Author: Financial Management Resource Bureau
The DLS Financial Management Resource Bureau (formerly the Technical Assistance Bureau) has offered financial management advice to municipalities across the state for over 30 years. To share this guidance more broadly, we thought it would be helpful to highlight some of our more useful, timely, or interesting recommendations for the benefit of City & Town readers.
For effective financial planning and budgeting, it’s vital to understand your community’s primary and most dependable revenue source, the property tax. The Financial Management Resource Bureau (FMRB) has developed an Excel-based Financial Indicators tool to help communities monitor their financial condition. In this article, we’ll review the Financial Indicator Tool’s Levy Limit Analysis metric, which illustrates the historical trend of a community’s tax base.
Annual growth in the property tax is limited by Proposition 2½ to a 2.5% increase over the prior year’s levy limit, increases stemming from new construction added to the tax rolls, and any voter-approved overrides or exclusions. As long as property value trends are favorable, the property tax levy should grow sustainably year-over-year. We’ll be referencing the levy limit, levy ceiling, override, override capacity, and maximum allowable levy in this article. A primer on the specifics of Proposition 2½ can be found on the Municipal Finance Training and Resource Center.
The levy ceiling (an amount equal to 2.5% of the community's total assessed value) is a limit to the size of a city or town’s maximum allowable levy. Although a community can pass an override or a temporary debt exclusion to exceed its levy limit, only the debt exclusion can exceed the levy ceiling. Except for the amount of the debt exclusion, if the levy limit calculation produces a number greater than the levy ceiling, the ceiling must be used in its place. If a community cannot increase its levy limit normally, it is said to have reached the "levy cap."
Using publicly available data from the Municipal Databank and the Municipal Finance Trend Dashboard, it’s possible to calculate a community’s levy limit, maximum allowable levy, and override capacity (the difference between the levy limit and the levy ceiling). This data can be used to determine override capacity as a percentage of the levy ceiling. Let’s look at “Community A” as an example.
In this example, the community’s override capacity as a percentage of the levy ceiling can be used as an indicator for how much room the tax levy can grow under proposition 2½, including its capacity to pass overrides if the need arises. A steady increase is optimal, while a steady decrease indicates significant revenue constraints. This principle is more apparent in the chart below.
For our example, the levy limit is equal to the maximum allowable levy, which is the case when there are no exclusions or other adjustment permitted in excess of the limit. Note how much override capacity separates the levy limit and maximum levy from the levy ceiling, showing that this community is far from the levy cap. This equates to increased potential revenue through an override in the near term and through annual tax rate increases in the long term. Furthermore, while operating under the levy cap this community can take full advantage of revenue growth from the annual 2.5% increase and new growth. Once the cap is hit, the municipality is forced to “leave money on the table” and set their levy limit equal to the levy ceiling.
When a community hits the levy cap and its levy ceiling is in decline, it becomes progressively more difficult to raise funds from the property tax. This environment also severely hampers a community's ability to expand services or finance large capital projects through an override, since the levy ceiling is directly tied to a town's override capacity (the difference between the levy limit and the levy ceiling). You can see this happening in the following graphical representation of Community B hitting the levy cap.
From Years 7 through 10, the levy limit calculation resulted in a larger tax levy than the levy ceiling allowed (red line), so the ceiling was used to calculate the subsequent year’s levy limit. Each year, this resulted in vast dollars of unrealized potential revenue and zero override capacity. The trend in override capacity as a percentage of the levy ceiling followed the levy limit’s progress toward this situation, bottoming out in Year 7 when the community finally hit the levy cap.
Distance from the levy cap is linked directly to assessed property values, since it is a function of the levy ceiling (2.5% of total assessed value). This how the Levy Limit Analysis tracks whether the community’s tax base is eroding. High property values lead to a comfortably high levy ceiling and more latitude when setting the tax rate. Low values require an ever-increasing tax rate to ensure the same revenue but are limited to $25 per $1,000 of assessed value (or 2.5%).
In Community B, assessed values for the same time period declined steadily, precipitating it hitting the levy cap. The loss of assessed value drives the drop in the levy ceiling until it dips below what would otherwise be the levy limit and replaces it, severely constraining annual growth.
Tracking override capacity as a percentage of the levy ceiling (and considering the underlying data) can provide an early warning that the tax base is in decline and that hitting the levy cap is on the horizon. While it will not provide solutions per se, a declining trend can raise the alarm for budget planners and policymakers. This may be in the form of bolstering the city or town’s reserves, but in this case may mean that the community should redouble its efforts in encouraging economic development or identifying and tackling the factors behind declining property values. Updating the Financial Indicators Analysis annually will allow a community to keep track of these and other potential warning signs and create a plan of action to deal with them.
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| Date published: | October 20, 2022 |
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