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Page last updated: 07/31/07

School Tax Change Under Act 50 of 1998

A version of this publication is available in PDF format, or as a printed Penn State Cooperative Extension bulletin from your local Penn State Cooperative Extension office.  The  complete text of Act 50 of 1998 is also available on-line.

Table of Contents:
What are the local tax changes from Act 50 of 1998 requiring local approval?
1. Greater reliance on the earned income tax
    a. Eliminate nuisance taxes and reduce the real property tax
    b. Require voter approval of tax increases
    c. Target real property tax reductions via a homestead exclusion
2. Allow low income taxpayers to defer tax increases

How can these tax changes be implemented in my school district?
How can residents put the referendum on the ballot?

How might Act 50 impact my community?

What doesn’t Act 50 of 1998 address?
1. Equity across districts
2. The real property tax will remain school districts’ most important tax
3. Not enough options for some school districts
4. The earned income tax itself is subject to criticisms
5. No additional options and tools for school districts to control spending
6. Future flexibility of school districts

In Summary

School Tax Change Under Act 50 of 1998

School taxes are of great interest to most taxpayers in Pennsylvania. They typically account for the largest share of local tax bills, so they have a major impact on taxpayers. In May, 1998, the General Assembly and the Governor approved a bill which makes major changes to school taxes. Called Act 50 of 1998, the act offers the opportunity for school districts to shift the local tax burden away from the real property tax (sometimes called the "real estate" or "property" tax) and towards the earned income tax. It also provides taxpayers new rights and abilities that they have not had previously.

Several of Act 50 of 1998's most significant changes will only take place in specific school districts if they are approved locally by voters in what are called "front end" referendum. This means voters in many Pennsylvania school districts will have to learn about the changes possible with Act 50, and the benefits and limitations of their school district’s existing local tax structure.

What are the local tax changes from Act 50 of 1998 requiring local approval?

The school tax aspects of Act 50 of 1998 are intended to shift the source of local taxes, not change the total amount of tax dollars generated locally. Increased revenues from the new structure must be used to eliminate and/or reduce other taxes. Two of the major school tax changes in Act 50 only apply to a specific school district if they are approved in that district. Other important changes from Act 50 go into effect automatically without local approval, such as a reduction in the school debt limit, a taxpayers bill of rights, and changes in the amusement and mercantile taxes. The two changes requiring approval include:

1. Greater reliance on the earned income tax
    a. Eliminate nuisance taxes and reduce the real property tax
    b. Require voter approval of tax increases
    c. Target real property tax reductions via a homestead exclusion

2. Allow low income residents to defer taxes

Note that these need not be separate decisions. If a school district chooses to place greater reliance on the earned income tax, for example, it is required to target real property tax reductions through a homestead exclusion.

1. Greater reliance on the earned income tax

Under the act, school districts can levy a higher earned income and net profits tax rate, up to a maximum of 1.5 percent. Formerly they were allowed a maximum of 1 percent, but this had to be shared equally with local governments if the municipalities also levied the tax. The earned income and net profits tax is a tax on wages, salaries, net profits, or other compensation people receive, and is already used (with a lower tax rate) in most school districts.

a. Eliminate nuisance taxes and reduce the real property tax

In exchange for the higher earned income tax limit, school districts adopting the tax structure under Act 50 of 1998 are required first to use the new revenues to eliminate nuisance taxes (the occupation tax, occupational privilege tax, and the per capita tax) and reduce the real property tax with a homestead exclusion, which is also authorized by Act 50. The homestead exclusion targets tax reductions to permanent residents by reducing their homes’ assessed values for tax purposes. Act 50 clearly specifies the order of how new tax monies from a change to the new tax structure should be used:

1. Eliminate nuisance taxes
2. Keep a nominal amount of the increase (the total tax increase cannot exceed the percentage increase in the statewide average weekly wage in the previous year)
3. Reduce real property taxes with a homestead exclusion
4. If the size of the homestead exclusion would exceed the constitutionally set maximum, all remaining new revenues must be used to reduce the real property millage rate

b. Require voter approval of tax increases

The most significant change under Act 50 of 1998 is that school districts adopting the new tax structure will be required to get voter approval of any future non-inflationary increases in real property tax rates. Pennsylvania taxpayers previously have not had the ability to vote directly on local tax increases. Any tax rate increase greater than the percentage increase in the average weekly wages in Pennsylvania will have to be approved by local voters through these "back-end" referenda.

There are six exceptions to this referendum requirement; (1) for an emergency declared by the governor; (2) to implement a court order or an administrative order from the state or federal government; (3) to pay interest and principal on existing debt; (4) to respond to conditions that pose a threat of serious physical harm to students or staff; (5) for special purpose taxes authorized by voters; and (6) to maintain per-student tax revenue for those districts with enrollment growing faster than 10 percent over a three year period. If a ballot proposal to increase the real property tax rate fails at the polls, the real property tax rate stays at rate already in effect at the time of the referendum.

c. Target real property tax reductions via a homestead exclusion

The homestead exclusion is a way to target real property tax relief to homeowners who have their permanent residence in the taxing jurisdiction (school district, county, or municipality). The homestead exclusion reduces the assessed values of homestead properties, reducing the property tax on these homes. The homestead exclusion provides the same dollar tax break to all eligible homestead properties in the taxing jurisdiction, including houses on farms, condominiums, single family homes, and other places of permanent residence.

Any tax shift from the real property tax to local income taxes without a homestead exclusion could provide a windfall to some businesses and non-resident property owners while increasing the tax burden on homeowners. Businesses and non-resident property owners do not pay any earned income tax to the school district, so would not pay more as a result of the local tax changes. And yet if real property tax rates were simply decreased for all taxpayers because of the new income tax revenue, businesses and non-resident property owners would pay less in local tax. Supporters of homestead exclusions say this is unfair, because tax reform wasn’t intended to provide tax breaks paid for by homeowners to local businesses or non-residents.

Act 50 of 1998 also authorizes a farmstead exclusion, which targets real property tax reductions to buildings on farms not already exempt from real property taxation. By law, if the homestead exclusion is implemented in a community, the farmstead exclusion must also be implemented. The size of the farmstead exclusion cannot exceed the size of the homestead exclusion.

2. Allow low income taxpayers to defer tax increases

Low income taxpayers can be allowed to defer real property tax increases on their homestead if the school district, county, or municipal government decides to allow such deferrals. To qualify, taxpayer’s income has to be less than the income requirements defined for the Senior Citizens Property Tax and Rent Rebate program ($15,000 in 1997). Any tax increase above what the taxpayer paid in the year before they signed up will be deferred until the taxpayer either sells their homestead or passes it on to their heirs. The amount of deferred taxes, other unpaid liens, and outstanding mortgage on the property cannot exceed 85 percent of the market value of the homestead. Similarly, the outstanding mortgage cannot exceed 70 percent of the market value for the taxpayer to be able to participate. Taxpayers wishing to defer real property tax increases must submit an application to the school district, county, or municipal government.

How can these tax changes be implemented in my school district?

School districts are not required to change to the new tax structure, but can stay with their current structure if they prefer. School districts must use a local referendum to adopt the new local tax structure. The referendum must be written in clear language that is readily understood by a layperson, such as:

"Do you favor the imposition of an earned income and net profits tax of X% to be used to replace (NAMES OF LOCAL TAXES TO BE REPEALED), reduce real property taxes by X% by means of a homestead exclusion and provide for a one-time revenue increase of X% over the preceding fiscal year?"

The referendum question can get put on the local ballot either through a decision by the school board, or if the school board does not act within two years, through a series of petitions and actions by residents. If the referendum fails at the polls, no matter how it was placed on the ballot, the existing local tax structure will continue to be used in the school district.

Whether to offer the tax deferral program is a separate decision that the school board can make on their own, irregardless of whether other tax changes from Act 50 are adopted. The homestead exclusion, similarly, can be a decision separate from these broader tax changes. School districts, counties, and municipalities can adopt a homestead exclusion under Act 50 as long as they do not raise real property taxes to pay for the exclusion. If schools adopt the higher earned income tax they are required to use the homestead exclusion, but they can choose to offer a homestead exclusion without adopting these other changes. The amount of revenue needed to pay for a homestead exclusion, however, makes it unlikely that most school districts, counties, or municipalities will be able to offer it without new revenues from tax reform.

How can residents put the referendum on the ballot?

If your school board does not act within two years to place a referendum question about Act 50 of 1998 on the ballot, school district residents can attempt to place it on the ballot through a series of petitions and steps. These include:

1) Circulating a petition requiring the school board to establish a local tax study commission. If the petition is signed by 2 percent of the number of residents who voted for the office of governor in the last gubernatorial election, the school board must create such a commission to study the current local tax structure and possible impacts of Act 50 on the school district. The local tax study commission is required to make a recommendation to the school board about whether Act 50 reforms should be adopted. Commissions are composed of five residents or taxpayers, chosen to reflect the age, socioeconomic, and occupational diversity of the district. Only one member can be a member of the school board, and none of the other four can be an official or employee of the district, or be related to an official or employee of the school district.

2) The local tax study commission will then do their study of local taxes, following general guidelines laid out in Act 50. These include considering the historic and present use of taxes by the school district; age, income, employment, and property use characteristics of the existing tax base; and projected revenues from different taxes. Within 90 days of the appointment of the commission, they are required to make their recommendation about whether to adopt the new tax structure to the school board. The recommendation is non-binding. The local tax study commission is required to publish a final report of its findings, and to make all its records available to the public.

3) If the local tax study commission recommends that the school district adopt the new system, the school board can place the referendum on the ballot. If the school board fails to do so, residents can circulate another petition requesting the referendum. If the petition is signed by 5 percent of the number of residents who voted for the office of governor in the last gubernatorial election, the petition compels the referendum be placed on the ballot. If the local tax study commission does not recommend adoption of the new system, the board is not required to place a referendum on the ballot, nor can it be compelled to do so via petition.

How might Act 50 impact my community?

Analysis using Pennsylvania school district data suggests the tax change aspects of Act 50 would have provided an average 27 percent reduction in residential property taxes in Pennsylvania school districts in 1995. These savings vary significantly across the districts, however (see county level summary of impacts, or for specific school districts by counties A-B, C-E, F-L, M-P, or S-Y). Forty school districts would actually have had to raise their real property taxes under the plan, because it will cost them more to eliminate nuisance taxes than they will gain from the higher earned income tax rates. These estimates assume school districts increase total revenues the maximum possible in the implementation year; if the increase is less, the real property tax reductions will be greater.

The effect of tax change on individual taxpayers (particularly those with high earned income) is difficult to estimate because so much depends upon how much they already pay in nuisance taxes, in which school district they live, the size of the earned income tax increase, and the size of the homestead exclusion. In general, however, property owners with little earned income, such as seniors and others on fixed incomes, should end up paying less in school taxes as a result of the reforms.

Renters likely will pay more in earned income tax, but are unlikely to benefit from the real property tax reductions because they are not ineligible for the homestead exclusion. The reform will have little short term effect on businesses, vacation homes, camps, or second homes because they do not pay the earned income tax and similarly will not receive reductions in real property taxes. In the long run, however, they should benefit if the referendum requirement for future tax increases reduces the growth of school tax bills.

What doesn’t Act 50 of 1998 address?

There are important local tax reform issues that Act 50 of 1998 does not address, which might affect the appropriateness of the new local tax structure for specific school districts. Voters in many school districts will have to evaluate whether they believe the reforms are good or bad.

1. Equity across districts

Act 50 does nothing to improve fairness across school districts. Most poor districts will still be poor after Act 50, and most rich districts will still be rich. Individual taxpayers lucky enough to be living in a rich school district, in general, will continue to pay lower real property taxes than individual taxpayers who happen to live in poorer districts. This occurs because Act 50 only addresses the mix of taxes within each district, and does nothing to address the revenue inequities across districts.

This approach to local school tax reform contrasts with the approach recently used by several other states, who deliberately increased the state share of local school revenues to reduce local reliance on the real property tax and to reduce such inequities. Kansas and Michigan raised state taxes to get the needed revenues, while South Carolina and Wisconsin promised to do so without increasing state taxes. Their approach reduced total local school taxes instead of merely shifting them to a different local tax within each district. This makes the tax burden fairer across districts instead of just within districts. On the other hand, some argue that increasing reliance on state revenues reduces local ownership and control of schools.

2. The real property tax will remain school districts’ most important tax

The tax changes under Act 50 of 1998 reduce real property taxes, but the real property tax will remain the most important local tax for most school districts. The real property tax will be the only tax most school districts can use to balance their budget each year. Future increases in the earned income tax rate are restricted by Act 50 for use solely to reduce the real property tax, so it cannot be used in this role.

Concerns about the fairness of the real property tax will remain important in many school districts because it will continue to play a central local role. The tax deferral parts of Act 50, if approved by school boards, should reduce the likelihood that participating low income homeowners will be forced from their homes by tax increases. But other concerns about the real property tax, such as property assessment and administration, are not addressed by Act 50.

3. Not enough options for some school districts

The only new local tax option Act 50 of 1998 provides school districts is a higher earned income tax rate. This may be useful in many school districts, but not all because local conditions vary across Pennsylvania. An estimated 40 school districts, for example, won’t even be able to implement Act 50 without raising their real property tax rates because the amount of money they will lose from their nuisance taxes is greater than the amount they will get from the higher income tax. The amount school districts along the border with New York and New Jersey (which have many residents who work out of state) will collect will be restricted because they are required by state law to credit the income tax their residents pay out of state. More options would have allowed communities to develop and choose the new tax structure that is best for themselves.

4. The earned income tax itself is subject to criticisms

The earned income tax itself is subject to concerns about sufficiency and fairness, which means it might not be the best alternative for some school districts. Because the amount of revenue coming from the earned income tax depends directly upon how much income residents earn, the earned income tax is susceptible to business cycles. Collections will boom when the economy is good, but they will fall when the economy declines. This makes the earned income tax a less steady and reliable source of tax revenue, and makes it difficult for school districts to accurately predict earned income tax revenues at the beginning of each year. On the other hand (and unlike the real property tax), earned income tax collections will naturally grow due to inflation, as wages increase.

The earned income tax also suffers from criticisms about its fairness because it discriminates against certain types of income. Wealthy taxpayers may have a high percentage of their income coming from dividends or interest, but because the earned income tax only collects from earnings and net profits, this income will be ignored. As a result, wealthy residents who get most of their income from investments can pay less than their lower income wage-earning neighbors.

5. No additional options and tools for school districts to control spending

Cost control clearly is an important issue for taxpayers and school districts. Higher costs either lead to further tax increases, program cuts, or a mixture of both. The reforms under Act 50, however, do nothing to give school districts additional ability to control their costs. The referendum requirement for future tax increases likely will make it more difficult for school districts to raise their tax rates, placing school boards between a rock and a hard place, with no way out. Cost control is vitally important if taxpayers are concerned about both the size of tax burdens and the quality of local education. Without a greater ability to control costs, revenue restrictions may create severe challenges for school districts.

6. Future flexibility of school districts

Act 50 of 1998 might make it more difficult for school districts to adapt to future needs because of the local referendum requirement. Many people would agree in principle that local referendum on tax rates are good, because they provide additional local control over tax rates. They also, however, create the opportunity for needed revenue increases to be prohibited. Pennsylvania has the second largest percentage of elderly of any state, and has other large segments of the population without a current direct link to local schools, which may make it difficult to pass local school tax referendum. Several other states with local referendum have already found that they make passage of needed tax changes difficult. The highly publicized difficulties in Michigan’s Kalkaska School District in 1993, for example, when the school closed in March because a budget could not be approved, served as a major impetus for that state’s takeover of local school finance.

In addition, the restrictions on tax rate increases are not tied to the needs of the school district. Act 50 does allow a school district to avoid the referendum if the number of students has grown more than 10 percent over the past 3 years, but the Senate Policy Development and Research Office estimates only 38 school districts currently would qualify under that criterion. There is little guarantee that schools with lower but steady growth in the student population will be able to maintain their per pupil revenues, or that school districts will be able to adapt to changing educational needs. Time and experience with local tax referendum in Pennsylvania will demonstrate whether the referendum requirement proves a method of merely stopping school tax increases, or if it instead will be a method of controlling tax increases while at the same time insuring quality schools.

In Summary

Act 50 of 1998 gives Pennsylvania school districts another major choice in local taxation. It is not a comprehensive local tax reform package, as some would have preferred, because it only provides one new tax option to school districts, does little to address fairness issues across school district boundaries, and provides no major tax reforms for county and municipal governments. But Act 50 does give more choices to school districts, allowing many to reduce real property taxes and target real property tax relief to homeowners and farmers. It also potentially gives local taxpayers more voice in tax increases, giving them greater control over their taxes.

The local referenda components of Act 50 (both front- and back-end) provides an exciting opportunity for Pennsylvania voters. With that opportunity comes responsibility, however. Voters will need to carefully and thoughtfully examine the potential impacts of Act 50 in their own community, or they might unintentionally make local taxes in their community worse. Considerations about local tax fairness, who will pay more and who will pay less in their school district under Act 50, the potential impact of "back end" referenda on the school district’s ability to adapt to changing conditions and needs, and educational quality will be especially important.

Local decisions about whether to stay with the current local tax system or adopt Act 50 will have major consequences for local tax fairness, citizen control, and the quality of public schools.

References:

Center for Rural Pennsylvania. Rich Schools - Poor Schools; Challenges for Rural and Urban Pennsylvania. Harrisburg, PA: Center for Rural Pennsylvania. Technical Paper No. 8. 1991.

Hovey, Hal. "The Property Tax in the 21^st Century." The Finance Project. 1996.

Kelsey, Timothy W. "Understanding the Homestead and Farmstead Exclusions," College of Agricultural Sciences, Penn State University. University Park, PA. 1998.

National Conference of State Legislatures. Final Report: Education Equity in Pennsylvania. Presented to the House Committee on Education and the House Committee on Appropriations. December 30, 1992.

Pennsylvania Department of Community and Economic Development. Local Government Financial Statistics, 1995. Harrisburg. 1996.

Pennsylvania Department of Education. Selected Revenue Data for Pennsylvania Public Schools, 1994-1995. Harrisburg. 1996.

Pennsylvania Senate Policy Development and Research Office. Summary of Major Provisions of Taxpayers’ Local Control Act. May, 1998.

U.S. Dept of Education, National Center for Educational Statistics. Statistics of State School Systems. 1996..

Prepared by:

Timothy W. Kelsey, Associate Professor of Agricultural Economics, Penn State University

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