Property Tax Hikes Hurt Home Values and Drive Up Rental Costs

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by Dick Clark

 

Property taxes are controversial, but they are heavily relied upon by local governments across the United States. Described as a “fundamental source of revenue,” property taxes total approximately 73 percent of local government tax revenue nationwide.[1] The final report from the Nebraska Unicameral’s Tax Modernization Committee in 2013 found that Nebraska’s “reliance on property taxes as a share of state and local taxes is greater than the national average and greater than most of our border states.”[2]
 

While members of the Tax Modernization Committee claimed that they consistently heard more about property taxes than anything else on their listening tour across the state, local policymakers have not been so consistent in addressing these concerns. The City of Omaha’s proposed 2015 budget incorporates a property tax cut of about two percent,[3] but the latest budget proposed in Papio-La Vista would hike property taxes.[4] North Platte property taxes went up substantially last year to pay down municipal debt,[5] and a report from Nebraska Department of Revenue indicated that North Platte taxpayers were not alone — property taxes increased in all but four Nebraska counties in 2013, with an average growth of more than five percent.[6]
 

Elected officials surely recognize that taxpayers do not enjoy paying higher taxes, but they presumably believe that the public services financed by the additional revenues are worth the cost to their constituents. What many of these policymakers may not realize is that higher property taxes have negative long term effects on real estate values. These effects are not borne only by property owners: they are even more pronounced for renters.
 

Property taxes are an ongoing cost of real estate assets, and this cost is recognized by market actors. Property tax liabilities are accounted for in the market value of assets through a process called “tax capitalization.” Investors capitalize expense and revenue streams all the time when estimating an asset’s market value by projecting cash flows out into the future and adding up their net present value.[7] Since property taxes are an ongoing expense associated with holding real estate, the price of that real estate will be affected by the level at which it is taxed. When property taxes go up, the cost of owning a piece of real property goes up, and the market value of that property declines accordingly. Likewise, when property taxes go down, property values will generally increase to reflect the lower expense of owning property.
 

Public officials might object that the increase in public services should offset the expense of higher property taxes; however, the offset is not 1:1, but rather some fraction of the total cost of the taxes. It is true that “property taxes and the value of public services are [both] capitalized into house prices,”[8] but higher taxes mean that there will be fewer willing buyers, with lower home values as a result. But these values are not lower because the housing is suddenly a better deal. In fact, the impact of artificially depressed housing prices on local housing stock will ultimately mean higher rental costs for those who do not own their own homes. According to research conducted by two Kansas economists,
 

“Capitalization of the property tax into housing rent-to-value ratio is between 62 and 100 percent… [suggesting] that the amount of property tax passed onto the renter may be substantial…. Whatever the structure of the housing industry, the tax generates a decrease in the housing stock. Because of the resulting smaller flow of housing services, the rental value of a given unit will be higher than the pre-tax change level.”[9]
 

These higher rental costs are particularly damaging for the poor because they are less likely to be able to escape rising rents by moving to a more affordable housing market. And because property owners who reside on their own property tend to receive favorable tax treatment compared to landlords, the impact of property tax hikes on low-income renters will be disproportionately high.
 

Property tax increases depress property values, hurt renters, and cause damaging distortions in the housing market for years to come. While it seems to make sense for policymakers to ratchet up government revenue-gathering when a tantalizing new public project presents itself, the more responsible course is to allow local markets to develop organically without the added burden of higher taxes. It is also important to recognize that property tax relief actually boosts home values to a greater degree than it reduces government revenues. This is because while the nominal tax rate falls, home values rise as a result, meaning that a particular tax rate will actually net more tax dollars from the same house.
 

Reducing the property tax burden on Nebraskans means allowing them to better provide for their families right away, whether they rent or own. It also means protecting Nebraska’s high quality of life by ensuring that vital public services can be sustainably funded into the future. A more favorable tax environment will reliably grow economic opportunity in Nebraska for everyone, and protecting those who pay property taxes — directly or indirectly — is a critical part of that solution.
 

Stay tuned this fall for a comprehensive Platte Institute study of property taxes by Professor John Anderson of the University of Nebraska-Lincoln, and the Platte Institute’s announcement of the Strong Roots Nebraska plan for tax relief at the 2014 Legislative Summit on September 19.

 

[1] Tsoodle, Leah J. and Tracy M. Turner. “Property Taxes and Residential Rents.” Journal of Real Estate Economics. Vol. 36, no. 1. 2008. pp. 63–80.

[2] “Balancing the Scales: A Comprehensive Review of Nebraska’s State-Local Revenue System.” Report to the Legislature: LR 155. Tax Modernization Committee. Nebraska Legislature. 2013. [URL: http://nebraskalegislature.gov/pdf/reports/committee/select_special/lr155_taxmod2013.pdf]

[3] Robb, Jeffrey and Roseann Moring. “Omaha City Council approves 2015 budget, including property tax cut; Stothert weighing vetoes.” Omaha World-Herald. August 27, 2014. [URL: http://www.omaha.com/news/metro/omaha-city-council-approves-budget-including-property-tax-cut-stothert/article_3602899e-2d5f-11e4-9405-0017a43b2370.html]

[4] Dejka, Joe. “Papio-La Vista’s budget plan would boost property taxes.” Omaha World-Herald. August 25, 2014. [URL: http://www.omaha.com/news/metro/papio-la-vista-s-budget-plan-would-boost-property-taxes/article_75b8aefb-9c6e-5967-99a6-08f030f4b855.html]

[5] Clark, Dick. “Teeing Off With Tax Dollars in North Platte.” Platte Chat. Platte Institute for Economic Research. August 20, 2014. [URL: http://www.platteinstitute.org/research/detail/teeing-off-with-tax-dollars-in-north-platte]

[6] Stoddard, Martha and Faiz Siddiqui. “Report shows property taxes up in much of Nebraska.” Omaha World-Herald. January 17, 2014. [URL: http://www.omaha.com/news/report-shows-property-taxes-up-in-much-of-nebraska/article_fd0cfc98-855c-5817-a75e-d6c92911b20d.html]

[7] Anderson, Patrick L. “Appendix II: Tax Capitalization.” Proposal A: An Analysis of the June 2, 1993, Statewide Ballot Question. Mackinac Center for Public Policy. May 1, 1993. [URL: http://www.mackinac.org/5797]

[8] Tsoodle and Turner.

[9] Ibid.

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