The Property Tax Lag
For the first time since 2008, state and local governments are finally beginning to see signs of fiscal relief. Last week, the National League of Cities released results from their survey of local government finance officers, indicating cities are beginning to hire again, property tax revenues are on the rise, and ending balances are improving for the first time since the Great Recession. It has been more than five years since the recession officially ended in the second quarter of 2009, so why has it taken local government revenue streams so long to recover?
Property Taxes in Local Government Finance
Property taxes are a cornerstone of local government finance, accounting for roughly three quarters of all local tax revenues. Property taxes as a share of local tax revenues vary widely across states: In Maine, local property taxes account for 99 percent of local tax revenues; in Alabama, property taxes account for only 41 percent of local tax revenues. Local services such as education, police, fire, and parks all rely on property taxes to fund their activities.
Property tax assessments are directly tied to local housing prices. When property values decline, the tax base upon which the tax is levied shrinks. If city leaders cannot raise the tax rate to offset the reduced tax base, then tax collections will also decline.
In recent recessions prior to 2007, home prices values were fairly stable. As a result, property tax revenue remained buoyant and rebounded quickly once the economy started growing. According to the Brookings Institute, real property tax revenues have historically averaged 10 percent cumulative growth over the three years following a recession’s trough. In the three years following the Great Recession’s trough, however, real property tax revenues saw a cummulative decline of one percent.
Property Tax Collections Lag Economic Activity
Because local governments typically assess property taxes every 18 to 36 months, changes in tax collections lag fluctuations in the housing market. A 2008 study by the Federal Reserve Bank in Washington, D.C. estimated the effect of home price changes on property tax revenues and found that a 10 percent appreciation in home prices will result in a 4 percent long-run increase in property taxes. However, the sensitivity of property taxes to changes in home prices operates with a multi-year lag. The study finds that, on average, property tax revenues reflect changing conditions in housing markets three years after the price changes occur.
The chart below illustrates the relationship between the housing market and state and local property tax collections during the Great Recession. Property tax collections actually rose over the course of the recession due to the rapid increases in home price values prior to the peak. Even as the economy declined, property tax assessments were still responding to the housing boom. Property tax collections peaked 15 quarters after the housing market did.
Local Government Impact
The shortfall in property tax revenues in recent years forced cities to reduce spending, often by eliminating staff positions and delaying capital investments. Both state and local employment fell more during the Great Recession and subsequent recovery than in each of the previous four recessions.
Local governments are still feeling the pain, but the tide is beginning to turn. Take for example Riverside County, located in California’s Inland Empire and one of the hardest hit areas of the housing crisis. Riverside’s housing boom and bust coincided with the overall US market, albeit with much more severe fluctuations, shown in the chart below.
Property tax collections in Riverside County fell by 16 percent in fiscal year 2009-2010 alone and remained at this lower level through the 2012-2013 fiscal year. The figure below illustrates this trend, showing property tax revenues in the county’s general fund since the recession, compared to the amounts forecasted in the county’s annual budget each year.
In its most recent budget update, the County Budget Office asserts:
The long-awaited recovery in Riverside County’s assessment rolls commenced at last in FY 2013-2014. Secured valuations grew by 4.2% after four consecutive years of decline, a welcome reversal even if the turnaround is rather moderate.
The county also predicts that secured valuations will gain momentum over the next several years, with a year-over-year increase of 6.4% by fiscal year 2018-2019.
A Long-Awaited Fiscal Recovery
The Great Recession was one of the worst economic downturns on record for local governments. State and local government expenditures continued to decline for three consecutive years following the official end of the recession in June 2009.
The good news for civic leaders in locales hard hit by the collapse of the housing bubble–like Riverside County–is that property tax revenues are finally beginning to reflect a recovering housing market. The bad news is that historical experience suggests these municipalities are still several years away from seeing property tax receipts reach pre-recession levels.
For Further Reading:
Harris, Benjamin H. and Yuri Shadunsky. State and Local Governments in Economic Recoveries: This Recovery is Different. Urban-Brookings Tax Policy Center. April 22, 2013.
McFarland, Christiana and Michael A. Pagano. City Fiscal Conditions in 2014. National League of Cities Center for City Solutions and Applied Research. October, 2014. https://www.nlc.org/wp-content/uploads/2016/12/CSAR_City_Fiscal_Conditions_20140_0.pdf
Dadayan, Lucy. The Impact of the Great Recession on Local Property Taxes. The Nelson A. Rockefeller Institute of Government. July, 2012.
Lutz, Byron F. The Connection Between House Price Appreciation and Property Tax Revenues. Finance and Economics Discussion Series Divisions of Research & Statistics and Monetary Affairs. Federal Reserve Board, Washington, D.C. September 12, 2008
Category: Government Finance