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Article Excerpt
INTRODUCTION
In the wake of the real estate boom in the first half of this decade, the property tax revenues of local governments soared, growing 50 percent faster from 2001 through 2005 than they did from 1996 through 2000. (1) More recently, the downturn in the housing market has generated concern that property tax revenues will slow or decline. (2) Although many analysts and commentators have noted the connection between house prices and property tax revenues (e.g., National League of Cities, 2007), there is only limited research on the precise nature of the relationship. This paper provides evidence on two aspects of the relationship. First, the paper addresses the question: "when house prices rise, how much do property tax revenues rise?" This can be viewed as assessing the magnitude of the relationship. Second, the paper addresses the question: "when house prices increase, how long does it take for property tax revenues to increase?" This can be viewed as assessing the timing of the relationship.
Understanding how the evolution of house prices influences property tax revenues is important for at least three reasons. First, the tax plays a central role in financing local public goods in the U.S. Property taxes account for around three-fourths of local government tax revenue and a quarter of total local government revenue. They are particularly important for education as they provide approximately 95 percent of tax revenue for independent school districts (Evans, Murray, and Schwab, 2001). Given the magnitude of the tax and the fact that most local governments must balance their budgets, fluctuations in property tax revenue--driven by changes in property values--would be expected to influence local government spending decisions.
Second, the connection between property tax revenues and real estate values likely influences the ability of the state and local government sector as a whole to weather fiscal crises. During the state fiscal crisis of 2002-2004, localities responded to cuts in state education aid by increasing property tax revenues in order to prevent cuts in education budgets (Dye and Reschovsky, 2008). Their ability to do so was likely a function of the strong state of the housing market at that time. Localities may not be well positioned to offset reductions in state funding during the current period of slow economic activity given the softening of house values.
[FIGURE 1 OMITTED]
Finally, the relationship between the housing market and property taxes may impact the political viability of the property tax. The share of income devoted to the property tax has risen sharply in recent years (see Figure 1), likely due, in part, to the housing boom, (3) and this appears to have generated a political backlash. Several states have either enacted, or seriously considered, significant reforms of their property tax in recent years. (4)
Although past research has examined the effect of home price appreciation on property tax revenues in specific states (e.g., Bloom and Ladd, 1982; Cornia and Walter, 2006; Dye, McMillen, and Merriman, 2006; Ladd, 1991), I am unaware of any systematic studies conducted on the national level. The lack of previous research may reflect the widely held view that the property tax is a stable revenue source. Indeed, the relative stability of the property tax over the course of the business cycle is often cited as one of the primary virtues of property taxation (e.g., Brunori, 2003; Giertz, 2006). The recent nationwide housing market run-up and subsequent weakness, however, raises the possibility that the property tax will not be as stable going forward as it has been in the past.
The topic of this paper has parallels with the literature on the marginal propensity to consume (MPC) out of housing wealth (e.g., Carroll, Otuska, and Slacalek, 2006; Case, Quigley, and Shiller, 2005; Lehnert, 2004; Skinner, 1996). This literature seeks to understand how changes in housing market wealth influence personal consumption decisions. Although the literature is far from conclusive, MPC estimates are generally around $0.03--i.e., every additional dollar of housing wealth leads to an additional three cents of consumption. If local public good decisions are viewed through the lens of the median voter model (Black, 1948), this paper can be viewed as the public goods analogue to the housing market MPC literature (which examines private goods consumption). When the median voter experiences a wealth shock due to an increase in his home value, he will vote to increase his consumption of public goods by his marginal propensity to consume public goods out of wealth. Although there is a large literature on the marginal propensity to consume public goods out of income---it is generally thought to be equal to around five to ten cents per dollar of income (Hines and Thaler, 1995)--I am unaware of any work on the public goods MPC out of wealth. The results of this paper can be interpreted as providing such estimates, subject to a significant caveat: Increases in the value of residential real estate may increase the share of residential property in the tax base relative to commercial and industrial property and thereby increase the median voter's tax price--i.e., the median voter may be required to fund a higher percentage of public expenditures at the margin. The positive price shock may partially offset the positive wealth shock, suggesting that the estimates in this paper should be viewed as lower-bound estimates of the public goods MPC out of housing wealth.
The remainder of the paper is organized as follows. The second section provides background information; the third section presents the empirical estimates of the connection between house prices and property taxes, and the fourth section concludes.
BACKGROUND
The property tax is assessed on the value of residential real property (i.e., personal real estate), commercial, business and farm real property, and personal property (e.g., automobiles). Residential real property, the focus of this paper, accounts for approximately 60 percent of taxable assessments and is the largest component of the tax base by a significant margin; commercial, industrial and farm property account for around 30 percent, and personal property accounts for less than ten percent. (5)
There is significant heterogeneity in the administration of the tax across jurisdictions--a "bewildering array" of different institutional features (Giertz, 2006). Abstracting from this heterogeneity, property tax revenue can be defined as being equal to the effective tax rate times the market value of property:
[1] R = [[tau].sup.*] V,
where R is property tax revenue, [tau] is the effective tax rate (which should be distinguished from the statutory rate), and V is the market value of taxable property.
When the market value of property increases, tax revenue will mechanically increase. Policy makers, however, do not have to accept this mechanical increase; they may choose to offset some or all...
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