Economist's Commentary: May 22, 2008
Real Estate Tax Impact
By Danielle Hale, Research Economist
The Center for Budget and Policy Priorities (CBPP) has for some time been sounding the alarm about state budget deficits in upcoming fiscal years. We took a look at their research and tried to flesh out the impact that these tight-budget times will have for Realtors® and the real estate market.
First, how big is the problem? When CBPP first focused on the issue of state budget gaps in January, 28 states were facing shortfalls. Recently, that number has been reduced to slightly more than 20 states. Still, states have had to make tough choices to close the gaps between projected spending and projected revenues - cutting spending, raising taxes, or dipping into reserves.
We took a look at two revenue raising remedies that have a very direct impact on the real estate market - property taxes and transfer taxes. Currently, the degree to which states and local governments rely on these two revenue raisers varies. Local governments in most states rely heavily on property taxes while they are a smaller source of state taxes. In New Hampshire, Vermont, Washington, and Wyoming, property taxes amounted to 10 percent or more of total taxes raised by the state. There is much more variation in the use of transfer taxes at both the state and local levels. Only in New York and Delaware do transfer taxes comprise more than 4% of total local taxes raised.
To determine the impact of a change in the transfer tax rate, we conducted an impact analysis. We examined conditions at the status quo, using data from the Federal Housing Finance Board and Census Bureau, and then asked what might change if a transfer tax were to be implemented.
We added a transfer tax of 1% to the house price, and assumed that households must borrow money to cover any increased transfer tax fee. This leads to an increase in the loan needed to purchase an equally valued home, and subsequently requires the purchaser to have a higher monthly income to qualify for borrowing that higher amount. If we look at the precise amount of additional income that would be needed, we can compare this against the distribution of household income in the state to get a sense of how many households may be impacted by a change in the tax - a number that varies by state. For example, in Missouri - a state that currently does not levy such a tax - 9,595 households would be unable to purchase a home if a 1% transfer tax were added. See how your state compares here (log-in required). It is worth noting that the current low mortgage rates lead to a very forgiving outcome. If interest rates begin to rise, the cost of borrowing goes up. This in turn pushes up the amount of income required and increases the number of households impacted by the transfer tax.
To analyze the impact of a property tax, we use a method called capitalization whereby we assume that the price of a house is reduced to offset any additional future taxes (net present value). With reasonable assumptions, we find that a $1,000 per year increase in property taxes reduces home value by about $13,000.
Certainly, property taxes collected by governments, if well-spent, can add value to a property. However, considering the fact that tax increases decrease property values and shut potential home-buying households out of the market, they should not be regarded as quick, costless remedies.
This is one in a series of commentaries by the Research staff of the National Association of REALTORS®. Read more commentaries >
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