1. LECTURE 8 PROPERTY TAX INCIDENCE State and Local Public Finance Professor Yinger Spring 2016

2. State and Local Public Finance Lecture 8: Property Tax Incidence  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 Class Outline

3.  The first question in property tax incidence is: o Who bears the burden of a nationwide property tax (or, equivalently) of the average property tax rate?  Three answers have appeared: 1.The Traditional View 2.The New View 3.The New New View State and Local Public Finance Lecture 8: Property Tax Incidence Property Tax Incidence

4.  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. State and Local Public Finance Lecture 8: Property Tax Incidence The Traditional View

5.  The Traditional View focuses on the behavior of responsive firms with property as an input: P Q S S+tax D P 1 =P 3 P2P2 Product markets (commercial & industrial property is an input) or the rental housing market. State and Local Public Finance Lecture 8: Property Tax Incidence The Traditional View for Business Property

6.  Even in the Traditional View, the property tax on land is progressive: Q PS D P3P3 P 1 =P 2 tax The land market State and Local Public Finance Lecture 8: Property Tax Incidence The Traditional View for Land

7.  For single-family houses, the Traditional View depends on the income elasticity of demand for housing ( θ ): State and Local Public Finance Lecture 8: Property Tax Incidence o To see why, note that: The Traditional View for Single-Family Houses

8.  An examination of the national average tax holds t/r constant, so o T/Y increases with income if θ >1 o 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. State and Local Public Finance Lecture 8: Property Tax Incidence Why the Property Tax on Single-Family Housing Is Regressive

9.  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. State and Local Public Finance Lecture 8: Property Tax Incidence The New View

10.  In effect, the New View assumes the supply of property in the nation (K) is fixed: i K D i1i1 S i2i2 Burden on owners of K tax State and Local Public Finance Lecture 8: Property Tax Incidence The National Market for Property

11.  The New New View points out that the amount of property might respond to interest rates over time o through investment decisions o 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. State and Local Public Finance Lecture 8: Property Tax Incidence The New New View

12.  The New View (S-R) and the New-New View (L-R) i K L-R S (L-R S)+t D i1i1 i2i2 i3i3 tax L-R burden on consumers/workers L-R burden on owners of K S-R S i4i4 S-R burden on owners of K tax State and Local Public Finance Lecture 8: Property Tax Incidence The Long Run and the Short Run

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

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

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

16.  The Benefit View implies that there will be no capitalization: o 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. State and Local Public Finance Lecture 8: Property Tax Incidence The Benefit View and Capitalization

17.  Capitalization implies that property owners cannot escape a tax increase, even if they have opportunities elsewhere. o 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). State and Local Public Finance Lecture 8: Property Tax Incidence Capitalization And Incidence

18.  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. o This distinction does not correspond to the categories in previous incidence analysis (such as owners, consumers, workers, and renters or rich and poor). State and Local Public Finance Lecture 8: Property Tax Incidence Time of Ownership

19.  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. o With capitalization, the burden falls on current property owners, who have relatively high incomes. o 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. State and Local Public Finance Lecture 8: Property Tax Incidence Capitalization and the Traditional View

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

21.  Higher property taxes alone do not make an apartment more desirable to a tenant, so in the case of mobile tenants: P Q S S+tax D P3P3 P 1 =P 2 tax The rental housing market (within an urban area) State and Local Public Finance Lecture 8: Property Tax Incidence Mobile Tenants

22.  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? State and Local Public Finance Lecture 8: Property Tax Incidence Service Capitalization

23.  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. State and Local Public Finance Lecture 8: Property Tax Incidence Estimates of Property Tax Shifting

24.  All views of property tax incidence say that taxes on homeowners are regressive.  Voters want programs to cut this regressivity. o Voters are particularly concerned about elderly homeowners. State and Local Public Finance Lecture 8: Property Tax Incidence Property Tax Incidence And Public Policy

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

26.  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. State and Local Public Finance Lecture 8: Property Tax Incidence  Design: Circuit Breakers

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

28.  Weaknesses o 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! o Circuit breakers for all taxpayers lower tax prices and have unintended consequences. o Circuit breakers cannot be given to renters without an implicit analysis of property tax incidence! State and Local Public Finance Lecture 8: Property Tax Incidence Problems with Circuit Breakers

29.  Governor Cuomo has proposed a circuit breaker for New York State.  It is an additional break on top of the STAR exemptions.  It applies to renters and owners; taxes are assumed to be 13.75% of rents.  It is much fairer than STAR exemptions, but does little for children in districts with poor schools. State and Local Public Finance Lecture 8: Property Tax Incidence A Circuit Breaker For New York?

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

31.  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.http://www.lincolninst.edu State and Local Public Finance Lecture 8: Property Tax Incidence Popularity of Exemptions

32.  Strengths o Homestead exemptions cut the regressivity of the property tax on homeowners.  Weaknesses o Reimbursed homestead exemptions lower tax prices and have unintended consequences. o Homestead exemptions cannot be given to renters without an implicit analysis of property tax incidence! State and Local Public Finance Lecture 8: Property Tax Incidence Strengths and Weaknesses of Exemptions