Property Tax Equation Explained

The property tax equation is an often-misunderstood equation.  We are going to spend the next two minutes explaining how local governments calculate the property tax that property owners are required to pay each year.

Here is the property tax equation:

Tax Levy  =  Value ¸ $100  x  Tax Rate

(We divide the value of property by $100 because the tax rate applies to each $100 of property value.  This method of adjusting the value, which is required by law, allows us to state the tax rate in terms of dollars and cents or as a percentage. For example, a tax rate of 0.10 means a tax of 10 cents (or $0.10) on each $100 of property value. A tax rate of $0.10 is equivalent to a tax of 0.1% of the value of property. A tax rate of $1.00 on each $100 of value would be equivalent to a tax of 1% of the value of property.)

The property tax equation works for local governments in assessing property tax on all property in their jurisdictions and for property owners in calculating their individual tax bills.

Thus, the tax levy is not just the amount of tax a property owner has to pay.  When all tax bills (or tax levies) of all property owners are added together, the tax levy also equals the amount of revenue a local government collects from all property owners to fund its budget.

Values and tax rates are intended to float so that local governments can raise the amount of revenue they need regardless of market conditions. Therefore, both values and tax rates can move up or down.

The value of property is entirely dependent on market conditions.  The appraisal district is required by law to value all property at market value on January 1 of the tax year.  Markets can move either up or down.

Property tax rates, unlike other types of tax rates, are not set in stone.  Property tax rates are intended to float up or down each year, usually in the opposite direction of market values.

Let’s go through a simple example of a local government that needs $50,000 to fund its budget for this year.  Let’s say the value of property is $500,000 after dividing by $100. (If the market value of all property this year is $50,000,000, then $50,000,000 ¸ $100 = $500,000.)

The local government then sets the tax rate at $0.10 to generate the $50,000 needed to fund the budget:

$50,000 = $500,000 x $0.10

Let’s look at the following year. The local government decides to maintain the same $50,000 budget as the previous year, which requires it to collect, again, $50,000 of property tax revenue from property owners. However, the market has heated up since the prior year, and property values have increased to $550,000 (after dividing by $100). The local government can adopt a lower tax rate than the previous year in order to raise $50,000. A tax rate of roughly $0.09 (or, more precisely, $0.090909 ) will raise the same $50,000 of revenue as the previous year:

$50,000  =  $550,000  x  $0.090909

Even with the higher value of $550,000, the lower tax rate of $0.090909 means that everyone pays roughly the same amount of property tax as the previous year.

If, instead of heating up, the market has cooled and values have fallen to $450,000, the local government can adopt a higher tax rate than the previous year in order to raise $50,000. A tax rate of roughly $0.11 (or, more precisely, $0.111111) will raise the same $50,000 of revenue as the previous year:

$50,000  = $ 450,000  x  $0.111111

Again, even with the lower value of $450,000, the higher tax rate of $ 0.111111 means that everyone pays roughly the same amount of property tax as the previous year.

In summary, whether values go up or down, a local government is free to adjust its tax rate to raise the revenue necessary to fund its budget.