Property tax stability: a tax system model of base and revenue dynamics through the great recession and beyond.

Author:Mikesell, John L.
 
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  1. INTRODUCTION

    Why did revenue from the local property tax remain relatively stable during the Great Recession, despite the substantial decline in the value of housing, a major component of the tax base, in many parts of the country? Local income and sales tax revenues fell during the recession, so what about the property tax system makes this tax different? Does the overall stability mask special problems that will emerge before the economy has fully recovered from the recession shocks? Those questions will be addressed here, but a full understanding requires some discussion of the significance of the tax and of the way in which the property tax system differs from that of other major American taxes.

  2. PROPERTY TAXATION IN THE UNITED STATES

    Property tax revenues continue as a critical foundation for finance of local governments in the United States. The 2007 Census of Governments shows that local governments received 71.69% of their tax revenue from the property tax, a collection total that was more than six times the collections from any other tax. The tax is important for municipal governments, although not quite so significant as for all localities. For cities, it generated 48.25% of tax revenue. (2) Although general sales or income taxes yield more revenue in a number of cities, the property tax dominates both in total and in most individual cities. Even when the property tax is not the biggest tax source for a city, in most jurisdictions the tax is still significant. In spite of property tax rebellions and efforts to de-emphasize the tax in government finances in response to the considerable public unpopularity of the tax, the property tax remains an integral part of local government finance, making a great contribution to the fiscal autonomy of these governments that are closest to the people. As Youngman (1998, pp. 123-124) observes, "In an economy firmly committed to private property, a public claim on a specified portion of the value of realty is inherently controversial." But its desirable attributes have led to its survival.

    Property tax reliance appears to have been fortunate for local governments in recent years. Local governments must closely constrain their spending to available revenues, because of both legal requirements and economic conditions for long-term sustainability, so property tax stability and reliability has been particularly valuable for them. It has partially insulated them from the spending reductions that reliance on other less stable taxes would have brought. Except during the depths of the Great Depression of the 1930s, property tax collections have been reliable through all manner of national economic conditions.

    That reliability continues: total collections across the nation from the local property tax have been impacted less by the Great Recession than have other substantial local taxes. (3) For local governments, property tax collections increased by 21.3% from the year ending June 30, 2007, just before the start of the Great Recession, to the year ending June 30, 2011. The property tax share of local tax collections increased over that period from 75.5% to 80.3%. (4) The higher share is the product of both property tax stability and greater sensitivity of other significant local taxes to the economic decline. Figure 1 shows the path of local property, general sales, and individual income tax collections since 1988, clearly demonstrating the greater stability of the property tax and the impact of the recession on the other major local taxes. The data report twelve month totals for each tax on a quarterly basis over those years, with each tax total being reported relative to its fourth quarter 1988 value so that the data from the different taxes can be easily shown in a single graph.

    Property tax collections lack the fluctuations of either the income or sales tax over the years and, very importantly, they do not show the substantial declines at the beginning of 2008 that both sales and income taxes exhibit. While sales and income tax collections fell, property tax collections continued to increase. On a national basis, it is a stable and reliable tax, not as sensitive to dramatic fluctuations in economic activity. In addition to being stable, property tax revenue also grew more rapidly than did the other two taxes. At least in terms of these dynamic characteristics, the property tax has important advantages for local government use. However, it should be noted that in the last quarters in the graph, property tax revenues have leveled off. The economic decline may finally be reaching the property tax (some evidence of what may be going on with this decline even as the economy recovers is made apparent in a late section of this article). The behavior of the property tax during the recession era makes it clear that the logical model for understanding the sales and income tax systems may not be appropriate for understanding the property tax. Something in the revenue system intervenes in the connection between economic activity and tax revenue.

    The Great Recession did challenge local finances in general and the property tax in particular. The property tax issue stems from the fact that in most jurisdictions the property tax base is heavily dependent on the value of residential property. While the Bureau of Census stopped collecting data on the residential share of the property tax base in 1987, Gravelle and Wallace (2009, p. 37) have estimated that, in a sample of states, the residential share in 2004 was around 64%, up from 52% in 1981. This component of total property value has been badly hit by the recession. The national house price index based on sales, as reported by the Federal Housing Finance Agency, shows uninterrupted increases from the first quarter of 1991 through the first quarter of 2006, increasing at an annual rate of 4.7% over those years. But from its peak a year later, in the first quarter of 2007, the index has fallen to only 84.6% of that peak by the second quarter of 2012. (5) Figure 2 shows how the great interruption in the long term trend in housing prices that occurred as the economy entered into the Great Recession, providing some idea of how it could represent a shock to local governments (and others) who may have taken continued growth as the standard. (6)

    This decline in the value of a major share of the tax base certainly gives reason for concern about the security of this previously stable local revenue source. However, a decline in the property tax base may not result in a decline in the property tax levied by a government and a change in the planned levy may not immediately translate into a change in actual property tax collections. That certainly appears to have been the case, as previously noted. But how can that be so? The next section examines the linkages from the property tax base to property tax collections. To understand the special tax system that applies in real property taxation in the United States is crucial to understanding how property tax collections have remained stable during the Great Recession and other economic downturns.

  3. LITERATURE REVIEW

    Tax collections are expected to be sensitive to economic activity. First, changes in economic activity are likely to impact the size of the tax base and, second, changes in economic activity may impact the degree to which taxpayers actually pay the tax they owe. Accordingly, it would not be surprising to find evidence that the Great Recession had adversely impacted the revenues of American local governments. When the value of a major component of a tax base--like housing in the property tax base falls, it is normal to expect that revenue from that tax will fall as well. Dadayan (2012, p. 8) makes the point: "... there is a natural and causal relationship between property values and real property tax collections." Except that an understanding of the property tax system and recent empirical evidence (for instance, Figure 1) show this relationship to be far less straightforward and certainly less direct than would be expected by the unwary.

    A number of researchers have examined this relationship between values from the property market and property tax collections. (7) The Great Recession (December 2007-June 2009) and the associated housing value collapse (the Federal Housing Finance Agency price index peaked in the first quarter of 2007) had barely started before researchers initiated examinations of how the property tax and local governments dependent on it would be impacted. Indeed, some research began even before many jurisdictions had sent out tax bills, let alone received (or failed to receive) any collections that were due, after the start of the recession. However, the uniqueness of a major decline in housing values, the significance of housing in the property tax base, and the importance of the property tax to the finances of local governments made investigation of the property tax collections impact particularly significant. The property tax had always been regarded as an excellent revenue source for local governments because of its stability and reliability and the housing collapse and the recession raised questions about these perceptions. Would the decline in the value of a major component of the property tax base put finances of local governments at risk, contrary to the prevailing views about property tax stability?

    One early study by Lutz (2008) used Bureau of Census data (mostly ending in the first quarter of 2008 or before) at both national and jurisdictional level to estimate the sensitivity of property tax collections to the collapse of the housing market. His evidence indicated an elasticity of about 0.4 and showed that there was about a three year lag between housing price changes and tax revenue. He suggested that the lag was the result of assessment practices that only slowly brought assessed values into line with market values and of various caps and...

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