Chairman Evans and other members of the committee, thank you for the opportunity to testify today. My name is Ed Lazere, and I am the executive director of the DC Fiscal Policy Institute. DCFPI engages in research and public education on the fiscal and economic health of the District of Columbia, with a particular emphasis on policies that affect low- and moderate-income residents.
DCFPI agrees that legislation is needed to clarify the recordation tax treatment when a commercial property undergoes a refinancing of its debt, and we appreciate the committee’s effort to move ahead on this matter. The issue before us is whether the recordation tax should apply to the full amount of a refinancing loan, in cases when the initial debt was not subject to tax, or whether the tax should apply only to any additional borrowing amount above the initial loan amount. The District’s current practice is to tax only the additional borrowing.
DCFPI does not have a clear-cut recommendation but instead would like to raise some points on both options. Our review of practices in other states shows that some, including Maryland and Virginia, apply the tax to the entire debt amount, while others apply the tax only to any addition to the original debt. Moreover, our review of the literature on this tax does not provide a clear policy rationale for one approach over another.
On one hand, it is reasonable to argue that the full amount of the loan should not be taxed ‘ but instead only any increased debt ‘ because tax was paid on the sales price when a property was acquired.
On the other hand, the recordation tax is a tax on recorded liens, and thus it also is reasonable to apply the tax to the full amount of refinanced debt. Moreover, it is reasonable to tax commercial real estate activity in the District because our commercial real estate market is so strong.
Ultimately, the answer to the question of the appropriate base for recordation tax on refinanced commercial property loans in DC should rely on the possible impacts on this sector of our economy. There are some reasons to suggest that altering current practice and moving to tax refinanced debt fully would have a modest impact6, but this is something DCFPI would like to see studied more.
While DC’s commercial property tax rate is higher than in neighboring jurisdictions, this does not appear to be an impediment to our real estate market. The amount of commercial real estate in the city continues to grow, and the office vacancy rate in the District consistently is the lowest in the region. Maryland and Virginia levy their recordation tax on the full amount of refinanced debt, with no apparent harm to their economies. The fact that our immediate neighbors levy the tax in is way also means DC would not be at a competitive disadvantage if it did the same.
That said, DC’s recordation tax rate and our commercial property tax rates are higher than in the suburbs, and while research suggests that taxes generally play a minor role in business location decisions, taxes do matter when they reach a certain level.
DCFPI believes that the possible economic impact of taxing refinanced commercial property loans in their entirety would be well served by further analysis, including input from independent economists with real estate tax expertise. This issue also could be considered by the forthcoming Tax Revision Commission, which among other things is charged with looking at how DC’s tax system affects our competitiveness. If the latter route is taken, the District could adopt clarifying legislation for now that would keep in place the current practice of taxing only incremental debt incurred in a refinancing, while making clear that the issue will be discussed further in the future.
If the District ultimately moves forward with a plan to tax refinanced debt in its entirety, there are two other issues worth considering. First, the District should take steps to limit the possibility for tax avoidance or evasion, through legislative provisions and effective tax administration. Second, any analysis of the economic impacts of DC’s commercial real estate taxes should differentiate between properties in the strongest areas such as downtown and those properties in other areas. The appropriate tax policy for K Street properties may not be the same as the right policy for Rhode Island Avenue, Alabama Avenue, and Georgia Avenue.
Thank you for the opportunity to testify.