Property Taxes: Savior or Satan?

Are property taxes heroically keeping state and local economies afloat or villainously prolonging the recession? Both.

Kim Rueben from the Tax Policy Center celebrates property taxes for the first reason. She explains that property taxes are slow to come down as real estate prices decline. As a result, people are stuck paying higher property taxes than the new market value of their real estate would imply. Explaining what she learned at a recent Tax Policy Center conference, she says:

Nationally, property tax revenues have yet to fall both because the levy tends to be backward-looking (it takes a while for assessed values to catch up with reality on both the upside and the downside) and because local governments can raise rates. The strength of the property tax was the main driver of the small positive growth in overall state and local taxes for the fourth quarter of 2009. This was a theme in many of the presentations. New research by Byron Lutz, Raven Malloy and Hui Shan illustrates that house value declines don't necessarily lead to lower property taxes, and when they do, it can take a while. With luck, by the time property taxes do dip, sales and income taxes will be recovering. The good news is that if property taxes could stand up in this recession, which was both deep and caused by a housing collapse, they can stand up to most crises.

That's certainly one way to look at it. Good for those state and local governments for getting more money in tax revenue than they should be. Now there is a smaller chance that they'll default, or crawl to Washington and plead for a federal bailout.

On the other hand, however, isn't this a grave injustice for property taxpayers? Many of these people have already seen their real estate decline in value substantially -- in some areas the decline approaches 50%. So if someone now has a home that's worth $100,000, is it fair that the homeowner owes property taxes that assume it's worth $200,000? The percentage decline in value will be proportional to the amount people are now overpaying in taxes.

The last thing these frustrated homeowners need is another reason to consider walking away from their home. Not only are many Americans stuck with paying a mortgage for more than their property is now worth -- but they're paying excessive taxes as well. This definitely makes strategic default look even more attractive.

Then, there's the effect on the recession. If these people weren't paying that money as taxes, they could be stimulating the economy. Spending would be higher, businesses would grow, and employment would improve. While the state and local governments certainly could use this money, it's hard to justify providing the government with more money at a time when the private sector so desperately needs it.

This reveals a problem with property taxes. Their sticky nature leads to their unjust application when real estate values decline -- or rise -- quickly. They oppose economic cycles, which will make bubbles bigger and recessions more severe. This contrasts with income taxes or sales taxes. It's impossible to ultimately over- or under-tax people based on their income or spending, because the taxes adjust dynamically as those variables change. That's one reason to favor these alternatives to property taxes.