Notes on the Incidence of the Property Tax
State and Local Government Finance
These notes review the basic analysis of property tax incidence and present one recent result concerning the incidence of the property tax on rental housing.
An Overview of Property Tax Incidence
An analysis of property tax incidence must address the following three types of questions.
I. The question first asked by scholars was: “Who bears the burden of a nationwide property tax (or, equivalently) of the average property tax rate?”
A. The traditional view, based on an analysis of the markets for individual types of property, leads to the conclusion that the burden of the property tax is regressive. In particular, business owners, who have many options, are able to escape the burden of the tax; that is, they are able to shift it onto consumers, workers, and renters, who have lower incomes, on average, than property owners.
B. The new view, based on a general equilibrium analysis of all markets, leads to the conclusion that the burden of the tax is progressive. Because the amount of property (or physical capital) is fixed at any given time, the owners of property cannot alter their behavior in response to the tax and therefore are stuck with the burden.
C. The new new view points out that property owners might be able to change the amount of property over time, either through investment decisions or through international capital flows. This “correction” implies that the new view may be too extreme, but does not alter the conclusion that a large share of the burden is likely to fall on property owners.
III. The next development in the literature was the recognition that the traditional view and the new view are not really incompatible, but are instead appropriate for different questions.
A. The traditional view seems appropriate for determining the incidence of a property tax increase in one community, holding property taxes in other communities constant. In this case, national prices and totals are not affected, but economic actors can move from one jurisdiction to another in order to escape the tax increase. Thus, several scholars have concluded, the burden of a property tax increase in one jurisdiction, such as a big city, is likely to be very regressive.
B. The new view (or the new new view) seems appropriate for determining the incidence of the property tax nationwide. Overall, therefore, most scholars agree that the property tax as a whole is progressive. This conclusion is not linked to any particular policy choices, but it is relevant for determining the extent to which a federal system should should rely on local property taxes.
III. The final complication is that property tax changes may be capitalized into property values. This has important implications for the second incidence question above, namely who bears the burden of a tax change in one jurisdiction relative to others.
A. The first implication of capitalization is that property owners may not be able to escape a tax increase, even if they have opportunities elsewhere. 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)
B. The second implication is that any incidence analysis has a new distinction, namely between owners at the time a tax change is announced and future owners. This distinction does not correspond to the categories in previous incidence analysis (such as owners, consumers, workers, and renters or rich and poor).
C. The third implication is that the conclusion from traditional incidence analysis, namely that property tax increases in one jurisdiction have a regressive impact, may no longer be true. With capitalization, the burden falls on current property owners, who have relatively high incomes. Of course, the burden only falls on a subset of high-income people, namely high-income owners of property in the jurisdiction where taxes go up, not on all high-income people. Moreover, many property owners in a particular jurisdiction may not be residents of that jurisdiction. For example, they could be corporate shareholders who live around the country or landlords who live in nearby jurisdictions. When there is capitalization, therefore, the exact pattern of incidence could be quite complex.
An Application to Rental Housing
In one case, namely rental housing, one paper that accounts both for traditional incidence analysis and capitalization (Carroll and Yinger, National Tax Journal, 1994) actually estimates the extent to which property owners can shift taxes onto tenants. This is the easiest case to study, because tax shifting must take the form of higher rents. As a result, one can estimate the extent to which higher taxes in one jurisdiction are shifted onto tenants by determining whether rents are higher in jurisdictions with higher tax rates, all else equal.
If renters are fairly mobile, as seems likely, landlords cannot simply raise rents when property taxes go up. After all, higher property taxes alone do not make an apartment more desirable to a tenant, and mobile tenants will respond to a rent increase by moving. However, tenants will pay higher rents if they receive better public services, which form part of the benefits from living in a particular place. Public services and tax rates are not, of course, perfectly correlated. Some jurisdictions face high costs in providing public services, for example, and therefore must raise taxes more than other places to obtain the same public-service improvement. Nevertheless, a property tax increase does lead to some increase in the quality of public services. Thus, landlords can shift a property tax increase to tenants only to the extent that this increase is associated with better public services.
Using data for communities in the Boston area, Carroll and Yinger estimate that a $1.00 increase in property taxes results in a rent increase of only about $0.15, on average, even if the underlying supply curve for housing is very elastic (that is, even if landlords have many options). In the average community, therefore, landlords bear about 85% of the property tax burden. The burden on landlords varies across communities, depending on the cost of public services, among other things, but the landlord share is above 75% in every community. This study cannot observe the incomes or residential locations of landlords, but it implies that tenants, who almost certainly have lower average incomes than landlords, bear a relative small share of the burden of a property tax increase. Thus, the usual conclusion from traditional incidence analysis, namely that tenants are likely to bear a large share of the burden of a property tax increase, is not correct, at least not in the Boston area.
This result for rental housing may not carry over to other types of property. Property tax increases for commercial and industrial property, for example, may be shifted to a greater or lesser degree than those on rental property. Moreover, in the case of owner-occupied housing, capitalization simply adds a new dimension to the incidence analysis. The burden of a property tax increase still is likely to have a regressive impact, because higher-income owners spend a smaller share of their income on housing than do lower-income owners, but now the burden falls entirely on owners who own at the time the tax increase is announced, not on future owners — a distinction not recognized in traditional incidence analysis.