Real Property Taxes, Local Public Services, and Residential Property Values

Abstract

Recent empirical work on the effects of property taxes on residential property values has suggested that much of the tax is capitalized. Oates [6], in a cross-sectional analysis of fifty-three residential communities in north-eastern New Jersey, concluded that a substantial portion of the residential property tax is capitalized in the form of depressed property values. Orr [8], in studying thirty-one communities in the Boston area, reached a similar conclusion for the effects on property values of property tax differentials among communities. This evidence supports the hypothesis that property taxes are not shifted but are borne largely by property owners at the time the tax is levied. The theory of tax incidence suggests that taxes on land cannot be shifted. Under competitive conditions, shifting occurs only if the quantity of land supplied is decreased when the tax is imposed.' If the supply of land is perfectly inelastic as typically assumed, the property tax will be capitalized and the value of the land will decrease. If existing landowners attempt to maintain the pre-tax price of land (assuming the supply of land is perfectly inelastic), the result will be excess land supplied and consequent downward pressure on land prices until the tax is fully capitalized. Even if the tax on land is fully capitalized, however, an increase in property taxes will not necessarily *The authors thank Dale M. Hoover and an anonymous referee of this journal for some helpful suggestions. Paper No. 3753 of the Journal Series of the North Carolina State University Agricultural Experiment Station, N.C. 'For a discussion of the theory of incidence of the property tax, see Netzer [4]. decrease land values. The proceeds of the tax may be used for public services, which may serve to increase land values and offset the tax capitalization. Property taxes on land improvements such as residential housing may be shifted forward. The taxes will increase costs causing capital to flow to alternative uses until the return to capital in housing in the long run rises to that available on other investments. If the supply of capital to construction is responsive to the lower return, the tax will, in the long run, reduce the supply of housing, thereby bidding up its price. For owner-occupied housing structures, however, the annual increment to the supply is usually a small fraction of the total housing stock. In the case of residential housing, therefore, structures might be considered to be inelastically supplied in the short run. Hence, one might argue that it is less likely that shifting will occur in the short-run and consequently the tax will tend to be capitalized into lower property values. However, the actual short-run elasticity of supply of residential construction remains a parameter to be determined empirically. The incidence of the residential property tax in the long run depends on the long-run elasticity of supply of housing which is dependent on both the supply of land and the supply of structures.