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

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).