House Prices Down, Property Taxes . . .Up?

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One of the worries as house prices began their now three-year plunge back in 2007 was the affect of falling values would have on budgets of cities and other local governments, which rely heavily on property taxes. Well it turns out, property tax revenue is far more resilient than people thought.

The strength of the property tax was the main driver of the small positive growth in overall state and local taxes for the fourth quarter of 2009.  This was a theme in many of the presentations.  New research by Byron Lutz, Raven Malloy and Hui Shan illustrates that house value declines don’t necessarily lead to lower property taxes, and when they do, it can take a while. With luck, by the time property taxes do dip, sales and income taxes will be recovering. The good news is that if property taxes could stand up in this recession, which was both deep and caused by a housing collapse, they can stand up to most crises.

The fact that property taxes held up despite the housing bubble bursting has ramafications for tax policy in general. Here’s why:

First of all, it is just interesting that property taxes held up despite the real estate recession. In fact, property tax revenue has held up better than any other of the general ways states and local governments raise money. Sales and individual tax revenue were both down sharply in 2009. Property taxes, on the other hand, were up. Why is that? The professors said that was mostly the result of the fact that local governments tend to offset declines in house prices by raising taxes. Or they just don’t lower the assessment on houses when property values fall, which essentially does the same thing as raising tax rates.

Here’s why I find this interesting and why it says something about the tax code in general. A favorite argument of people who believe we should cut taxes or are against taxes in general is that higher tax rates don’t produce higher tax revenue. In fact, they often argue that higher tax rates cause revenue to drop because as rates get higher people put more energy into dodging taxes, either through loop-holes or just working less, or being less productive.

Well with the test case of property taxes, that seems to be not how things work out. In fact, higher rates did seem to have a positive affect on property tax revenues. Raise taxes and you will get more government revenue. The question is how high did those rates have to go to get that positive affect. The tax-haters argue that that is their point. No matter how high you raise the rate you don’t get much more. Eventually we will be at a 90% tax rate, and no one will want to own or do anything.

Well if you look at the states individually, most didn’t have to raise their rates very much to generate more property tax revenue. If you look at California, Ground Zero for the housing crisis, the state’s small mandated property tax increase was enough to keep revenue stable.

Again, people will say that local property taxes are not a good study of tax policy. City governments game assessments and set tax rates to a level that they know will generate the right amount of income to match spending, or at least come close. OK. But maybe that’s what we should do on a national level. Instead of keeping our income tax rates the same level every year, and trying to change spending around to reflect that. Maybe income tax rates should float based on the government’s spending needs. Deficit commission, the ball is in your court.