The Curious Case of Property Taxes

Federal lawmakers should remember that property taxes are key to state and local budgets.

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As a consequence of falling home prices, some housing observers expected property tax collections to fall as well, exacerbating budget challenges for state and local governments. But this did not happen. In fact, property tax collections remained fairly stable in the years after the Great Recession, resulting in higher effective tax rates for homeowners and other property owners.

Taxes on homes, land, farms and other forms of real estate make up an important revenue source for state and local governments. Over the last year of Census data available, property taxes were the leading category of revenue for state and local governments, yielding 34 percent of tax collections. The next leading source, individual income taxes, constituted only 23 percent of the total.

Property taxes help finance local government services, especially education. Indeed, property taxes directly targeted to education funds alone are responsible for approximately one-third of local education financing. But the amount of this tax revenue varies across jurisdictions and time.

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One way of comparing the relative burden of taxes collected on home owners is to measure effective tax rates, or the amount of tax paid divided by the value of the underlying property. The following map presents county-level effective tax rates (per $1,000 of value) during the housing boom period, when property values were high and effective rates were at cycle lows. The effective rate of tax on homeowners varies greatly across regions, with some states in particular relying on property taxes in lieu of other forms of taxation.

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Of course, in recent years property and housing prices have fallen substantially, with national housing price indices down about one-third at their lowest levels. While such declines in prices and wealth have had significant impacts for homeowners, these changes have also resulted in higher effective tax rates on homes because property tax collections did not decline significantly with housing values. 

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For example, as of the first quarter of 2013, the pace of  property tax collections was at a record high (about a $478 billion annualized pace of tax collected on all types of property). The rate of property tax revenues did decline a little from the middle of 2010 to the start of 2012, but the peak decline was only about 2 percent - nowhere near the price declines registered for housing and other forms of real estate.

Why? Property taxes are not automatically connected to home prices, with time lags existing between assessed values and market values. Moreover, governments can increase the rate of tax, thus offsetting any declines in assessed values.

In contrast, other taxes collected by state and local governments – most notably income taxes – staged significant cyclical declines during and after the Great Recession, thus increasing the overall share of property taxes in terms of all state and local revenues. During 2010, the property tax share reached a cycle high of more than 37 percent of such revenues.

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The Census data do not allow a detailed breakout of the housing contribution of property taxes, but given the size and value of the housing stock (owner-occupied, rental, under construction, etc.) this share is the largest source among all forms of property. So the relative stability in property tax collections suggests that, ironically, taxes paid by homeowners increased in importance during the very period when housing was under the most economic stress.

More fundamentally, the role of property taxes, and the burden on housing in particular, has implications for federal tax policy debates. Some discussions of the mortgage interest deduction and other housing tax incentives, including the deduction for state and local property taxes, incorrectly suggest that housing does not generate significant amounts of tax revenue. In fact, for no other reason than the hundreds of billions of taxes paid by property owners each year, the contribution of real estate to the public coffers is substantial.

Perhaps the tax contribution of housing is sometimes underestimated in Washington, D.C. because most of this revenue flows to state and local governments instead of the U.S. Treasury. Regardless, this very real benefit for local public services financed with taxes connected to home values should be part of any future federal tax policy debate. And it should be part of any calculation measuring housing's total tax contribution.

Robert D. Dietz is an economist with the National Association of Home Builders. Previously an economist with the Congressional Joint Committee on Taxation, Robert writes on housing and policy issues at NAHB's Eye on Housing blog and @dietz_econ on Twitter.

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