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The Theory of Property Tax

The Theory of Property Tax. LECTURER: JACK WU. Outline. Topic I: What Are Property Taxes? Topic II: Property Tax Incidence Topic III: Property Tax Capitalization Topic IV: Property Tax Competition and Provision of Local Public Goods. Topic III. Property Tax Capitalization.

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The Theory of Property Tax

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  1. The Theory of Property Tax LECTURER: JACK WU

  2. Outline • Topic I: What Are Property Taxes? • Topic II: Property Tax Incidence • Topic III: Property Tax Capitalization • Topic IV: Property Tax Competition and Provision of Local Public Goods

  3. Topic III. Property Tax Capitalization • The Property tax capitalization occurs when the present value (PV) of future tax liabilities is incorporated into real estate values.

  4. Testable Hypothesis • Oates (1969, JPE) was the first to formulate and test the hypothesis of property tax capitalization as an implication of Tiebout’s (1956, JPE) model of efficient housing markets with inter-jurisdictional mobility. • The large volume of empirical literature that followed Oates largely documents that property values are impacted by future tax liabilities, but fails to reach a consensus regarding the “extent” of tax capitalization.

  5. The Extent of Property Tax Capitalization • Full capitalization: property tax fully reduces the property rate • Partial capitalization: property tax partially reduces the property value • Overcapitalization: property tax increases the property value • Zero capitalization: no relationship • Overcapitalization suggests the current tax rate is smaller the optimal rate.

  6. Mixed Empirical Results • No Significant Capitalization Effects: • Wales and Wines (1974, REST) 0% • Chinloy (1978, CJE) 0% • Gronberg (1979, SEJ) 0%

  7. Varying Degrees of Partial Tax Capitalization • Oates (1969, JPE) 61% • King (1973, Book) 18% • Edel and Sclar (1974, JPE) 20% • Gustely (1976, SEJ) 34% • King (1977, JPE) 36% • Rosen and Fullerton (1977, JPE) 58%

  8. Dusansky et al. (1981, JUE) 22% • Gabriel (1981, NTAP) 36% • Richardson and Thalheimer (1981, SEJ) 15% • Ihlanfeldt and Jackson (1982, SEJ) 66% • Lea (1982, PFQ) 26% • Rosen (1982) 22% • Goodman (1983) Intra-jurisdiction 65% Inter-jurisdiction 25%

  9. Full- or Over-Capitalization: • Oates (1973, JPE) 90% • Church (1974, NTJ) > 100% • Reinhard (1981, JPE) Aggregate: 107% Micro data: 120%

  10. Empirical Models of Property Tax Capitalization • Amenity models • Capitalization models • A Modified Capitalization models

  11. Amenity Models(Oates 1969, JPE) • The level of property tax rates is treated as one among several attributes (amenities/disamenities) affecting home values. • where Pi≡ the value of the i-th property • Zjs ≡ structural and locational characteristics • (including measures of public services in the area) • ti ≡ the annual rate of property taxation. • ≡ the estimated coefficient of the property tax rate

  12. Capitalization Models(Mill and Hamilton, 1994) • Capitalization Models — property values are viewed as the capitalized value of future housing services net of costs.

  13. Capitalization where S ≡ the value of housing services r ≡ the real discount rate g ≡ the expected real rate of marketwide appreciation • d ≡ the depreciation rate of property with age m ≡ the rate of maintenance costs t ≡ the property tax rate

  14. The Capitalization Model Property values are viewed as the capitalized value of future housing services net of costs. • The Estimating Equation: Non-linear Regression Model where r = r – g + d + m r  the netof property tax user costof housing Si  the value of housing service provided by the i-th property • Measure of the degree of capitalization:

  15. Testing Hypothesis • Full Capitalization • Zero Capitalization

  16. The Estimating Equation: The equation identified above cannot be directly estimated, because S and r are not directly observable. where S(Zij) ≡ the hedonic function for housing services  the specified netuser costof housing

  17. The Modified Capitalization Model(Palmon and Smith 1998, JUE) • The modified capitalization model avoids using fixed estimates of net user costs conjectured from rates of return found outside the housing market. The identification is accomplished by estimating the values of housing services from rental data. Note: Utilizing the rent-to-price ratio as the dependent variable provides a means to estimate both bt and r directly from the housing market, thereby eliminating the need to conjecture the net user cost from other markets.

  18. Estimating the Rental Values where i ≡ the i-th property, n k ≡ the k-th MUD (municipal utility district), K = 45 R ≡ Annual rent SF ≡ Square feet of living area Age ≡ Home age in year CBD ≡ Distance from the central business district Bath ≡ Number of bathrooms

  19. Estimating the Rent-to-Price Equation • Testing Hypothesis • Full Capitalization • Zero Capitalization

  20. Table: Estimated Coefficients • The estimate of the capitalization coefficient is 0.9166. Palmon & Smith (1998) Table 1, p. 311.

  21. H0: – 1 = 0 cannot be rejected at any acceptable level of confidence. • H0: = 0 can be rejected at the 5% confidence level.

  22. Evidence from Taipei • Partial capitalization • Partial capitalization for low value houses and overcapitalization for high value houses • The current property tax rate for high value houses is smaller than the optimal rate.

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