If you’re a homeowner, you probably don’t like paying property taxes. But economists like property taxes for the same reason taxpayers hate them: They’re hard to avoid.
A 2008 study by researchers at the Organization for Economic Cooperation and Development looked at a number of countries and found that taxes on real property caused the least drag on gross domestic product per dollar of revenue raised. Next came sales taxes, personal income taxes and corporate income taxes. In other words, property taxes were the best way to collect revenue without hurting the economy too much.
As the economist Greg Mankiw wrote in this space three years ago, “A good rule of thumb is that when you tax something, you get less of it.” That idea helps explain why property taxes do relatively little economic damage.
The main way taxes harm the economy is by causing people to change their behavior. Raising the income tax can cause people to work less; a higher sales tax can make people spend less. But the only way to avoid a property tax increase is to sell your property, and even then, you have to find a buyer who’s willing to take on the tax burden you’re giving up.
Real property is an excellent tax base because it can’t be moved and it lasts a long time. In the case of land, it usually lasts forever. We, as economic actors, cannot respond to a higher tax on land by reducing the amount of land that exists. We may change what buildings to construct and where, but once a building exists, it’s not likely to move in response to tax changes.
In rare cases, property taxes can get so high that they encourage people to abandon their property (see Detroit). But in general, property taxes simply lead to an efficient transfer of wealth from property owners to the government. That’s not necessarily lovely for property owners, but we need to finance government somehow, and it’s best for the economy that the manner be an efficient one.
So from an economist’s perspective, it’s a bit of a problem that Americans have fought so strongly against property taxes for the last 40 years. Since the 1970s, most states have significantly restricted how high local property taxes can go. The main effect has been not to restrict the growth of government but to push government to rely on less economically efficient taxes.
Property taxes declined to 24 percent in 2007 from 31 percent of local government revenues in 1977. Even as property taxes were restricted, local government grew as a share of the economy, driven by a combination of higher sales and income taxes and greater aid from state governments.
Increased reliance on these taxes has brought problems, and not just because they cause people to change how much they work or where they spend:
Sales tax, which falls disproportionately on the poor, is what economists call regressive. Property tax is often perceived as regressive, but because wealthy people own much more property than poor people do, it is more progressive than sales tax, though not as progressive as income tax.
Sales tax receipts are suppressed by several trends. Online sales have cut into the sales tax base, and the economy has shifted over time away from goods toward services, which most states don’t subject to sales tax. States have responded to this base erosion by raising sales tax rates over time, increasing the extent to which the sales tax damages the economy.
The shift toward sales and income tax has led to an erosion of local control. Sales and income taxes are often levied across a large geographic area (lest people simply shop across municipal borders to get a better sales tax rate). The shift away from property tax has meant that local governments have had to depend on state governments to collect taxes and send them aid. This structure is fairer to poor cities and towns with weak property tax bases, but it also leaves local officials responsible for providing services without control over the revenue sources to fund them.
Sales and income taxes are volatile. It’s their biggest problem. State and local income tax receipts fell 12 percent from 2007 to 2009, igniting budget crises around the country. In past recessions, sales tax held up much better than income tax, but not this time: Sales tax receipts fell nearly as much, 9 percent, over the same period.
The federal government deals with revenue volatility by borrowing money. But states and cities are supposed to balance their budget every year. Governments were caught off guard as the recession hit. Half of states missed their revenue projections by more than 10 percent in 2009, forcing large midyear budget cuts.
Property tax was the only major state and local government tax that held up well in the Great Recession. In most states, property tax collections are devised to grow in a stable, steady manner, with the tax rate falling when property values spike and rising when they fall.
Indeed, property tax has grown as a share of total state and local government receipts since 2007. In 2012 it was 27 percent, up from 24 percent in 2007, not because governments have re-evaluated their choice to de-emphasize property tax, but because sales and income taxes have been so extraordinarily weak in the recession and its aftermath that property tax has grown by comparison.
That growth serves as a reminder of the virtue of property tax: In good times or bad, it provides a stable, efficient source of revenue.