123 million is still in excess of Livingston's Adequacy Budget, so my point isn't to worry about Livingston itself, but the raise the possibility that if an ultra-high income person happens to live in a small town or a middle-class town, that person will distort the town's Local Fair Share.  What if David Tepper had fallen in love with an historic mansion in a middle-class town and moved there?  What if David Tepper had decided to live in a grand country estate somewhere in rural New Jersey?  Tepper's arrival would have crashed that district's Equalization Aid.  What if David Tepper lived like Warren Buffett in a middle-class house?  

Since a Board of Education cannot tax a rich person's income, it doesn't make sense to use Aggregate Income to calculate Local Fair Share.  

And, If New Jersey ever gets to the point where every district receives 100% of its Uncapped Aid and that principle is followed year to year, New Jersey will develop problems because Aggregate Income & Local Fair Share -- and hence Equalization Aid -- fluctuate year to year.

---- Residential PILOT and Tax-Exempt Property Distortion ----

Another oddity of using Aggregate Income to calculate Local Fair Share is that residents of tax-exempt buildings and PILOTed buildings will have their incomes count towards Local Fair Share, even though their properties are not taxable by a Board of Education.

---- Conclusion ----

New Jersey may not be able to ever have low or moderate property taxes, but at least we should have equitable taxes, in the sense where there is equity between taxpayers in different towns, where people generally pay the same property tax rates, unless one town is paying for extra services that other towns eschew.

SFRA is intended to equalize school spending and create a spending advantage for high-FRL districts, but as we can see here, it does not do as much to equalize school taxes and can actually exacerbate existing disparities.

The distortions from using Aggregate Income in the formula for Local Fair Share have been obscured by the completely off-formula distribution of state aid in New Jersey that existed because of Chris Christie and SFRA's own Adjustment Aid provision, but if New Jersey got to the point in 2024 where every district is funded at 100%, the disparities that result from SFRA's own core formulas will be harder to ignore.  

And since Boards of Education can't tax income, getting rid of income as a component of Local Fair Share (or at least using a median!) would make sense


See Also:


Note on Sources of Equalized Valuation & Aggregate Income 

To calculate Local Fair Share, the Department of Education uses Equalized Valuation from previous budget year (so tax year 2017 for 2018-19 state aid and Aggregate Income is from two pre-budget years previous, so 2016 for 2018-19.

Note on Non-K-12 Districts

If a town sends students to two sequential school districts, like a K-8 and then a 9-12, the tax base is split according to a formula where the percentage of taxable property is equal to the percentage of a town's students in a district.  If 75% of the students are in the K-8 district, then that district's Equalized Valuation is equivalent to 75% of the full, real Equalized Valuation.  If 60% of a town's students are in the K-8 district, then the K-8 district's Equalized Valuation and Income are equivalent to 60% of the full, real Equalized Valuation.

To give a real world example, Chesterfield's real Equalized Valuation (used for county taxes) was $793,850,669 for tax year 2017, but the Chesterfield Public Schools' Equalized Valuation is only $472,499,918 because Northern Burlington County Regional also taxes Chesterfield Township. 

This is because 60% of Chesterfield's public school students were at Chesterfield Elementary School and 40% of the students were at Northern Burlington Regional.

If a town has a K-8 district and then has a Send-Receive relationship for its high school-age children, then the state calculates Local Fair Share on the district's full Equalized Valuation.

No comments:

Post a Comment