First, the tax plays a central role in financing local public goods in the U.S. Property taxes account for around three-fourths of local government tax revenue and a quarter of total local government revenue. They are particularly important for education as they provide approximately 95 percent of tax revenue for independent school districts. Given the magnitude of the tax and the fact that most local governments must balance their budgets, fluctuations in property tax revenue – driven by changes in property values – would be expected to influence local government spending decisions.
Second, the connection between property tax revenues and real estate values likely influences the ability of the state and local government sector to weather fiscal crises. During the state, fiscal crisis of 2002 – 2004, localities responded to cuts in state education aid by increasing property tax revenues to prevent cuts in education budgets Their ability to do so was likely a function of the strong state of the housing market at that time. Localities may not be well positioned to offset reductions in state funding during the current period of slow economic activity given the softening of house values.
Finally, the relationship between the housing market and property taxes may impact the political viability of the property tax. The share of income devoted to the property tax has risen sharply in recent years, likely due, in part, to the housing boom, and this appears to have generated a political backlash. Several states have either enacted, or seriously considered, significant reforms of their property tax in recent years.
The evidence suggests that property tax revenues are quite responsive to changes in house prices. Although it takes several years for house price appreciation to feed through to property tax revenues. On average, policy makers are estimated to respond to increasing home prices by reducing effective tax rates to offset 60 percent of the increase in tax revenue that would have occurred in the absence of a change in the effective tax rate. Institutional features of the property tax, such as delays in bringing assessed values into line with market values and caps and limitations on the tax, likely explain the lag between house prices and tax revenues.