State and Local Public Finance
Professor Yinger
Spring 2016
LECTURE 8
PROPERTY TAX INCIDENCE
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
State and Local Public Finance
Lecture 8: Property Tax Incidence
Property Tax Incidence
 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
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.
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
P2
P1=P3
S+tax
S
D
Q
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 Land
 Even in the Traditional View, the property tax on land is progressive:
P
S
P1=P2
tax
P3
D
Q
The land market
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):
o To see why, note that:
( PH ) / PH

Y / Y
T tV t  PH / r   t  PH 


  

Y Y
Y
 r  Y 
State and Local Public Finance
Lecture 8: Property Tax Incidence
Why the Property Tax on Single-Family Housing Is Regressive
 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
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.
State and Local Public Finance
Lecture 8: Property Tax Incidence
The National Market for Property
 In effect, the New View assumes the supply of property in the nation
(K) is fixed:
S
i
i1
tax
i2
D
Burden on owners of K
K
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
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 Long Run and the Short Run
 The New View (S-R) and the New-New View (L-R)
S-R S
i
(L-R S)+t
L-R S
i2
i1
i3
i4
tax
tax
L-R burden on consumers/workers
L-R burden on owners of K
D
S-R burden on owners of K
K
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 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
When To Use the New View and the New New View?
 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
The Benefit View
 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 and Capitalization
 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
Capitalization And Incidence
 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
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.
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
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.
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
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).
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
Mobile Tenants
 Higher property taxes alone do not make an apartment more desirable
to a tenant, so in the case of mobile tenants:
P
S+tax
P1=P2
tax
S
D
P3
Q
The rental housing market
(within an urban area)
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?
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
correct, at least not in the Boston area.
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.
o Voters are particularly concerned about elderly homeowners.
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.
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
Circuit Breakers
 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:
CB   (tV  W ) if (tV  W )  0
CB  0
if (tV  W )  0
State and Local Public Finance
Lecture 8: Property Tax Incidence
Benefits of Circuit Breakers
 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.
 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
Problems with Circuit Breakers
 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
A Circuit Breaker For New York?
 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
Homestead Exemptions
 Design
oThe formula:
T  t (V  X )
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
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 http://www.lincolninst.edu.
State and Local Public Finance
Lecture 8: Property Tax Incidence
Strengths and Weaknesses of Exemptions
 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!