Oceans of tax revenue—from taxes on incomes, company profits, and real-estate transactions—poured into the city's treasury over the past half-decade, even as municipal spending grew annually. So much money was sloshing around that few noticed—and virtually nobody protested—the system's ever widening disparities. The heavy tax burden on the city's commercial sector and rental buildings increased even as the more favored tax treatment of homes—cooperative and condominium apartments as well as single-family homes—continued. But when the tide of record-breaking Wall Street profits and rapidly inflating real-estate values went out last year, it revealed a landscape littered with arbitrary and inequitable tax policies. Now, to raise the revenue to pay for running the city in this new era of austerity, the authorities find themselves returning to their old standby, property assessments and the varying tax treatments of a range of property types. Because property taxes are set to shoot up, it suddenly matters who is assigned to pay what—and why.

For decades, a broad consensus has accepted overtaxing commercial (and utility) property so that residential property owners can receive a break. This consensus has also supported undertaxing existing homes and overtaxing new residential construction. The disparities in tax treatment among property classes continue to widen—and not even as a result of any considered policy process, but rather a mixture of tradition, politics, and legal sophistry. The result is an ad hoc patchwork of bizarre assessment guidelines, exemptions, abatements, and rebates.

While the imbalances have existed for decades, they have actually worsened over the past twenty years—particularly since the city's economic recovery after 2002. These disparities have persisted despite a major effort by the Bloomberg administration to improve assessment practices—and its success in bringing about much greater equity among properties within tax classes.

CLASS STRUCTURE
New York City divides property into four "classes" for assessment purposes:

Class 1 one- to three-family structures, vacant land zoned for residential use, and small co-op and condominium apartment buildings
Class 2 residential rentals, co-ops, and condos
Class 3 utilities
Class 4 all commercial and manufacturing properties in the city, including the major office buildings in Manhattan and Brooklyn

Three factors determine the amount of tax imposed on a property: the assessment ratio (that is, the fraction of the assessed value on which taxes are to be paid) and the tax rate for the property's class, plus the market valuation of the property itself.

Taken alone, these tax rates would suggest that Class 1 property is most heavily burdened by taxation. However, an assessment ratio for Class 1 property that is more than 85% lower than that of the other classes almost guarantees that it is not.

Overall, rental properties subsidize homeowners, and the residents of the four other boroughs subsidize Manhattanites. Non-residential (Class 3 and Class 4) properties subsidize owner-occupied residential properties as well, with Class 3 yeoman Con Edison paying more in real estate taxes than any other property owner. And Class 4 tenants in Manhattan south of 96th Street get hit worst of all—subject as they are to New York's special commercial rent tax (a tax on the sum a rental building pays in real-estate taxes) in addition to the disproportionately high real-estate taxes passed along to them by their landlords. Although it is true that other cities also tax their commercial properties more heavily than they do their residential properties, the disparity is greatest in New York.

SHARE AND SHARE NOT ALIKE
The mayor and the City Council together set the tax rate, but it is New York City's tax collector, the Department of Finance, that determines the assessment ratios and valuation methods. The agency must tweak the variables to ensure that each class yields essentially the same share of the total levy that it did in 1981, when the state legislature adopted Chapter 1057 of the Laws of 1981, known more familiarly as S7000A. Thus, Classes 3 and 4 together, with approximately one-quarter of the market value of New York City property, account for half of the revenue from the tax. And Class 1, with more than half of the city's market value, accounts for approximately 15% of the take.

S7000A effectively legalized tax practices long in place but invalidated by the courts. In Hellerstein v. Assessor of Islip (1975), the New York State Court of Appeals upheld a 1788 state law that required all assessments to be based on the full market value of property. The court required the Town of Islip to implement its order no later than the last day of 1976. After years of additional court cases and debate, the legislature overrode Governor Hugh Carey's veto to enact S7000A. The new law explicitly repealed the 1788 requirement for full-value assessment and preserved the existing tax shares by class in New York City and Nassau County.

In addition, S7000A prohibited changes in assessments of Class 1 properties exceeding 6% in one year, or 20% over five years, although assessments due to physical improvement would not be subject to this cap. This rule has served to hold down Class 1's effective tax rate (the straightforward ratio of total property tax per $100 in market value) during years when the market values of small homes have increased rapidly throughout the five boroughs.

Shortly before the adoption of S7000A, major analyses by a New York University team led by Dick Netzer (Real Property Tax Policy for New York City, December 1980), and by the New York Public Interest Research Group (City of Unequal Neighbors, February 1981), had demonstrated that assessments and tax levies differed dramatically, not only among boroughs and neighborhoods, but also within neighborhoods and frequently along the same block.

In a study issued in 2006 to commemorate the twenty-fifth anniversary of S7000A, the city's Independent Budget Office (IBO) demonstrated that modernized assessment practices, computer-controlled valuations, and lowered assessment ratios had largely corrected the wide disparities within property classes, particularly for Class 1. The IBO concluded that the disproportion between the tax burden on rentals and the burden on co-ops was widening, however. It calculated that in 1997 the effective tax rate for rental buildings had been 1.8 times that of co-ops, but that by FY2007, rentals were paying an effective rate 5.5 times that of co-ops.

MARKET VALUE
The Department of Finance is legally required to estimate the value of every taxable property in the city every year. Phase-in periods for Classes 3 and 4 and caps on assessment increases for Class 1 serve to limit wild fluctuations in assessed values.

The total market value of the city's taxable property reached nearly $800 billion in FY2008, which ended last June—before the effects of the encroaching recession began to affect home sales in the five boroughs and Manhattan's office market. This value represents an 18% increase from the previous fiscal year. Half of the growth came from Class 1 properties, which increased by $60 billion in market value over the year, to $427 billion. In that last year of the real estate boom, all kinds of property appreciated in the city—but only the valuations of Class 1 properties are based on recent sales prices.

The law requires income-based techniques to be used for the other property classes. Traditionally, the finance department has multiplied net income by a capitalization rate (an estimated rate of return) to arrive at the amount of taxable income; more recently, the agency has been using a gross income multiplier (GIM), which is simpler to understand and implement, but, according to real-estate attorney Joel Marcus, less accurate, as it generates a theoretically derived value instead of reflecting the real value of the land and its improvements.

Whatever the particular technique, an income-based approach makes sense for income-producing commercial and residential properties. The amount of income that should be paid in taxes is, of course, a matter for debate. Owners of income-producing properties argue that 30% of gross income—corresponding to, on average, 42% of net income—is unreasonably high. The artificially low taxes on owner-occupied properties, including some of Manhattan's most valuable residences, compound the injury.

NEITHER FISH NOR FOWL
Then there are New York City's co-ops and condos. As Class 2 properties, they must, by state law, be valued by income rather than sales price. As owned residences, they do not generate an income stream. The result? For such buildings, the finance department has to estimate what the rent would be if the co-op or condo units were rentals.

The taxes on condos more closely approximate those of rental apartment buildings, particularly in Manhattan, largely because many condos have been built in recent years and are thus assessed against the market value of comparable rental buildings.

The situation with co-ops constructed before 1974, however, is truly aberrant, with New York City's Law Department instructing the finance department to select a rent-regulated building as the co-op or condo's assessment comparable, even if the co-op or condo building in question includes no rent-regulated units at all. Thus, some of the city’s most precious apartments—prewar gems on Park Avenue, Fifth Avenue, and Central Park West, for example—are given the market valuations of rent-controlled or rent-stabilized buildings in Manhattan and taxed accordingly. Toss in the co-op and condo tax abatement adopted as a temporary measure in 1997 (and renewed regularly since then, most recently in June 2008), and the taxes on such properties can end up being lower than the legendarily low Class 1.

The Law Department's requirement that rent-regulated apartment buildings serve as comparables for pre-1974 co-ops and condominiums is strange enough. But the selection of particular comparable buildings can be even stranger.

The finance department chooses comparables on the basis of characteristics such as location, local amenities, building age, size, and type of construction. It considers financial adjustments offered by government, such as rent regulation, subsidies, and exemptions, as well. In a triumph of transparency, the agency publishes its full list of comparables—a policy that seems to raise as many questions as it answers. Choosing famous buildings at random yields these oddities:

Officially, the buildings most comparable to 740 Park Avenue, a 36-unit 1930 cooperative apartment house that may be the most exclusive prewar building of its kind in New York City, are 1493 York Avenue (250 units, 1956) and 303 East 83rd Street (263 units, 1977).

Across the street from 740 Park Avenue is 737 Park Avenue, a 120-unit prewar (1940). It is the comparable for 775 Park Avenue (48 units, 1927), but not for 740, which is even nearer.

The comparables assigned to eighteen-unit 998 Fifth Avenue, across from the Metropolitan Museum since 1912, are 1450 Third Avenue (94 units, 1961) and 400 East 66th Street (129 units, 1999).

Central Park West’s Langham (64 units, completed 1906 at 73rd-74th Streets) serves as a comparable for 6 West 77th Street (102 units, 1928) and for one of its immediate neighbors, the Dakota (94 units, 1884)—but not for another, the San Remo (146 units, 1930).

Recent estimates by the Department of Finance indicate that income-based valuation for Manhattan co-ops generated approximately $135 million in tax revenue, instead of the $760 million that would be produced if sales prices were used. Residents of classic co-op buildings may benefit from valuations based on estimates of ghost incomes, but as a consequence, other property classes have to compensate for the revenue lost. At least the comparable for new condominium construction is new rental construction, which is less illogical, although here, too, the theory underlying these comparisons is flawed.

ADJUSTMENTS TO THE SYSTEM
Rather than take on the politics—and daunting administrative challenge—of addressing the fundamental structure of the property tax, elected officials have implemented a series of additional complexities in order to correct for various disparities.

By the early 1990s co-op and condo owners were paying an effective tax rate approximately twice that of Class 1 homeowners. The most obvious result of the efforts of the 1993 New York City Real Property Tax Reform Commission, appointed jointly by Mayor David Dinkins and City Council President Peter Vallone and chaired by former Finance Commissioner Stanley Grayson, was the 1997 adoption of a special tax abatement to correct for this anomaly. This co-op/condo abatement was supposed to last only until Albany came up with a longer-term, larger-scale solution. Instead, the legislature has renewed it whenever expiration loomed, most recently last summer. (The original abatement legislation required that the city report to Albany with a plan for more comprehensive changes to the co-op and condo assessment problem. The deadline was June 1999, but the report has never been produced—or demanded, for that matter.)

For eligible units with assessed values of at least $15,000, the abatement deducts 17.5% from the tax calculation. The abatement has reduced the effective tax rate for some co-ops and condos below even that of owners of single-family homes. The IBO's 2006 study showed that $156 million of the $293 million spent on the previous year's abatement went to apartment owners whose effective tax rate was already lower than that of the owners of single-family houses, mostly outside Manhattan—with co-op and condo owners on Manhattan's Upper East Side and Upper West Side claiming sizable chunks of the cash. In FY2009, this citywide abatement totaled $337 million.

Then there's the problem of new construction. In addition to all the extra costs and risks associated with putting up housing, New York's builders labored under the inequity of a tax law that favored existing properties over new buildings—even before 1981, the year of S7000A's adoption. With city construction at a virtual standstill, the state adopted Section 421a of the Real Property Tax Law in 1971 to encourage multi-family residential development. Property owners continued paying tax on the value of the land, but none on the improvement for two years. Following the two-year exemption, the tax phased in over the following eight. Simple as 421a was in the beginning, however, its benefits have been nibbled away over time, with major changes made in 1985 and again in 2007. Now, 421a incentives vary by location and include requirements for provision of subsidized housing. Even with the new limitations, in FY2009 the citywide exemption totaled $607 million.

Well before the inequitable treatment of new construction had been addressed, landlords were given a financial incentive to make major capital improvements to their buildings. New Yorkers still call it the J-51 program, despite the fact that the part of the New York City Administrative Code authorizing it is now called Section 11-243. It is possible under the J-51 program to obtain not only an exemption from the taxes on the increase in assessed value resulting from significant renovation work, but also a tax abatement usually equal to 90% of the value of the cost of the work performed. In FY2009, the two J-51 programs together totaled $243 million.

STATE OF THE REAL PROPERTY TAX
The tax system favors residents over businesses and homeowners over renters. It prefers long-term residents to more recent arrivals, with rent regulation adding to the complexity and confusion. The City Council can reallocate the class shares of tax levy, which date back to 1981, but political considerations militate against even reconsidering, not to say revising, the ratios of tax liabilities among the different classes. The mayor and City Council together can change the property-tax rate on their own—which is not the case with all the other city taxes, whose rates and administration are controlled by Albany. Thus, in tough fiscal times, a mayor typically zeroes in on the property tax to obtain more revenue. Sure enough, in late 2008, the council and Mayor Michael Bloomberg moved the expiration date of a lowered tax rate from the start of July 2009 to the start of January 2009.

While the city can play with the rate, assessment, and valuation variables that determine the revenue yield, only Albany can recast the system's fundamental structure and overcome a history of periodic tinkering and temporary fixes, resulting in a mind-boggling patchwork of laws, rules, and administrative interpretations. In 1993, the Grayson Commission concluded that "New York City's multi-class property tax system is inordinately complex and is poorly understood by taxpayers. Inordinately complex taxes suffer inherently from the appearance of unfairness. Further, the property tax in New York City not only appears unfair, it is unfair."

Now, more than fifteen years since that study, and despite the city's efforts to remedy the inequalities, the property tax system remains unfair. And despite the strenuous efforts of the current finance commissioner, Martha Stark, to make the system more transparent, the average New Yorker surely finds it as mystifying as ever.

WHAT’S NEXT
In a case brought by tenants of Stuyvesant Town and Peter Cooper Village against landlord Tishman-Speyer, a state appellate court ruled in early March that a property owner who accepts J-51 tax benefits for capital improvements may not then seek, under the luxury-decontrol provisions of the rent-stabilization law, deregulation of the rents that can be charged for those units—whether or not the units are regulated for reasons besides J-51. A few weeks later the court gave judicial permission for Tishman-Speyer to appeal its ruling to the state’s highest court.

The J-51 case followed implementation of the 2007 restrictions on the 421a program for new construction. With incentives for improvements and new construction diminishing, landlords and developers are again alert to the significance of the property tax and its inequities.

Could an increase in property taxes, and thus, inevitably, rents finally wake renters up to the fact that at least 30% of their rent bill actually goes to the city? And that, unlike homeowners, they cannot deduct that cost from their federal income taxes? Former Finance Commissioner Carol O'Cleireacain suggests that information on the gross tax assessment of each rental building and on nearby buildings including co-ops and condos—information that is now publicly available on the agency's web site—should be posted in the rental building's lobby to make renters more aware of the taxes levied.

Meanwhile, the number of appeals to the Tax Commission brought by property owners who believe their assessments are too high has jumped 5.6%, a "substantial increase," according to Commission President Glenn Newman.

As the city's budget surpluses of recent years disappear and revenues from the various non-property taxes melt away, the pressure on the property sector for revenue will increase. The New York State Comptroller's recent review of the city's latest financial plan predicts that by 2013, property taxes will account for 43% of all city tax revenues, a substantial increase from the 33.7% of FY2008, and a return to its 1980s workhorse levels.