Declining Housing Prices and Property Taxes - Institute of ...

Declining House Prices andProperty Taxes in IllinoisWhat is the effect of rapid increases and large drops inhouse prices on property taxes?

Declining House Prices and Property Taxesin IllinoisBy Daniel P. McMillen1 The data on houseprices are drawnfrom the FederalHousing FinanceAgency’s web site,http://www.fhfa.gov/Default.aspx?Page=87. The priceindices are basedon a combinationof sales andappraisal data. TheFHFA data areunique in thebreadth ofgeography andtime covered bythe price indices.The past decade has been an extraordinarytime for the housing market inthe United States. According to data fromthe Federal Housing Finance Agency(FHFA), from the first quarter of 2000 tothe peak of the housing market in the firstquarter of 2007 the average Americanhome increased in value by 67 percent, oran average annual rate of approximately7.6 percent. The price declines since thenhave also been dramatic. From the firstquarter of 2007 to the second quarter of2010, the price of an average Americanhome fell by 11.2 percent, which translatesinto an average annual rate of about 3.6percent. Although the rate of decline hasslowed, it is not yet clear whether thehousing market has truly reached bottom,and it may be some time before pricesreturn to the heights reached in 2007. 1What is the effect of rapid increases andlarge drops in house prices on propertytaxes? To a first approximation, it might beexpected that there is a simple proportionalrelationship between house pricesand property taxes—taxes rise when houseprices increase and taxes fall when pricesdecline. This simple relationship wouldhold if taxes were a constant percentage ofproperty value, assessments were accurateand timely, and all property valuesincreased at the same rate. Because theactual tax system is much more complicatedthan this, it turns out to be very hardto predict how taxes will react to changesin property values. In fact, a much betterfirst approximation to the effect of houseprice changes on property taxes is thatthere simply is no relationship: taxes aredetermined independently of property values,with the tax rate adjusting to keep revenueconstant even in times when pricesare changing dramatically.Even if total tax revenue did, in fact, remainconstant as house prices change, there stillmay be significant changes in individual taxbills. Taxes go up in places where houseprices increase unusually rapidly, and allresidential tax payments may increase if therate of appreciation of commercial andindustrial properties does not keep pacewith residential appreciation rates. Moreover,changes in property values directlyaffect homeowners’ wealth, and significantdeclines in property values may force localjurisdictions to reduce their expenditures.Other changes are even more indirect—ifconsumers feel less wealthy when propertyvalues decline, then revenue from the salestax may decline when consumers spend lessthan before, and income tax revenue may beaffected if lower property values lead to lessbuilding and thus to lower employment inthe construction industry. But the sum of allsuch indirect changes is likely to be far lessthan the direct change that would result ifproperty taxes were, in fact, proportional toproperty values.In this chapter, I review some of the evidenceabout the relationship between propertyvalues and taxes with an emphasis onIllinois generally and the Cook County proportionof the Chicago metropolitan area inparticular. The main conclusion is simple:falling property values do not necessarilylead to declines in property taxes becausetax rates increase when assessments decline.However, the distribution of tax paymentsacross households can vary greatly. Householdsin places with relatively small declinesin house values may see their tax paymentincrease even if their assessments have beenreduced. The main effect of house pricedeclines on property taxes is much lessdirect: if homeowners feel less wealthy, theyare less inclined to support tax increases.

House Price VolatilityFigure 1 shows the path of house prices forthe United States, the Chicago-Joliet-Naperville metropolitan area (not includingLake County), the full state of Illinois,and the parts of Illinois that are not in metropolitanareas. After a period of moderategrowth in the late 1990s, prices began torise rapidly in the U.S. beginning about2001, and a period of extraordinary appreciationbegan around 2003. Price began tofall sharply in 2007. The Chicago metroarea’s experience is nearly identical to thenational average through 2007, but the rateof decline since then has been greater. Thefull state of Illinois has had more moderateprice growth and more moderate declines.Non-metro Illinois neither shared in therapid price appreciation of the early part ofthe decade nor suffered any significantprice declines.Figure 2Average Annual Changes in House Prices105Figure 1House Price IndicesIndex, 1995:1 = 1002502001501005001995199619971998199920002001200220032004200520062007200820092010USIllinoisSource: Federal Housing Finance AgencyIt is clear from Figure 1 that 2003-2007 wasa unique period of extraordinary appreciationin house prices for Chicago, Illinois,and the U.S. How has the rest of metro-Chicago-Joliet-NapervilleIllinois, Non-MetroThe Chicagometro area’sexperience isnearly identicalto the nationalaveragethrough 27,but the rate ofdecline sincethen has beengreater.Percent0-5-10Bloomington-NormalChampaign-UrbanaChicago-Joliet-NapervilleDanvilleDecaturKankakeeLake CountyPeoriaRockfordSpringfieldIllinois, Non-MetroUSA2003:1 - 2007:1 2007:1 - 2010:1Source: Federal Housing Finance Agency

The Illinois Report 20112 Lutz, Byron F., “TheConnectionBetween HousePrice Appreciationand Property TaxRevenues,” NationalTax Journal 61(2008), 555-572.2Illinois fared over the last decade? Figure 2compares annual average house pricechanges for the first quarter of 2003 to thefirst quarter of 2007 and from 2007:1 to2010:2 across all of Illinois’ metropolitanareas, along with non-metro Illinois andthe nation. Chicago and Lake County hadvery high growth followed by sharpdeclines. Danville, Kankakee, andRockford had more moderate declinesafter periods of growth. The price indiceshave not declined since 2007 inBloomington-Normal, Champaign-Urbana, Decatur, Peoria, and Springfield.Figure 3Property Tax as a Percentage of Total State and Local TaxRevenuePercent4035302520151002000200120022003200420052006Source: U.S. Census Bureau, Quarterly Summary of State and Local Tax RevenueFigure 4Property Tax as a Percentage of State Tax Revenue in IllinoisPercent32102000200120022003200420052006Source: U.S. Census Bureau, Quarterly Summary of State and Local Tax Revenue200720072008200820092009Trends in Property TaxesThe path of house prices over the lastdecade might lead one to expect that propertytax revenue would have increaseddramatically up to 2007 and then fallensignificantly since then. The relationshipbetween house prices and property taxpayments is far from mechanical, however.For example, if property taxes increased inproportion to house prices when terms like“bubble” are used to describe the state ofthe housing market, it is reasonable toexpect that property taxes would accountfor a larger share of total state and local taxrevenue. Figure 3 shows the trend for theentire U.S. for property tax revenue as apercentage of total state and local tax revenuefor 1998-2008. The percentage hardlychanged between 2003 and 2007, and onlybegan to rise significantly as house pricesfell sharply in 2009.Similar trends were evident in Illinois.Figure 4 shows the trend for the statebudget for 2000-2009. Despite the hugegrowth in house prices, the property taxaccounted for a lower share of total taxrevenue for the state in 2007 than it hadearlier in the decade. However, the propertytax accounts for only a trivial percentageof the state government’sbudget—well under one-half percentagepoint in each year over the past decade.In contrast to the state, Illinois’ local governmentsrely heavily on the property tax.As can be seen in Figure 5, the property taxaccounted for more than 71 percent of localgovernments’ general own-source revenuein 1997 in Illinois. This figure fell over thecourse of the last decade to just over 68percent in 2007—even as property valueswere increasing significantly.Empirical StudiesA study by Byron Lutz was the first to usenational data to estimate the elasticity ofproperty tax revenue with respect to house

Figure 5Property Tax as a Percentage ofGeneral Own-Source Revenue, LocalGovernmentsPercent727170696867661997 2002 2007Source: U.S. Census Bureau, Census of Governmentsprices. 2 Lutz conducts the analysis usingtwo data sets—aggregate national data for1976-2007 on property tax revenue andhouse prices, and a comparable data setcovering all local governments in the U.S.for 1985-2005. Both of these periods aretimes when house prices were risingthroughout most of the nation. In contrastto the evidence presented in Figures 3-5,he concludes that:“The evidence suggests property tax revenuesare quite responsive to changes inhouse prices. Although it takes several yearsfor house price appreciation to feed throughto property tax revenues, the long-run elasticityis on the order of 0.4. On average,policymakers are estimated to respond toincreasing home prices by 60 percent of theincrease in tax revenue that would haveoccurred in the absence of a change in theeffective tax rate.” (Lutz, 2008, p. 566)In a subsequent paper, Lutz, Molloy, andShan analyze the channels by which thehousing market affects state and local taxrevenue. 3 At its most basic level, a jurisdiction’sproperty tax revenue (T) is simplythe product of its effective tax rate (t) andthe market value of its taxable property(V): T = tV. The first channel by whichchanges in house prices affect revenue isentirely mechanical: if the tax rate is constantand the market value of taxable propertychanges from V 1 to V 2 , then revenuerises by t(V 2 -V 1 ). However, tax rates maychange when property values increase. Ifboth V and t change, then the full changein revenue is T 2 -T 1 = t(V 2 -V 1 ) + (t 2 -t 1 )V 1 .Other channels by which changes in houseprices affect tax revenue are less direct.Declining house prices may reduce construction,which reduces sales tax revenuefrom construction materials and perhapsincome taxes from construction workers. Agrowing recent literature suggests that risinghouse prices increase consumptionexpenditures by making consumers feelwealthier. 4 Thus, declines in house pricesmay lead to lower sales tax collections.Similarly, voters will be less inclined tosupport expenditure bills when their propertyvalues fall.The study by Lutz, Molloy, and Shan suggeststhat the direct channels are muchstronger than the indirect ones. However,both this study and the earlier one byByron Lutz suggest that there are long lagsbetween house price changes and theireffects on tax revenue. Recent declines inhouse prices may affect revenue sometimein the future, but it could easily take 5-10years until their effect becomes pronounced.These long lags may help explainwhy Figures 3-5 show little response ofproperty taxes to rising house prices. Thelags may also explain why recent studiesshow little response in property tax revenueto the recent declines in house prices. 5Several factors account for these long lags.Assessments may take quite some time torespond to price changes, in part becauseassessors may not respond immediately tothe price changes and in part becausemany jurisdictions assess property relativelyinfrequently. In Illinois, CookCounty assesses properties every threeyears while other counties in the state havea four-year assessment cycle. Thus, it caneasily take five years or more for assessmentsto catch up to market trends. Inaddition, nearly all states have adoptedsome form of property tax limitation measurewhich restricts jurisdictions’ ability to3 Lutz, Byron, RavenMolloy, and HuiShan, “The HousingCrisis and LocalGovernment TaxRevenues: FiveChannels,” workingpaper, FederalReserve Board ofGovernors (2010).4 Recent studiesinclude Attanasio,Orazio, Laura Blow,Robert Hamilton,and AndrewLeicester, “Boomsand Busts: Consumption,HousePrices and Expectations,”Economica76 (2009), 20-50;Bostic, Raphael,and Gary Painter,“Housing Wealth,Financial Wealth,and Consumption:New Evidence fromMicro Data,”Regional Scienceand Urban Economics39 (2009),79-89; Campbell,John Y. and João F.Cocco, “How DoHouse Prices AffectConsumption?Evidence fromMicro Data,” Journalof MonetaryEconomics 54(2007), 591-621;and Case, Karl E.,John M. Quigley,and Robert J.Shiller, “ComparingWealth Effects: TheStock Market versusthe HousingMarket,” Advancesin Macroeconomics5 (2005).5 Alm, James, RobertD. Buschman, andDavid L. Sjoquist,“Rethinking LocalGovernmentReliance on theProperty Tax,” workingpaper, GeorgiaState University(2010), andDoerner, William M.and Keith R.Ihlanfeldt, “HousePrices and CityRevenues,” workingpaper, Florida StateUniversity (2010).

The Illinois Report 20116 Anderson, NathanB., “Property TaxLimitations: AnInterpretiveReview,” NationalTax Journal 59(2006), 685-694.7 According to datafrom the IllinoisDepartment ofRevenue, all but 19of the 101 othercounties in thestate had multipliersof 1 in 2007(http://www.revenue.state.il.us/LocalGovernment/2007-table-3-multipliers.pdf),meaning that theirassessments wereaccurate on average.The averagemultiplier for these19 states was 1.026,with a range of .960to 1.131.8 A full list of exemptionsis available onthe IllinoisDepartment ofRevenue’s web site:http://www.revenue.state.il.us/localgovernment/propertytax/taxrelief.htm.raise revenue when prices increase. 6 Inmany cases, these limits on the response ofproperty tax revenue when prices rise alsolead to some catch-up when prices fall,which has an ameliorative effect on revenueresponses to price declines.The most important source of lags is oftenoverlooked: in many jurisdictions, tax ratesrespond more mechanically than tax paymentsto changes in house prices. If T = tVand V is an accurate and timely measure ofhouse prices, then either T or t can respondto maintain the equality when V changes.In many—perhaps most—jurisdictions, Tis determined in local elections, while V isdetermined by local assessment practices.The tax rate then responds mechanically toensure that the equality holds. It shouldhardly be surprising, then, to find thatproperty tax revenue bears little or no relationshipto house prices; it is t thatresponds, not T.Property Tax Administration in IllinoisIllinois is part of a group of states in whichproperty tax rates bear a more mechanicalrelationship to property values than is thecase for revenue. Consider the followingtable that the Cook County Assessor’sOffice website uses to illustrate how to calculatean estimated tax bill (http://cookcountyassessor.com/estimatedtaxbill.aspx).Table 1How to Calculate an EstimatedResidential Tax Bill in Cook County$ 100,000 Estimated Market Value× .10 Assessment Level (10 percent)$ 10,000 Proposed Assessed Valuation× 2.8439 2007 State Equalizer$ 28,439 Equalized Assessed Value (EAV)– 5,500 Homeowner Exemption$ 22,939 Adjusted Equalized Value (AEAV)× .10 Sample Tax Rate (your tax ratecould vary)$ 2,293 Estimated Tax Bill in DollarsSource: http://cookcountyassessor.com/estimatedtaxbill.aspxThe Assessor’s Office is in charge of estimatingmarket values every three years inCook County. By statute, residential assessmentsare supposed to be set at 16 percentof market value in Cook County, but in2009 the Assessor’s Office recentlyannounced a “recalibration” of the assessmentprocess and now announces a targetof 10 percent for the assessment ratio ratherthan 16 percent. Similarly, commercial andindustrial assessment levels have been recalibratedto 25 percent rather than theirstatutory 38 percent and 36 percent rates.Assessment levels are 1/3 of all propertyclasses in the other counties in state.Although Cook County is allowed to havedifferent assessment levels for differentproperty classes, the total of all assessmentsmust end up being 1/3 of propertyvalue for all counties in the state, includingCook. In Cook County, each property’sproposed assessed valuation in 2007 wasmultiplied by the state equalizer—the“multiplier”—of 2.8439 to ensure that totalassessment averaged 1/3 of propertyvalue, i.e., the average assessment acrossall property classes was .33/2.8439 = 11.6percent of market value in 2007. Multipliershover near 1 in all other counties in thestate, which implies that assessment levelsare close to their statutory 1/3 rate. 7The final step in the transition from marketvalue to the property tax base is the homeownerexemption. 8 The basic homesteadexemption was increased to $6,000 in 2009.Other special exemptions are available forfavored groups such as senior citizens, veterans,and people with disabilities. CookCounty has some additional exemptionsfor people who have lived in their homefor 10 years and have household incomesof less than $100,000, as well as an alternativegeneral homestead exemption forhomes with assessed values that haveincreased by more than 7 percent.The Illinois Department of Revenue calculatesequalization factors by comparing

Institute of Government & Public Affairseach county’s assessments to actual salesprices. Equalization factors are calculatedwith some lag because the Department ofRevenue compares a year’s assessments tosales prices from the previous year, andassessments themselves take place on arotating three-year cycle within CookCounty and on a four-year cycle elsewhere.These lags mean that equalized assessmentscan easily take four to five years tofully react to changes in market values.Apart from these lags and the panoply ofexemptions, the assessment process isdesigned to produce assessments thatclosely track market values. A jurisdiction’sproperty tax base is the sum of theadjusted assessed values, i.e.,B = ∑ n t = AEAV iwhere B is the tax base and AEAVi is theadjusted equalized assessed valuation forthe ith property in the jurisdiction. Oncethis base is determined, all properties inthe jurisdictions are taxed at the same rate,t. The total tax revenue for the jurisdictionsis thus T = tB.Given this reasonably straightforward relationshipbetween assessed values and taxrevenue, changes in actual property valueswould lead in time to proportionatechanges in tax revenue if the tax rate wereconstant. In Illinois, as in most states, it isthe tax rate that adjusts when the tax basechanges, not revenue. In other words, thesimple identity should be re-written as t =B/T to reflect the actual direction of causation:each jurisdiction’s tax base and totaltax extension interact to determine its taxrate. The tax rate falls when assessed valuesrise in response to rising property values,and it rises when assessed values fallin response to declining property values.However, the change does not comeovernight. Property values began todecline in 2007 and many properties areonly now being re-assessed to reflect thechanging market conditions. Once theproperties are re-assessed, tax rates willrise unless voters agree to reduce expenditurelevels.The Distribution of TaxesThe way tax rates are calculated in Illinoismeans that an individual’s property taxbill will be unchanged if all prices rise orfall by the same percentage and the numberof properties does not change overtime. This unrealistic scenario does nottake into account the fact that new propertiesare added over time and others aredemolished or are converted to alternativeuses. It also involves an unrealisticassumption that all properties appreciateor decline in value at the same rate.These issues are particularly relevant inCook County. Unlike the other counties inthe state, Cook County’s classified tax systemmakes residential properties a favoredclass with lower effective rates than otherproperty classes. Non-residential propertiesare not the beneficiaries of exemptionsand are subject to higher property assessmentlevels. Table 2 shows the calculationof the tax bill for a representative commercialor industrial property in Cook Countyif the recent recalibration for non-residentialassessments to 25 percent of propertyvalue had been applied in 2007.Table 2How to Calculate an Estimated Tax Billfor a Commercial or IndustrialProperty in Cook County$ 100,000 Estimated Market Value× .25 Assessment Level (25 percent)$ 25,000 Proposed Assessed Valuation× 2.8439 2007 State Equalizer$ 71,098 Equalized Assessed Value (EAV)– 0 (No Exemption)$ 71,098 Adjusted Equalized Value (AEAV)× .10 Sample Tax Rate (your tax ratecould vary)$ 7,110 Estimated Tax Bill in DollarsSource: http://cookcountyassessor.com/estimatedtaxbill.aspxUnlike theother countiesin the state,Cook County’sclassified taxsystem makesresidentialproperties afavored classwith lowereffective ratesthan otherpropertyclasses.

The Illinois Report 20119 Note that these calculationsuse thesame $5,500 homesteadexemptionthat was used inthe table from theCook CountyAssessor’s Office.When the figure israised to $6,000 tobe consistent withthe current exemption,the value of$116,667 rises to$118,000 for countiesother thanCook and the valuerises from $269,340to $271,107 in CookCounty.10 The exact calculationsare 2.69 ×1,040,964 × (73,002– 69,262) =104,772,722,420 forcommercial and2.69 × 685,920 ×(27,879 – 25,100) =5,127,601,819 forindustrial.The total tax bill for a commercial orindustrial property with a market value of$100,000 in this example is 7,110; it wouldbe $2,293 for a residential property withthe identical market value. The effectivetax rate is 7,110/100,000 = 7.11 percent,compared with 2.29 percent for the residentialproperty. The tax bill is more thanthree times higher for commercial propertythan for a residential property that has thevery same market value.In any county in the state, a loss of commercialor industrial property will necessarilylead to higher taxes on residentialproperty owners unless the tax extensionchanges. In other counties, each $100,000of market value that is lost in commercialor industrial property value only needs tobe replaced with $116,667 in residentialproperty to keep taxes the same as before.The additional $16,667 is needed to compensatefor the exemption that is providedto residential property owners. These calculationsare shown in the first twocolumns of the tables below, which showthat representative $100,000 commercialindustrial properties produce the same taxrevenue as a $116,667 residential propertyin 101 of the state’s 102 counties. 9 Similarcalculations in columns 3 and 4 show thatthe $100,000 non-residential property hasto be replaced with a $269,340 home tokeep taxes the same in Cook County. Thissituation provides a huge disincentive forcommercial property owners to locate inCook County, and also means that any lossof non-residential property is likely to produceincreases in residential tax bills evenas homes drop in value.Unfortunately for Cook County, the numberof commercial and industrial propertieshas been falling over time. Datapresented in the Cook County Assessor’sOffice Final Assessment Abstracts show thatthe total number of commercial propertiesin the county fell from 73,002 to 69,263 in2008, and the total number of industrialproperties declined from 27,879 to 25,110.The average commercial assessment was$262,491 in 2008 and the average industrialassessment was $171,480; these figurestranslate into market values of $1,049,964and $685,920 at the re-calibrated 25 percentassessment level. Because each propertyneeds to be replaced by a residential propertywith a value that is 2.69 times asexpensive to keep property valueunchanged, the commercial propertieswould need to be replaced by more than$100 billion in residential homes to keepthe property tax bill constant, and another$5 billion would be needed to compensatefor the loss of commercial property. 10Table 3Comparison of Residential and Commercial Property TaxRates and Their Influence on Each OtherOther CountiesCook CountyRes. Com. or Res. Com. orInd.Ind.$116,667 $100,000 $269,340 $100,000 Estimated Market Value× .33 × .33 × .10 × .25 Assessment Level (33 percent)$ 38,500 $ 33,000 $ 26,934 $ 25,000 Proposed Assessed Valuation× 1 × 1 × 2.8439 × 2.8439 2007 State Equalizer$ 38,500 $ 33,000 $ 76,598 $ 71,098 Equalized Assessed Value (EAV)– $5,500 – 0 – $5,500 – 0 (Exemption)$ 33,000 $ 33,000 $ 71,098 $ 71,098 Adjusted Equalized Value (AEAV)× .10 × .10 × .10 × .10 Sample Tax Rate$ 3,300 $ 3,300 $ 7,110 $ 7,110 Estimated Tax Bill in DollarsSource: http://cookcountyassessor.com/estimatedtaxbill.aspxThese calculations show that a loss of nonresidentialproperty in a jurisdiction canlead to increases in homeowners’ propertytax bills even if all residential assessmentsremain constant over time. Tax bills willalso change when property values changeat different rates in different area within ajurisdiction. For example, suppose a jurisdiction’sentire tax base is residential, with1,000 properties that initially all haveadjusted equalized assessed values of$50,000. The tax base is $50 million. If votersin the jurisdiction have authorizedproperty tax extensions of $10 million,then the tax rate is .20, and each homeownerpays $10,000 in property tax. Now

The Illinois Report 201111Dye, Richard F.,Daniel P. McMillen,and David F.Merriman, “TheEffect of DecliningHouse Prices onSchool PropertyTaxes and SchoolAid in Illinois,”University of IllinoisInstitute ofGovernment andPublic Affairs(2010).side of the city. If tax extensions remainedconstant during time and there were nochange in the number of properties or themix of residential and non-residentialproperties and assessments accuratelyreflect changes in market value, then taxpayments would increase in the areas ofthe city that are in red relative to the areasshaded in blue. If the red areas also experiencedgreater declines in property valuesafter prices began to decline in 2007, thenthese areas will eventually come to be thebeneficiaries of lower tax payments whilethe blue areas may make higher tax paymentseven as their homes drop in value.The Illinois Property Tax ExtensionLimitation Law (PTELL)PTELL was first adopted in 1991 by thefive collar counties of suburban Chicago. Itwas extended to Cook County in 1994, andhas since been adopted by another 33counties in the state. PTELL limits thegrowth rate in total property tax to thelesser of the rate of inflation and 5 percent.The limits are implemented by imposing amaximum tax rate for jurisdictions inPTELL areas. Because declining assessmentsmust be accompanied by higher taxrates to keep extensions at their target levelsand PTELL imposes maximum tax rateson jurisdictions, do falling house pricesnecessarily lead to lower property taxextensions in PTELL jurisdictions?This question is addressed in a recent studyby Dye, McMillen, and Merriman. 11 Theanswer to the question is no; althoughPTELL imposes limits on increases in propertytax extensions, the interaction betweenfalling assessments and the maximum taxrate imposes no additional constraints ontax extensions. The reason for this somewhatcounter-intuitive result is that themaximum tax rate is not set by law;instead, it varies to allow extensions toreach the same level that would have beenreached if assessments had not changed.An example from the Dye, McMillen, andMerriman study captures the essence ofthe rate setting process. The maximum taxrate imposed by PTELL can be written asfollows:Maximum tax rate = {(prior extensions)× (1 + inflation factor)}/(new total taxbase), ortptell =( T last year) * (1+p)B this yearwhere, as before, T represents total taxextensions, B represents the total assessmentbase, and t represents the tax rate.The new variable is p, which representsthe inflation factor—the less of the rateof inflation or 5 percent.In times when assessments are rising,PTELL is implemented by imposing alimit on the tax rate. An example based onone presented in the Dye, McMillen, andMerriman study illustrates how PTELLaffects total tax extensions for arepresentative school district in a timewhen assessments are falling. Therepresentative district starts with totalEAV (B) of $100 million and a tax rate (t)of 2.5 percent, a combination that provides$2.5 million in total tax extensions (T).Suppose that assessments fall by 10percent so that the new tax base is $90million instead of $100 million. Also,suppose that the overall inflation rate iszero, and the district therefore decides toleave tax extensions unchanged from theprevious period. The tax rate then mustrise by exactly the amount that assuresthat the $90 million tax base produces $2.5million in taxes. Thus, the new tax rate inthis non-PTELL district is simply 2.5/90 =2.78 percent, or an increase of 0.28percentage points.Suppose that an identical district that issubject to PTELL also began with a $100million tax base, a tax rate of 2.5 percent,and total tax extensions of $2.5 million. Ifthe district’s maximum rate remained at2.5 percent, then tax revenue would fall to

Institute of Government & Public Affairs.025 × 90 = $2.25 million. But themaximum tax rate adjusts to allow thedistrict’s expenditures to keep up with theless of 5 percent or the inflation rate,which in this case is simply zero. So thenew maximum tax rate is 2.5/90 = 2.78percent, which is exactly the same as inthe otherwise identical non-PTELL district.The general point is quite simple: propertytax rates are not constant over time inIllinois. Rather, the tax rate changes tokeep ensure that the tax base provides theamount of revenue agreed upon by voters.Though PTELL places limits on totalincreases in tax extensions, it places nolimits on how much tax rates can changein response to changing assessments.ConclusionFalling property values do notautomatically impose fiscal stress on stateand local governments. In the short run,assessments do not change and tax ratesstay the same unless tax extensionschange. Although assessments eventuallywill fall to reflect changing marketconditions, homeowners’ tax paymentsmay stay the same as before. In Illinois, asin most of the country, tax extensions donot adjust passively to changes inassessments: increases in assessments donot automatically produce increases inproperty taxes, and declines inassessments do not automatically producedecreases in property taxes. Instead, it istax rates that adjust to changingassessments.The distribution of assessment changescan have a significant effect on ahomeowner’s tax bill, however. Areaswith smaller declines in assessments mayend up having higher tax bills eventhough their homes have decreased invalue. Declines in the non-residential taxbase can lead to large increases inresidential tax bills irrespective of thedirection of change in home prices. But theDaniel P. McMillen has a jointappointment in the Departmentof Economics and the Institute ofGovernment and Public Affairs. Healso is a visiting fellow at theLincoln Institute of Land Policyand a consultant at the FederalReserve Bank of Chicago. Heserved as the Director of theCenter for Urban Real Estate at theUniversity of Illinois at Chicagofrom 1999-2005, and has been amember of the economicsdepartments at the University ofOregon, Santa Clara University,Tulane University, and theUniversity of Illinois at Chicago.McMillen received his Ph.D. inEconomics from NorthwesternUniversity in 1987. Hispublications have appeared insuch academic journals as theJournal of Urban Economics,Regional Science and UrbanEconomics, the Review ofEconomics and Statistics, RealEstate Economics, and the Journalof Business and Economic Statistics.He has been co-editor of RegionalScience and Urban Economics since2007.most fundamental effect of declininghouse prices on property taxes is muchless direct: if voters turn down taxrequests when property values fall, thentaxes will eventually fall. In the end, it isvoters who determine the overall size ofproperty tax extensions, not house prices.Fallingpropertyvalues do notautomaticallyimpose fiscalstress on stateand localgovernments.In the shortrun, assessmentsdo notchange andtax rates staythe sameunless taxextensionschange.