Are property tax limitations more binding over time?

INTRODUCTION

In July 1991, Illinois enacted a limit on the growth rate of property tax revenues for some, but not all, local jurisdictions in the Chicago metropolitan area. The "tax cap," as it is known in Illinois, initially affected municipalities, school districts and other types of local governments in the five metropolitan "collar" counties, but not those in the central metropolitan county of Cook. (1) Dye and McGuire (1997) exploit this "natural experiment" to finesse some of the econometric difficulties in earlier studies of property tax limitations and find that the limitation measure effectively constrained the growth rate of property taxes in the first three years of the limit. (2) Dye and McGuire (1997) could only speculate about the longer-term effects of the limit. In this paper, we explore whether property tax limitations become more binding over time.

Dye and McGuire (1997) venture that the long-run effects of the limit could be stronger or weaker than the short-run effects. A limit that applies to the growth rate of property taxes could become more binding over time because the easy means of accommodating the cap may become exhausted after the first few years. In addition, the impact of such a limit may compound over time because the revenue base to which the growth limit applies is lower in each future year than it might otherwise have been. On the other hand, with time, local officials might devise means for circumventing the state-imposed limit. There is some evidence, for example, that local officials in Arizona circumvented that state's property tax limit in part by shifting to forms of property taxation not subject to the limit (see Fisher and Gade (1991)). Also, the extraordinarily large number of local jurisdictions in Illinois is often attributed to Illinois' much older property tax rate limit--creating a new local government was one means of circumventing that limit.

In this paper, we estimate the effects of the Illinois property tax limitation measure after many more years of experience and after many more jurisdictions have been brought under its purview. The collar-county jurisdictions have now been subject to the tax cap for over ten years. In the spring of 1995, following a non-binding referendum favoring the cap in Cook County, the Illinois legislature extended the tax cap to Cook County. In the spring of 1996, enabling legislation was passed allowing voters in the remaining 96 counties in Illinois to approve by countywide referenda imposition of the limit on their non-home--rule local governments. As of September 2003, local jurisdictions in 39 counties in Illinois were subject to the tax cap. Thus, the treatment and control groups have changed over time, and in all but the six-county metropolitan area, the tax cap is endogenously chosen by the county voters. This local--option policy selection complicates the econometrics of estimating the impact of the cap. Addressing the problem of endogenous policy change is an important concern of the present paper.

We estimate the effect of the tax cap using a statewide sample of municipalities and a statewide sample of school districts in Illinois. (3) We ask two related questions: (1) is the tax cap effective; and (2) is the tax cap more binding over time? Our answer to the first question is yes; the tax cap appears to slow the growth of municipal and school property taxes and the growth of school expenditures. For property taxes, our answer to the second question is yes; the cap appears to have a larger impact for municipalities and school districts subject to the cap throughout the nine-year period of analysis relative to those with fewer years of experience under the cap. For school expenditures, there does not seem to be a difference between the short-run and long-run effects of the cap.

DATA AND SPECIFICATION

The property tax extension limitation law, as it is formally named, or tax cap, as it is more commonly known, limits the growth in total property tax collections of a local government to a price inflation factor. There are exceptions for newly developed property in its first year on the rolls, for debt service for obligations incurred before the imposition of the cap, and for override by special referendum. The tax cap is imposed on all local governments in designated counties, (4) with the exception of home-rule jurisdictions. (5)

All municipalities and school districts in Illinois for which data are available over the sample period are included. (6) Even though other types of government, such as townships and library districts, are also subject to the cap, we focus on municipalities and school districts because together they are responsible for raising over three-quarters of total property taxes (Illinois Department of Revenue, 2002).

Table 1 indicates the number of counties and the associated number of "treatment" municipalities and school districts made subject to the cap in different years, as well as the number of "control" jurisdictions with home-rule status or located in never-capped counties. In 1991, all 144 school districts and 112 non-home-rule municipalities in the five heavily populated suburban collar counties were made subject to the cap, with 113 collar-county municipalities exempt because of their home--rule powers. In 1995, the cap was extended to another 144 school districts and 54 non-home-run municipalities in the central metropolitan county of Cook, with the city of Chicago and 15 other home-rule municipalities in Cook County exempt. Eighteen counties had successful referenda to impose the cap on their school districts and non-home-rule municipalities in 1997, the first year of the local option, and four or fewer additional counties voted to impose the cap in each of the subsequent years. The capped-by-referendum and never-capped counties are scattered around the state; there is little in the way of obvious characteristics to distinguish them.

Outside the six Chicago-area counties, the imposition of the cap follows a countywide vote of residents in jurisdictions that would be subject to the cap. Even though the vote is countywide rather than jurisdiction-by-jurisdiction, it may not be appropriate to treat the tax cap as exogenous in these jurisdictions for at least two reasons. First, there may be an omitted factor or set of factors that is a co-determinant of both property tax growth rates and whether voters elect to impose the cap. For example, there may be a taste for or against local government that we do not measure. Second, it may be that past growth of property taxes influences voters and is correlated with future growth of property taxes.

To control for omitted co-determinants of property tax growth rates and tax cap status, we employ fixed effects estimation. The implicit assumption is that the unobserved heterogeneity does not vary over time, which seems reasonable given our relatively short panel and the nature of the suspected unobserved local preferences. We consider the fixed effects estimator as our base specification. To test the robustness of the model and to address other potential sources of endogeneity of the tax cap variable, we estimate the equation using both an instrumental variables model and a matching estimator technique.

Each regression includes a full set of yearly dummy variables to capture statewide changes in economic conditions and relevant policies over time. We also include a dummy variable for the "window" year--the year immediately after a county has voted to impose tax caps, but before the caps are in effect--which arguably provides an incentive to increase property taxes. With a fixed effects specification, the possible additional control variables are limited to those that vary over time. We include a variable for the residential share of total property value (equalized assessed value or EAV) to capture the possibility that heavily residential jurisdictions might be more, or less, willing to increase property taxes than jurisdictions with a greater share of commercial and industrial property. For the municipal tax growth regressions only, we include a dummy variable for home-rule status to capture the notion that home-rule status municipalities have access to a broader array of revenue sources and, thus, may not put as much pressure on the property tax. Finally, for the school tax and expenditure growth regressions, we include a measure of the growth in the number of pupils (the change in the log of "average daily attendance") to capture the fact that state aid and other school budget elements are strongly linked to pupil counts.

RESULTS