During the spring, 2006, Pennsylvania legislators passed a bill intended to provide significant local tax relief. Entitled "Act 1 of Special Session 2005-2006," the bill creates new opportunities for local taxpayers and school districts, including targeted tax relief to some groups of taxpayers, and the ability for voters to approve (or disapprove) major local school tax increases. Because Act 1 relies upon local action and voter approval, it is important that citizens learn about the act, what it does and does not do, and how they can influence its implementation in their own community.

Act 1 is intended to reduce the real property tax burden on homeowners and on farmers, and involves several important components:

1. Targeted real property tax reductions via the Homestead & Farmstead exclusions

2. Real property tax and rent rebates for low income seniors

3. Reimbursement to school districts who lose income tax revenues to Philadelphia

4. Wage tax reductions in Philadelphia

5. Voter approval for future large tax increases (called "Back End" referendum)

The tax reductions and reimbursements will be paid for with state gaming revenues, and in districts who choose to provide larger reductions, with higher local income taxes. It is important to note that Act 1 is a tax shift rather than an overall tax cut, since the targeted reductions are paid for by these two sources of new revenue.

Act 1 is very similar to the earlier Act 72 of 2004, but differs in a few significant ways. Unlike Act 72 (and other earlier major tax reform bills Act 50 of 1998 and Act 24 of 2001), all local school districts automatically are subject to Act 1's provisions, with no local choice about whether to participate. The three earlier local tax reform bills instead were voluntary, giving school districts an additional local tax option that the school board (and voters) could choose to adopt if they believed the change was the best option for their own school district. Act 1 instead mandates changes in how all Pennsylvania school districts operate, with little local option to opt out.

In addition, unlike the earlier tax reform acts, Act 1 provides school districts the option of shifting to a Personal Income Tax similar to that used by the Commonwealth. Some tax reform advocates believe this change would make local taxes fairer since it would include interest and investment income, instead of just earnings income.

One optional choice school districts do have under Act 1 is whether to increase their local income tax rate to provide even larger real property tax reductions than would be possible solely with state gaming monies. School districts are required to ask voters in the May, 2007, primary election whether they want to raise the income tax (or levy the personal income tax) for this purpose, but the outcome of the election solely affects the tax rate, and thus the size of the Homestead and Farmstead Exclusions that will be provided in each school district, not whether the district itself should participate in Act 1. School districts are still subject to Act 1's back end referendum and other provisions, whether or not voters approve the tax change in the May election.

Act 1 creates several opportunities for citizen participation in local school district decisions, so it is important that residents understand the Act and its implications. Act 1 is complex with many different components. This publication is written to help local taxpayers and residents understand the provisions of the Taxpayer Relief Act. By learning its potential impact on your school district and local taxes and how it can be carried out in your own community, you will be in a better position to make informed decisions about it.

Since Act 1 is a tax shift rather than an overall tax cut, the source of the funds it uses for tax reductions is important to understand. Some people will pay more so that others will pay less. Act 1 relies upon a combination of (1) state gaming revenues and (2) optionally higher local income taxes to pay for the targeted tax reductions it provides. Each source of new revenue will be explained in turn.

The Commonwealth will accumulate gaming revenues in a state Property Tax Relief Fund, from which it will make distributions to school districts. Distributions will not occur until the fund has reached at least $400 million. Act 1 says that disbursements from the fund must first go to reimburse school districts for foregone income tax revenues of residents who work in Philadelphia (who pay income tax to the city rather than their home community), and to cover all supplemental claims under the Senior Citizen Property Tax and Rent Rebate program. After these disbursements, remaining funds will then be distributed statewide to school districts for real property tax reductions (in Philadelphia, these real property tax reduction dollars instead must be used to reduce the wage tax).

Under the Sterling Act, people who work in the Philadelphia pay income tax to the city, and if they live outside the city, receive a "credit" for this payment on their local income tax. Some school districts and municipalities outside the city thus lose a lot of potential local income tax revenue. Act 1 uses state gaming revenues to reimburse school districts for this foregone revenue due to the Sterling Act, but the districts can only use these reimbursements for real property tax reductions through Homestead and Farmstead Exclusions. To receive the reimbursements, school districts must certify to the Department of Education by December 15 each year the amount of tax credits they are due.

Act 1 provides funds to supplement the Senior Citizen Tax and Rent Rebate program, which previously has been funded solely through state lottery revenues. The amount provided by state gaming revenues will vary depending upon the number of claimants in the program. (These rebates are discussed more fully in the "What Are the Tax Savings Under Act 1?" section of this publication).

If the amount of state money varies from year to year, districts are allowed to adjust the size of the Homestead and Farmstead Exclusions to compensate. If the amount of money they receive from the state and from their new local income tax exceeds the maximum allowable size of Homestead and Farmstead exclusions, they must use the "surplus" funds to either (1) reduce their local income tax rate or (2) lower their real property tax rate. There are clearly different implications of these two choices under Act 1:

A school district with surplus tax relief funds and who is already providing the maximum possible Homestead and Farmstead Exclusions, can choose to reduce their earned income or personal income tax rate sufficient to eliminate the surplus. Such an action would return the tax dollars back to the residents who helped pay for the surplus, essentially saying "we raised our local income tax rate too much."

A school district who reduces its local income tax rate because it has such a surplus, may in a later year raise its income tax rate back to its original level without voter approval if the district no longer has sufficient money to fully fund Homestead and Farmstead exclusions. Such a shortfall could occur if state funds fall one year, local income tax collections fall (such as may occur if a major employer closes), or if the number of homestead and farmstead properties increases significantly. The school district thus retains flexibility under this option to adjust the income tax rate to continue to fully fund Homestead and Farmstead Exclusions.

Alternatively, a school district with surplus tax relief funds can keep their local income tax rate the same and instead reduce the real property tax rate for all properties in the school district. Unlike if it reduces the local income tax, if in a later year a school district no longer has sufficient money to fully fund Homestead and Farmstead Exclusions, the district cannot return the real property tax rate back to its original level without voter approval. This is very different than the flexibility they have if they instead adjust their local income tax rate.

There also are very clear differences between these two approaches in who receives tax reductions, and how much tax savings individual taxpayers receive. Reducing the real property tax rate gives a tax break to every property owner in the school district, including local businesses, non-resident property owners, industrial properties, and camps. In addition, the dollar tax break for each individual property owner will vary directly by the value of their property; properties that are worth more will receive larger dollar tax breaks than properties that are worth less. The large ‘Big Box’ retail store, for example, will receive a significantly larger tax break than will a typical homeowner or small business, because the assessed value of the store is much more than the value of a typical home or small business. Expensive homes similarly will get larger dollar tax breaks than will low income housing.

Such tax reductions from a lower real property tax rate would be paid for, in part, through the higher income taxes paid by residents. Indeed, statewide about 26 percent of such tax reductions would go directly to businesses. Concern about the fairness of such tax breaks is one major reason the General Assembly chose to rely upon the Homestead and Farmstead Exclusions for most of Act 1's reductions, since the exclusions target tax reductions directly to homeowners.

Each individual school district (other than Philadelphia) has the opportunity under Act 1 to increase their earned income tax rate to pay for larger real property tax reductions. If a school district increases their local income tax under Act 1, all new revenues they generate from the higher tax rate must be used for real property tax reductions through the Homestead and Farmstead Exclusions (in later years after adoption of the higher local tax rate, the school district must devote the same amount of income tax money to these tax breaks, but they may use any natural growth in this tax for other purposes).

School districts have the option of instead levying a Personal Income Tax for the same purposes. If they choose to levy it, the Personal Income Tax replaces their existing earned income tax, so the tax rate must be adjusted to be revenue neutral, not providing a windfall to the district. As with the earned income tax, all new revenues from the tax must be used solely for real property tax reductions. The choice of whether to use an earned income or personal income tax under Act 1 has important implications for tax fairness, and should be carefully considered.

Each school district was required to create a Local Tax Study Commission during the fall, 2006, to analyze the district’s local tax situation, and to make a recommendation about which local income tax to use and what tax rate to levy for the purpose of real property tax reductions through Homestead and Farmstead Exclusions. Their recommendation is non-binding on the school board, who can choose another option but must make a decision by March 13, 2007. Voters within the school district have final approval on the proposed tax and tax rate increase during the 2007 primary election (on May 15).

Importantly, Act 1 states that any credits taxpayers receive for income taxes paid to other states do not apply to local income tax increases for real property tax reductions. Under previous law, taxpayers who live in Pennsylvania but work in several other states, such as New York and New Jersey, could receive a credit for the income tax they pay to those other states. Since tax rates in New Jersey and New York tend to be higher than in Pennsylvania, this essentially meant that those taxpayers paid little or nothing in local income tax to their home school district or municipality. These credits have been a concern with previous local tax reform bills in Pennsylvania, since they meant that any increased income tax burden would only fall upon taxpayers who work in Pennsylvania, and that Pennsylvania taxpayers working outside the state wouldn’t be paying their share of such an increase. Act 1 explicitly says that such income tax credits do not apply to any local income tax increases intended for real property tax reductions, so all Pennsylvania taxpayers will be equally subject to local income tax increases intended for reducing real property taxes, irregardless of where they work.

School districts are required by Act 1 to propose a local earned income tax rate increase for real property tax reductions sufficient to provide Homestead and Farmstead Exclusions of 25 percent or more, with the exception that Act 1 does not require them to propose greater than a 1 percent earned income tax rate (but they may voluntarily propose such a higher rate if they choose). In addition, the proposed rate cannot be more than the amount necessary to fund exclusions of 50 percent, which is the constitutionally set maximum allowable for Homestead and Farmstead Exclusions.

In 2009 or later years, a school district can increase their local income tax rate or change to relying upon the personal income tax rate, provided that the proposed rate does not exceed Homestead and Farmstead Exclusions of 50 percent. As with the proposed increase in 2007, all new such revenues must be used solely for Homestead and Farmstead Exclusions, and the increase or change must be approved by voters through referendum.

Some people believe the personal income tax is fairer than the earned income tax because it doesn’t discriminate on the basis of income sources. The earned income tax applies only to earned sources of income, and ignores investment income. It thus can have a bigger impact on working-age people with little investment income, than on higher income residents with broader sources of income. Higher income residents who make most of their money through investment income can end up paying little or nothing in earned income tax, simply because their sources of income are not subject to the tax. Increasing the earned income tax rate to pay for real property tax breaks means that low- and middle-income households could end up paying for tax breaks received by some of their wealthier neighbors. This concern was raised under Act 50 by local officials and residents in several parts of Pennsylvania where large numbers of wealthy retirees have moved in from out of state.

Statewide, income subject to the earned income tax (compensation and net profits) accounted for about 90.9 percent of the income subject to the personal income tax in 2002. This varied between school districts, ranging from a low of 70.8 percent (in the Ligonier Valley school district in Westmoreland County) to a high of 97.8 percent (in the Chester Upland school district in Delaware County).

Shifting from the earned income tax to the personal income tax would bring additional tax savings for the many low- and middle-income taxpayers who have little interest or dividend income; some people would argue that this makes the local income tax a more complete reflection of a taxpayer’s ability to pay. Statewide, the average reduction in the local income tax rate with this change would be 9.1 percent, but the reduction would vary tremendously across school districts: from 29.2 percent in the Ligonier Valley school district to only 2.2 percent in the Chester Upland school district.

Act 1 redefines the Senior Citizens Property Tax and Rent Rebate Assistance Act, which was initially passed in 1971 and provides real property tax rebates to low income seniors. That original act had relied upon lottery funds to pay for rebates, and Act 1 supplements this with state gaming dollars.

As with the earlier act, the Senior Citizens Property Tax and Rent Rebate Assistance component of Act 1 provides real property tax rebates for both homeowners and for renters, explicitly recognizing that renters indirectly pay the real property tax through their rent payments; landlords base the rent, in part, upon the local property tax, and thus tend to pass on the tax to their renters (this is consistent with how the program has operated prior to Act 1).

To be eligible for a property tax or rent rebate in lieu of property taxes, a claimant must be either:

In addition, claimants must meet the household income requirements. For this purpose, the Act defines household income as all income received by the claimant and their spouse, including wages, pensions, Social Security, capital gains, interest, and interest from tax-free municipal bonds. People receiving public assistance from the Department of Public Welfare are ineligible to receive the rent rebate during the months they receive such public assistance. Only one claim per household shall be granted; if more than one claim is filed and the household members cannot decide which should be paid, the Department of Revenue shall make the decision.

The size of the real property tax rebates under Act 1 vary, depending upon the household income of the claimants. Lower income households are eligible to receive a larger rebate than do somewhat higher income households (see Table 1), but in no case can the rebates exceed the amount of real property taxes a claimant actually paid.

The size of the supplemental rebate for homeowners similarly depends upon household income, but eligibility for it varies depending upon where the claimant lives (see Table 2). Claimants in Philadelphia, Pittsburgh, and Scranton can receive the supplement if their household income is $30,000 or less. Claimants in other Pennsylvania communities must meet the same household income requirement, but in addition, their real property taxes must exceed 15 percent of their household income.

How Large are the Rent Rebates?

The size of the rent rebates similarly vary by income (see Table 3). Rent rebates cannot exceed 20 percent of the gross rent paid by a claimant. Act 1 provides no supplemental rebates for renters.

Act 1 uses Homestead and Farmstead Exclusions, authorized under the Pennsylvania Constitution and Act 50 of 1998, to target its real property tax reductions to homeowners and farmers. The targeted aspect of the tax reductions is intentional; the tax reductions under Act 1 will be paid for by residents through higher income taxes and by gamers through slot machines. If these tax savings were given by simply lowering millage rates, businesses statewide would get about 26 percent of the tax savings since they currently pay about 26 percent of all real property tax dollars in the Commonwealth. Many legislators felt this would be unfair since local businesses would get tax savings paid for by residents and gamers, and they did not want to be accused of raising residents’ taxes to give tax breaks to local businesses.

The homestead exclusion targets tax relief to homeowners whose permanent residence is in the school district by reducing the assessed value of their homestead (home), which thus reduces their property tax. The homestead exclusion provides the same dollar tax reduction (such as $300) for all eligible properties in the taxing jurisdiction, including houses on farms, condominiums, single family homes, and other places of permanent residence owned by the occupant.

A homestead property is a dwelling primarily used by an owner as a permanent home. The owner may be living temporarily at another location, but he or she must have the intention of returning to that home. No one can have more than one permanent home at any one time. Homestead properties do not include rental units, vacation homes, camps, or other homes in which the owner does not live on a permanent basis. In general, it is the address where you have registered to vote and have registered your driver’s license.

The homestead property includes the land under the dwelling, as long as it is owned by the same person who owns the dwelling. The formal definition is the same as is used for determining residence status for the earned income tax.

The farmstead exclusion is a similar method of targeting real property tax relief to farmers. It allows real property tax relief for farmers on the taxes they pay on farm buildings (other than the farm house, which receives tax breaks through the homestead exclusion), so long as at least one farm owner lives on that farm. This is in addition to other existing real property tax relief programs aimed at farms, such as "Clean and Green," which reduce the assessed value of farmland. It is important to note that eligible farmers will receive both a homestead exclusion and a farmstead exclusion on their farm, the homestead on their house and the farmstead on the rest of their farm buildings.

A farmstead property is all buildings and structures on a farm of ten contiguous acres or more in size that are used primarily for agricultural purposes (such as housing animals or storing supplies, production, or machinery). The farmstead must be the permanent residence of at least one owner, as defined under the homestead definition. The farmstead exclusion would be applied to buildings and structures that are not already exempt from real property taxation under other laws. The requirement that an owner live on the farm means that farms owned and operated by absentee owners are not eligible for the farmstead exclusion.

The amount of real property tax owed by any taxpayer is the tax rate (measured in mills) multiplied by the assessed value of his or her property (see Example 1). If the assessed value of the property is made smaller, the amount of the tax owed will be smaller. With a homestead exclusion of $20,000, the taxpayer in Example 1, for example, would only owe $600 in taxes (see Example 2).

Example 1: A taxpayer in Sample School District with a property assessed at $50,000 will owe $1,000 in property tax if the tax rate is 20 mills (2 percent).

Assessed value X tax rate = tax owed

or

$50,000 X 20 mills (2 percent) = tax owed

or

$50,000 X 20 mills (2 percent) = $1,000

Example 2: The same taxpayer in Sample School District receives a $20,000 homestead exclusion on his or her property and now owes only $600 in property tax. The homestead exclusion gives the taxpayer a $400 tax savings.

(Assessed value – homestead exclusion) X tax rate = tax owed

or

($50,000 – $20,000) X 20 mills (2 percent) = tax owed

or

$30,000 X 20 mills (2 percent) = $600

 

School districts are required under Act 1 to propose a local income tax increase sufficient to provide Homestead and Farmstead Exclusions of at least 25 percent of the median homestead value (which means an average 25 percent tax reduction in real property taxes). These new local revenues will be supplemented by state gaming revenues to provide Homestead and Farmstead Exclusions of up to 50 percent (an average 50 percent tax reduction), which is the maximum allowable exclusion under Pennsylvania’s constitution.

The size of the Homestead and Farmstead Exclusions will vary across school districts due to differences in the state allocation, the income tax rate proposed (and approved) in each district’s referendum, and differences in the value of homestead and farmstead properties. In school districts where properties in general are worth a lot, the dollar value of their homestead exclusions can be high because the median value of homestead properties likely also will be high. If the median value of homestead properties is $60,000, for example, the maximum exclusion for all eligible properties will be $30,000 (one-half the median value of $60,000); in contrast, if the median value is $80,000, the homestead exclusion in the jurisdiction will be a maximum of $40,000 (one-half the median value of $80,000). A larger median value in the jurisdiction means that larger homestead and farmstead exclusions are possible in that jurisdiction.

School districts that implement Homestead and Farmstead Exclusions must itemize these on tax bills sent to homestead and farmstead property owners. In addition, they must include a statement that at a minimum takes the following form:

Notice of Property Tax Relief

The City of Philadelphia must use the state gaming funds it receives to reduce the city’s wage tax on residents and non-residents, not to reduce its real property tax. All money it receives from the fund must be used for such wage tax reductions. Act 1 also mandates an additional wage tax reduction schedule the City must follow for 2005 through 2009. The property tax reduction allocation for Philadelphia will be paid directly to the City, which will then transfer the funds to the school district.

Act 1 includes a "back-end" referendum to give local voters greater voice in future tax increases and to help prevent real property tax bills from creeping back to their previous levels. Under Act 1, if a school district wants to increase its tax rates by greater than inflation, it must get voter approval through a local tax referendum during the spring primary election. If voters approve the extra-inflationary increase, the tax rates increase as requested. If voters disapprove of the proposed increase, the tax rate increase is not allowed and the school district is allowed to take an increase of up to the inflation index. The inflation increase for the referendum is an index averaging the percentage increase in the statewide average weekly wage (typically called the SAWW and calculated annually by the Pennsylvania Department of Labor and Industry), and the percentage increase in the Employment Cost Index for Elementary and Secondary Schools (calculated annually by the Bureau of Labor Statistics in the U.S. Department of Labor).

Act 1 specifies ten exceptions that allow a school district to raise tax rates by more than the index. Three must be approved by the Court of Common Pleas in the judicial district in which the school district’s administrative office is located, and seven must be approved by the Department of Education. Districts planning to use one of the exceptions must follow a strict protocol for approval and must provide clear and convincing evidence that it qualifies for each exception sought.

The specific exceptions that must be approved by the court include:

1. Costs incurred in responding to or recovering from an emergency or disaster;

2. Costs of implementing a court order or administrative order from a federal or state agency as long as the tax increase is rescinded after fulfillment of the court or administrative order;

3. Costs of responding to conditions posing an immediate threat of serious physical harm or injury to students, staff, or residents, but only until the conditions causing the threat have been fully resolved.

A school district seeking an exception via court action must give public notice in a newspaper (and Web site, if it has one) that it is seeking approval for an exception at least one week before formally filing the petition with the local court. When the school district receives information from the court that a hearing has been scheduled, it needs to publish notice of this in a newspaper (and on a Web site, if it has one), and include the date, time, and place of the hearing.

The court is supposed to rule on the school district’s petition at least 55 days prior to the election, which thus allows the district to request a referendum vote if its petition is rejected. Any person residing within or paying real property taxes to a school district petitioning the court for an exception has the right to file with the court written objections to that petition.

Exceptions decided by the Department of Education include:

1. Costs associated with several debt repayment and construction issues, including paying interest and principal on indebtedness incurred prior to the effective date of the act, on voter-approved debt, and under several conditions on indebtedness for school construction projects (up to 60 percent of the construction cost average on a square foot basis).

2. Costs incurred in special education programs and services to students with disabilities, if the annual increase in expenditures on special education programs and services was greater than the index. The dollar amount of the exception must only be equal to the amount of the increase that exceeds the index.

3. Costs that were incurred to implement a school improvement plan required under the Elementary and Secondary Education Act of 1965 and that were not offset by a state allocation.

4. Costs necessary to maintain:

(a) per-student local tax revenue, adjusted by the index, if the percentage growth in average daily membership between the school year and the third school year preceding that year exceeds 7.5 percent; or

(b) actual instruction expense per average daily membership, adjusted by the index, if the increase between the school year and the preceding school year is less than the index.

5. Maintaining revenues from the real property, earned income, personal income, basic education funding allocations, and special education funding allocations, adjusted by the index, when the percentage increase in these revenues has been less than the index.

6. Costs for health-care-related benefits that are directly attributable to a collective bargaining agreement in effect on January 1, 2006, if the anticipated increase in costs is greater than the index. This exception does not apply to collective bargaining agreements renewed, extended, or created after January 1, 2006.

7. Costs for the school district’s share of payments to the Public School Employees’ Retirement System, if the dollar increase between the current year and the upcoming year is greater than the index. The dollar amount of the exception must be equal only to the amount of the increase that exceeds the index.

A school district seeking an exception via Department of Education approval must give public notice in a newspaper (and on its Web site, if it has one) that it is seeking approval for an exception at least one week before formally submitting its request to the department. If the department schedules a hearing on the request, the district must immediately publish notice of this in a newspaper (and on its Web site, if it has one), and include the date, time, and place of the hearing.

When making its decision, the department must use data collected under the public school code, which may not necessarily be the prior year (since it takes time to collect and collate this information) and must inform school districts of the years it will use in this determination. The department must make a decision on the exception request at least 55 days prior to the election, and if the request is denied, the district is allowed to request a referendum vote.

Through Act 1, school districts must get voter approval if they want to start levying a tax they were not using in the 2005-2006 fiscal year. If a district was not levying a Per Capita Tax in 2005-2006, for example, they can only start using that tax in a future year with the explicit approval of voters via referendum.

The overall impact of Act 1 on local taxpayers is difficult to predict since it depends so much on the local income tax a specific school district uses (earned income versus personal income) and its tax rate, the amount of money available at the state level for distribution through the property tax relief fund, and on the state formula used for distributing these funds. It also depends on the income sources of individual taxpayers and whether they live in a homestead or farmstead property.

All taxpayers should benefit from the back-end referendum since it gives them a formal voice in approving future tax rate increases that exceed inflation (as defined by the state index). How Pennsylvania voters will respond to this new great responsibility is unclear since they have never had this opportunity previously. Will many automatically vote "no" on increases or will they carefully weigh each referendum request carefully and thoughtfully before making their decision? Will they vote "no" on unreasonable requests and "yes" when the school district and students truly need a large tax rate increase?

Low income seniors will be the immediate beneficiaries of Act 1 through the supplements to the Senior Citizens Property Tax and Rent Rebate, since this program receives precedent for state funds. Eligible home-owning seniors will receive larger rebates paid for with gaming revenues.

The impact of the voter-approved higher income taxes on seniors is less clear. Seniors will be subject to the higher earned or personal income tax rate, so they may end up paying more, depending upon their sources of income. The earned income tax is levied against salaries, wages, and other sources of earned income, which tend to be a very small part of the typical senior’s income. If the new local tax is a personal income tax, higher income seniors with investment and interest income will begin having to pay local income tax on these. Neither local tax is levied on social security income. Seniors who own their own home generally will be eligible to receive the Homestead Exclusion, so they should see their real property taxes decrease.

Homeowners and farmers in the Philadelphia suburbs will be immediate beneficiaries of Act 1 since their school districts will receive credits for the income tax the districts lose due to the Sterling Act. The school districts must use such credits solely for real property tax reductions through Homestead and Farmstead Exclusions, funding tax breaks for these homeowners and farmers. These credits receive precedent for state funds.

Act 1 should also benefit permanent residents owning their home or farm in other school districts across Pennsylvania. All owners of homesteads and farmsteads in a school district will receive the same dollar tax savings, but this will make a bigger difference for owners of lower-valued properties than for owners of higher-valued properties. The percentage reduction in your real property tax bill will be influenced by how the value of your own property compares to the median value of homesteads (see table). If your property is worth less than the median value of homestead properties in your community, you may experience a larger percentage reduction in property taxes. Conversely, if your property is worth more than the median homestead, you may experience a smaller percentage decrease in your real property taxes.

In the example shown in Figure 1, notice that all properties receive a $15,000 reduction in assessed value because of the Homestead Exclusion. The properties with the lowest values receive the largest percentage reductions in their taxes, while the higher valued properties receive smaller percentage reductions. Everyone’s taxes are reduced by $300, but this makes a bigger relative impact on properties with smaller values than on properties with larger values. An owner of a property with an initial assessed value of $30,000 in this sample community would enjoy a 50 percent reduction in property taxes, while this same $300 would represent only a 15 percent reduction in real property taxes to the owner of a property valued at $100,000.

These Homestead and Farmstead Exclusions will be paid for with state gaming funds, and with higher local income taxes in the school districts where such an increase was approved by voters in the May, 2007, primary. Whether the Homestead and Farmstead Exclusion is more or less than the higher local income taxes paid by a taxpayer depends upon the taxpayer’s sources and amount of income, how high the new income tax rate is increased, and whether the voters approve an earned income or personal income tax.

In some school districts with significant personal income (which isn’t subject to the earned income tax), switching to the personal income tax may actually mean a lower local income tax since the change must be revenue neutral, benefitting taxpayers whose income primarily is wages and salaries. Taxpayers with significant dividend and interest income will likely pay more in local income taxes because they will be paying tax on that formerly exempt income. Since the change to the personal income tax is primarily a tax shift, it means that some taxpayers (those with significant interest and dividend income) will be paying somewhat more, while others (those who have wage or salary income primarily) will be paying somewhat less.

Renters (other than low income seniors) in school districts where voters increase the local income tax generally will lose as a result of Act 1. Rental properties are not homestead properties, so renters will receive no tax break on the portion of their rent that goes to pay the real property tax. And yet renters in these districts will be paying more in local income tax rate so homeowners and farmers can have larger real property tax breaks.

Renters will not be negatively affected in school districts where the local income tax is left unchanged by voters. Homestead and farmstead exclusions in those districts will still be provided to eligible property owners, but the exclusions will be somewhat smaller since they will be funded solely with state gaming funds. Renters in these districts will not be paying higher local taxes to give such breaks to others.

A common misconception is that renters pay no real property tax; it is true that they do not formally receive a property tax bill, but landlords typically consider property taxes when setting rent. When property taxes go up, generally rents go up as well. Act 1 treats renters inconsistently; its Senior Citizens Property Tax and Rent Rebate Assistance provisions provides low income seniors who rent a rebate on their rent payment, consistent with the earlier Pennsylvania’s Senior Citizens Rebate and Assistance Act (which Act 1 supersedes). Yet its Homestead and Farmstead provisions, which provide property tax reductions to other taxpayers, do not apply to other renters.

People paying wage taxes to the City of Philadelphia will benefit from Act 1. The Act mandates a schedule for reducing the wage tax for both resident and non-resident taxpayers. In addition, the gaming revenue received by Philadelphia must be used for additional reductions in the wage tax.

Taxpayers living in school districts who lose a significant amount of income tax revenue due to residents who work in Philadelphia (which means those taxpayers currently pay little or nothing in income tax to the school district) will benefit from Act 1 because their district will receive credits for this lost revenue. All such reimbursements to the school district must be used for Homestead and Farmstead Exclusions.

Act 1 should have little short-run effect on local businesses, non-resident property owners (such as owners of vacation homes, second homes, and camps), and owners of other properties ineligible for homestead and farmstead exclusions. Local businesses and non-residents do not pay earned income tax to school districts (nor would they pay a personal income tax, if one were levied), so their tax bills will not increase because of the higher local income tax. Since the real property tax reductions will only be given to homestead and farmstead properties, the owners similarly will not receive any of the real property tax reductions (though business owners who live in the community can receive a homestead exclusion on their house, if it is their homestead). In the long run, these property owners might experience lower real property tax increases because of the back-end referendum.

Several of the most significant impacts for school districts of Act 1 include a changed relationship with the public, changes in districts’ budgeting cycle, and the effect of the back-end referendum on their future flexibility to respond to changing situations.

Act 1 fundamentally changes school districts’ relationship with the public because of the back-end referendum. School districts will need to focus much more on nurturing their relationship with taxpayers and voters, and do a better job of explaining and justifying budget decisions. This relationship between school boards and the public will be very different from that between the public and other elected officials (such as township supervisors, county commissioners, or even state legislators), since school board members will be the only elected officials needing direct voter approval for future large tax increases.

The back-end referendum, even with the ten exceptions under Act 1, will reduce school districts’ flexibility to respond to future needs and conditions in the district. It will give local voters the ability to restrict future large tax rate increases, yet it gives neither voters nor school boards greater ability to respond to future unfunded mandates from the state or federal governments, such as "No Child Left Behind," prevailing wages, charter schools, or collective bargaining. If the district has little or no control over the amount that it must spend in response to mandates, simply restricting tax revenues can create very difficult local choices that may adversely affect the quality of education.

Act 1 similarly changes when school districts budget for the succeeding year. School districts typically follow a fiscal year calendar of July 1 through June 30. Because back-end referenda will occur during the spring primary, school districts must have their preliminary budget finished in time to determine if they likely will exceed the allowable tax rate increase. If so, they must either petition their local court or the Department of Education for a tax rate increase exception or put the proposed increase on the spring primary ballot.

This timing accelerates their traditional budgeting cycle, requiring them to adopt their preliminary budget for their upcoming fiscal year at least 90 days prior to the spring election, which means sometime in February (almost five months before the new fiscal year begins) – around the time of the governor’s proposed state budget announcement, which means districts will have to approve their preliminary budget when they may not even know the proposed increase in state aid they might receive (much less the actual amount).

The need for early budget preparation under Act 1 will pose a challenge for many school districts since they will need to make major budget decisions before the current school fiscal year is even halfway completed. School districts will have to forecast their expenses and revenues much further into the future, increasing the possibilities of error.

School districts near Philadelphia will be compensated for the local income tax revenue they lose on suburban commuters due to the Sterling Act, which "credits" taxpayers for the income tax they pay in the city. Yet all such reimbursement funds can only be used for taxpayer real property tax reductions, so the funds will not directly benefit the school districts themselves. School districts’ ability to change from the earned income tax to the personal income tax gives them an additional opportunity to improve the fairness of their local taxes, since this change more accurately reflects taxpayers’ ability to pay. But the change will be revenue neutral for school districts since it will be dollar for dollar.

By giving voters greater formal voice in school district decision-making, Act 1 places great responsibility upon citizens to become knowledgeable about school district issues, such as educational quality, local taxation and fairness, changing state and federal mandates, and the ability of the school district to attract and retain good teachers and staff. The various referenda under Act 1, such as the initial vote on increasing local income tax rates to pay for real property tax reductions, potential follow-up referenda changing this tax rate, and the back end referendum about proposed large tax rate increases, all assume that voters will be informed and make decisions for the common good. It is important that citizens learn about and understand the issues rather than just voting based upon impressions or anecdotes.

To claim a property tax or rent rebate, eligible seniors must file a claim with the Pennsylvania Department of Revenue on or before June 30 of the following year (e.g. to receive a rebate on your 2006 taxes, you must file on or before June 30, 2007). Claims received after the June 30 deadline, but before December 31, shall be accepted as long as funds are available to pay the claims.

To receive a Homestead or Farmstead Exclusion on your property, you must submit an application form with your county assessor. Unless the assessor specifically denies the application, a property is deemed eligible. Once enrolled, property owners cannot be required to resubmit an application more than one time every three years. The deadline for applying is March 1 of every year, and applicants cannot be required to pay a fee for filing or review of the application.

If your application for a homestead or farmstead exclusion is denied, the assessor must give you written notice by first-class mail not later than 30 days after the application was received.

If your application is denied, you can appeal the assessor’s decision to your county’s board of assessment appeals (the exact name of this board varies depending on the class of county). This board is the same one to which assessment appeals are made. Appeals generally are limited to whether the parcel under question meets the definition of "farmstead property" or "homestead property."

Act 1 includes several other important provisions that may affect taxpayers and school districts. These include the ability for school districts to offer installment payment plans for taxpayers, sunsetting nuisance taxes, and the relationship of Act 1 with some prior local tax reform options.

Act 1 requires school districts (other than Philadelphia) to give taxpayers with Homestead or Farmstead property the option of paying real property taxes on such properties in installments, rather than as one single payment. Each school district can determine how many installment payments they want to allow, but the Act specifies that districts must allow at least three payments (and no more than monthly). School Boards must approve an installment payment plan before June 30, 2007. Districts are required to include information about their installment payment plan on the tax notices they annually send to Homestead and Farmstead property owners.

School districts currently are authorized under the Local Tax Enabling Act (commonly referred to as "Act 511") to choose from a variety of different local tax options, including the per capita, occupation, occupational privilege, realty transfer, mechanical devices, amusement, business gross receipts, and earned income taxes. They also receive some tax authorization through the Public School Code. Act 1 changes this list of authorized taxes by allowing school districts (with voter approval) the option of levying the personal income tax. It also changes the list by taking away options from school districts not using certain taxes.

Act 1 says that after December 31, 2011, school districts can only use the taxes authorized under Act 511 that they are using at that time; if they aren’t using one of Act 511's taxes as of December 31, 2011, they forever lose the ability to use that tax. These specifically include the Per Capita Tax (though this will continue to be authorized under the School Code), Occupation (flat rate), Occupation (millage), Occupational Privilege, Realty Transfer, Mechanical Devices, Amusement, and Business Gross Receipts, and Earned Income Tax. School districts already lost the ability to newly impose the Amusement Tax under Act 50 of 1998, and the Business Gross Receipts Tax under the Local Tax Reform Act of 1989.

Act 1 does not address some of the issues underlying arguments for tax reform. It does little to address inequities across school districts, particularly with regard to the dissimilar amount of local revenue that districts are able to generate through local taxes and the amount that they spend per student. The act provides real property tax reductions (and wage tax reductions in Philadelphia), but does nothing to increase or change state aid to school districts. It does little to rectify the long-term decreasing state share of local school expenses, which many school district officials argue is one of the main underlying reasons for rising local tax rates. Wealthy districts under Act 1 will continue to spend more per student than do less wealthy districts.

Act 1 may inadvertently exacerbate some tax fairness issues at the local level due to how it treats renters compared to other taxpayers. In districts where local voters choose to increase the local income tax to provide larger Homestead and Farmstead Exclusions, renters will be paying higher local income taxes to pay for tax breaks for homeowners and farmers. Yet homeowners in Pennsylvania tend to have about twice as much income as do renters ($47,611 in average annual income to homeowning households, compared to $24,601 in average annual income to renting households. Source: 2000 U.S. Census), which means low income residents would pay for tax breaks received by their wealthier neighbors. Statewide, about 25 percent of all households rent (and the percentages are much higher in some school districts), so this affects a significant number of Pennsylvanians.

In addition, Act 1 treats senior and non-senior renters differently. Low income seniors who rent will receive partial rebates of their rent payments, while working age renters, even if they have the same low level of income, will receive no rebate. If the school district increases the earned income tax rate to pay for real property tax breaks, low income working age renters will actually be worse off than prior to Act 1, since they’re local tax bills will have increased.

Act 1 also does not address the local tax reform needs of other local jurisdictions, such as county governments, which by state law are almost exclusively dependent upon the real property tax.

Act 1 requires that on a regular basis school districts, the Department of Education, and the Department of Revenue develop and publicly release several different reports, including:

1) Senior Citizens Property Tax and Rent Rebate Assistance

2) Index for Maximum Tax Rate Increases Not Subject to Referendum

To whom: The Pennsylvania Bulletin

3) School Districts Requesting Exemption from the Back-end Referenda

Report deadline: At least 15 days before that year’s primary election

Governor’s Center for Local Government Services. Taxation Manual. Harrisburg, PA. 2003.

Kelsey, Timothy W. Understanding the Homestead and Farmstead Exclusions. Penn State Cooperative Extension Bulletin. College of Agricultural Sciences, The Pennsylvania State University. University Park, PA. 1998.

Kelsey, Timothy W. Understanding School Tax Change Under Act 50 of 1998. Penn State Cooperative Extension Bulletin. College of Agricultural Sciences, The Pennsylvania State University. University Park, PA. 1998.

Kelsey, Timothy W. Understanding Act 24 of 2001: The Optional Occupation Tax Elimination Act. Penn State Cooperative Extension Bulletin. College of Agricultural Sciences, The Pennsylvania State University. University Park, PA. 2001.

Kelsey, Timothy W. Understanding the Homeowner Tax Relief Act: Act 72 of 2004. Penn State Cooperative Extension Bulletin. College of Agricultural Sciences, The Pennsylvania State University. University Park, PA. 2004.

Pennsylvania Department of Education. Act 511 Taxes for Pennsylvania School Districts, 2000-2001. Harrisburg, PA. 2002.

Pennsylvania Department of Education. Selected Revenue Data for Pennsylvania School Districts, 2000-2001. Harrisburg, PA. 2002.

Prepared by Timothy W. Kelsey, professor of agricultural economics

Note: This publication is intended strictly to help you know and understand more about the school tax changes possible under Act 1 of Special Session 2005-2006. The material is general and educational in nature. It is not intended to be legal advice, nor to replace the need for legal advice. If legal advice is what you need, please seek the aid of a competent professional in your area.