Taxation Committee

TAXATION COMMITTEE

The Taxation Committee was assigned four studies. House Bill No. 1206 directed a study of special assessments and property tax assessment and abatements, to include valuation of subsidized housing and the homestead tax credit for senior citizens. Senate Bill No. 2448 directed a study of compliance and jurisdictional issues under the tobacco, alcohol, and fuels tax laws. House Concurrent Resolution No. 3047 directed a study of the property tax assessment and valuation of agricultural property. Senate Concurrent Resolution No. 4031 directed a study of the state corporate income tax laws.

Committee members were Senators Rich Wardner (Chairman), Dwight Cook, Kenneth Kroeplin, Ronald Nichols, Randy A. Schobinger, Ben Tollefson, and Herb Urlacher and Representatives Michael Brandenburg, Al Carlson, Byron Clark, David Drovdal, Michael Grosz, Gil Herbel, Frank Klein, Joe Kroeber, Edward H. Lloyd, Eugene Nicholas, Kenton Onstad, Dennis J. Renner, Earl Rennerfeldt, Dan Ruby, Arlo E. Schmidt, and Ray H. Wikenheiser.

The committee submitted this report to the Legislative Council at the biennial meeting of the Council in November 2002. The Council accepted the report for submission to the 58th Legislative Assembly.

PROPERTY TAX ASSESSMENT STUDY

The committee treated the study directed by House Bill No. 1206 as separate studies of property tax assessments and abatements and improvements by special assessment. Within the study of property tax assessment and abatements, the committee addressed issues of valuation of subsidized housing and the homestead tax credit.

Background

Property Tax Liability Determination and Payment

Property tax liability is determined by multiplying taxing districts' combined mill rates times the taxable value of the property. Issues often arise regarding the determination of the mill rate, taxable value, and tax status for the property.

Property taxes are collected by the county and distributed among taxing districts according to their interests in the revenues. Property taxes are due January 1 following the year of assessment and are payable without penalty until March 1 of the year they are due. If property taxes are paid in full by February 15, the taxpayer is entitled to a 5 percent discount. Penalties begin to accrue if property taxes are not paid by March 1. Taxpayers have the option of paying property taxes in installments.

Determination of Mill Rate

The mill rate for a taxing district is established through the budget process. Final budgets of taxing districts must be submitted to the county auditor by October 10. The county auditor prepares tax lists, which must be delivered to the county treasurer by December 10, and tax statements must be mailed to property owners by December 26.

The amount budgeted by a taxing district may not result in a tax levy exceeding levy limitations established by statute. Statutory limitations of a certain number of mills per dollar of taxable valuation have been imposed for most property tax levies by political subdivisions. Since 1981 the Legislative Assembly has provided optional authority to levy taxes with a maximum amount determined by comparison with a base year levy amount in dollars. Most taxing districts in the state use this optional method of determining the maximum levy to which they are entitled. From 1981 through 1996, percentage increases were allowed by law over the base year levy in dollars. The compounding of these increases allowed taxing districts to increase levies well beyond the amount they would be able to levy under mill levy limitations. For taxable years after 1996, taxing districts may use the optional method to levy up to the amount levied in dollars in the base year without a percentage increase.

To determine the mill rate for a taxing district, the county auditor determines whether the amount levied is within statutory levy limitations and, if it is, the county auditor divides the total property taxes to be collected for the taxing district by the taxing district's total taxable valuation. This generates a percentage that is the mill rate for the district.

Assessment

Real property must be assessed with reference to its value on February 1 of each year. All property must be valued at true and full value which is defined as the value determined by considering any earning capacity, the market value, and all other matters that affect the actual value of the property. For agricultural property, this value is determined by operation of a productivity formula based on the capitalized average annual gross return of the land.

The assessed value of property is 50 percent of the true and full value of the property. Taxable valuation is a percentage of assessed valuation, which is 9 percent for residential and 10 percent for agricultural, commercial, and centrally assessed property. The taxable valuation is the amount against which the mill rate for the taxing district is applied to determine the tax liability for individual parcels of property.

Property of railroads, public utilities, and airlines is assessed by the State Board of Equalization as required by Article X, Section 4, of the Constitution of North Dakota. The owner of centrally assessed property must file an annual report with the Tax Commissioner by May 1. The Tax Commissioner prepares a tentative assessment for the property by July 15. Notice of the tentative assessment is sent to the property owner at least 10 days before the State Board of Equalization meeting, which is held on the first Tuesday in August to finalize assessments.

Equalization and Abatement

Equalization is the process provided by law to adjust property assessments to be consistent with market value or agricultural value. Property owners who are dissatisfied with assessment levels may appeal assessments through the township board of equalization or the city board of equalization in April, the county board of equalization in June, and the State Board of Equalization in August.

As an alternative to the equalization process, a taxpayer may pursue the abatement process by filing an application for abatement and refund of taxes. Several levels of review may be involved in the abatement process, which may culminate in appeal of the decision of the board of county commissioners to the district court and then to the North Dakota Supreme Court. Several statutory grounds exist for granting an abatement, including that the assessment is invalid, inequitable, or unjust.

Homestead Property Tax Credit

Since 1969 North Dakota law has provided a property tax reduction for persons 65 years of age or older with limited income. As created in 1969, the provision allowed a person 65 years of age or older with an income of $3,000 or less per year from all sources to claim a 50 percent reduction in the assessment on the person's homestead up to a maximum reduction of $1,000 of assessed valuation. This provision has been amended by 23 bills since 1969.

The income limitations in North Dakota Century Code (NDCC) Section 57-02-08.1 have been increased by legislation approved in 1973, 1975, 1977, 1979, 1981, 1985, 1989, 1993, and 1999. Other significant changes to this section include adding a matching credit and refund for renters in 1973, state reimbursement to political subdivisions of property tax revenue losses from the credit in 1975, extending the credit in 1975 to a person who is permanently and totally disabled, adding a deduction from income for medical expenses in 1977, changing the basis of the tax credit from assessed valuation to taxable valuation and proportionately reducing the amount of reductions allowed in 1983, adding an exclusion in 1983 to disallow the credit to a person whose assets exceed $50,000 not including the value of the homestead, excluding federal rent subsidies from income and excluding tax-exempt property from eligibility for the credit for renters in 1985, imposing a $6,000 limit on the credit allowed against special assessments in 1985, allowing the credit to remain available upon absence of the person from the homestead for nursing home care or care in a similar facility in 1989, and creating a definition for permanent and total disability in 1993.

Under NDCC Section 57-02-08.1, a person who is 65 years of age or older or permanently and totally disabled and whose income is $14,000 or less per year from all sources is entitled to a reduction in taxable valuation of the person's homestead. The exemption continues to apply if the person does not reside in the homestead and the person's absence is due to confinement in a nursing home, hospital, or other care facility for as long as the portion of the homestead previously occupied by the person is not rented to another person. The reduction in taxable valuation varies depending upon income as follows:

Income	Maximum Reduction in Taxable Valuation	Maximum Percentage Reduction in Valuation
$8,000 or less	$2,000	100%
$8,001 to $9,500	$1,600	80%
$9,501 to $11,000	$1,200	60%
$11,001 to $12,500	$800	40%
$12,501 to $14,000	$400	20%
Over $14,000	$0	0%

A person claiming the homestead property tax credit exemption must sign a statement that the person is 65 years of age or older or permanently and totally disabled, the person's income does not exceed $14,000 per annum, and the value of the person's assets, excluding the value of the person's homestead, does not exceed $50,000, including the value of any assets divested within the last three years.

An illustration of the effect of the homestead property tax credit may be useful in understanding how the credit applies. For the following examples, a home with a $60,000 true and full value is assumed for each homeowner, and the 1999 statewide average mill rate of 394 mills is applied to the property:

	Annual Income	Taxable Valuation Reduction	Property Tax Obligation	Property Tax Savings
Homeowner A	$7,500	$2,000	$276	$788
Homeowner B	$10,000	$1,200	$591	$473
Homeowner C	$13,500	$400	$906	$158
Homeowner D	$15,000	$0	$1,064	$0

For homeowners in the following examples, the same assumptions are used except the true and full value of the home is reduced to $30,000. In these examples, Homeowner E is eligible for complete elimination of the property's taxable valuation. Homeowners F and G are limited in the reduction they receive because the maximum percentage reduction in valuation applies to them rather than the maximum dollar amount reduction under NDCC Section 57-02-08.1.

	Annual Income	Taxable Valuation Reduction	Property Tax Obligation	Property Tax Savings
Homeowner E	$7,500	$1,350	$0	$532
Homeowner F	$10,000	$810	$213	$319
Homeowner G	$13,500	$270	$426	$106
Homeowner H	$15,000	$0	$532	$0

Homestead Property Tax Credit for Renters

Any person 65 years of age or older or permanently and totally disabled and whose income of $14,000 or less per year from all sources and who rents living quarters is eligible for a refund of a portion of the person's rent deemed to constitute payment of property taxes. Twenty percent of the person's annual rent, excluding federal rent subsidy and utilities, services, furniture, furnishings, or appliances furnished by the landlord under the rental agreement, is considered payment made for property taxes. This 20 percent of annual rent, to the extent it exceeds four percent of the annual income of the person, is refunded from the state general fund, but the refund may not exceed $240. A husband and wife who are living together are entitled to only one rent refund. The refund is not available for living quarters, including a nursing home, that is exempt from property taxes.

State Reimbursement of Homestead Property Tax Credits

Under NDCC Section 57-02-08.2, since 1975 the state has provided reimbursement to political subdivisions for property taxes lost as a result of the homestead property tax credit, and the state has also provided refunds to eligible renters under the homestead property tax credit. Each county is required to certify to the Tax Commissioner the name and address of each person allowed the homestead property tax credit for the previous year, the amount of the exemption, and the total of tax mill rates against the property. The Tax Commissioner is required to certify to the State Treasurer for payment to each county the amount of property tax excused under the homestead property tax credit.Renters entitled to a refund must apply annually to the Tax Commissioner for refunds.

The following table shows appropriations made for state reimbursement to political subdivisions and payments to renters for the homestead property tax credit for each biennium since the state began providing reimbursement:

1975-77	$3,286,014
1977-79	$2,900,000
1979-81	$3,550,000
1981-83	$6,290,000
1983-85	$5,341,000
1985-87	$4,250,000¹
1987-89	$4,706,000²
1989-91	$5,000,000
1991-93	$4,879,163
1993-95	$5,375,000
1995-97	$5,181,250
1997-99	$4,790,813
1999-2001	$4,540,813
2001-03	$4,540,813
¹ After $750,000 reduction by the 1987 Legislative Assembly.
² After $456,000 deficiency appropriation added by the 1989 Legislative Assembly.

The following table shows the number of claimants, total payments, and average payments per claimant under the homestead property tax credit:

Tax Year	Qualifying Homeowners	Paid for Homeowners	Average Per Homeowner	Qualifying Renters	Paid to Renters	Average Per Renter	Total Payments
1975*	6,004	$650,693	$108	414	$26,182	$63	$676,875
1976	6,738	$691,592	$103	508	$37,367	$74	$728,959
1977*	9,663	$1,351,324	$140	1,325	$143,352	$108	$1,494,676
1978	10,736	$1,556,881	$145	2,301	$292,458	$127	$1,849,339
1979*	10,529	$1,582,655	$150	2,572	$353,058	$137	$1,935,713
1980	10,633	$1,881,602	$177	2,594	$365,696	$141	$2,247,298
1981*	10,158	$1,970,208	$194	2,635	$387,906	$147	$2,358,114
1982	9,411	$1,886,433	$200	2,664	$414,429	$156	$2,300,862
1983	8,820	$1,841,081	$209	3,133	$516,244	$165	$2,357,325
1984	8,206	$1,818,526	$222	3,068	$519,667	$169	$2,338,193
1985*	7,362	$1,697,678	$231	2,206	$159,713	$72	$1,857,391
1986	7,567	$1,987,970	$263	1,994	$161,905	$81	$2,149,875
1987	7,540	$2,011,933	$267	1,878	$163,092	$87	$2,175,025
1988	7,546	$2,142,139	$284	1,881	$163,357	$87	$2,305,496
1989	7,307	$2,158,650	$295	1,657	$149,666	$90	$2,308,316
1990*	7,188	$2,336,992	$325	1,601	$149,705	$94	$2,486,697
1991	7,029	$2,230,637	$317	1,582	$151,600	$96	$2,382,237
1992	6,743	$2,181,292	$323	1,534	$155,205	$101	$2,336,497
1993	6,576	$2,184,714	$332	1,563	$166,739	$107	$2,351,453
1994	6,376	$2,159,466	$339	1,626	$175,554	$108	$2,335,020
1995*	6,095	$2,194,689	$360	1,590	$177,782	$112	$2,372,471
1996	5,680	$2,072,141	$365	1,499	$166,841	$111	$2,238,982
1997	5,278	$1,974,283	$374	1,482	$165,060	$111	$2,139,343
1998	4,943	$1,852,124	$375	1,454	$173,370	$119	$2,025,494
1999	4,457	$1,817,552	$408	1,508	$190,211	$126	$2,007,763
*Denotes years in which income limitations for credits were increased. The 1990 increase was approved in 1989 legislation, the 1995 increase was approved in 1993 legislation, and an increase for 2000 was approved in 1999 legislation.

Homestead Credit for Special Assessments

Under NDCC Section 57-02-08.3, a person who is qualified for the homestead property tax credit may also elect to qualify for a homestead credit against special assessments. The credit is available only for annual installments of special assessments and must be claimed each year the applicant wants the credit. The total amount of credits allowed for any parcel of property may not exceed $6,000, not including interest charged by the governing body levying the special assessment. The amounts claimed are to be reported by the county to the Tax Commissioner for payment to the special assessment district.

The amount of the homestead credit for special assessments, plus interest of 9 percent per year, is a lien in favor of the state against the property upon which the special assessment credit is allowed. The lien is generally payable from the estate of the claimant, and title to the homestead may not be transferred without the lien being satisfied, except in the case of a transfer between spouses because of the death of one of them, in which case the lien need not be satisfied until the property is again transferred.

Subsidized Housing Valuation

The three basic approaches to valuation of property are the income approach, cost or replacement approach, and sales comparison or market approach. Senate Bill No. 2348, which failed to pass in 2001, would have required valuation of subsidized housing by the income approach and consideration of only actual rental income and expenses. The legislation was supported by developers of low-income housing under Section 42 of the Internal Revenue Code.

Under Section 42 of the Internal Revenue Code, a developer is eligible for an income tax credit for developing qualifying low-income rental property. The credit may be sold to investors to raise money to make financing a project feasible. For 30 years, rent limitations and tenants' income limitations apply to the rental units. The North Dakota Housing Finance Agency selects and monitors buildings under the tax credit program. Different tenant income and rental unit rent restrictions are established by the Department of Housing and Urban Development for each county.

Committee Consideration

Assessment Issues

The committee reviewed the effect of special assessments on the assessed valuation of the property. The Property Tax Division of the State Tax Department has taken the position that the amount of special assessments should be added to the true and full value of property because special assessment projects are improvements to property.

The committee reviewed use of the sales ratio study in smaller communities. The sales ratio study is intended to improve assessment quality by comparing sales prices to true and full valuation. A minimum sample of 30 sales each for residential and commercial property is required for use of the sales ratio study in each county and major city. If the number of sales in the year does not meet the minimum sample size, data must be supplemented with sales from three prior years or the current year appraisals. For communities in which property sales are infrequent or there are no purchasers for property, the sales ratio study is a reference, but valuations should reflect local conditions.

Property tax burden has shifted from agricultural property to residential property from 1990 to 2000. During this period, there have been increases in property taxes levied on all classes of property. From 1990 to 2000, agricultural property declined from 43 to 38 percent of property valuation and from 34 to 29 percent of total property taxes. In that period, residential property increased from 29 to 35 percent of property valuation and from 34 to 41 percent of total property taxes. Commercial property and centrally assessed property remained fairly constant in their shares of valuation and taxes levied from 1990 to 2000.

The committee reviewed when fee hunting or similar use would cause agricultural property to lose its agricultural tax status. If the primary use of property is for hunting or some other nonfarming activity, the property should be classified as commercial property. If farming is the primary or dominant use of property and commercial hunting or other activity on the property is incidental, the property does not lose its status as agricultural property.

Homestead Property Tax Credit

Income limits under the homestead credit law have been increased in recent years, but the maximum reduction against property values has not been changed. Homeowners who previously received complete exemption of their property may now be subject to taxes on part of the value of the property because the maximum reduction has not kept pace with property valuations. The existing maximum reduction eliminates taxes on about $44,000 of true and full value, which covered most eligible property at the time the exemption was created. Other weaknesses noted by the committee under the homestead property tax credit are that income limitations do not respond to changing economic conditions and the same income limit applies to a single person and a married couple.

Subsidized Housing Valuation

The committee was asked to recommend legislation to provide for uniform valuation of Section 42 properties across the state. The committee considered legislation enacted in Iowa and noted there were resulting problems in valuation of similar properties. An approach was recommended to provide a partial property tax exemption for housing that qualifies for the Section 42 credit. The committee considered an approach to value these properties under normal assessment procedures and subtraction from the true and full value of components of the value to the renter of having rent restrictions and the value of the income tax credit under Section 42. The committee was urged not to recommend the bill draft for property tax exemption of subsidized housing. Developers of property under Section 42 receive an upfront subsidy under federal tax law and providing a property tax break for these properties was characterized as an additional competitive advantage for these developers, with whom private developers compete in the housing market. The state supervisor of assessments said proper assessment of subsidized housing should recognize limitations on valuation, using either the income approach or the market approach. Committee members noted other types of subsidized housing programs would not be provided special valuation under the approach considered. The committee makes no recommendation with respect to a partial property tax exemption for subsidized housing.

Recommendation

The committee recommends House Bill No. 1054 to revise eligibility for the homestead property tax credit. The bill establishes income limits in five income categories. If an eligible person's income does not exceed the federal poverty level, the person is entitled to a reduction of 100 percent of taxable valuation of the person's homestead, with a maximum reduction of $80,000 in true and full valuation. Based on February 2002 guidelines from the United States Department of Health and Human Services, the federal poverty level was $8,860 for a single person and $11,940 for a couple. Income up to 110 percent of the federal poverty level would entitle the claimant to an 80 percent reduction of the taxable valuation of the homestead, with a maximum reduction of $64,000 in true and full valuation. The 110 percent limit is equivalent to $9,746 for a single person and $13,134 for a couple. Income not exceeding 120 percent of the federal poverty level would entitle the claimant to a 60 percent reduction of the taxable valuation of the homestead, with a maximum reduction of $48,000 in true and full valuation. The 120 percent limit is equivalent to $10,632 for a single person and $14,328 for a married couple. Income not exceeding 130 percent of the federal poverty level would entitle the claimant to a 40 percent reduction of the taxable valuation of the homestead with a maximum reduction of $32,000 in true and full valuation. The 130 percent limit is equivalent to $11,518 for a single person and $15,522 for a couple. The highest income category of eligibility in the bill is 140 percent of the federal poverty level, which would entitle the claimant to a reduction of 20 percent of the taxable valuation of the homestead, with a maximum reduction of $16,000 in true and full valuation. The equivalent income at the 140 percent limit is $12,404 for a single person and $16,716 for a couple. Current law limits the credit to claimants with income of $14,000 or less, so the bill would reduce the income limitation for a single person and increase the income limitation for a couple. The bill provides that for renters the maximum $240 rent refund per year would remain available, but the same income categories are applied by the bill for the homestead credit based on the federal poverty level. The state reimburses political subdivisions for property tax revenues not received because of the homestead credit, so the bill would have a fiscal effect to the state. The estimated fiscal effect to the state of the bill would be an additional $1,362,244 per biennium, which would be added to the current state cost per biennium of $4,540,813.

SPECIAL ASSESSMENTS STUDY
Background

Under North Dakota law, cities have had authority to levy special assessments for improvements since 1897, counties have had that authority since 1983, and townships were given that authority in 2001.

Eight chapters of the North Dakota Century Code govern improvements by special assessment in cities. County authority for improvements by special assessments is based on a reference to city provisions. Township special assessment levy authority is governed by an abbreviated statutory procedure provided under NDCC Chapter 58-18. Special assessments for city projects are the most common and were the primary focus of the study.

An improvement district must be created by ordinance or resolution as a jurisdictional prerequisite before a public improvement to be paid for by special assessments may be undertaken. There is no statutory provision for initiation of improvements by special assessment by petition but it appears that special assessment districts are almost universally initiated by petition of property owners. After a petition is received or the governing body decides to proceed, the city generally schedules an informal meeting with property owners or notifies them by mail that a project will be considered. The size and the form of a special assessment district is decided by the city governing body after consultation with the city engineer.

A city may create a water district, sewer district, water and sewer district, street improvement district, boulevard improvement district, flood protection district, or parking district. After a district is created, the city governing body must direct the city engineer to prepare a report as to the nature, purpose, and feasibility of the improvement, an estimate of the probable cost of the project, and detailed plans and specifications for construction.

After filing and approval of the city engineer's report, the city governing body may adopt a resolution declaring the necessity of the improvements. A resolution of necessity is not required if the improvement is a water or sewer improvement, service charges will pay for the improvement, or a petition signed by owners of a majority of the area of property included within the district has been received. The resolution must be published once each week for two consecutive weeks in the official newspaper of the city. Within 30 days after the first publication of the resolution of necessity, owners of property in the proposed improvement district may file written protests. If protests are received from owners of a majority of the area of property within the improvement district, the protest is a bar against the improvement project. If protests are received from owners of a majority of any separate property area within the district, the protest is a bar against the portion of the improvement to be assessed in whole or in part upon property within that area.

If sufficient protests are not filed and the resolution of necessity is adopted, the city governing body must advertise for bids on a project. The governing body must award a contract for construction of a public improvement to the lowest responsible bidder. The governing body may reject any bid and readvertise for proposals if no bid is satisfactory. If a contract for construction of a public improvement is estimated to exceed $100,000, plans, drawings, and specifications must be procured from a licensed architect or registered professional engineer. Before acceptance of any bid, the governing body must require the city engineer to reestimate the cost of the work under the bids. The governing body may not award the contract if the city engineer's estimate of work under the bids exceeds the engineer's original estimate by 40 percent or more.

A special assessment commission of three appointed city residents must determine the amount each parcel of property will be especially benefited and assess against each parcel the amount necessary to pay its just proportion of the total cost. Benefits are assessed against property on a per square foot basis or on a linear foot of frontage basis. Property of political subdivisions is not exempt from special assessments.

A complete list of assessments must be prepared showing each parcel benefited by the improvement and the amount assessed against it. The assessment list must be published in the official city newspaper once each week for two consecutive weeks and include a notice of the time and place to hear objections to assessments. At the hearing, the special assessment commission or the city auditor may make alterations in assessments. Any person still aggrieved after the hearing may file a written notice of appeal with the city governing body.

A special assessment is a lien against the property on which it is levied. Special assessments may be paid by a property owner without interest within 10 days after they have been approved by the city governing body. After 10 days, interest accrues on special assessments at an annual rate not exceeding one and one-half percentage points above the average net annual interest rate on any warrants or bonds for which they are pledged. Special assessments are generally payable in annual installments, which for most projects may be extended for up to 30 years. Annual installments of assessments must be certified by the city auditor to the county auditor for collection with property tax collections.

For a defined area outside the limits of any incorporated city, the board of county commissioners may levy special assessments for improvements. Initiation of a special assessment district by a county may be by receipt of a petition of 60 percent of the landowners in the defined area or by resolution of the board of county commissioners. A county is given all the statutory authority and duties with regard to special assessments which belong to cities.

A board of township supervisors may create an improvement district upon petition of 60 percent of the freeholders in a proposed improvement district. Each improvement district must be of a size and form to include all properties the township board of supervisors believes will be benefited by the improvement project.

Committee Consideration

Committee members expressed concern whether adequate notice of special assessment projects is provided to property owners. One concern is that current law does not require property owners to be informed of the estimated special assessment amounts against their property at the time they have an opportunity to protest a project. Another concern is that current law requires newspaper publication of notice of special assessment projects but does not require notice by mail to affected property owners. The committee considered and received testimony relating to a bill draft that would have required inclusion of estimated assessments against property in the resolution of necessity for a special assessment project. Representatives of the North Dakota League of Cities opposed the bill draft, saying that this requirement would add substantial costs to special assessment projects and that actual costs of projects are not known until completion of a project in most cases. The committee makes no recommendation with respect to the bill draft.

Committee members expressed concern that citywide special assessment projects do not require voter approval. The committee considered and received testimony on a bill draft that would have required voter approval of special assessment improvements in a city of 5,000 or more population if the improvement district contains 75 percent or more of the area of property within the city. The bill draft would have required voter approval after the opportunity to protest a project has passed and before the project is let for bids. Representatives of the North Dakota League of Cities said there may be some problems with the bill draft approach, including the fact that park districts may impose special assessments for certain projects and must do so on a citywide basis but do not have authority to call an election. The committee makes no recommendation with respect to the bill draft.

Committee members expressed concern about the amount of expenses that may be added to special assessment improvement projects. The committee considered a bill draft that would have provided that expenses added to a special assessment improvement project may not exceed the actual expenses for engineering and attorneys' fees, publication, and other administrative expenses. City officials reviewed the fees added to construction costs in special assessment projects. Estimated fees are added to special assessment projects and although fees vary on individual projects, estimated fees prove to be quite accurate over time and a variety of projects. City officials opposed the bill draft on the grounds that actual costs and fees on projects may not be known until long after the assessments must be spread against property and in some cases it may never be possible to determine actual costs and fees. It was also suggested that determination of special assessment costs and fees is a local issue and should be left to local decisionmakers. The committee makes no recommendation with respect to the bill draft.

The committee reviewed city flood control special assessments applied in Grand Forks. State property in Grand Forks is exempt from flood control special assessments under NDCC Section 40-23-22.1 in recognition of state financial assistance for flood control provided to Grand Forks. Grand Forks city officials requested authority to impose city flood control special assessments against private commercial structures on state land and University of North Dakota officials stated that they would not object to this approach if it is carefully structured to not impact existing facilities.

Recommendation

The committee recommends Senate Bill No. 2052 to allow imposition of city flood control special assessments against private commercial structures on state land. The bill is intended to allow flood control special assessments against a hotel and another commercial venture to be located on University of North Dakota property. The bill would not allow assessments against a structure if the net profit is dedicated to the state institution, which is intended to exempt the Engelstad Arena at the University of North Dakota from assessments.

The committee recommends Senate Bill No. 2053 to provide for uniform use of phrases in special assessment provisions relating to "probable cost of the work" and "probable cost of the improvement." The bill provides that cost of the work refers to construction costs. The cost of the improvement refers to all special assessment project costs, including cost of the work plus costs of extra work, fees, publication, and other associated expenses.

COMPLIANCE AND JURISDICTION UNDER TOBACCO, ALCOHOL,
AND FUELS TAX LAWS STUDY
Background

Legislation was considered and defeated in 2001 (Senate Bill No. 2448) which would have reinstated the use of tax stamps on cigarette packages, as was required by law from 1925 until 1991. Since 1991 distributors have been required to remit taxes monthly on all taxable sales of cigarettes, but stamps on packages have not been required. The bill was introduced because of concerns that evasion of the state tobacco tax might be the cause of recent substantial declines in tobacco tax revenues. A substantial amount of opposing testimony was received on the issue of reinstating tax stamps. The bill was amended to provide for a Legislative Council study and alcohol and fuels taxes were added to the study subjects. Tobacco, alcohol, and fuels taxes are collected at the wholesale level.

A state tax of 44 cents per package of cigarettes is imposed at wholesale. Cigars and pipe tobacco are taxed at 28 percent of wholesale purchase price. Snuff is taxed at 60 cents per ounce and chewing tobacco is taxed at 16 cents per ounce. Because the state lacks tax jurisdiction on Indian reservations under federal law and court decisions, sales by a distributor to enrolled tribal members are not subject to state taxes.

A motor vehicle fuels tax and a special fuels tax of 21 cents per gallon is imposed on fuels sold to retailers or directly to consumers. Special fuel that is dyed for federal fuel tax exemption purposes and sold for use as heating fuel or for an agricultural, industrial, or railroad purpose is exempt from the 21 cents per gallon tax but is subject to a special excise tax of 2 percent of the purchase price. Dyed fuel may not be used in a licensed motor vehicle.

Alcoholic beverage taxes are imposed at the wholesale level. Taxes are imposed on a per gallon basis ranging from eight cents per gallon for beer in bulk containers to $4.05 per gallon for alcohol. Effective July 1, 2001, alcoholic beverage tax collection responsibilities were transferred from the State Treasurer to the Tax Commissioner.

Tribes have authority to impose taxes on reservations in this state. Collection of tribal taxes by the state is allowed if a tribal-state tax collection agreement is executed and previously approved by the Governor. Agreements are in place with the Standing Rock Sioux Tribe in which the Tax Commissioner acts as an agent of the tribe for collection of tribal cigarette and tobacco taxes and fuels taxes.

Committee Consideration

The Tax Department reported a high level of compliance under the tobacco tax laws. In response to concerns about tax-free cigarettes being purchased on Indian reservations and resold at retail outside the reservations without payment of taxes, the Tax Department conducted over 120 field reviews of businesses located outside Indian reservations in the state and found no evidence of illegal sale of untaxed tobacco products. A nonmember of a tribe is entitled to have in possession one carton of untaxed cigarettes under state law. It appears reductions in tax revenues are substantially attributable to legal purchases and possession of untaxed cigarettes and tobacco products on Indian reservations by nonmembers of tribes.

The Tax Department reported a high level of compliance with the dyed fuels provisions of state law. The Internal Revenue Service checked vehicles in North Dakota and Minnesota and found minimal violations on either side of the border. The Tax Department reported that special fuels dealers have been doing an excellent job in attempting to make sure they are selling dyed fuels for use in nonlicensed vehicles only.

The North Dakota Highway Patrol is responsible for enforcement of the law prohibiting use of dyed fuels in licensed vehicles. An officer will request a fuel sample from a vehicle when the officer has reasonable suspicion to believe the vehicle is using dyed fuel or as part of an investigation following information received of an alleged violation. Highway Patrol enforcement of the dyed fuels law is subject to constitutional limitations on search and seizure, which the Highway Patrol understands to mean that roadblocks similar to sobriety checkpoints may not be used to collect fuel samples to check for the presence of dyed fuels.

During the interim, the Wahpeton-Sisseton Sioux Tribe began ownership and operation of a fuel-blending facility that purchases fuel from out-of-state sources and sells fuel at wholesale to a retail facility also owned and operated by the tribe. Because the wholesale and retail operation are owned by the tribe, sales of fuel are not subject to state taxes. Retail prices of gasoline at the retail outlet were substantially less than the prices of other retailers in the region.

The Tax Department reviewed the jurisdictional issues involved in tribal fuel sales and state tax authority. North Dakota is one of eight states that have entered fuels tax agreements with tribes. The Standing Rock Sioux tribe and the Tax Commissioner have entered a state-tribal tax collection agreement for motor fuels taxes and other tribes in North Dakota have inquired about the possibility of entering similar fuels tax agreements with the state. In 2001 the Idaho Supreme Court decided that Idaho could not levy its motor fuels tax on fuel sold to an Indian tribe on its reservation and federal law does not authorize a state levy on those fuels. This decision has been appealed to the United States Supreme Court and the outcome may dictate the future of state and tribal motor fuels tax authority on reservations.

The objectives of state-tribal fuels tax agreements are to provide a method for the tribes to gain tax revenue, allow the state to share revenue, allow the state to protect non-Indian fuel dealers from a competitive disadvantage caused by a difference in tax rates, and allow the tribes and the state to avoid the cost of expensive litigation. There appears to be no advantage for the state to enter a tax collection agreement with a tribe if the state and tribal fuels tax rates are not the same. If the rates are not the same, some taxpayers will be at a competitive disadvantage.

A Tax Department representative said the 2001 transfer of alcohol tax collection responsibilities from the State Treasurer to the State Tax Commissioner has gone smoothly. Cooperation from the beverage industry and the office of the State Treasurer have assisted in the transition. The Tax Department reported no problems with compliance and jurisdiction issues under the alcohol tax.

Conclusion

The committee makes no recommendation with respect to the tobacco, alcohol, and fuels tax compliance and jurisdiction study.

CORPORATE INCOME TAX STUDY
Background
Tax Rates History

Corporate income taxes were first imposed in North Dakota in 1919, with the imposition of a flat rate tax of 3 percent on total net income of corporations. The 1919 legislation also imposed an additional tax of 5 percent on total net income of corporations received during a calendar or fiscal year and remaining undistributed six months after the end of that year.

In 1923 the corporate income tax was imposed at a flat rate of 3 percent of net income taxable to this state, and provisions were added for allocation of income to the state. The 5 percent additional tax on undistributed income was eliminated.

In 1937 a graduated corporate income tax rate structure was created. The highest rate, 6 percent, was applied to corporate income exceeding $15,000 per year.

In 1978 an initiated measure was approved by the voters to add a rate of 8.5 percent for corporate taxable income exceeding $25,000.

In 1981 the highest corporate income tax rate was reduced to 7 percent and applied to income exceeding $50,000 per year.

In 1983 corporate income tax rates were increased by 50 percent. After the 1983 changes, which are still in effect, North Dakota corporate income tax rates are:

Taxable Income	Taxable Rate
$3,000 or less	3.0%
Over $3,000 but not over $8,000	4.5%
Over $8,000 but not over $20,000	6.0%
Over $20,000 but not over $30,000	7.5%
Over $30,000 but not over $50,000	9.0%
Over $50,000	10.5%

Exempt Corporations

An insurance company paying the insurance premiums tax is exempt from the corporate income tax. Insurance company earnings from business activities not subject to insurance premiums taxes are subject to corporate income taxes.

Financial institutions paying a financial institutions tax are exempt from corporate income taxes. Financial institutions pay a tax of 7 percent of taxable income.

Any organization exempt from the federal income tax is exempt from state income taxes. A substantial number of corporations, including several kinds of nonprofit corporations, are exempt from federal income taxes under the Internal Revenue Code. The most common basis for invoking tax-exempt status is an exemption for organizations operated exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes or to foster national or international sports competition or prevent cruelty to children or animals. Other Internal Revenue Code provisions provide exemptions for civic leagues or social welfare organizations; labor, agricultural, or horticultural organizations; business leagues, chambers of commerce, real estate boards, and boards of trade; social clubs; credit unions; farmers' cooperatives; political parties; homeowners' associations; fraternal benefit societies; cemetery companies; local life insurance associations; mutual irrigation companies; or mutual or cooperative telephone companies or similar organizations; certain insurance companies; certain United States instrumentalities; teachers' local retirement fund associations; certain fraternal organizations; farmers' cooperative associations; certain veterans' organizations; qualified state tuition programs; and certain other special purpose corporations.

Taxable Income of Corporations

The starting point for determination of North Dakota corporate income taxes is a corporation's federal taxable income. Corporate taxable income can be an extremely complicated calculation but simply stated consists of gross income minus deductions. Federal gross income includes gross profit, determined by totaling gross sales and gross receipts from services minus the cost of goods sold; receipts from dividends, interest, rents, and royalties; net gain on sales or exchanges; and other income. Deductible expenses include salaries and wages of officers and employees, repairs, bad debts, rents, taxes, interest expenses, losses on sales or exchanges, contributions, amortization, depreciation, depletion, advertising, pension and profit-sharing, employee benefits, casualty losses, research and experimental costs, and certain other special deductions.

The North Dakota corporate income tax applies to the portion of a corporation's taxable income that is derived from sources within North Dakota. A corporation that conducts business only within North Dakota uses its federal taxable income as its North Dakota taxable income. A corporation that conducts business inside and outside North Dakota must apportion its federal taxable income to determine the portion that is attributable to sources within North Dakota. The apportionment factor is a percentage that is the average of North Dakota property, payroll, and sales compared to the corporation's total property, payroll, and sales.

Unitary Business Reporting

A corporation that is part of a unitary business involving one or more corporations, including consideration of operations outside the United States, must file using the combined reporting method. A "unitary business" is a group of corporations carrying on activities that transfer value among themselves through the unities of ownership, operation, and use. Unity of ownership means the group is under the common control of a single corporation, which is also a member of the group. Control exists when the controlling corporation directly or indirectly owns more than 50 percent of the voting stock of a controlled corporation. Unity of operation means the group receives benefits from functional integration or economies of scale. Unity of use means the group of corporations contributes to or receives benefits from centralized management and policy formation. When unity of ownership exists, there is a presumption that the corporations are engaged in a unitary business if all activities of the group are in the same general line or type of business, activities of the group constitute different steps in a vertically structured enterprise, or the group is characterized by centralized management.

North Dakota is one of 23 states that have adopted the Uniform Division of Income Tax Act. This provides for apportionment of corporate income and contains detailed provisions relating to property, payroll, and sales factor computations.

Water's Edge Election

A corporation required to file its North Dakota return using the worldwide unity combined reporting method may elect to use the "water's edge" method. This election allows exclusion of consideration of most corporate income sourced outside the United States. The water's edge election must be made on the return as originally filed and is binding on the corporation for five consecutive years. If the election is made, the corporation may not use the deduction for federal income taxes paid. A corporation electing to use the water's edge method must file with the Tax Commissioner a domestic disclosure spreadsheet and must refile the spreadsheet every third year while the election remains in effect. A domestic disclosure spreadsheet must fully disclose income reported to each state, state tax liability, the method used to apportion or allocate income to the various states, and other information required to determine the proper tax due to each state and to identify the water's edge group.

Deductions, Additions, Credits, and Exemptions

A corporation is entitled to subtract from taxable income each of the following items:

Interest received from obligations of the United States included in taxable income on the federal return.
Income included in taxable income on the federal return which is exempt from taxation by the state under the Constitution of the United States or the Constitution of North Dakota.
The amount of federal income tax liability to the extent those taxes are computed on income that becomes part of North Dakota taxable income.
Net income not allocated and apportioned to this state which was included in federal taxable income.
Dividends received by the corporation from a corporation that has paid North Dakota corporate income taxes or from a financial institution that has paid financial institutions taxes under NDCC Chapter 57-35.3.

The following must be added to taxable income:

Income taxes, including taxes of foreign countries, that were deducted to determine federal taxable income.
Interest and dividends from foreign securities and securities of states and political subdivisions exempt from federal income taxes, but not including obligations of the state of North Dakota or any of its political subdivisions.
Accelerated cost-recovery system depreciation on assets placed in service in 1981 or 1982.
Safe-harbor lease amounts deducted on the federal return if the minimum investment by the lessor is less than 100 percent.

Corporate income tax credits are allowed for:

Wages and salaries paid by a new business, in the amount of 1 percent of all wages and salaries for the first three years and one-half of 1 percent of all wages and salaries for the fourth and fifth years. A corporation that receives a new or expanding business income tax exemption under NDCC Chapter 40-57.1 does not receive this credit.
Investment in a North Dakota venture capital corporation in the amount of 25 percent of the investment or $250,000, whichever is less.
Investment in a small business investment company, limited to 25 percent of the amount invested.
Investment in a certified nonprofit development corporation, limited to 25 percent of the amount invested.
Research and experimental expenditures incurred within North Dakota.
Contributions to nonprofit private high schools and nonprofit private colleges in the state.
Installation of geothermal, solar, or wind energy devices.
Installation of alternative fuel equipment on a North Dakota licensed motor vehicle.
A portion of North Dakota wages paid to a developmentally disabled or chronically mentally ill employee.
Qualified investments in a North Dakota renaissance fund corporation.
Investment in historic property preservation or renovation in a renaissance zone.

Certain activities are exempt from corporate income taxes. A new or expansion project in primary sector business or tourism qualifies for an income tax exemption for up to five years. The exemption is limited to income earned from the qualifying project and the operator is required to file a return even though an exemption is granted. A project may not receive the exemption if the project receives a tax exemption under tax increment financing, the exemption fosters unfair competition or endangers existing business, or there is a recorded lien for delinquent property, income, or sales or use taxes against the project operator or principal officers.

Renaissance zone exemptions are available to exempt business income for five years for purchasing or leasing renaissance zone real property for use in the business or for improving renaissance zone real property used in the business. A renaissance zone exemption is also available for investment income for five years from renaissance zone residential or commercial real property purchased solely for investment purposes.

Tax Collections

The corporate income tax is a significant source of revenue for the state general fund. The following table shows corporate income tax collections in recent years:

Fiscal Year	Net Collections
1990	$40,486,001
1991	$49,321,208
1992	$36,778,251
1993	$42,525,921
1994	$50,727,400
1995	$44,027,738
1996	$49,047,417
1997	$50,300,520
1998	$65,543,025
1999	$57,877,194
2000	$47,528,001
2001	$51,606,853

Committee Consideration

The committee received information from several sources on the significance of corporate income taxes as a business location factor. Testimony supported the conclusion that state tax policy is not a primary consideration of businesses in choosing a location for new or expanding business. Even when tax policy becomes a consideration, it is not only corporate income taxes that must be considered but also workers' compensation and unemployment insurance rates, property taxes, and other state and local government costs of business. Studies of the issue indicate that tax policy is only a small part of business costs, but it receives attention because businesses view taxes as negotiable by use of tax incentives in business location decisions. The Economic Development and Finance Division applied an economic analysis model to gauge the effect on the North Dakota economy of eliminating the corporate income tax. The analysis projects increases in employment and statewide economic output, but these gains did not offset the loss of corporate income tax revenue to the state. A Tax Department analysis of the same issue concluded that it would be necessary to create 75,000 new jobs paying an average annual salary of $50,000 to offset the revenue lost to the state from elimination of the corporate income tax.

The committee considered a bill draft that would have repealed the corporate income tax. The Tax Department estimated the fiscal effect of repeal of the corporate income tax as a loss of $8.6 million in the first six months of 2003 and a loss of $79.5 million in the 2003-05 biennium. The committee makes no recommendation with respect to the bill draft.

North Dakota is one of five states that allow a corporate income tax deduction based on the amount of federal corporate income taxes paid. A revenue-neutral elimination of the federal income tax deduction for North Dakota corporations would result in a substantial reduction in the corporate income tax rates in North Dakota. However, the change would not be revenue-neutral for all corporations. Because of variable circumstances of corporations, eliminating the federal income tax deduction and making a corresponding reduction in the state corporate income tax rates would result in some paying more and some paying less than they pay under current law. The committee considered but makes no recommendation with respect to a bill draft that would have eliminated the federal income tax deduction and made corresponding revenue-neutral reductions in state corporate income tax rates.

Recommendation

The committee recommends Senate Bill No. 2054 to eliminate the federal income tax deduction for state income tax purposes and to replace existing graduated corporate income tax rates with a corporate income tax flat rate of 6.84 percent. The bill provides a corporate income tax flat rate of 9.9 percent for taxable income of corporations filing under the water's edge election. The reason for the higher rate for water's edge filers is that under current law, those filers must forego the federal income tax deduction for the privilege of filing on a water's edge basis and because the federal income tax deduction is eliminated by the bill, not imposing taxes at a higher rate would provide a much greater incentive for filing on a water's edge basis than exists under current law. The bill is intended to enhance the attractiveness of North Dakota's tax climate by reducing corporate income tax rates from the existing high of 10.5 to 6.84 percent. The fiscal effect of the bill is estimated to be a loss of $700,000 in the first six months of 2003 and a loss of $3.2 million for the 2003-05 biennium.

AGRICULTURAL PROPERTY ASSESSMENT STUDY
Background

In 1981 the Legislative Assembly restructured property tax assessments in the state and changed the basis for valuation of agricultural property to a formula based on the property's productivity value. True and full value of agricultural property for property tax purposes is based on productivity, as established through computation of the capitalized average annual gross return of the land as made by North Dakota State University Department of Agricultural Economics.

The Department of Agricultural Economics determines annual gross return for property based on the best statistical agricultural production information it can obtain. For minor production crops, such as lentils and field peas, production statistics are not available so values based on known crops are substituted. Canola was in this category until 2000, when the National Agricultural Statistics Service recognized the growth in canola production and began gathering production data. It is not believed that lack of data on minor crops has a substantial impact on countywide valuations.

Annual gross return for rented land is determined from crop share or cash rent data, and for other land, annual gross return is 30 percent of annual gross income for cropland used for growing crops other than sugar beets or potatoes, 20 percent of annual gross income for cropland used for growing sugar beets or potatoes, and 25 percent of annual gross income potential based on animal unit carrying capacity of the land for land used for grazing animals. Average annual gross return for each county is determined by using annual gross returns for the county for the 10 most recent years, discarding the highest and lowest annual gross returns from those years, and averaging the returns for the remaining eight years. Average annual gross return is indexed for inflation to reflect changes in prices paid by farmers. This cost of production factor is determined by the Department of Agricultural Economics by comparing National Agricultural Statistics Service indexes of prices paid by farmers over a period of 10 years, discarding the highest and lowest years' indexes, and averaging the remaining eight years' indexes. This amount is divided by the base year index of prices paid by farmers during the seven-year period ending in 1995.

Average annual gross return for agricultural property is capitalized using a 10-year average of the most recent 12-year period for the gross Farm Credit Services mortgage rate of interest.

An average agricultural value per acre is established for cropland and noncropland on a statewide and countywide basis. The Department of Agricultural Economics provides this information to the Tax Commissioner by December 1 of each year, and the Tax Commissioner provides the information to each county director of tax equalization. The county director of tax equalization uses the countywide average received from the Tax Commissioner as the basis for determining and providing each assessor in the county with an estimate of the average agricultural value of agricultural lands within the assessor's district. The assessor uses the average valuation received from the county director of tax equalization to determine the value of each assessment parcel within that district. Within each county and assessment district, the average of values assigned to agricultural property must approximate the averages determined under the formula for the county or assigned to the district by the county director of tax equalization. In determining relative values of parcels of property, local assessment officials are to use soil type and soil classification data whenever possible.

Inundated agricultural land is an exception to the valuation formula. Inundated agricultural land is defined as agricultural property containing a minimum of 10 contiguous acres, if the value of the inundated land exceeds 10 percent of the average agricultural value of noncropland for the county, which is inundated to an extent making it unsuitable for growing crops or grazing farm animals for two consecutive growing seasons or more and which produced revenue from any source in the most recent prior year which is less than the county average revenue per acre for noncropland. Application for classification as inundated agricultural land must be made in writing to the township assessor or county director of tax equalization by March 31 of each year. Before all or part of a parcel of property may be classified as inundated agricultural land, the board of county commissioners must approve that classification for that property for the taxable year. The agricultural value of inundated agricultural lands must be determined by the Department of Agricultural Economics to be 10 percent of the average agricultural value of noncropland for the county as determined under the formula. Valuation of individual parcels of inundated agricultural land may recognize the probability that the property will be suitable for agricultural production as cropland or for grazing farm animals in the future.

Committee Consideration

The committee received a detailed review of the gathering of statistics and operation of the agricultural property valuation formula. Production statistics for the most recent 10 years are used in the formula and the high and low years are eliminated and the remaining eight years averaged. Gross revenue for cropland in each county is based on acreage yield per acre and price for each crop for the county. These statistics are gathered by the National Agricultural Statistics Service of the United States Department of Agriculture. Gross revenue from crop production is determined for each crop grown in the county by multiplying acreage times yield per acre to determine production, production is multiplied times price to determine value of production for each crop in the county, acres for summer fallow and all crops are added, and values of production for all crops are totaled to determine county cropland production. Rangeland and pastureland is valued by estimating value of calves and cull cows produced per acre. These estimates are based on the livestock carrying capacity measured in animal unit months, which is assumed to be enough grazing capacity to support a 1,000-pound cow and her calf for one month. For purposes of these calculations, it is assumed that one-sixth of the cow herd is culled each year and a six-month grazing season is assumed. Production estimates based on weight gain are multiplied by the price reported by the North Dakota Agricultural Statistics Service to determine a cull cow income per animal unit month. Calf income is determined using a similar method and incorporating statistics on calf production per month and calf prices. Statistics are gathered and incorporated in county production statistics based on government program payments, exclusive of the conservation reserve program. Conservation reserve program payments are divided in half and the remaining amount is included as gross revenue for agricultural land.

The capitalization rate used in the formula has declined each year since 1994. It is estimated that the decline will continue for the foreseeable future and a decline in the capitalization rate produces increasing agricultural property valuations.

A representative of the Department of Agricultural Economics at North Dakota State University pointed out some issues that could be addressed to make the formula more accurate. Reducing conservation reserve program payments by 50 percent understates the income to the landowner of these payments. Crop insurance indemnity payments are not included in statistics used in the formula but have become a significant source of revenue to farmers. Valuation of noncropland assumes a grazing season of six months for all counties, but actual grazing season length varies from north to south and east to west. Total value of calves and cull cows sold is counted as revenue for noncropland, but winter feed for animals comes from cropland and is already included in cropland revenue calculations.

The committee reviewed statistics on agricultural property valuation for each county from 1982 through 2001. From 1982 through 1985 agricultural land valuations under the formula increased. From 1986 through 1992 valuations decreased. From 1993 through 2001 formula valuations have steadily increased with a statewide average valuation increase of more than 37 percent over eight years. Farmers in some parts of the state have expressed frustration with continuing increases in agricultural property valuation when they have observed disaster declarations because of flooding problems for several consecutive years, increased farm foreclosures, weak market prices, and drought in some parts of the state.

The committee explored information on the status of soil surveys in North Dakota. A representative of the United States Department of Agriculture Natural Resources Conservation Service said the intended soil survey cycle is to provide for resurveys for each county within each 30-year period. It was observed that resurveys should be completed more frequently but the Natural Resources Conservation Service is limited by budget and staffing restraints.

The committee explored a suggested change to using cash rent as the landlord's share of gross returns under the formula. It was suggested that cash rent would be a better measure than the current method of estimating production value. Cash rent information is gathered by the North Dakota Agricultural Statistics Service through surveys of 3,000 farm operators in North Dakota each year. Mail surveys are sent to farm operations and a telephone followup survey is conducted to check accuracy. The committee considered a bill draft that would have substituted cash rent as a basis for computations in the valuation formula. The committee makes no recommendation with respect to the bill draft. Committee members expressed concern that basing assessed valuations on unverified reports of operators is not a reliable method.

The committee explored the history and estimates for future changes in the capitalization rate used in the valuation formula. The committee considered but makes no recommendation with respect to bill drafts that would have established a floor on the capitalization rate and frozen agricultural property assessments. The Agribank annual mortgage rate, which is used as a basis for the capitalization rate under the formula, declined substantially to 6.48 percent for 2001. It is likely that in the next few years substantial decline in the capitalization rate will result in substantial increases in agricultural property valuation.

It was recommended by a local tax official that the agricultural property assessment formula be adjusted to add consideration of an effective tax rate for agricultural property. It was suggested that the agricultural property valuation formula does an adequate job of reflecting the productivity valuation of agricultural property, but the weakness in the capitalization rate used in the formula is that it does not reflect property tax payments by farmers and ranchers.

Recommendation

The committee recommends House Bill No. 1055 to incorporate an effective tax rate calculation in the capitalization rate used for valuation of agricultural property. It was estimated that the effective tax rate would be approximately 1.5 percent, which upon being added to the capitalization rate, would result in a statewide agricultural property valuation decrease of approximately 14 percent. The bill phases in the use of an effective tax rate over four years. The capitalization rate under the current formula is expected to decline, so it is anticipated that the addition of an effective tax rate will not cause substantial shifts in property tax burden among property types.