Measuring the Extent of Property Tax Capitalization for Single Family Residences

Abstract

In recent years there has been a revival of interest in measuring the extent to which property tax levels are capitalized into the market values of individual residences. Recent taxpayer reaction to higher property tax rates and government spending, resulting in actions such as Proposition 13 in California, has undoubtedly contributed to renewed interest in this question. The question may be simply stated as given two residential parcels alike in every respect (including receipt of local government services) but subject to different property tax rates, to what extent is the market value of the house with the higher tax rate reduced relative to its neighbor? The argument is a special case of the Tiebout [8] hypothesis, which states that if we consider differences in local government services then housing values will vary directly with receipt of those services and inversely with the cost of those services. Measuring the extent of tax capitalization is important because it leads to inference as to who bears the burden of changes in property taxes. If taxes are capitalized, then buyers benefit when taxes are raised and sellers benefit when they are lowered. For rental property, tax capitalization implies that owners realize capital gains when taxes are lowered and capital losses when taxes are raised.