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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).
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