1. State and Local Public Finance Professor Yinger Spring 2019
Lecture 8
PROPERTY TAX INCIDENCE

2. State and Local Public Finance Lecture 8: Property Tax Incidence
Class Outline
Four Approaches to Property Tax Incidence
Nation-wide Incidence with a Single Rate
A Focus on Homeowners
The Impact of Capitalization
The Property Tax as a Benefit Tax
Property Tax Incidence and Public Policy

3. State and Local Public Finance Lecture 8: Property Tax Incidence
Property Tax Incidence: Approach 1
The first approach to property tax incidence is to ask:
Who bears the burden of a nationwide property tax (or, equivalently) of the average property tax rate?
The standard answer to this question, often called the “New View,” is that the property tax falls on the owners of real estate, including residential, commercial, and industrial property.
Because property ownership is concentrated among high income households, this answer implies that the property tax is progressive.

4. State and Local Public Finance Lecture 8: Property Tax Incidence
Approach 1: The New View
In contrast to traditional analysis, 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 by turning to another type of property.
The inability of property owners to shift the tax combined with the concentration of property ownership at high incomes leads to the conclusion that the property tax is progressive.

5. State and Local Public Finance Lecture 8: Property Tax Incidence
Approach 1: The National Market for Property
Although it is often expressed in a mathematical model, the intuition of the New View is simply that the supply of property in the nation is fixed and taxes on property therefore cannot be shifted:
Price of Property
Property D P1 S P2
Burden on owners of K
tax

6. State and Local Public Finance Lecture 8: Property Tax Incidence
Approach 1: The New New View
An amended new view (the New New View?) points out that the amount of property can change slowly over time due to construction, remodeling, and demolition.
Alternatively, some scholars argue that the property tax is roughly a tax on physical capital and the supply of physical capital can vary in the long run based on investment responses to the rate of return.
This amendment implies that the New View may be too extreme but that most of the burden is still likely to fall on property owners
Because changes in the amount of property are small relative to the stock of property, only a small share of the burden can be shifted to renters, consumers, and workers.

7. State and Local Public Finance Lecture 8: Property Tax Incidence
Approach 1: The Long Run and the Short Run
Property
L-R S
(L-R S) + t D P1 P2 P3
tax
L-R burden on consumers/workers
L-R burden on owners of K
S-R S P4
S-R burden on owners of K
The New View (S-R) and the New New View (L-R)
Price of Property
For readability, this graph exaggerates shifting onto consumers and workers.

8. State and Local Public Finance Lecture 8: Property Tax Incidence
Approach 2: Focus on Owner-Occupied Housing
A second approach is to focus on the property tax on owner-occupied housing.
Because most owner-occupied housing sales involve existing housing, the two parties to the transaction are both households.
It follows that households bear the burden of the tax,
And the question is: How does the property tax burden change as household income changes?

9. State and Local Public Finance Lecture 8: Property Tax Incidence
Approach 2: Property Taxes and Rents
For owner-occupied housing, property tax incidence depends on the income elasticity of demand for housing .
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 the property tax burden is:

10. State and Local Public Finance Lecture 8: Property Tax Incidence
Approach 2: The Income Elasticity of Demand for Housing
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):
These formulas imply that the change the average tax rate, T/Y, in percentage terms is

11. State and Local Public Finance Lecture 8: Property Tax Incidence
Approach 2: Progressive or 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.

12. 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

13. State and Local Public Finance Lecture 8: Property Tax Incidence
Approach 2: Variation in Property Taxes Across Jurisdictions
The property tax on owner-occupied housing is even more regressive when variation in tax bases across jurisdictions is considered.
Some jurisdictions have high property values per household, while others do not.
Hence, some jurisdictions can obtain any given amount of revenue at a much smaller burden on their homeowners than can other jurisdictions.
These disparities are offset to some degree by state aid to local governments, which is considered in later classes.

14. State and Local Public Finance Lecture 8: Property Tax Incidence
Approach 2: Variation in Property Taxes Across Jurisdictions, 2
Suppose school districts are expected to raise half of the state-wide average revenue for K-12 schools.
In New York State this amount is $9,443 per pupil ( school year, without NYC). (Source: NY State Education Department)
Property value pupil in New York State is $182,948 in the least wealthy decile of districts and $1,491,480 in the wealthiest.
As a result, the least wealthy districts would have to pay a property tax rate of 5.2% to reach this spending target, but the wealthiest districts would only need a rate of 0.6%.
This is obviously a very regressive outcome.

15. State and Local Public Finance Lecture 8: Property Tax Incidence
Approach 3: Property Tax Incidence with Capitalization
A 3rd approach to property tax incidence is to consider the role of property tax capitalization.
This capitalization shifts the focus to property owners at the time a tax increase (or decrease) is passed.
Owners at that time cannot escape the tax change.
If they stay in their house, they pay the tax change directly, and if they sell their house, they pay the tax change in the form of a capital gain or loss.
If they move, the people who buy their house do not bear any of the burden of the property tax increase because the tax change is offset by a change in sales price.
According to this approach, therefore, the burden of any property tax change falls on the owners of property at the time of the change in the jurisdiction where the change took place.

16. State and Local Public Finance Lecture 8: Property Tax Incidence
Approach 3: Property Tax Incidence with Capitalization
Capitalization arguments are often ignored.
The implications of this approach are quite counter-intuitive,
And the affected groups (e.g. homeowners at time t) may be quite similar to the unaffected groups (e.g. homeowners who buy a house after time t).
Nevertheless the logic of this view and the evidence supporting it are quite strong.
Recall the strong evidence for property tax capitalization.

17. State and Local Public Finance Lecture 8: Property Tax Incidence
Approach 3: Application to Economic Development
One important application of this approach is to economic development.
With full capitalization, lower property tax rates lead to higher property values and hence to no net advantage in attracting business for a low-tax jurisdiction.
This argument helps to explain why scholars have not found consistent evidence to support the view that property tax rates affect economic development and why some careful studies do not find any such impact at all.
We will return to these issues in a later class.

18. State and Local Public Finance Lecture 8: Property Tax Incidence
Approach 4: The Property Tax as a Benefit Tax
A final approach to 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.
In this context, the property tax is called a “benefit tax.”

19. State and Local Public Finance Lecture 8: Property Tax Incidence
Approach 4: Mixing Positive and Normative
This argument incorrectly mixes positive analysis (the property tax equals a household’s benefits from the services it funds) with a normative principle (the benefit principle).
A finding that the property tax is a benefit tax does not make the benefit principle any more or less compelling.
One could agree that the property tax is a benefit tax and still reject the benefit principle as an appropriate fairness standard.
One could conclude that the property tax is not a benefit tax, but still believe that the benefit principle is appropriate for judging the fairness of the tax.

20. State and Local Public Finance Lecture 8: Property Tax Incidence
Approach 4: Evidence
The Benefit View implies that the value of public services will not be capitalized into the price of housing.
If households all select their optimal community, they have no reason to bid up the price of housing anywhere else.
The extensive evidence of public service capitalization (discussed in an earlier class) therefore leads to a clear, unambiguous rejection of the Benefit View.

21. 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 and veterans.

22. 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 homestead exemptions and circuit breakers instead.

23. State and Local Public Finance Lecture 8: Property Tax Incidence
Homestead Exemptions
Design
The formula:
These exemptions may or may not lead to reimbursement by the state.
In New York’s STAR program, X is higher in counties with expensive houses, which undermines both equity and efficiency, as it rewards (mostly wealthy) homeowners who move to high-cost locations.

24. 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.

25. 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

26. 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 encourage property tax rate increases.
Homestead exemptions cannot be given to renters without an assumption about the (unknown) extent to which landlords shift the property tax onto renters.

27. 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, Y.
Design:
with a typical α = 0.5 and a typical β = .035.

28. 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.

29. 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 experience a negative income shock that makes it hard for them to pay property taxes out of their income.

30. 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 subsidizes their children’s inheritance.
Circuit breakers reward people who buy an expensive house.
Circuit breakers for all taxpayers lower tax prices for some voters and may have unintended consequences, such as higher spending.
Circuit breakers cannot be given to renters without an assumption about the (unknown) extent to which landlords shift the property tax onto renters.

31. 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.

32. State and Local Public Finance Lecture 8: Property Tax Incidence
A Better Solution for Cash-Flow Problems
Many people like circuit breakers because they help empty nesters and people in vacation areas that experience rapid property-value growth.
In fact, however, these people have a valuable asset and do not need to be subsidized.
Instead, they need help with a cash-flow problem.
A better solution for this cash-flow problem is a “tax deferral” program.
This type of program allows people in certain groups to postpone property tax increases until a house is sold or passed on to heirs; at that time all postponed payments are due, with interest.
About two dozen states currently have a program of this type.