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

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.