The benefit of switching to a set dollar exemption is taxpayers would receive a predictable and permanent form of relief that does not depend on the state’s fiscal situation.
A tax bill proposed in the 2023 Legislature would switch Iowa from a credit to an exemption as the form of property tax relief for homesteads — or residents’ primary housing. This policy brief provides background on the change, explaining the difference between the policies, describing Iowa’s experience with its homestead credit, and considering the impact the change will have on taxpayers.
Homestead programs are among the most common approaches to property tax relief. As of 2018, 33 states had homestead credits, exemptions, or both. The benefits are usually available for all owner-occupied primary residences, although some states expand their programs for seniors.
Businesses, renters, and owners of second homes are typically not eligible for homestead relief and, as a result, bear a larger share of the property tax burden. Although states’ programs vary, they all are structured around either fixed dollar amounts or specified percentages. The overall effect is to reduce property taxes and make them more progressive
Source: Lincoln Institute of Land Policy
Homestead exemption programs reduce property taxes by exempting a certain amount of a home’s value from taxation. A taxpayer’s reduction depends on the property’s assessment and the exemption amount, which reduces the portion of the real estate value that is subject to the local government’s tax rate.
Homestead credit programs, in contrast, reduce the homeowner’s tax bill directly. Qualifying taxpayers receive discounts on their bills or rebates equal to a percentage of the taxes due or a fixed amount. States sometimes reimburse local governments for the revenue lost through homestead programs, in whole or in part. Otherwise, the local government either absorbs the loss or shifts the tax burden to properties without the exemptions, such as business properties, which do not qualify as homesteads
Homestead exemptions reduce the value of a property for tax purposes, which then reduces the homeowner’s bill when the tax rate is applied. For example, providing a $35,000 exemption for a home valued at $250,000 with a 2% tax rate would reduce the tax bill from $5,000 (2% x $250,000) to $4,300 (2% x $215,000), for savings of $700.
Homestead credits simply reduce tax bills by a certain amount. A $500 credit, for example, reduces the tax bill by $500 regardless of the tax rate
Iowa’s Homestead Property Tax Credit was introduced in 1935 but was vetoed by Governor Herring, who reasoned that the income and sales taxes had been created to offset real estate taxes for all property owners, not only those paying on homesteads. The legislation reemerged in 1937, with successful passage and the signature of newly elected Governor Nelson Kraschel. Helping the 1937 version along was expanded eligibility to more homeowners than the original bill allowed.
In addition to providing property tax relief, the law’s backers intended it to encourage home ownership. Estimates found between one-third and one-half of the taxing districts had tax rates less than the credit itself and many were surprised by the large number of homeowners who were therefore credited the entire amount of their property tax bill. The state reimbursed local governments for these losses, leading opponents to complain the system was unfair, given the state had just enacted sales and income taxes four years prior, promising to reduce property taxes. Uneven benefits from the credit made the trade seem more like a tax shift, forcing state income and sales taxpayers to fund others’ relief from real estate property taxes.
Making matters worse, the legislation included no provision to control local governments’ expenditures. It only took city, county, and school taxing districts a few years to increase their spending enough to offset homeowners’ entire credit
The current homestead credit is equal to the levy on the first $4,850 of each homestead’s value, with a minimum annual credit of $62.50. The state reimburses local governments for a portion of the homestead credit, which amounted to 63% in 2021.
According to data from the Iowa Factbook, Iowa has annually spent between $86 million to $140 million since 1985 on the homestead tax credit. More recently, the State of Iowa has spent an average of $138.22 million per year on the homestead credit since 2017.
Source: Iowa Factbook, State Government General Fund Assistance to Local Governments
The state added elderly and disabled property tax credit and rent reimbursement provisions into the homestead tax credit law in 1974 to provide additional relief to lower-income people who are elderly or have disabilities. Legislators also intended to provide property tax relief to all low-income homeowners beginning in 1994 and low-income renters in the form of reimbursement payments beginning in 1995. However, money has never been appropriated to fund that portion of the law.
The current bill language slowly phases out the homestead credit while phasing in a homestead exemption, creating an overlap of both policies for a few years. The exact dollar impact to the taxpayer is unknown because it will vary as the phase-out and phase-in process is executed. Once fully implemented, the homestead exemption would reduce the assessed value of a taxpayer’s home for the purposes of taxation by $10,000. For example, if the county assessor says your home is worth $250,000, the new homestead exemption will reduce the value of your home to $240,000 before tax calculations begin.
As illustrated from the image above, one problem with utilizing the current credit to provide property tax relief is that it relies on the state’s budget and the funding whims of the General Assembly. In some years the state was able to spend more on the credit whereas in other years, like the Great Recession, the state was unable to spend what they had in the past. Ultimately, the credit must receive an appropriation (be funded) from the legislature each year or the taxpayer misses out on the intended savings.
One benefit of switching from a credit that depends on legislative action to a set dollar exemption is taxpayers would receive a predictable and permanent form of relief that does not depend on the state’s fiscal situation.