June 24, 2009

By Danielle Hale, Research Economist

 New state-by-state presentations are available to help you understand the budget situation, how it affects revenues and spending in your state, and how potential coping measures, namely transfer and property tax increases, may impact the housing market in your state.

State Fiscal Conditions and Property Taxes: 2009

Last year as the economy trudged into a recession, state budget troubles began to surface. The National Association of Realtors® Research group compiled information on the crisis and considered what the impact to states might be if legislators choose to address shortfalls by raising taxes on property or the transfer of property. These taxes have a specific impact on the housing market and are exactly the opposite of what is needed in a time of distress.

This year, the economy is tripping along somewhere between stabilization and further decline, but because state and local governments operate with such a lag, budget troubles are clearly worsening. Consider that 47 states report a shortfall between revenues and desired expenditures in either fiscal year 2009 or fiscal year 2010 according to the Center on Budget and Policy Priorities. Of course some states have already found ways of addressing these shortfalls, but many still remain and tough choices are ahead.

Tough Choices Ahead

What might those tough choices entail? They are likely to include some combination of raising additional revenues by instituting new taxes or tax rate increases, cutting spending, tapping into reserves, and using money from the Federal stimulus. Reserves and Federal stimulus money, while helpful, are not enough to cover the full shortfall. States will have to turn to some form of spending cuts or increasing revenue. The historical trend for state and local spending when considered in the aggregate suggests that increasing revenue is the avenue governments are more likely to pursue.

How States and Local Governments are Financed

States and local governments spend and raise money in a variety of ways. Understanding how your state raises revenue will help you understand how it might be affected by the down turn. We can consider all the state and local revenue across the US to get an idea of average government financing. In Fiscal Year 2006 across the US, state and local governments brought in 24 percent of revenue from sales and gross receipts taxes, 21 percent of revenue from property taxes, and 19 percent of revenue from individual and corporate income taxes.

Of course the experience for individual states varies substantially. State and local reliance on sales and gross receipts taxes was as high as 41 percent in Washington and Nevada and as low as five percent in Alaska and Oregon. Property taxes were 43 percent of New Hampshire state and local government revenue compared with eight percent of state and local revenues in New Mexico. Individual and corporate income taxes were not used as a revenue base at the state and local level in four states: Wyoming, Washington, Texas, and Nevada, and they were less than 5 percent of revenue in Florida, South Dakota, and Tennessee. By comparison, individual and corporate income taxes were 31 percent of Maryland’s state and local revenue.

Housing Market Related Revenue Raisers

Directly housing-related taxes, such as the transfer tax and property tax, are considered in the state-by-state analysis. The property tax is generally assessed annually on the value of a house. Theory suggests that because a home is a long-term asset, its value can be understood as the present value of a series of costs and benefits that accrue to the owner. Annual costs, such as taxes that do not have any offsetting increase in benefits to the home owner, will be capitalized into the value of a home and reduce its price. For example, an increase in annual tax payments of $1,000 without an increase in benefits could reduce the value of the home by $12,000 - $15,000 depending on the degree of capitalization .

A transfer tax, generally a tax on the recordation of a deed of title and/or mortgage, is a very targeted tax that increases the cost associated with buying or selling a home. It is assessed during the sale on the sales price of the home. Currently, state and local governments assess a transfer tax of anywhere between 0.01 and 3 percent.

To study the short-run impact of a transfer tax, we conceptualize it by looking at what might happen to the number of households in a state whose income would no longer qualify them to purchase the median priced home after a 1 percent increase in a transfer tax. The number varies by state based on the population, median home price, and income distribution. Download the presentation for your state to see what the impact might be there.

In Conclusion

In a downturn, there is always a temptation to raise real estate and other taxes to cover budget shortfalls. Both policymakers and the general public should be aware of potential unintended consequences of the actions they are considering. A prudent government might have accumulated a rainy-day fund during the boom years rather than spending as if growth were guaranteed. Growth will return, and perhaps governments will take the opportunity to prepare for the future.

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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