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.

Nechyba also points out that the efficiency of property taxation under the benefit view is often achieved through binding zoning. Translated into blunter terms, the property tax is an efficient method of funding expenditures if richer homeowners can keep poorer residents out of their community. This raises another key theme of the book: the tension between efficiency and equity. Most of the authors agree that the benefit of local property taxation is that it ties the costs of public service provision closely with the benefits of those services. This close tie of tax and benefit allows residents to choose a more efficient amount of the public service being provided. However, a result of this is that higher income communities are able to finance substantially higher expenditures at a lower tax rate. The resulting inequality in spending, especially in school spending, has been the impetus to much of the litigation and reform discussed in the chapter by Evans, Murray, and Schwab.

Arthur O'Sullivan provides a brief overview of the history of property tax limitations, discussing both the limitations put in place in the great depression and in the modern tax revolt of the 1970s and 1980s. One of his more interesting observations is that 38 percent of California's residents believed that State and local governments could absorb a 40 percent cut in tax revenue without having to cut services, and 82 percent of the supporters of Massachusetts's Proposition 2 1/2 believed that it would cut taxes without reducing services.

It is not surprising that property tax limitations are popular if voters believe they can lower their taxes without seeing service cuts. One explanation for this finding noted by O'Sullivan is that between 1970 and 1976, the share of school expenditures spent on instruction fell sharply. If taxpayers did not value non-instructional expenditures, they may have felt that a reduction in funds would primarily reduce funding on non-instructional inputs while preserving the instructional services they preferred. However, taxpayers were most likely disappointed since O'Sullivan finds that although the surplus money received between 1970 and 1976 was spent disproportionately on non-instructional inputs, when spending was reduced between 1976 and 1980, instructional and non-instructional inputs fell proportionately.

O'Sullivan also notes that the ability to override property tax limitations may have important consequences for local service provision. Areas with override provisions have a higher share of administrators, suggesting that local governments can protect funding for administrators by threatening to cut teachers, police or some other valued good triggering a funding protecting override.

O'Sullivan's findings fit in well with the chapter by Duncombe and Yinger. Duncombe and Yinger derive a model of the effects of various types of property tax relief programs on property tax rates, the demand for public services, and government efficiency. They model both the direct and indirect effects of the various programs. Both their model and their findings make for fascinating reading. For example, their model shows that while property tax relief programs provide direct tax relief to taxpayers, they also alter the tax price of these programs affecting the demand for public services. This may in turn lower the level of local government efficiency.

While I found the Duncombe and Yinger chapter to be excellent, a valid criticism of the chapter is raised by David Bradford in his commentary. Duncombe and Yinger's focus is on the degree of property tax relief provided by various programs. We should be less interested in the degree of property tax relief provided by these programs and more interested in the level of welfare. Bradford notes that it is not clear whether less property tax relief but more government services is a better or worse outcome.

The effects of property taxes on urban sprawl are addressed in the chapter by Jan Brueckner. Brueckner finds that the property tax reduces the intensity of land development and thus contributes to sprawl. Brueckner's chapter is interesting but a little on the technical side. Therefore, the discussion of this chapter by Karl Case was quite helpful. Case notes a number of other factors contributing to urban sprawl that are outside of Brueckner's model.

Case also raises an issue that troubled me when I read Brueckner's chapter: Should we worry about sprawl at all? On the one hand it is easy to mourn the loss of green space due to sprawl. On the other hand, the loss of green space is due to, as Case puts it, people wanting a backyard and a dog. If we put policies in place to discourage sprawl, are we also putting in place policies that limit the ability of people to afford their yard and their dog? Exploring land use issues is a hot topic for state policy makers, although unfortunately somewhat outside the scope of this book.

Several chapters is this book address the property tax limitations that have been put in place during various property tax revolts. Evans, Murray, and Schwab look at what is perhaps a bigger threat to the local property tax--school finance litigation. School finance litigation results from the basic fact that using local property taxes to fund education results in richer districts spending substantially more per pupil than poorer districts. The consequential inequities in school spending have resulted in much litigation through the years, as is chronicled in this chapter.

Evans, Murray, and Schwab find that successful court challenges do tend to lead to an increase in the resources available to low income districts, an encouraging thought for reform proponents. Of course, determining whether additional resources lead to better student performance is still an open empirical question.

One of the more important questions that needs to be addressed when attempting school finance reform is whether the goal is equality or adequacy. This debate is confounded somewhat by the difficulty in defining these two terms. Evans, Murray, and Schwab support reforms that would guarantee all children an adequate education with the State providing enough resources to assure that each district can provide this level of spending.

I thoroughly enjoyed Property Taxation and Local Government Finance and highly recommend it for anyone with an interest in local public finance. The issues surrounding property taxes and local public service provision will be at the forefront of public policy debate for years to come. This book presents the thoughts of some of the top academics in this area and will be a valuable resource to researchers and policy makers for years to come.

REFERENCES

Tiebout, Charles M. "A Pure Theory of Local Expenditures." Journal of Political Economy 64 No. 5 (October, 1956): 416-24.

Mieszkowski, Peter. "The Property Tax: An Excise Tax or a Profits Tax?" Journal of Public Economics 1 No. 1 (April, 1972): 73-96.

Jeffrey P. Guilfoyle

Office of Revenue and Tax Analysis

Michigan Department of Treasury

Lansing, Michigan 48922