Property Taxation and Local Government Finance.

Edited by WALLACE E. OATES. Cambridge, Massachusetts: Lincoln Institute of Land Policy, 2001, pp. 345.

Property Taxation and Local Government Finance lives up to its name, providing an excellent introduction to both property taxes and local government finance. The book covers a lot of ground with chapters on the theory of property taxes, their history, property tax limitation and relief programs, alternatives to local property taxation, and the property tax and education finance. The book is highly readable and not overly technical, and is suitable for both policy makers and academics.

Property Taxation and Local Government Finance begins with an excellent overview by the book's editor, Wallace Oates. Oates addresses what is, in essence, the book's fundamental question: Is local property taxation the best method to finance local government expenditures? In Oates' view, the answer is clearly yes, and he cites the considerable evidence presented in this book to back up his arguments.

This answer immediately raises a second important question that Oates also addresses: If the local property tax is the best tool available for financing local public expenditures, why are property taxes so unpopular with the electorate? He cites four reasons for the unpopularity. First, the property tax is very visible, with taxpayers receiving an explicit bill, which they often have to pay all at once. Second are the administrative issues surrounding assessments, although Oates notes that much of this concern has been resolved through improved assessment practices. Third, there is an imperfect association between homeowner incomes and tax liabilities, making the property tax unpopular, especially with taxpayers on a fixed income. Finally, there is the issue of fiscal disparities across districts. Some districts have access to more wealth and can thus supply more of a public good at a lower tax rate. This issue is particularly important with respect to public education, where fiscal disparities have often led to litigation and reform efforts.

These issues are all addressed in the book in some depth. On the subject of fiscal disparities, Oates wisely notes that this is not so much a criticism of local property taxes as it is of local taxation in general. Possible local tax alternatives to the property tax and the question of whether we should rely on local taxation at all are thoroughly addressed in an excellent chapter by Therese McGuire.

One area not addressed which also contributes to the unpopularity of the property tax is the ability of local officials to control the voting agenda for tax rates. Local millages are frequently subject to renewal votes, and increases are often bundled with the renewal into one ballot question. Voters are often faced with the choice of approving an increase or rejecting funding entirely, putting a valued public service at risk. The ability of local governments to manipulate the voting agenda seems to be a key area of dissatisfaction with voters and an exploration of this phenomenon would have fit in well with the book's subject matter.

Three chapters are devoted to the long-standing debate over whether the property tax is best viewed as a "benefit" tax or as a tax on capital. In the first, William Fischel argues for the "benefit" view of property taxation. In the second, George Zodrow argues for the so-called "new" view of property taxation: viewing the property tax as a tax on capital. In the third chapter, Thomas Nechyba summarizes the current state of the property tax debate.

The benefit view sees the local property tax as an efficient method of taxation. This view is an extension of the Tiebout models of local public finance. Tiebout (1956) developed a list of assumptions under which local public goods would be provided at an efficient level. He relied on a head tax as the means of financing expenditures. Fischel cites the work of subsequent authors who have extended Tiebout's model to show that efficiency can still be achieved with a property tax under certain assumptions.

Binding zoning is an important assumption needed to maintain efficiency with a local property tax. The benefit tax view assumes that the cost of public services to homeowners is equal to both the cost of providing those public services and the benefit of those services to the homeowners. To maintain these conditions, communities need to be able to prevent new arrivals from building lower priced homes in the community, thus having access to the same public services, but at a lower cost. Alternatively, if fiscal benefits are capitalized into the house prices, the efficiency conditions can still be met since owners would pay for any benefit they receive and there would be no incentive to free ride.

Fischel argues that binding zoning is a realistic assumption. From a theoretical standpoint, municipal governments can be viewed as corporations with homeowners as the primary stockholders. The goal of homeowners is to protect the value of their capital, namely their homes. This argument is both interesting and convincing. However, the discussion of the empirical evidence is less compelling. Fischel's argument that communities can zone to an extent that allows for efficient taxation would seem to be the exception rather than the rule. I live in a mid-sized suburban community with a population of about 20,000. The house prices range from about $90,000 to over $300,000, and I believe that this type of range is by no means uncommon, suggesting a fair amount of heterogeneity in the housing stock of many communities.

Of course, the zoning restriction is not needed if the tax advantage that would occur from building a smaller house in a high service area is lost due to the capitalization of any fiscal benefit into the house price. Fischel briefly reviews some of the capitalization literature and concludes "that persistent property tax differentials among homes within the same housing market will be fully capitalized" (p. 60).

This conclusion is too strong given the current state of the capitalization literature. How much should a $1 differential in property taxes change house prices under full capitalization and does the empirical evidence support this? One study cited by Fischel argues that full capitalization of a $1 differential would cause a $33 price difference and another argues the difference would be $19. The capitalization evidence is a long way from being conclusive.

The effects of property tax differentials on home prices is an important issue from a practical public policy standpoint and one I wish this book had addressed in more detail. This volume discusses many forms of tax limitations and property tax relief but does not address how we should expect house prices to change if any of these policies were implemented. How changes in property taxes will affect house prices is of key interest to voters when any change is proposed. While this volume does illustrate how much we do know about property taxes, it is somewhat remarkable that we cannot yet answer basic questions about the effects of property taxes and property tax limitations on house prices and rents.

George Zodrow's chapter compares the new view and the benefit view of the property tax with the goal of convincing the reader that the new view is a better way of viewing the property tax. The new view of the property tax, which is not so new anymore, was proposed by Mieszkowski (1972). He argues that the property tax is best viewed as a distortionary tax on capital. Zodrow's chapter is very readable and does a good job in laying out the arguments surrounding both the new and benefit views of the property tax.

Zodrow notes that there are two burdens associated with the property tax. First is the burden caused by the average rate of property taxation in the nation, reflected primarily in a reduction to the overall rate of return of capital in the economy. Second is the local burden, which is caused by local deviations in the tax rates from the national average. This burden is borne by local labor and land-owners and consumers of locally produced goods. Local residents bear the cost of a tax increase in both the new view and the benefit view. The difference is that under the new view the cost arises from the outflow of capital from the taxing jurisdiction.

It is unrealistic to think that the debate over the new and benefit views of property taxes would be resolved in this book. However, the open questions surrounding the debate increase the difficulty in making policy decisions involving property taxation. If your state finances local public schools with a property tax, are you encouraging efficient taxation or are you supporting a distortionary tax that will encourage capital flight? Nobody would argue that local property taxation is a good method of achieving equity. If local property taxation also fails from an efficiency standpoint, there is far less to recommend it. Therefore, the answer to the efficiency question is key in deciding the merits of the tax.

Thomas Nechyba's chapter provides a good middle ground in the debate. Nechyba points out that capital will move when confronted with property taxes if, and only if, there are no corresponding benefits that go with the taxes. Capital will move only if the taxation redistributes resources. Therefore, it may turn out that the benefit view is more plausible for thinking about housing and the new view is more plausible for thinking about business capital since local property taxes often finance services that directly benefit homeowners.