1. State and Local Public Finance Professor Yinger Spring 2017
Lecture 8
PROPERTY TAX INCIDENCE

2. State and Local Public Finance Lecture 8: Property Tax Incidence
Class Outline
Who Bears the Burden of the Property Tax?
The Traditional, New, and New New Views
Accounting for Variation in the Property Tax Across Jurisdictions
Including the Role of Property Tax Capitalization
Property Tax Incidence and Public Policy

3. State and Local Public Finance Lecture 8: Property Tax Incidence
The first question in property tax incidence is:
Who bears the burden of a nationwide property tax (or, equivalently) of the average property tax rate?
Three answers have appeared:
The Traditional View
The New View
The New New View

4. State and Local Public Finance Lecture 8: Property Tax Incidence
The Traditional View
The Traditional View, based on an analysis of the markets for individual types of property, concludes that the property tax is regressive.
Business owners, who have many options, can escape the burden of the tax, and shift it onto consumers, workers, and renters.
Because business owners have relatively high incomes, this shifting makes the tax regressive.

5. State and Local Public Finance Lecture 8: Property Tax Incidence
The Traditional View for Business Property
The Traditional View focuses on the behavior of responsive firms with property as an input: P Q S
S+tax D
P1=P3 P2
Product markets (commercial & industrial property is an input) or the rental housing market.

6. State and Local Public Finance Lecture 8: Property Tax IncidenceQ P S D P3
P1=P2
tax
The land market
The Traditional View for Land
Even in the Traditional View, the property tax on land is progressive:

7. State and Local Public Finance Lecture 8: Property Tax Incidence
The Traditional View for Single-Family Houses
For single-family houses, the Traditional View depends on the income elasticity of demand for housing (θ):
where T is the property tax payment, t is the effective property tax rate, V is house value, R is the annual rental value of housing, r is a discount rate, and V = R/r.
To see why, note that:

8. State and Local Public Finance Lecture 8: Property Tax Incidence
The Traditional View for Single-Family Houses
Because we are holding t/r constant at the national average, this formula implies that the change in T/V depends on the change in R/V, which is measured by the income elasticity of demand for housing (θ):
It turns out that the change the average tax rate, T/Y, in percentage terms is

9. State and Local Public Finance Lecture 8: Property Tax Incidence
Why the Property Tax on Single-Family Housing Is Regressive
This result implies that
T/Y increases with income if θ > 1;
T/Y is the same at all incomes if θ = 1;
T/Y decreases with income if θ < 1.
There is a strong consensus that θ < 1, so T/Y decreases with income and this portion of the tax is regressive.
This analysis helps to explain why, as we will discuss later in the class, so many states have programs to lower property tax rates for lower- valued houses.

10. State and Local Public Finance Lecture 8: Property Tax Incidence
θ > 1; tax is
progressive
θ < 1; tax is
regressive
Evidence says that θ < 1.
The Income Elasticity of Demand for Housing, θ, and the Progressivity of the Property Tax on Owner-Occupied Housing

11. State and Local Public Finance Lecture 8: Property Tax Incidence
The New View
The New View is based on a general equilibrium analysis of all markets.
A property owner cannot escape a tax in one market if the same tax is levied everywhere.
Since almost all property is taxed, property owners cannot escape the tax.
Because property owners have relatively high incomes, the property tax is progressive.

12. State and Local Public Finance Lecture 8: Property Tax IncidenceK D i1 S i2
Burden on owners of K
tax
The National Market for Property
In effect, the New View assumes the supply of property in the nation (K) is fixed:

13. State and Local Public Finance Lecture 8: Property Tax Incidence
The New New View
The New New View points out that the amount of property might respond to interest rates over time
through investment decisions
or through international flows in financial capital.
This "correction" implies that the New View may be too extreme, but concludes that most of the burden is still likely to fall on property owners.

14. State and Local Public Finance Lecture 8: Property Tax IncidenceK
L-R S
(L-R S)+t D i1 i2 i3
tax
L-R burden on consumers/workers
L-R burden on owners of K
S-R S i4
S-R burden on owners of K
The Long Run and the Short Run
The New View (S-R) and the New-New View (L-R)

15. State and Local Public Finance Lecture 8: Property Tax Incidence
What Question Does the Traditional View Answer?
Some scholars say that the Traditional View and the New View address different questions.
The Traditional View
This view applies to the incidence of a property tax increase in one place, holding property taxes in other places constant.
In this case, property owners can move from one place to another to escape the tax increase.
Thus, the burden of a property tax increase in one place, such as a big city, may be regressive.

16. State and Local Public Finance Lecture 8: Property Tax Incidence
When To Use the New View and the New New View?
The New View or the New New View
These views seems appropriate for the incidence of the property tax nationwide.
Thus, most scholars agree that the property tax as a whole is progressive.
This conclusion is relevant in deciding the extent to which a federal system should rely on local property taxes.

17. State and Local Public Finance Lecture 8: Property Tax Incidence
The Benefit View
A final view of the property tax incidence is the Benefit View.
According to this view, the property tax is simply the price a household pays to live in a community.
Households live where this price equals their benefits from the public services, so the property tax is fair according to the benefit principle.

18. State and Local Public Finance Lecture 8: Property Tax Incidence
The Benefit View and Capitalization
The Benefit View implies that there will be no capitalization:
If households all select their optimal community, they have no reason to bid up the price of housing anywhere else.
The extensive evidence of capitalization therefore leads to a clear, unambiguous rejection of the Benefit View.

19. State and Local Public Finance Lecture 8: Property Tax Incidence
Capitalization And Incidence
Capitalization implies that property owners cannot escape a tax increase, even if they have opportunities elsewhere.
If tax changes are capitalized into property values, then owners bear the burden of the tax if they stay (and pay higher taxes) or leave (and experience a capital loss).

20. State and Local Public Finance Lecture 8: Property Tax Incidence
Capitalization and the Traditional View
Capitalization also implies that a key conclusion of the Traditional View, namely, that property tax increases in one jurisdiction are regressive, may not be correct.
With capitalization, the burden falls on current property owners, who have relatively high incomes.
Moreover, many property owners in a particular jurisdiction may not be residents, but may instead be:
corporate shareholders who live around the country
landlords who live elsewhere.  

21. State and Local Public Finance Lecture 8: Property Tax Incidence
The Case of Rental Housing
In the case of rental housing, some evidence on these points is provided by Carroll and Yinger (NTJ, June 1994).
Tax shifting from landlords to tenants must take the form of higher rents.
C&Y estimate the extent to which higher property taxes lead to higher rents in the Boston area, all else equal.

22. State and Local Public Finance Lecture 8: Property Tax Incidence
Mobile Tenants P Q S
S+tax D P3
P1=P2
tax
The rental housing market (within an urban area)
Higher property taxes alone do not make an apartment more desirable to a tenant, so in the case of mobile tenants:

23. State and Local Public Finance Lecture 8: Property Tax Incidence
Service Capitalization
However, tenants will pay higher rents if they receive better public services.
Thus, landlords can shift a property tax increase to tenants only to the extent that this increase leads to better public services.
The question is: To what extent does this type of shifting occur?

24. State and Local Public Finance Lecture 8: Property Tax Incidence
Estimates of Property Tax Shifting
C&Y estimate that a $1.00 increase in property taxes results in a rent increase of about $0.15, on average, which implies that landlords bear about 85% of the property tax burden.
Thus, the conclusion from the Traditional View, namely, that tenants bear a large share of the burden of a property tax increase, is not supported, at least not in the Boston area.

25. State and Local Public Finance Lecture 8: Property Tax Incidence
Time of Ownership
Capitalization also implies that any incidence analysis has a new distinction, namely between owners at the time a tax change is announced and future owners.
This distinction does not correspond to the categories in previous incidence analysis (such as owners, consumers, workers, and renters or rich and poor).  

26. State and Local Public Finance Lecture 8: Property Tax Incidence
How to Frame Incidence Analysis
Framing an analysis of property tax incidence can be confusing because the progressivity/regressivity approach is so different from the capitalization approach.
In practice, however, the progressivity/regressivity frame makes the most sense in some contexts and the capitalization frame makes the most sense in others.

27. State and Local Public Finance Lecture 8: Property Tax Incidence
How to Frame Incidence Analysis, 2
The equity of tax provisions that have been in place a long time should be evaluated based on their progressivity or regressivity; gains and losses to property owners are not relevant.
The equity of new tax provisions that are intended to be in place for a long time (e.g. a new property tax or income tax) should be evaluated primarily on the basis of their progressivity or regressivity, but gains or losses to specific groups are worth noting.
Gains to a politically connected group (e.g. homeowners on Long Island in the case of New York’s STAR program) should be part of the discussion.
One way to minimize these gains and losses is to have a phase-in period.

28. State and Local Public Finance Lecture 8: Property Tax Incidence
How to Frame Incidence Analysis, 3
The equity of temporary tax policies should be framed primarily on the basis of the capitalization view.
The equity of a revaluation that is followed by a return to poor assessments should be evaluated on the basis of the (often unfair) gains and losses it generates.
The equity of a revaluation that is followed by the implementation of an accurate assessing system should be evaluated on the basis of the horizontal and vertical equity it generates.

29. State and Local Public Finance Lecture 8: Property Tax Incidence
Property Tax Incidence And Public Policy
All views of property tax incidence say that taxes on homeowners are regressive.
Voters want programs to cut this regressivity, which applies to the component of the property tax that is of greatest concern to voters.
Voters are particularly concerned about elderly homeowners.

30. State and Local Public Finance Lecture 8: Property Tax Incidence
Graduated Property Tax Rates
Graduated property tax rates are possible (e.g. Minnesota) but do not make sense for nonresidential property.
The issue is regressivity across people, not across businesses.
A business with a small factory may be owned by a very rich person!
So states turn to circuit breakers and homestead exemptions

31. State and Local Public Finance Lecture 8: Property Tax Incidence
Circuit Breakers
A circuit breaker provides a tax break (usually through an income tax rebate) if a person’s property tax payment exceeds a given share of their income, W.
Design:
with a typical α = 0.5 and a typical β = .035.

32. State and Local Public Finance Lecture 8: Property Tax Incidence
Benefits of Circuit Breakers
Popularity
About half of the states have circuit breakers for elderly homeowners or elderly renters.
A few states have circuit breakers for all homeowners or all renters.
For details, go to
Strengths
Circuit breakers provide tax relief for people who have a hard time paying property taxes out of their income.

33. State and Local Public Finance Lecture 8: Property Tax Incidence
Problems with Circuit Breakers
Weaknesses
Circuit breakers help many home owners who do not need help.
Empty-nesters can borrow against their equity; the circuit breaker just protects their children’s inheritance!
Circuit breakers reward people who buy an expensive house.
Circuit breakers for all taxpayers lower tax prices and have unintended consequences.
Circuit breakers cannot be given to renters without an implicit analysis of property tax incidence!

34. State and Local Public Finance Lecture 8: Property Tax IncidenceV t t*
t*(1-α)
βY1/t
βY2/t
Property Tax Schedule with a Circuit Breaker
Schedule for Y2>Y1
Schedule for Y1
In this figure, t* is the legislated tax rate and α and β are the parameters of the circuit breaker formula.
The tax relief starts sooner for people with lower incomes—a progressive provision.
The tax relief increases with house value—a regressive provision.

35. State and Local Public Finance Lecture 8: Property Tax Incidence
A Circuit Breaker For New York?
Last year Governor Cuomo proposed a circuit breaker for New York State.
It was an additional break on top of the STAR exemptions.
It applied to renters and owners; taxes were assumed to be 13.75% of rents.
Adding renters makes it fairer than STAR exemptions, but would do little for children in districts with poor schools.
It was not passed.

36. State and Local Public Finance Lecture 8: Property Tax Incidence
Homestead Exemptions
Design
The formula:
In New York, X is higher in counties with expensive houses.
These exemptions may or may not lead to reimbursement by the state.

37. State and Local Public Finance Lecture 8: Property Tax Incidence
Popularity of Exemptions
Almost all states have some form of homestead exemption.
Most states have special exemptions, usually for the elderly or veterans.
Several states have general exemptions.
A few states reimburse local governments for the exemptions.
For details, go to

38. State and Local Public Finance Lecture 8: Property Tax Incidence
Strengths and Weaknesses of Exemptions
Strengths
Homestead exemptions cut the regressivity of the property tax on homeowners.
Weaknesses
Reimbursed homestead exemptions lower tax prices and have unintended consequences—and also substitute for fairer forms of state aid.
Homestead exemptions cannot be given to renters without an implicit analysis of property tax incidence!

39. State and Local Public Finance Lecture 8: Property Tax IncidenceV t
X = Exemption
No exemption: proportional
Exemption: progressive
Property Tax Schedule with an Exemption t*
The tax rate is zero below V = X and moves toward t* (the legislated rate) as V increases.