Performance audit, Department of Revenue, Property and Special Tax Division

              PERFORMANCE AUDIT
DEPARTMENT OF REVENUE
PROPERTY AND SPECIAL TAX DIVISION
Report to the Arizona Legislature
By the Auditor General
March 1986
86- 2
DOUGLAS R NORTON. CPA
AUDITOR GENERAL
STATE OF ARIZONA
OFFICE OF THE
AUDITOR GENERAL
March 24, 1986
Members o f the Arizona Legislature
The Honorable Bruce Babbitt, Governor
J. E l l i o t t Hibbs, Director
Department o f Revenue
Transmitted herewith i s a report of the Auditor General, A Performance
Audit o f the Department o f Revenue, Property and Special Tax Division.
This audit i s a l i m i t e d review conducted i n response to the January 21,
1986 resolution of the J o i n t Legislative Oversight Committee.
After noting the progress the Department has made i n achieving greater
uni fomrti ty o f property valuation, the report i d e n t i f i e s areas for
improvement. An updated system f o r val uing commercial and i n d u s t r i a l
property based on costs i s needed, and statutory equal i z a t i on authority
needs to be c l a r i f i e d . In addition, DOR should involve county assessors
more e f f e c t i v e l y i n the preparation and use o f sales r a t i o studies.
bly s t a f f and I w i l l be pleased t o discuss or c l a r i f y itenis i n the report.
Respectfully submitted,
DOU~ WR. SN orton
Audi t o r General
S t a f f : M i 11 i am Thomson
Peter M. Francis
Steven G. Adelstein
Kimberly S. H i 1 debrand
Margaret E. Cawley
Enclosure
2700 NORTH CENTRAL AVE. SUITE 700 PHOENIX, ARIZONA 85004 ( 602) 255- 4385
The Office o f the Auditor General has conducted a l i m i t e d review o f the
Department of Revenue ( DOR), Property and Special Tax Division. This
review was conducted i n response to a January 21, 1986, r e s o l u t i o n o f the
J o i n t L e g i s l a t i v e Oversight Committee, and i n accordance with Arizona
Revised Statutes § § % I - 2351 through 41 - 2379.
The Property and Special Tax D i v i s i o n exercises general supervision over
Arizona's property tax laws t o ensure t h a t a l l property i s uniformly
valued f o r State property tax purposes. Uniformity i s needed t o ensure
t h a t the tax burden i s f a i r l y d i s t r i b u t e d and t o prevent lawsuits charging
property t a x d i s c r i m i n a t i o n and p o s s i b l e r e s u l t a n t tax refunds. Further,
State and county a i d i s often allocated to l o c a l govern~ ents or school
d i s t r i c t s based on assessed val ues. Equi tab1 e v a l u a t i o n s a r e needed f o r
f a i r d i s t r i b u t i o n o f t h i s aid.
Improvements Can Be Made
I n The Property Tax Division ( see Finding, pages 5 through 18)
The Department o f Revenue, Property and Special Tax D i v i s i o n i s generally
e f f e c t i v e , however, some improven~ ents are neeaecr. The D i v i s i o n ' s current
system f o r valuing property based on costs i s outdated. A1 so, s t a t u t e s on
u n i f o r m i t y and equalization are unclear and have l e d to confusion. In
addition, county assessors 1a ck confidence i n DOR's method o f ~ nontio r i n g
property valuations.
The Department's construction cost system i s inadequate. A construction
cost system generates cos t- based v a l uations p r i m a r i l y for
comlnercial/ inaustrial property based on such factors as materials,
l o c a t i o n and size. The e x i s t i n g syste~ n, o r i g i n a l l y developed i n the mid
1960s, i s outdated and has generated valuations t h a t are s u b s t a n t i a l l y
less than market values. An updated system i s c u r r e n t l y being developed
by DOR i n cooperation w i t t l the county assessors, however, lack o f
resources may hinder i t s development and use. For example, DOR
lacks s u f f i c i e n t resources to conduct a reappraisal o f a l l
commerci a1 / i n d u s t r i a1 properties. This reappraisal i s necessary t o ensure
t h a t r e l i a b l e data i s used i n the new system. Further, the system w i l l
have t o be p e r i o d i c a l l y updated w i t h new cost data t o remain e f f e c t i v e .
Because accurate valuations are essential, funding f o r the development and
implementation o f a new construction cost system, including reappraisals
and periodic updates, should be considered by the Legislature.
Equal i z a t i o n a u t h o r i t y needs c l a r i f i c a t i o n . Confusion e x i s t s because both
the Department o f Revenue anci the Board o f Tax Appeals appear to have
equal i z a t i o n a u t h o r i t y by statute. A 1985 Maricopa County Court decision
pointed out t h i s confusion and upheld DORIS a u t h o r i t y to issue valuation
d i r e c t i v e s by voiding f o u r Board equal i z a t i o n orders. However, the Board
o f Tax Appeal s has appealed t h i s decision. Because DOR has more resources
t o devote t o e q u a l i z a t i o n a n a l y s i s and research, it i s b e t t e r suited t o
c a r r y o u t the equal i z a t i o n function. Therefore, the Legislature should
consider c l a r i f y i n g equal i z a t i o n a u t h o r i t y by g i v i n g DOR f u l l equalization
a u t h o r i t y , w h i l e r e t a i n i n g the power to hear and decide appeals i n the
Board o f Tax Appeals.
County Assessors may lack confidence i n D( jR's sales r a t i o studies as a
r e s u l t of i n s u f f i c i e n t involvement i n t h e i r development and use. DOR uses
these studies to monitor the accuracy o t valuations by measuring the
r e l a t i o n s h i p bett~ een appraisal s and market val ue. Based on these studies,
DOR establ i shes adjustment factors f o r those property c l asses w i t h i n a
county t h a t are not appraised near market value. Increased cooperdtion
between the assessors and DOR regarding the preparation and use o f sales
r a t i o studies may strengthen re1 ations and increase confidence i n the
studies. Further, DOR should consider supplementing sales r a t i o studies
w i t h on- site appraisals when sales data i s inadequate. I n a d d i t i o n , t h e
time frame f o r adjusting assessRents based on DOR factors may be
i n s u f f i c i e n t t o ensure equity between parcels w i t h i n classes. This i s
because assessors h i s t o r i c a l l y have not haa enough t i n e t o determine where
s p e c i f i c valuation adjustments need t o be made. Instead, adjustment
f a c t o r s have generally been applied across- the- board f o r c e r t a i n classes
o f property. While t h i s addresses uni f o m i t y among classes and among
counties, it can perpetuate inequity among parcel s. Therefore,
a1 t e r n a t i v e s t o the c u r r e n t time schedule should be considered t o address
these problems. Options i n c l ude :
e Applying adjustment factors to the f o l l o w i n g y e a r ' s valuations
instead of the c u r r e n t y e a r ' s .
e Basing adjustment factors on p r i o r years' valuations.
Moving deadlines f o r p r e l i m i n a r y v a l u a t i o n s t o an e a r l i e r date.
TABLE OF CONTENTS
- Page
INTRODUCTION AND BACKGROUND . . . . . . . . . . . . . . . . . .
FINDING: IISPROVEMENTS CAN BE BiADE I N THE PROPERTY TAX DIVISION
Property Valuations Are Becoming More Uniform . . . . . . .
Construction Cost System I s Inadequate. . . . . . . . . . .
E q u a l i z a t i o n A u t h o r i t y Needs C l a r i f i c a t i o n . . . . . . . . .
County Assessors Lack Confidence
I n Sales Ratio Studies. . . . . . . . . . . . . . . . . . .
Recommendations . . . . . . . . . . . . . . . . . . . . . .
AREA FOR FURTHER AUDIT WORK . . . . . . . . . . . . . . . . . .
DEPARTMENT RESPONSE . . . . . . . . . . . . . . . . . . . . . .
LIST GF TABLES AND FIGURES
TABLE 1 - DOR Property And Special Tax D i v i s i o n - Actual
Expenditures For Fiscal Years 1983- 84 And 1984- 85,
And Budget For Fiscal Year 1585- 86 . . . . . . . . .
FIGURE 1 . M edian Sales Ratios 1982- 56. . . . . . . . . . . . .
FIGURE 2 . M edian C o e f f i c i e r l t s G f Dispersion 1982- 86. . . . . .
INTRCDUCTION AND BACKGROUND
The Office o f the Auditor General has conducted a l i m i t e d review o f the
Department o f Revenue ( DOR), Property and Special Tax Division. This
review was conducted i n response to a January 21, 1986, r e s o l u t i o n o f the
J o i n t L e g i s l a t i v e Oversight Committee, and i n accordance w i t h Arizona
Revised Statutes § § 41- 2351 through 41 - 2379.
Arizona's Property Tax System
Three e n t i t i e s administer Arizona's property tax system. DOR's Property
and Special Tax D i v i s i o n i s responsible f o r general oversight o f the
system. The State Board of Tax Appeals has f u l l power t o equalize the
valuation o f a l l property throughout the State, and t o hear and decide a l l
appeals r e s u l t i n g from Departr~ ent of Revenue decisions. County assessors,
who are s t a t u t o r i l y designated as deputy d i r e c t o r s o f the Department o f
Revenue for State property tax purposes, are responsible f o r determining
the valuation o f a l l l o c a l l y assessed property w i t h i n t h e i r counties.
The Property and Special Tax D i v i s i o n exercises general supervision over
Arizona's property tax laws t o ensure t h a t a l l property i s uniformly
val ued f o r S t a t e property tax purposes. Property appraisal duties are
divided between the State and counties, with the m a j o r i t y o f property
being appraised by the county assessors. Tne D i v i s i o n val ues central ly
assessed properties ( i. e., u t i l i t i e s , communication companies, r a i l r o a d s ,
p i pel ines and nli n i n g p r o p e r t i e s ) . County assessors, are responsible f o r
appraisal o f 1 ocal ly assessed properties ( i . e. , vacant 1 and, r e s i denti a1 ,
and commercial and i n d u s t r i a1 c l asses).
The Property and Speci a1 Tax D i v i s i o n supervi ses the assessors ' appraisal
a c t i v i t i e s by:
adopting standard appraisal methods and teckrniques,
preparing and maintaining manuals and a construction c o s t system,
e performing audits ,
educating and t r a i n i n g county assessor s t a f f , and
0 coordinating data processing a c t i v i t i e s .
In addition, the Division provides appraisal assistance to county
assessors through regional representatives. Assistance consists o f a i d on
complex appraisals, review of valuation changes, and review o f new
pol i c i e s and procedures with the assessors. Division personnel a1 so
prepare and present cases t o the various appeal boards.
S t a f f i n g And Budget - For f i s c a l year 1985- 86, the Property and Special
Tax Division was authorized 80 f u l l - t i m e equivalent ( FTE) positions,
although e i g h t of these were not funded. The Division has an approved
General Fund budget of $ 2,734,500. Table 1 shows actual expenditures for
f i s c a l year 1983- 84, estimated expenditures f o r f i s c a l year 1984- 85, and
the approved budget f o r f i s c a l year 1985- 86.
FTE Positions
TABLE 1
DOR PROPERTY AND SPECIAL TAX DIVISION
ACTUAL EXPENDITURES
FISCAL YEARS 1983- 84 AND 1984- 85
AND BUDGET FOR FISCAL YEAR 1585- 86
( UNAUDITED)
Actual Actual Approved
1 983- 1 984 1584- 1 985 1985- 1 586
Expendi tures:
Personal Services $ 1,727,800 $ 1,692,400 $ 1,897,300
Employee Related 366,600 367,400 398,600
Professional And
Outside Services 332,100 175,000 226,200
Travel
I n State 88,200 72,200 100,000
Out O f State 12,500 11,200 15,500
Other Operating 82,100 109,100 57,500
Equi prnent 8,200 1,200 9,400
OPERATION SUBTOTAL 2,617,500 2,428,500 2,704,500
ADOT Mapping Service 30,000 30,000 30,000
Omnibus Tax R e l i e f 350,000
Railroad Tax Claims
Settlement 6,409,000
TOTAL $ 2,647,500 $ 9.21 7,500 42,734.500
Eight o f these p o s i t i o n s were not funded.
Source: State of Arizona Appropriations Report 1985- 86, and DOR Budget
Request 1986- 87
2
Sco~ e o f the Audit
Our a u d i t o f the Department o f Revenue, Property and Special Tax D i v i s i o n
was a l i m i t e d review. It focused on the r e l a t i o n s h i p o f the various
e n t i t i e s involved i n t h e a d m i n i s t r a t i o n o f the S t a t e ' s property tax systern
and the use o f sales r a t i o studies. S p e c i f i c a l l y , d e t a i l e d work was
conducted on the adequacy of DOR's construction cost system, the c l a r i t y
o f e q u a l i z a t i o n a u t h o r i t y , and DOR's use o f sales r a t i o studies.
Several s i g n i f i c a n t studies have been completed during the l a s t four years
on Arizona's property tax system.
9- 82 - " Study of Land Valuation Issues" by the I n t e r n a t i o n a l
Association o f Assessing O f f i c e r s
1- 83 - " Toward F u l l Cash Value" by the Governor's Task Force on
Assessment Practices
5- 85 - A cash equivalency study on Commercial Property i n biaricopa
County by Joseph M. Davis and Associates
6- 85 - " Final Report on Equalization o f Commercial and I n d u s t r i a l
Real Property Assessments i n t h e S t a t e o f Arizona" by Ronald
B. Welch and Robert H. Gustafson
We reviewed each o f these s t u d i e s d u r i n g our audit. Since these r e p o r t s
addressed many o f the c u r r e n t t o p i c s o f i n t e r e s t , we were able to l i m i t
our review. In addition, they provided information t h a t we incorporated
i n t o our r e p o r t . In general, these studies form a valuable framework f o r
strengthening Arizona's Property Tax system.
The Auditor General and s t a f f express appreciation t o the Director o f DOR
and the s t a f f o f the Property and Special Tax Division f o r t h e i r
cooperation and assistance d u r i n g t h e course o f our review.
FINDING
IMPROVEMENTS CAN BE MADE IN THE PROPERTY TAX DIVISION
The Department o f Revenue ( DOR), Property and Special Tax D i v i s i o n i s
general ly effective, however, some improvements are needed. The
D i v i s i o n ' s current system f o r valuing property based on costs i s
outdated. A1 so, statutes on u n i f o r m i t y and equal i z a t i o n are unclear and
have l e d t o confusion. I n addition, county assessors lack confidence i n
DOR's method o f monitoring property val uations.
Property Val uations Are Becoming More Uniform
A r i z ~ n a property valuations are moving toward greater u n i f o r m i t y .
Uniformity i n valuations i s necessary t o ensure t h a t the tax burden i s
f a i r l y d i s t r i b u t e d and t o prevent lawsuits. Therefore, DOR began t o work
toward t h i s goal more aggressively i n 1982. As a r e s u l t , improvements i n
Statewide u n i f o r m i t y have been made over the l a s t f i v e years.
Elecessity For Uni form Val uations - Arizona needs uniform v a l uations w i t h i n
and among classes o f property and counties f o r several reasons.
Uniforiility w i t h i n l e g a l classes i s needed so S t a t e g r a n t - i n - a i d t o school
d i s t r i c t s i s d i s t r i b u t e d f a i r l y . Equalization w i t h i n counties i s also
required f o r county a i d prosrams f o r school d i s t r i c t s . State a i d f o r
l o c a l government services i s also based on assessed values. Equalization
among classes i s needed so the tax burden i s n o t u n f a i r l y stli f t e d from
underval ued c l asses o f properties.
In a d d i t i o n , t h e Federal Railroad Revi t a l i z a t i o n and Regulatory Reform Act
o f 1976 protects r a i l roads, a i r 1 ines and motor c a r r i e r s from excessive
taxation. Federal 1 aw general ly protects i n t e r s t a t e t r a n s p o r t a t i o n
companies from property tax burdens greater than owners o f other
coinrnercial and i n d u s t r i a1 property. Noncompl i ance w i t h Federal 1 aw could
resul t i n serious consequences i f l o c a l l y assessed commercial and
i n d u s t r i a1 properties were underval ued w i t h respect to central ly val lied
railroad and a i r l i n e properties. For example, $ 7 million had to be
appropriated for fiscal year 1984- 1985 to pay railroads a court settlement
on overpaid property taxes. Similar actions are being considered by other
State property owners contending property tax discrimination. If locally
assessed commerci a1 and industri a1 properties continue to be underval ued,
mil 1 ions of additional do1 1 ars could be lost.
Improvements Have Been Made - The Department of Revenue has r~ ade important
strides toward ensuring uniformity among property val ues in Arizona. In
1979, DOR began using sales ratio* studies to monitor local assessment
performance i n order to achieve uniformity. Beginning i n 1982, DOR
adopted a more aggressive stance to ensure uniformity among classes of
properties w i t h i n counties and among counties. As a result, i f a county's
property valuations are not a t acceptable levels DOR directs the county
assessor to apply f a c t o r s t o their valuations to meet the required
standard.
In 1985, two nationally known property tax experts noted that Arizona
appears to have made considerable progress i n the area of equalizing
property val ues. ** In addition, these two experts predicted that Arizona
will be ranked among the best, i f not the best, i n the nation i n the 1987
Census of Governments for intercounty coefficients of dispersion*** for
simi 1 a r l y c l a s s i f i e d property. In fact, DOR s t a f f have been national ly
recognized . for their accomplishments in the property tax field. The
Department and its s t a f f have received three awards from the International
* Sales ratio i s appraised value divided by the sales price.
Increasing sales ratios indicate that val uations are approaching
market value. DOR considers a sales ratio of 50 percent to
approximate the point a t which nominal sales price equals full cash
val ue.
** \/ el ch and Gustafson, " Equal ization of Commerci a1 and Industri a1 Real
Property Assessments i n the State of Arizona," June 1985
*** The coefficient of dispersion shows the variation ot a group of sales
ratios around their median. According to a DOR o f f i c i a l , a
coefficient of dispersion less than .25 is acceptable for commercial
property. For residential property, .1 to .15 i s accepta~ le.
Association of Assessing O f f i c e r s ( IAAO) since 1981, i n recognition of
t h e i r e f f o r t s t o improve assessment a d m i n i s t r a t i o n i n Arizona. Further,
the DOR employee responsible f o r the design and maintenance o f sales r a t i o
studies i n Arizona i s a n a t i o n a l l y recognized expert i n sales r a t i o
studies and has authored several assessment- related pub1 ications.
Improvements i n Statewide u n i f o r m i t y have been made f o r a l l property
classes over the l a s t f i v e years. Median sales r a t i o s have improved,
moving closer t o 80 percent, as shown i n Figure 1. I n addition,
c o e f f i c i e n t s o f dispersion have been moving toward more acceptitble l e v e l s
over t h e p a s t f i v e years, as shown i n Figure 2. These Figures i n d i c a t e a
five- year trend t h a t property valuations are moving closer t o market value
and are more uniform.
Construction Cost System
I s Inadequate
The Property Tax D i v i s i o n lacks an updated construction cost system. A
new construction cost system was purchased, but due t o problems w i t h
imp1 ementation, was never used. A1 though e f f o r t s to develop an acceptable
system are c u r r e n t l y under way, lack of resources may hinder i t s
devel opment and use.
A construction cost system i s e s s e n t i a l , e s p e c i a l l y f o r
commercial / i n d u s t r i a l properties. Such a system a1 1 ows appraisers t o
value buildings based on cost data r 2 l a t i n g t o such f a c t o r s as materials,
qua1 i ty, 1 ocation, condition and size. Fie1 d appraisers gather s p e c i f i c
information on a b u i l d i n g and i n p u t it i n t o the system, which generates a
val uation. With t h e c u r r e n t use of the cost method f o r
cornmercial/ industri a1 val uations, a construction cost system v i i t h c u r r e n t
cost data and property information i s essential t o determine accurate,
f u l l cash val uations.
Ln 0 In 0 10 0 In 0
( D ( D
In'
cO 03 I\ I' In In *
Construction Cost System Purchased But Never Used - DOR contracted f o r a
new construction cost system which was eventually abandoned. DOR and two
1 e g i s l a t i v e i n v e s t i g a t i o n s revealed t h a t the Department's construction
cost system, o r i g i n a l l y developed i n the mid 1960s, was n o t generating
equitable val uations.* Therefore, the purchase o f a new commercial l y
developed construction cost system was considered i n 1981. A f t e r
evaluation of a l l timely submitted proposals, the E. H. Boeckh Company was
awarded the c o n t r a c t t o develop a new construction cost system. The
Department paid $ 253,950 f o r t h i s system i n f i s c a l year 1982- 83. However,
several problems were discovered a f t e r t e s t s were run on the new system.
Extensive m o d i f i c a t i o n to the system would be required to
f a c i l i t a t e i t s use.
0 A concerted t r a i n i n g e f f o r t would be required t o q u a l i f y
Department and county appraisers t o use the system.
0 Some o f the cost values generated by the system were not
consistent w i t h l o c a l market construction costs.
I n addition, the system was very conlplex and took f a r more time to
generate assessments than the system it was t o replace. Furthermore, the
county assessors were r e l u c t a n t to use t h i s new systeln because, i n t h e i r
opinion, it was not adequately t a i l o r e d t o Arizona and construction
methods used i n Arizona. Consequently, i n 1985 the Department decided not
t o implement t h i s Boeckh system due t o the many problems i d e n t i f i e d .
* According to a 1983 Governor's Task Force Report on Assessment
Practices, commercial and i n d u s t r i a l values are low because o f the
antiquated rnodel used f o r cost method appraisals. As a r e s u l t , the
e x i s t i n g system has created valuation problems and resul ted i n
cost- generated val ue estimates t h a t are substantial ly less than rrlarket
val ues.
System Under Development May Be Hindered By Lack O f Resources - Although
development of an updated construction cost system i s being undertaken,
resources may not be adequate to implement the system. Presently, a
committee consisting o f county assessors and DOR personnel has been formed
t o address the development o f a system. This new system w i l l i n t e g r a t e
parts o f the Boeckh system, DOR's current system, and i n p u t from DOR's
technicians and the county assessors. Additional funds are needed to
develop and irnple~ nent t h i s new system. I n the 1986- 87 budget $ 980,000 was
requested f o r tiii s new system. The bul k of these funds i s f o r pro y rammi ng
the automated portion of the system.
However, even if t h i s money were appropriated, a d d i t i o n a l resources woul d
be necessary t o implement the new system. A l l properties would need t o be
reappraised under the new cost system to ensure t h a t t h e i r proper
c h a r a c t e r i s t i c s were included. Failure t o do t h i s would r e s u l t i n
inaccurate val uations. It appears t h a t most county assessors 1 ack the
resources to undertake the needed comprehensive review. Although the
Department i s aware of the need f o r reappraisal, it a1 so c u r r e n t l y lacks
the resources t o accomplish t h i s reexamination. The Legislature approved
e i g h t f u l l - t i m e equivalent ( FTE) positions f o r t h i s purpose i n f i s c a l year
1985- 86, but no funding was provided.
: loreover, GOR may lack the resources to make necessary revisions i n the
future. Construction cost systems should be modified w i t h updated cost
data a t l e a s t annually, t o r e f l e c t changes i n construction methoas and
costs. Presently, the D i v i s i o n has one FTE responsible f o r updating the
system. The D i v i s i o n requested two FTEs i n the 1986- 87 budget request to
a s s i s t i n updating the cost data. However, t h i s updating i s merely an
across the board percentifge adjustment appliea to cost data. The
adjustment f a c t o r f o r the 1986 tax r o l l i s 155 percent dnd w i l l be applied
t o 1978 cost data. Use o f across the board factors o f suct~ a magnitude i s
generally inaccurate. For example, i f a square f o o t o f cement cost $ 1 i n
1978, DOR would use a 19% cost o f $ 1.55. The actual cost o f cement nay
be s i g n i f i c a n t l y d i f f e r e n t . The system w i l l become obsolete unless
c u r r e n t c o s t data i s incorporated i n t o the system annually. This could be
done by DOR or a contract service.
Equal iza tion Authori ty
Needs C l ari fication
Equal ization authori ty needs cl ari fication. Statutes appear to pl ace
equalization authority under both the State Board of Tax Appeals and The
Department of Revenue. This has created confusion i n roles and
responsibilities, and may s t r a i n relations between the two agencies.
Equal ization is not defined i n the statutes. However, equal ization is
defined by the IAAO as:
. . . the process by which an appropriate governmental
body attempts to ensure that a l l the property under its
jurisdiction is assessed a t the same assessment ratio
or a t the ratio or r a t i o s required by law.
IAAO further s t a t e s t h a t the power that defines an equalization body is:
. . . the authority to apply a f l a t , across- the- board
factor adjustment to the assessments on all the
properties i n a group concerning which an assessment
bias has been discovered.
By s t a t u t e , equal ization duthori ty appears to be placed under tne Board of
Tax Appeals and the Department of Revenue. Arizona Revised Statutes
( A. R. S. ) $ 42- 1 71 reads:
The board [ of Tax Appeals] shall have full power to
equalize the valuation of a l l property throughout the
state and to hear and decide a1 1 appeals from decisions
of the dqartment of revenue.
Under A. R. S. $ 42- 1 41 , the Department of Revenue is charged tri t h ensuring
t h a t a l l property is uniformly valued for s t a t e property tax purposes.
According to A. R. S. $ 42- 1 41 , the Departnent shall :
. . . exercise general supervision over county assessors i n the
administration of tne state property tax laws of tile stdte for
the purpose of insuring that a1 1 property is uniformly valued for
s t a t e property tax purposes.
DOR ensures uniforrnity of values through the use of adjustment factors
based on assessment r a t i o s . H i s t o r i c a l ly, DOR ' s adjustment factors have
general ly been appl ied by County assessors across- the- board. DOR' s
s t a t u t o r y a u t h o r i t y t o ensure u n i f o r m i t y and DOR's use o f adjustment
f a c t o r s i m p l i e s e q u a l i z a t i o n as defined by the IAAO.
This lack o f c l a r i t y i n e q u a l i z a t i o n a u t h o r i t y has l e d t o confusion over
r o l e s and r e s p o n s i b i l i t i e s , and may have strained relationships. This
confusion i s exemplified by a 1985 c o u r t a c t i o n brought by the Department
of Revenue against the Board of Tax Appeals i n the Qlaricopa County
Superior Court, i n which the Court upheld DOR's a u t h o r i t y t o issue
valuation d i r e c t i v e s based on i t s own guide1 ines. DOR claimed t h a t four
1985 Board e q u a l i z a t i o n orders were outside the Board's a u t h o r i t y . The
equal i z a t i o n orders i n s t r u c t e d four counties to ignore the market
adjustment factors i n the Department's d i r e c t i v e s dated December 31,
1984. The Court's decision voided the f o u r e q u a l i z a t i o n orders i n
question. The Boar6 o f Tax Appeals has appealed t h i s decision. The
decision s t a t e d t h a t :
If the Board has [ the power t o r e j e c t the guidelines
and d i r e c t i v e s o f the Departnent . . . and determine
f o r i t s e l f , by i t s o w methods, what f u l l cash value
i s ] , we would have . to assume t h a t the l e g i s l a t u r e has
empowered Vdo s t a t e agencies t o perform the same task.
This would create a confused and redundant system of
taxation. The case before t h i s Court shows the e f f e c t
of such confusion when counties are subjected t o
contradictory e d i c t s from txo s t a t e agencies.
The Department o f Revenue i s b e s t s u i t e d t o carry out t h e e q u a l i z a t i o n
function i n Arizona. DOR has s i g n i f i c a n t l y more resources devoted to the
property tax area than the Board o f Tax Appeals. The Board c u r r e n t l y has
a t o t a l s t a f f o f s i x FTEs, including three property appraisers. DCR
c u r r e n t l y has a t l e a s t 40 property appraiser and examiner p o s i t i o n s out o f
a t o t a l o f 72 FTEs. The process o f e q u a l i z a t i o n requires considerable
analysis and research, which requires s t a f f resources. Therefore, f o r the
Board t o e f f e c t i v e l y perform e q u a l i z a t i o n functions, i t s resources ~ i o udl
have t o be s i g n i f i c a n t l y increased. This could ledd t o d u p l i c a t i o n o f
e f f o r t between the Board and DGR.
If e q u a l i z a t i o n a u t h o r i t y i s placed under DOR, an avenue f o r assessors and
property owners t o challenge DOR actions i s s t i l l needed. The Board o f
Tax Appeals can e f f e c t i v e l y provide f o r t h i s , w i t h o u t the need f o r court
action. E x i s t i n g s t a t u t e s g i v e the Board the f u l l power t o " hear and
decide a l l appeals from decisions o f the department o f revenue." However,
i n order t o e l iminate e x i s t i n g confusion over equal i z a t i o n a u t h o r i t y , the
power to ". . . equalize the valuation o f a l l property throughout the
s t a t e . . ." should be taken from the Board and given t o the Department.
The Board should r e t a i n f u l l a u t h o r i t y to review the Department's
equalization orders f o r compliance w i t h the law i f so requested by a
county. House B i l l 2332 c u r r e n t l y being considered by the Legislature
places e q u a l i z a t i o n a u t h o r i t y under DOR.
County Assessors Lack Confidence
I n Sales 2atio Studies
Assessors lack confidence i n DOR's sales r a t i o studies. This may be due
t o inadequate assessor involvement i n the development and use o f the
studies. Furthermore, assessors expressed concern over i n s u f f i c i e n t time
t o adequately implement DOR f a c t o r s and make adjustments based on sales
r a t i o studies.
DOR uses sales r a t i o studies t o monitor whether valuations o f property
classes are equal w i t h i n counties and among counties i n Arizona. DOR's
sales r a t i o studies monitor valuations by measuring the r e l a t i o n s h i p
between appraisals and market values. Tie data f o r market values come
from sales prices reported on A f f i d a v i t s o f Real Property Value. The
appraisals o f these p r o p e r t i e s a r e t h e v a l u a t i o n s set by the county
assessors. From sal es r a t i o information, DOR establ ishes adjustment
factors f o r those classes o f properties w i t h i n a county t h a t are appraised
be1 ow or above market val ue. *
* Market value i s set by DOR a t a t a r g e t r a t i o o f 80 percent o f nominal
sales price. For example, i f an average property i n a class s e l l s for
$ 100,000, valuations i n t h a t class should average $ 80,000. DOR sets
market value a t t h i s t a r g e t r a t i o t o eliminate non- real estate
considerations from the sales price, such as financing and personal
property. This i s t o a r r i v e a t s t a t u t o r i l y required f u l l cash value.
Use of sales ratio studies is a standard practice in property tax
monitoring. Generally, property experts support the use of sales ratio
studies. In fact, a t least 40 states use sales ratio studies in some
manner. According to the IAAO:
" The uses of assessr! ient- ratio studies can be as
wi de- rangi ng as concerns about assessment dccuracy .
Assessors use assessment- ratio studies to deterr~~ inteh e
seed for a general reappraisal, . to establ i s h priorities
for reappraisal of selected groups of properties, to
identify potential problems with appraisal procedures,
to trend appraisal s between reappraisal s, to adjust
sales prices for time, and to develop depreciation
factors. "
Inadequate Assessor Involvement - County assessors may generally lack
confidence i n sales ratio studies because of insufficient involvement in
their development and use. For example, several county assessors express
concern over the sales data used in the sales ratio studies, especially
for the commerci al/ industri a1 cl ass. Tiiey sometimes be1 ieve that sal cs
data may be insufficient for effective use in the studies. Examples of
specific questions re1 ating to sales data incl ude:
Whether there are enough sales in some classes and areas for
valid ratios to be possible,
e Whether the sales are adequately screened and verified, and
Whether the sales are properly grouped.
Some of the assessors' concerns may be valid. For example, the concern
that there are insufficient sales in some areas to support sales ratio
studies ! nay be supported by consultants' analyses. These experts point
out the need to supplement sales ratio studies w i t h actual on- site
appraisals when sufficient sales data i s lacking. In addition, i t i s
unclear whether DOR has sufficient staff t o screen and verify all sales
data.* In the summer of 1985 DOR agreed to screen all commercial sales
* Screening of sales data is important to ensure that sales included in
the studies are valid arms length transactions. Further, sales with
unique aspects such as inclusion of a large amount of personal
property, or unusual creative financing may distort the studies. Such
sales need t o be adjusted or discarded.
15
and assessors agreed t o screen a1 1 r e s i d e n t i a l sales. However, screening
o f sales i s a time consuming a c t i v i t y . According t o a DOR employee, i n
the past DOR staff d i d comnercial/ industrial sales screening as time
permitted. The D i r e c t o r of DOR stated the Department w i l l meet i t s
commitment t o screen these sales i n t h e f u t u r e . However, county assessors
are concerned t h a t DOR may n o t have the resources t o do t h i s screening
t i m e l y or adequately.
Some of the concerns assessors have may be due t o a lack o f communication
between the assessors and DOR. This i s indicated by the f a c t t h a t
property tax experts generally have a high regard f o r DOR's sales r a t i o
studies. Therefore, closer coordination between DOR and county assessor
s t a f f may improve the preparation and use o f sales data and sales r a t i o
studies. Increased cooperation may 1 ead t o b e t t e r re1 ations between the
assessors and DOR, and greater confidence i n the studies.
I n s u f f i c i e n t Time To Respond To Factors And Appeals - Assessors i n d i c a t e
t h a t they need more time t o adequately implement factors derived by DOR
from the r e s u l t s of the sales r a t i o studies. I n s u f f i c i e n t time may
perpetuate uniformity problems w i t h i n classes. There are several possible
options t o increase t h e t i m e available to implement adjustments.
November 30 i s the deadline f o r counties t o send t h e i r valuations t o DOR.
DOR then completes i t s sales r a t i o reports and determines factors f o r
counties where r a t i o s i n d i c a t e over- or under- valuations. The counties
must make adjustments based on these factors and send o i l t a l l property
v a l u a t i o n n o t i c e s by the s t a t u t o r y deadline o f February 1 .*
A Gue to county delays i n g e t t i n g valuations and a f f i d a v i t s o f sale to
DOR, and DOK delays i n completing sales r a t i o studies, the February 1
deadline has been missed by several counties over the past two years.
If n o t i c e s a r e s e n t out l a t e by counties, it reduces tile time f o r
taxpayer appeals. A l l appeals must be completed by duly 25. Last
year the Board o f Tax Appeals heard 4,000 cases. The counties and DOR
need adequate time t o respond t o these appeals.
H i s t o r i c a l l y , due to time constraints, tlie system has not allowed the
counties t o research and determine where s p e c i f i c adjustments need t o be
made. As a r e s u l t , the f a c t o r s have generally been applied across the
board f o r affected classes w i t h i n market areas or e n t i r e counties.
While t h i s addresses the u n i f o r m i t y and e q u a l i t y between and among classes
and counties, it does not address the u n i f o r m i t y and e q u a l i t y o f one
parcel of property to another w i t h i n a class. Due to county assessors'
lack o f confidence i n data v a l i d i t y and v e r i f i c a t i o n o f sales, the
assessors would l i k e the time to determine exactly which properties i n a
class are inaccurately valued and adjust those r a t h e r than applying a
percentage increase or decrease t o a l l properties i n t h a t class. I n
addition, they would l i k e t o be able t o apply f a c t o r s t o smaller areas
such as neighborhoods or submarket areas.
Time pressure could be eased i f DOR f a c t o r s were applied t o t h e f o l l o w i n g
y e a r ' s valuation, instead o f the current year's. This would give county
assessors almost a f u l l year t o apply DOR factors instead o f j u s t one
month or less. ( House B i l l 2332 contains a provision providing f o r
e q u a l i z a t i o n orders and r e v i s i o n s t o be applied i n the f o l l o w i n g tax
year. An a1 t e r n a t i v e t o t h i s W O U ~ d be f o r DCR to provi de m ia year f a c t o r s
t o counties during the course o f a year, based on p r i o r years valuations.
DOR already conducts sales r a t i o studies four tiwes per year. Another
a l t e r n a t i v e would be t o siinply move the deadline f o r valuations w i n g sent
t o DO2 from November 30 t o an e a r l i e r date.
CONCLUSION
A1 though DORIS property tax system i s general l y working we1 1, several
improvements coul d increase i t s e f f i c i e n c y and effectiveness. The
e x i s t i n g construction cost systciil i s outdated. Statutes r e l a t i n g to
equal i z a t i o n autkori ty are n o t clear. Further, county assessors 1 ack
confidence i n COR's sales r a t i o studies.
RECOMMENDATIONS
1. The Legislature shoul d consider funding for development and
implementation of an updated construction cost system, incl uding
resources for computer automation, reappraisal of all properties and
annual revision of the system.
2. The Legislature should consider giving full equalization authority
to DOR, while maintaining full authority to hear and decide appeals
i n the Eoard of Tax Appeal s.
3- DOR should more closely coordinate w i t h county assessors on the
preparation and use of sales data and sales ratio studies. Further,
DOR should consider the use of on- site appraisals, where
appropriate, to supplement sales ratio studies.
4. Alternatives for increasing the length of time assessors have to
implement DOR valuation factors should be studied and an improved
time frame should be established.
AREA FOR FURTHER AUDIT WORK
During the course o f our review we i d e n t i f i e d one p o t e n t i a l issue t h a t we
could not pursue due t o time constraints.
a I s DOR's D i v i s i o n of Property and Special Taxes understaffed?
Many county and DOR employees have stated t h a t s t a f f l e v e l s i n
assessors' o f f i c e s and i n the D i v i s i o n o f Property and Special
Taxation are not adequate. With low county s t a f f i n g l e v e l s and
budget constraints, there appears to be no a l t e r n a t i v e t o DOR
taking an a c t i v e r o l e i n helping assessors w i t h necessary
appraisal work, such as the review o f commercial/ industria1
properties i n preparation f o r the new construction cost system.
Further, DOR functions such as screening a f f i d a v i t s o f sales,
updating t h e c o n s t r u c t i o n cost manual, a u d i t i n g county assessors
and conducting on- site appraisals may be understaffed. Overall
s t a f f i n g i n the D i v i s i o n has remained re1 a t i v e l y constant over
the past f i v e years, while DOR's t o t a l authorizea FTEs have
increased by more than one- third.
Further a u d i t work, or analysis on the p a r t o f DORY i s needed t o
c l e a r l y establ i sh the s t a f f i n g 1 eve1 s required w i t h i n the
D i v i s i o n o f Property and Special Taxes. A1 tt~ ouyh the D i v i s i o n
generates l i t t l e d i r e c t revenue t o the State,* t o t a l property tax
revenues i n Arizona w i l l t o t a l more than $ 1.3 b i l l ion f o r f i s c a l
year 1985- 86. This f i g u r e , combined w i t h the p o t e n t i a l 1 i a b i l i ty
r e s u l t i n g from equity considerations, makes adequate s t a f f i n g a t
the State l e v e l important.
* The State property tax r a t e i s only 40 cents per $ 190 o f assessed
valuation, while the average t o t a l primary tax r a t e i n Arizona i s
$ 7.44.
i
larwrzo~ l~ DEPARTMENT OF
RWEMUE ,%
J. Elliott Hibbs Bruce Babbitt
Director Governor
March 21, 1986
Mr. Douglas R. Norton
Auditor General
Office of the Auditor General
2700 North Central Avenue
Suite 700
Phoenix, Arizona 85004
Dear Mr. Norton:
I have reviewed the report draft of your performance audit of the
Division of Property and Special Taxes of the Department of Revenue.
I generally agree with the findings and recommendation contained in
your report. The problems cited are real and we are addressing
them. Your recommendations are constructive, and I believe they are
directed toward desirable improvements.
My following comments are intended to clarify several issues to
permit a broader understanding by readers of this report:
Recommendation 1
The Legislature should consider funding for development and
implementation of an updated construction cost system, including
resources for computer automation, reappraisal of all properties and
annual revision of the system.
Comment
The importance of an accurate and current construction
cost system for valuation of property cannot, be
overemphasized. Your report cited consequences of failure
to develop and implement an updated coi? struction cost
system. It should be noted that funding for that purpose
has been requestec! in this Department's 1986- 87 budget.
If that funding is made available, the new system will be
implemen- ted for 1988 and the underlying inequities which
exist because of the need for an updated system can be
addressed. Some of the inequities are being alleviated
through use of sales ratio studies, but large parcel
variances between commercial properties will generally
Mailing address CCapitoll:
1700 W. Washington
Phoenix, AZ 85007
Other locations:
Phoenix Uptown
5555 N. 7th Avenue
Tucson
402 W. Congress
Mr. Douglas R. Norton
Auditor General
March 21, 1986
Page Two
Comments ( continued)
continue until a reliable construction cos- t system is
implemented. While we anticipate developing the
computerization by January 1988, the needed recanvassing
of commercial/ industrial properties will occur later as we
acquire and train needed personnel.
Recorninendation 2
The Legislature should consider giving full equalization authority a
to DOR, while maintaining full authority to hear and decide awpeals
in the Board of Tax Appeals.
We believe that uniformity and equity for all taxpayers
would be served by implementing the recommended revisions
to the equalization process.
The Dqartment of Revenue should more closely coordinate with county a
assessors on the preparation and use of sales ratio studies.
Further, 30R should consider ' che use of on- site appraisals, where
appropriate, to supplement sales ratio studies.
The Department of Revenue has made substantial efforts to
involve the county assessors in the sales ratio process
and to recognize an6 be responsive to their legitimate
concerns.
When the sales ratio system was first developed in 1979,
input was sought from the assessors and the State Board of
Tax Appeals. Educational programs for assessors and their
staffs have been conducted to teach them how to
effectively use sales ratio studies. ?/ Iod. ifications to the
system have been made several times since then in response
to the assessors' recommendations. A josnt commit- tee of
assessors and DOR staff was established in 1985 to review
sales ratio studies and their use, and to make
recommendations for improvements. The assessors '
recommendations made through that committee have largely
Seen implemented. Enhancements adopted include extension
of the time period for commercial and industrial sales to
30 months. The Department stands ready to consider
Mr. Douglas R. Xorton
Auditor General
March 21, 1986
Page Three
Comments ( Continued)
additional constructive suggestions for improvements to
the system. It should also be noted that assessors were
given the opportunity to review sales in the system to
evaluate their status as " usable" or " not usablef1 for
sales ratio purposes, and to request changes as
appropriate after that evaluation. In 1986, six counties,
including Maricopa and Pima, made a request to change the
status of numerous commercial and industrial property
sales, of which at least 95 percent were approved by the
Department.
Through agreement with the assessors, and consistent with
recommendations contained in the Welch/ Gustafson Report to
the Legislature ( June 1985), the assessors now have
primary responsibility for screening all residential
property and vacant land sales. The Department of Revenue
has taken full responsibility for screening commercial and
industrial property sales. In response to that
commitment, a staff team has been assigned to complete the
screening of commercial and industrial sales during the
last quarter of the 1985- 86 fiscal year and into the first
month of the 1986- 87 fiscal year. That schedule will
permit the assessors sufficient time afterwards to review
the commercial and industrial ? roperty sales to be used
for the initial sales ratio reports produced in September
1987. ( This reshuffling of DOR resources has the drawback
that our ability to assist some counties on reappraisal
projects will be reduced.)
Y0u. r report noted that ". . . county assessors are
concerned that DOR may not have the resources to do this
screening timely and adequately." While existing
Department resources are being diverted froin other
projec- ts to screen comrnercial and industrial sales now,
additional personnel will be required to perform those
screenings in the future. The Department's budget request
for 1986- 87 includes requested funds for a permanent
program of sales analysis.
Mr. Douglas R. Norton
Auditor General
March 21, 1986
Page Four
Recommendation 4
Alternatives for increasing the length of time assessors have to
implement DOR valuation factors should be studied and an improved
time frame should be established.
a
Comment
The Department of Revenue agrees that the time frame
should be lengthened for assessors to effectively
implement measures required to assure compliance with
legal standards of value.
House Bill 2332, as amended, provides for revised
equalization procedures and time frames as you recommend.
The bill alters the equalization process and allows time
for assessors to be involved prior to implementing
equalization orders so that valuation factors can be
placed in a fashion that produces the greatest level of
uniformity between classes and between parcels within
classes of property.
We appreciate your recognition of the improvements in property
valuation performance achieved as a result of the Department's a
active role in assuring that property values are established at more
equitable levels of market value. Those results, particularly for
the 1983 and 1985 tax years, are depicted very significantly in the
graphs included in your report.
Your staff conducted this audit under stringent time constraints and
we commend them for their professionalism and their insight in
0
identifying the core issues affecting performance of the Division of
Property and Special Taxes in administering the property tax.
Sincerely,
ARIZONA DEPARTMENT OF REVENUE
YJ. Ell iott Hibbs
Director