Who pays property taxes?
[Another entry in our occasional series on local property taxation: previous posts 1, 2, 3, 4.]
Obviously the homeowner writes the check, but is that who really pays?
What are the secondary effects — in, for instance, house prices?
An intriguing Land Lines article by Rice University’s George Zodrow, who’s spent a decade researching this question, both defends his thesis (called the ‘capital tax’ approach) and provides a good introduction to the topic.
“Let’s get ready to rummmmble!”
As he opens the article:
A critical aspect of the property tax, but one that is rarely addressed in public debate, is its “economic incidence,” or who actually bears the burden of the tax, as opposed to its statutory incidence, or who literally pays the tax. For example, a landlord might pay a property tax bill, but if some of the tax is offset with a rent increase, then the tenant bears that part of the tax burden.
“Now let’s have a good clean intellectual brawl — no ad hominems, no yes-butting, no below-the-footnote snarking.”
Since market rents represent a median supply-demand equilibrium, over the long run there is no question increased property taxes lead to higher local rents. As for owners:
The economic incidence of a tax is also affected by the phenomenon of “capitalization” – changes in asset prices that reflect the discounted present values of the economic effects of future tax and/or public expenditure changes. For example, an increase in property taxes, holding expenditures constant, might be capitalized into land or house values. The prices of these assets might fall by the present value of the projected increase in future taxes, whereas increases in expenditures, holding property taxes constant, might have offsetting effects.
Well, do they? What does the evidence suggest? Because we cannot run parallel-universe side-by-side tests, it is extremely difficult to find decisive evidentiary proof, leading to a long-running feud:
Indeed, the debate over the incidence of the residential property tax has raged for at least the last thirty years, and is still far from resolved. Professional opinion on the incidence of the tax is generally divided between the “benefit tax” view and the “new” or “capital tax” view (Zodrow 2001).
And those are just the Hatfields!
Introducing the pugilists: in this corner, the benefit tax folks:
Under the benefit tax view, the property tax is considered a user charge for public services received. It thus serves the function of a local head tax or benefit tax as envisioned by Tiebout (1956) in his celebrated analysis of how inter-jurisdictional competition coupled with consumer mobility can lead to the efficient provision of local public services. The implications for taxpayers are threefold.
1. As a benefit tax the property tax is simply a payment for public services received, analogous to purchases of goods and services for private markets.
2. Because the property tax functions as a market price, its use implies that local public services are provided efficiently.
3. The property tax, like all benefit taxes, results in no redistribution of income across households and thus has no impact on the distribution of income.
The benefit tax proponents basically see property taxes as an efficient means of collecting money for local services. Since what they can collect depends on what the voters will tolerate, they are held in check by a political marketplace.
Plausible, no?
In the red corner, the capital tax proponents:
By comparison, under the capital tax view derived by Mieszkowski (1972) and elaborated by Zodrow and Mieszkowski (1986b), the property tax is a tax on the use of capital and thus inefficiently distorts resource allocation by driving capital investment out of high tax jurisdictions and into low tax jurisdictions.
Sort of like zoning oneself blue in the states, perhaps?
The capital tax view has different implications for taxpayers in all three of the areas noted above for the benefit tax view.
1. The tax has some significant benefit aspects in that local tax increases tend to be borne by local residents.
2. The tax inefficiently distorts housing consumption decisions; moreover, use of the local property tax can also lead to inefficient under-provision of local public services if government officials, concerned about tax-induced loss of investment, then reduce the level of public services (Zodrow and Mieszkowski 1986a).
3. Because the primary effect of nationwide use of the property tax is a reduction in after-tax returns to capital owners, it is a highly progressive tax [property owners pay more — Ed.].
As to the last point, if the rich pay more in property taxes, they have more property to be protected by police, fire, and snob zoning, don’t they? And people value only what they pay for.
Comparison table, from the article.
Professor Zodrow then built a large mathematical model:
My research begins by reconstructing the Tiebout-Hamilton benefit tax view within the context of a partial equilibrium version of the standard differential tax incidence model, which focuses on the effects of use of the property tax in a single taxing jurisdiction. […] Under this approach, the effects of the property tax are analyzed by first constructing an initial equilibrium with either no taxes or only non-distortionary lump-sum taxes, and then introducing property taxes and analyzing their effects.
In other words, he first imagined a mathematical marketplace without property taxes, then added their economic effects to see how the system changed.
Just add taxes and see what that precipitates!
Here’s what he was looking for:
Specifically, high-value homes sell at a discount that reflects the capitalized present value of their “fiscal differential” – the present value of the excess of future taxes paid relative to public services received.
Similarly, low-value homes should sell at a premium that reflects the capitalized present value of the extent to which future taxes paid are less than the value of public services received. As a result, all households “pay for what they get” in public services, and the property tax is an efficient benefit tax. Capitalization thus implies that it is futile to follow the conventional strategy of buying a low-value home in a high-value community in order to receive local services at relatively low cost.
In plain consumer English, per square foot of house, you will overpay for the privilege of sending your children to a better school along safer, nicer streets.
Did he find it? What results spilled out of the model?
1. For large homes, which experience a disproportionately larger increase in property taxes, the resulting negative fiscal differential is fully capitalized into lower housing prices.
2. Similarly, small houses sell at a premium that exactly reflects the negative fiscal differential between total property taxes paid and the associated benefits of the tax change as measured by the reduction in head taxes.
Translation: because of higher property taxes, bigger homes sell a little cheaper (O those taxes!) and smaller homes cost a bit more (O those schools!) than they would if taxes were lower. What you don’t pay in mortgage debt service you do pay in property taxes.
Professor Zodrow’s analysis is purely statistical, and if truth came perfectly through statistics then Gregor Mendel would not have needed his gardener to fudge his data.
We’re not saying you did it on purpose, brother Mendel!
Still, within the confines of his economic model, Professor Zodrow found that:
[I]f one adopts all of the admittedly stringent assumptions of the benefit tax view, complete intra-jurisdictional land value fiscal capitalization is also entirely consistent with, and indeed predicted by, the capital tax view of the property tax.
In blog-speak: the evidence supports either hypothesis. There’s no confirmatory evidence.
Michelson and Morley didn’t find what they were looking for either, and they won a Nobel!
To derive his negative result in a mathematical ‘clean room,’ Professor Zodrow:
Made two essential – and admittedly rather stringent – assumptions characteristic of derivations of the benefit tax view.
1. Households are perfectly mobile across competing local jurisdictions with an exogenous source of income.
2. There are a sufficient number of jurisdictions to satisfy all tastes for local public services.
Are households perfectly mobile within local jurisdictions? Within reason they are, although at some cost (that “exogenous source of income” is academic for “long commute to work”).
Do metropolitan areas offer a wide range of taxation/ public service levels? Not around
He concludes, with the subdued triumphalism of the besieged, that his position is still tenable:
Together, these results suggest, counter to the claims of benefit tax proponents [O those benefit-tax wild men! — Ed], that empirical evidence supporting full capitalization of property taxes in land values – either within or across jurisdictions – provides little if any evidence that allows researchers to distinguish between the capital tax and benefit tax views.
“So riddle me tax, Batman!”
Along the way, however, Professor Zodrow tries a throwaway aside:
[If the capital tax model is correct,] capital flows out of the production of large houses where property taxes are high relative to benefits received, and into the production of smaller homes where the property tax bill is low relative to benefits received.
That is, if property taxes are a surcharge on owners of large properties, rather than a pro-ration of efficient municipal services, then developers will build those little homes whose price gets an uplift, rather than the big homes that have to sell at a discount. Land owners, in short, will subdivide their estates in favor of condos, townhouses, and even — gasp — mid-rises.
Do property taxes provide updrafts?
Or downdrafts?
But this is precisely not the behavior we see in affluent communities, with their snob zoning, NIMBYism, conservation land, environmental reviews, and other development barriers. Professor Zodrow reluctantly concedes vulnerability here:
Instead, the key issue is whether the zoning restrictions or other mechanisms stressed by proponents of the benefit tax view are sufficiently binding to preclude the long-run adjustments in housing capital predicted by the capital tax view.
In simple terms, will NIMBYism overcome economic gravity and clearing markets?
The issue hangs in the balance
This issue promises to be a fertile topic for future research ….
More grant proposals needed!
