CHICAGO -- Property tax-cut fever has Midwest finance officers sweating.

Like a brushfire that at first seemed inconsequential, the drive to reduce local property taxes is spreading to the nation's heartland, and many local officials here are nervous about financing their operations.

Voter outrage has forced many states -- Illinois, Michigan, and Wisconsin among them -- to combat escalating property taxes using property-tax caps or alternative taxes.

While an advantage for voters, property-tax relief could seriously burn the municipalities that count on property-tax proceeds to secure bonds for infrastructure improvements.

And rating agencies have voiced concerns that property-tax caps could harm the creditworthiness of some affected governments.

Paul Devine, vice president and manager of the Great Lakes Region at Moody's Investors Service, said that any measure that restricts "revenue raising ability" is not a "favorable credit factor."

In Illinois, the General Assembly last July passed a property-tax cap law after metropolitan Chicago homeowners showed signs of revolt over rising property taxes.

The law, formally called the Property Tax Extension Limitation Act of 1991, took effect Oct. 1. It limits annual growth of property-tax collections by most local governments in five suburban Chicago counties to 5% or the rate of inflation, whichever is less. It also requires voter approval of all general obligation debt issued by those governments.

In addition, the law freezes property assessments in a sixth county -- Cook County -- this year, restricting local governments there from taking advantage of increased property-tax collections derived from higher assessments.

Long-Term Pain?

Furthermore, Republican leadership in the Illinois Legislature is committed to extending the property tax cap statewide.

But the movement won't enjoy clear sailing. A pending lawsuit filed in January challenges the constitutionality of the law. The suit, backed by the Illinois Library Association, the Illinois Education Association, and some suburban governments, claims that the counties' tax cap violates state constitutional provisions requiring uniformity of taxation and equal protection under the law.

And a study released earlier this month by a Chicago-based government watchdog group concluded that the Illinois property tax-cap could send state officials scrambling for solutions to a revenue crisis.

The group, called the Civic Federation, found that the tax cap will force local governments to seek "substantial economies," such as pursuing service cuts, finding other local, state, or federal revenue sources, and even considering municipal consolidation.

Hella Tomczak, vice president of the Illinois chapter of the Government Finance Officers Association, agreed with study's findings.

"It really ties our hands," said Ms. Tomczak, who is also the finance director for Burr Ridge, Ill. "We basically have no power to levy since our rate is so low."

The current village property tax rate in Burr Ridge is 16 cents per every $100 of equalized assessed valuations.

"For the short term, we're OK," she said. "But planning for the future doesn't look good."

The property-tax cap may force some municipalities and schools to cut their budgets and staff, Ms. Tomczak said, adding that Burr Ridge and other tax-cap communities may have to resort to special assessments for infrastructure improvements, instead of issuing bonds.

Property tax-cut fevel also has caught on in Michigan.

Two proposals will be on the November ballot, including a plan to reduce collections by $1.3 billion through 1997.

Schools to Suffer

The plan, sponsored by Gov. John Engler, would slash school operating property taxes 30% over five years and limit property assessment growth to 3%, or the rate of inflation, whichever is less. School districts would be reimbursed by the state for any lost revenue.

The governor's plan would be funded through downsizing state government and tapping into Michigan's 5% of annual average revenue growth.

Standard & Poor's Corp., which rates Michigan's GO bonds AA with a negative outlook, has questioned how the state will reimburse schools, given its recession-related pressures and aversion to raising taxes.

In a report last year, the agency said the state's "commitment to containing any increase in state taxes and to compensating for possible reductions in the local property tax burden will limit its financial flexibility."

The other plan on the ballot would cap future property-assessment increases to 5%, or the rate of inflation, which ever is lower.

Marion Hahn, the assessor in Lansing, Mich., was concerned about the impact of a tax cap.

"If it's a 5% cap, it may not have an effect [on the city's finances], but if it's 3% -- yes, it could," Mr. Hahn said. Property taxes in Lansing currently increase about 5% annually.

Communities outside Lansing, in addition, could be in a worse financial state than Lansing if the tax-cap law were passed, he said. Many of the surrounding towns have averaged 10% increases.

"We're running scared," Mr. Hahn said. "We're not sure what to look forward to."

In Iowa, Gov. Terry Brandstad has called for a two-year limit on property-tax growth. If the governor calls a special session to deal with the state's unresolved 1993 budget before July 1, the two-year property-tax measure may then be taken up by the legislature.

Wisconsin is taking a tax-relief measure directly to the voters. In November, Wisconsin residents will vote on an initiative that would allow the legislature to reduce residential and agricultural property taxes.

Shifting the Burden

Specifically, the proposed amendment would revise the state constitution's property-tax uniformity clause to authorize the state legislature to dole out the tax relief. A side effect could be higher taxes for some businesses and commercial properties, according to Mark Bugher, the state's revenue secretary.

The amendment was placed on the November ballot by the Democratic majority legislature.

Mr. Bugher said approval of the amendment could enable the legislature to tap into the state's shared-revenue fund, which ultimately could affect the financial standing of some municipalities.

"It could affect municipalities' existing shared revenue from the state, which is currently at $900 million," he said. "If that's tapped into, I would think that it should cause fear in local government officials. There's a real concern on about whether this will change the distribution to schools and local governments."

Mr. Bugher said that if the municipalities receive fewer shared-revenue dollars, they would have to limit their spending.

Edward Huck, executive director of the Wisconsin Alliance for Cities, said it was "unlikely" that a change in the shared revenue formula would adversely affect a local government's financial standing or its ability to issue bonds.

A local government would reap economic benefits from a reduction in property taxes which would off-set the change in shared-revenue distribution. Mr. Huck said. For example, lower property taxes in a certain area could attract new homeowners and businesses.

Businesses see the measure as a tax-shifting scheme that would decrease homeowners property tax rates by increasing business rates.

The state revenue department also is studying the option of levying an alternative tax to alleviate property taxes, said Margaret Derus, executive assistant to Mr. Bugher. Ms. Derus said that the study is expected to be completed by Nov. 1.

Some of the property-tax relief measures in the Midwest could receive a boost from last week's U.S. Supreme Court 8-to-1 decision to uphold California's Proposition 13. The California initiative had been challenged on the assertion that it was unconstitutional.

Justice John Paul Stevens was the only dissenting member of the Supreme Court Judge.

In 1978, California voters approved Proposition 13, a constitutional amendment that slashed property taxes and capped future growth of this revenue source.

Under the amendment, the maximum amount of the any ad valorem tax on real property cannot exceed 1% of the full cash value of the such property. Small increases in the tax are permitted to adjust for inflation.

The Proposition 13 provision that was being challenged before the Supreme Court permits property to be reassessed at full market value when it changes hands.

A homeowner who bought her property after Proposition 13 took effect charged that it was unfair for her to pay higher taxes than neighbors whose levies are frozen at pre-Proposition 13 levels.

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