L'ASSOCIATION QUÉBÉCOISE DE DROIT COMPARÉ
Municipal Taxation of Business in Ontario
Enid Slack Consulting Inc.
214 King Street West, Suite 214
le 20 avril 2001
Hôtel Marriott Château Champlain, Montréal
1. Property Tax Treatment of Business
It is common for the property tax to favour residential properties over commercial and industrial properties. This favouritism occurs in three ways:
At the same time, this differential treatment does not necessarily reflect the differential use of services by different property types. Results from a Vancouver study of relative consumption patterns between residential and non-residential properties indicated that residential properties pay 40 percent of the property taxes and consume 71 percent of the services; non-residential properties pay 60 percent of the property taxes and consume only 29 percent of the services(2). Kitchen and Slack reviewed property taxes and municipal expenditures in eight Ontario municipalities in 1990 and concluded that non-residential property taxes ranged from 28 to 51 percent of total local property taxes but accounted for only 31 to 40 percent of municipal expenditures(3).
One of the justifications for the higher taxation of business properties is that businesses can write off property taxes against income for income tax purposes whereas residential property owners in Canada cannot. It is not clear, however, that the lower income taxes compensate sufficiently for the higher property tax rates.
Table 1: Estimated Tax Ratios for Selected Canadian Cities
|City||Ratio of Non-Residential Tax Rates to Residential Tax Rate|
Commercial - 4.28
Non-residential - 3.00
Major industry - 10.2
Light industry - 4.99
Business - 4.97
Utilities - 10.0
Commercial/industrial - 1.85
Commercial/industrial - 1.44
Non-residential (urban) - 2.53
Source: Information collected from each city.
2. Impact of Non-Residential Property Taxes on Location
For any business, non-residential property taxes represent a cost. If these taxes are related directly to the cost of municipally provided services, they represent a cost of doing business and are similar to other input costs such as wages and salaries. On the other hand, if they are unrelated to the cost of municipal services, they represent a fixed charge that has to be paid - fixed in the sense that they are unrelated to the consumption of public services or income earned. The current property tax treatment of the non-residential sector in Canada suggests that this sector is over-taxed when compared to the services it receives(4).
The non-residential property tax may impact on location decisions. Since businesses generally locate where they can maximize profits, the provision of fiscal inducements such as lower property taxes can influence its location decision in the same way as the reduction in other production costs may play a role. The impact of property tax differentials depends on a number of factors including the size of the differential between competing municipalities and whether this differential is sufficient to offset differentials in other costs or market factors.
Although it is generally agreed that the cost of doing business is an important factor in location decisions, there is less consensus on the role played by property taxes in this decision. The evidence, most of which is drawn from the U.S., suggests that property tax differentials are relatively unimportant in inter-municipal or inter-regional location decisions but do play an important role in intra-municipal or intra-regional location decisions(5). In other words, property tax differentials are unlikely to play a significant role in a firm's decision as to whether to locate in Vancouver, Montreal, Toronto, Boston, or New York. The reason is that other factors are more important in their location decision - access to skilled labour, access to transportation and communication networks, quality of life, income taxes, and other factors. On the other hand, once a business decides to locate in a particular region, property tax differentials do play a role. Where access to skilled labour and transportation and the quality of life are similar, for example, but property taxes differ, property are more likely to affect location decisions.
3.Recent Reform of Property Taxes in Ontario
In January 1998, a uniform assessment system based on "current value" (or market value) was implemented province-wide in Ontario. Every property was assessed as of the same valuation date of June 30, 1996. The next reassessment was done for 2001; after 2005, annual updates will be done using a 3-year rolling average.
The change to a uniform province-wide assessment system by itself would have resulted in large shifts in tax burdens within and between classes of property. For this reason, it was necessary to introduce tax policy changes at the same time. Indeed, the provincial government introduced four pieces of legislation in all.
Prior to the reform, municipalities were required by legislation to levy differential tax rates on residential and non-residential property. Specifically, the residential rate had to be 85 percent of the non-residential rate. Following the assessment reform, municipalities are allowed to levy variable tax rates for different classes of property(6):
As well, optional classes which municipalities can choose include:
Variable tax rates permit municipalities to shift tax burdens among property classes within provincially-determined ranges of fairness. Transition ratios were calculated for each property class to reflect the relative distribution of burden by tax class prior to reform (the "starting point"). Transition ratios were calculated as the effective tax rate (property taxes relative to market value assessment) for each property class relative to the residential class. The transition ratio for residential properties -- the benchmark -- was set equal to 1.00.
Ranges of fairness were set by the provincial government as follows:
1.0 - 1.1
0.6 - 1.1
0.6 - 1.1
0.6 - 0.7
1.0 - 1.1
Municipalities could set their tax ratios so as to maintain the transition ratios, move towards the range of fairness, or vary tax ratios within ranges of fairness. For example, if the transition ratio on multi-residential properties was 4.1, a municipality could reduce it to 4.0 or below, or it could maintain it at 4.1. It could not increase it to 4.2 or beyond. In short, municipalities are not allowed to worsen the inequities but they can maintain or reduce them.
Variable tax rates within ranges of fairness were used to allow municipalities to maintain the existing tax burdens between classes and reduce the impact of a reassessment. Should municipalities be allowed to use variable tax rates to perpetuate these discrepancies and perhaps even widen them? Municipal politicians generally feel that provincial ranges of fairness are inappropriate because the property tax is a local tax. Since municipal politicians are accountable to the electorate, they should be responsible for setting tax rates without provincial constraints. Municipal officials, however, feel that municipalities would never eliminate the discrepancies on their own (especially if it meant shifting tax burdens on to residential properties) and thus some form of provincial regulation is required. The compromise was to establish provincial ranges of fairness and require that municipalities not move further away from them.
In addition to variable tax rates, the Province legislated phase-in provisions and tax deferrals to address the shifts that would occur within classes of property, especially within the residential property class. Municipalities, at their option, can apply a phase-in for up to 8 years for assessment-related tax changes. Interclass subsidization is not permitted - tax decreases in the commercial class, for example, cannot be used to subsidize tax increases in the residential class. Different schemes can apply to different classes; different phase-in periods can be used for decreases and increases.
Municipalities are required to establish a program to mitigate assessment-related tax increases for residential properties owned by low-income seniors and the disabled. They can design their own mitigation programs.
The timing of phase-ins is controversial because there is always a conflict between moving to a fairer system as quickly as possible and lessening the impact on those whose taxes will increase. One could argue on the one hand that the existing inequities should not be allowed to continue; on the other hand, it may not be wise to create undue hardship by not phasing in tax increases.
Even with all of the tax policy reforms and phase-in mechanisms, however, there were still large shifts in tax burdens. In particular, the tax burden on small retail commercial properties increased relative to large office towers because of the recession in office markets in June 1996 (the valuation date). To reduce the shift onto small commercial properties, the provincial government introduced optional classes for office towers, shopping centres, and parking lots. Also, it introduced optional capping. Municipalities could limit tax increases on commercial, industrial, and multi-residential properties to 2.5 percent a year for 3 years (1998, 1999, 2000). This meant that the property tax could not increase more than 2.5 percent on any of these properties over what it was prior to reform. Furthermore, any tax increases over the 3-year period resulting from increased expenditures, for example, would have to be financed from the residential property class. This measure was designed to move some of the burden away from the non-residential property classes and on to the residential class.
Only Toronto chose the capping option initially. When it became clear that there were large tax increases on small commercial properties in other municipalities in Ontario, the provincial government introduced another piece of legislation which restricted property tax increases on commercial and industrial properties to 10 percent in 1998, an additional 5 percent in 1999 and an additional 5 percent in 2000. This legislation was not optional but municipalities could decide how to achieve the 10-5-5 target - through phase-ins, capping or some other method.
The result of capping was to freeze the assessment roll based on 1997. In other words, the new assessment roll was not used to tax multi-residential, commercial, or industrial properties. Capping also meant that there was no effort to remove or even reduce the inequities in property tax burdens within the commercial, industrial, and multi-residential property classes. Instead of capping the amount of the tax increase arising from a reassessment, the tax itself was capped.
For 2001 and beyond, further legislation was introduced to maintain the capping provisions. Some changes were made to improve the capping mechanism but the result is still to maintain the inequities in tax burden across property classes.
4.Lessons from Ontario's Property Tax Reform
Important lessons can be derived from the reform of property taxation in Ontario. These include the following:
More generally, the lesson from the Ontario experience is that, no matter how economically desirable the long run outcome of any policy change may be, its transitional effects may be sufficiently undesirable in political terms to kill it. From a public choice perspective, the losers from a change in policy tend to be very vocal (even if they are the minority) because they value their losses more than the gainers (even if they are the majority) value their gains. This problem is not unique to property taxes but it is particularly significant because of the visibility of this tax(7)
5.Shifting Tax Burdens in the City of Vancouver
The City of Vancouver provides an interesting case study of an attempt to shift slowly some of the tax burden from the commercial property class to the residential property class.
From 1983 to 1994, the Vancouver city council set tax rates in a way that maintained the tax burden between property classes at the levels which existed in 1983, allowing for adjustments to the burden from reclassification, new construction, or zoning changes. As a result of a 1995 study that indicated that non-residential properties used fewer services than residential properties in Vancouver but paid more in taxes, city council decided to shift property taxes from the non-residential property classes to the residential property class(8). Although council has not adopted a target for the tax distribution by property class, it has approved shifts in four of the last six years.
Starting in 1994, Council has decided each year whether to shift the tax burden among property classes, in light of other taxation issues facing the City. In 1994, the City altered the burden proportions slightly by shifting about 1 percent of total taxes from the business class (about $3 million) to the residential class. In 1995, it shifted an additional 1 percent (again, about $3 million) of the total tax burden from industrial, business, and utilities classes to the residential class. No shift was made in 1996 (a municipal election year). A shift of $2.9 million onto the residential class was made in 1997. For the year 2000, another 1 percent (or $3.69 million) was shifted onto the residential property class.
The tax share for the residential tax class went from 39.4 percent in 1990 to 45.8 percent in 2000. Over the same ten-year period, the share of the tax levy from the commercial class fell from 54.9 percent to 50.7 percent. The other property classes (utilities, light industrial, major industrial, recreational/seasonal, and farm) account for the remaining 4 to 6 percent of the tax levy.
The commercial tax ratio (commercial tax rate relative to the residential tax rate) in Vancouver has been affected not only by the policy to shift some of the commercial and industrial tax burden onto residential property but also by other municipal policies. These include, for example, three-year land averaging and capping of tax increases. For this reason, the commercial tax ratio has moved around a fair bit over the last ten years. It started at 4.1 in 1990, increased to 5.5 in 1995 and was back down to 5.0 in 2000.
The one percent tax shift towards residential property resulted in an increase in the residential tax rate from $2.924 per $1,000 of assessment to $2.995 per $1,000 of assessment or an increase of 2.4 percent(9)
. The tax rate on business properties fell by 1.7 percent from $15.143 per $1,000 of assessment to $14.883 per $1,000 of assessment.
1. Business properties include commercial and industrial properties.
2. KPMG, Study of Consumption of Tax-Supported City Services, Vancouver, 1995.
3. Kitchen, Harry and Enid Slack, Business Property Taxation, Kingston: Queen's University, School of Policy Studies, The Government and Competitiveness Project, 1993.
4. Kitchen, Harry and Enid Slack, Ibid
5. Kitchen and Slack, Ibid.
6. Sub-classes to which rate reductions apply are: vacant commercial (35 percent reduction), vacant industrial (30 percent reduction), farmland pending development, and certain theatres in the City of Toronto. Furthermore, the commercial class can be divided into three sub-classes according to value with graduated tax rates applied to each sub-class. The tax rate on farms and managed forests is legislated to be 25 percent of the residential tax rate.
7. The property tax is visible because, unlike the income tax, it is not withheld at source. This means that taxpayers tend to be much more aware of the property taxes that they pay. The property tax also finances services that are very visible such as garbage collection, snow removal, and neighbourhood parks, for example. This visibility makes local governments accountable for the taxes they levy but, at the same time, it makes the tax difficult to reform.
8. KPMG, Consumption of Tax Supported City Services, Vancouver, 1995.
9. City of Vancouver, Policy Report, Finance, April 25, 2000.