State and Local Public Finance Spring 2014, Professor Yinger

1. State and Local Public FinanceSpring 2014, Professor Yinger Lecture 8 Property Tax Incidence

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

6. P S P1=P2 tax P3 D Q The land market State and Local Public FinanceLecture 8: Property Tax Incidence • Even in the Traditional View, the property tax on land is progressive:

7. State and Local Public FinanceLecture 8: Property Tax Incidence • For single-family houses, the Traditional View depends on the income elasticity of demand for housing (θ): • To see why, note that:

8. State and Local Public FinanceLecture 8: Property Tax Incidence • An examination of the national average tax holds t/r constant, so • T/Y increases with income if θ >1 • T/Y decreases with income if θ <1 • There is a strong consensus that θ < 1, so T/Ydecreases with income and this portion of the tax is regressive.

9. State and Local Public FinanceLecture 8: Property Tax Incidence • 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.

10. S i i1 tax i2 D Burden on owners of K K State and Local Public FinanceLecture 8: Property Tax Incidence • In effect, the New View assumes the supply of property in the nation (K) is fixed:

11. State and Local Public FinanceLecture 8: Property Tax Incidence • 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.

12. S-R S i (L-R S)+t L-R S i2 i1 tax L-R burden on consumers/workers i3 tax L-R burden on owners of K i4 D S-R burden on owners of K K State and Local Public FinanceLecture 8: Property Tax Incidence • The New View (S-R) and the New-New View (L-R)

13. State and Local Public FinanceLecture 8: Property Tax Incidence Other Questions • Some scholars say that the Traditional View and the New Viewaddress for 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.

14. State and Local Public FinanceLecture 8: Property Tax Incidence • 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.

15. State and Local Public FinanceLecture 8: Property Tax Incidence The Benefit View • A final view of the property tax incidence is the Benefit View. • In 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.

16. State and Local Public FinanceLecture 8: Property Tax Incidence • 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.

17. State and Local Public FinanceLecture 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)

18. State and Local Public FinanceLecture 8: Property Tax Incidence • 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).

19. State and Local Public FinanceLecture 8: Property Tax Incidence • 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.

20. State and Local Public FinanceLecture 8: Property Tax Incidence • 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.

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

22. State and Local Public FinanceLecture 8: Property Tax Incidence • 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?

23. State and Local Public FinanceLecture 8: Property Tax Incidence • 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 correct, at least not in the Boston area.

24. State and Local Public FinanceLecture 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. • Voters are particularly concerned about elderly homeowners.

25. State and Local Public FinanceLecture 8: Property Tax Incidence • 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

26. State and Local Public FinanceLecture 8: Property Tax Incidence • A circuit breaker provides a tax break (often through the income tax) if a person’s property tax payment exceeds a given share of their income. • Design

27. State and Local Public FinanceLecture 8: Property Tax Incidence • 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 http://www.lincolninst.edu. • Strengths • Circuit breakers provide tax relief for people who have a hard time paying property taxes out of their income.

28. State and Local Public FinanceLecture 8: Property Tax Incidence • Weaknesses • Circuit breakers help many home owners who do not need help. • Empty-nesters with a valuable house can borrow against their equity. • The circuit breaker just protects their children’s inheritance! • 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!

29. State and Local Public FinanceLecture 8: Property Tax Incidence • Homestead Exemptions • Design • The formula: • May or may not involve reimbursement by the state

30. State and Local Public FinanceLecture 8: Property Tax Incidence • Popularity • 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 http://www.lincolninst.edu.

31. State and Local Public FinanceLecture 8: Property Tax Incidence • Strengths • Homestead exemptions cut the regressivity of the property tax on homeowners. • Weaknesses • Reimbursed homestead exemptions lower tax prices and have unintended consequences. • Homestead exemptions cannot be given to renterswithout an implicit analysis of property tax incidence!