Author
Article Highlights
- Higher property taxes raise ongoing financial burden of homeownership but consequently lower initial home prices
- Model finds raising property taxes shifts homeownership toward younger families, motivates older adults to downsize
- Although welfare-improving, burden on older adults and low-income households would surely figure into policy debate
America’s two biggest states are having two very different housing debates.
In Eagle Rock, California, 35-year-old Brianna Mercado is making things work in a small apartment with her husband and young children. No yard, tight quarters, no separate bedrooms for the kids. But Mercado told LAist public radio she holds out little hope of buying a home given “outrageous” house prices. California’s median home price? $660,000.1
Meanwhile, Texas lawmakers have been on a multiyear mission to lower some of the nation’s highest property taxes—and especially to lessen the burden on older adults. Property taxes nearing 2 percent, on average, make homeownership in Texas a more expensive ongoing proposition compared with California, where property tax increases have been heavily restricted by a 1978 amendment to the state constitution.
On the other hand, getting into a home in Texas is much cheaper, given the median home price of only $240,000.
A new working paper from the Opportunity & Inclusive Growth Institute connects these dots in an intriguing way: Could Texas’ relatively high property tax rates be a factor keeping housing prices in check? Are California’s low property taxes placing a home purchase out of reach for young families like Mercado’s?
In the paper, economists Joshua Coven, Sebastian Golder, Arpit Gupta, and former Institute visiting scholar Abdoulaye Ndiaye find this property-tax/home-price connection is indeed meaningful, with property taxes shaping housing choices across the life cycle in ways that could affect labor mobility and overall social welfare.
More expensive tomorrow, more affordable today
According to a recent analysis by the Minneapolis Fed, property taxes account for a rising share of the average American housing budget—almost 17 percent in 2021 for homeowners with a mortgage. Given that higher property taxes raise the cost of owning a home, how can they simultaneously make housing more affordable?
The reason is that higher expected property taxes get factored into lower home prices today. Property taxes shift the total cost of housing into the future. For young households especially, this “capitalization” of property taxes into a lower purchase price can make all the difference. Although their expected future earnings might be more than enough to cover taxes down the road, many struggle right now to muster the cash for a starter home due to hefty downpayments.
“Property taxes effectively act like a forced mortgage and shift the burden” of housing costs, said Ndiaye, assistant professor of economics at the NYU Stern School of Business. “With this capitalization, families have lower prices to pay today, but on net the same amounts” over time.
For older homeowners, property taxes affect incentives to sell or stay put. Low property taxes make it financially advantageous to sit tight, even if the nest has long been empty—a powerful “lock-in” effect. Higher property taxes, by contrast, raise the motivation to downsize, which puts more homes on the market for young families who will make use of those empty bedrooms.
Along with other equity and efficiency justifications for property taxes, Ndiaye and his co-authors have added a new one to consider: reallocation of housing from smaller, older households to larger, younger ones.
Empty bedrooms
National statistics presented in the working paper show what the authors call “the age-biased character of homeownership.” Most bedrooms in the U.S. are owned by people between 50 and 70 years old (Figure 1). Many of these bedrooms are less than fully occupied, especially once owners enter their 60s.
Raw U.S. data on property taxes and home prices support the economists’ theory connecting the two. Controlling for factors like house characteristics and location, the economists find that a doubling of property tax rates is associated with a 20 percent drop in housing prices and lower home-price-to-rent ratios. They further find that higher property tax rates are associated with a younger-skewing population.
The economists compare owning and renting in the two states they use for their analysis. At younger ages, the homeownership rate is similar in high-tax Texas and low-tax California (Figure 2). But around age 50, the rates strikingly diverge.
Homeownership rates plateau among older Texans, while homeownership in California keeps growing, even through age 80. Although friends or grandkids may come to visit, that’s a lot of often-empty bedrooms.
Treating California with Texas-level taxes
The economists build a mathematical model in which overlapping generations of households choose to live in one of two states with varying house prices, property tax rates, and earnings climates. They calibrate the model to match the characteristics of California and Texas.
Households are financially constrained and must come up with 20 percent for a downpayment to buy a house. Older households derive pleasure from leaving money as bequests and, crucially, view housing as a savings vehicle for this purpose. In the core version of the model, property taxes are rebated as a lump sum, evenly distributed among each state’s population.
In the model, the economists raise California property tax rates (0.8 percent) to the level of Texas (2 percent).2 When they do this, the effects are large: House prices in California fall 18 percent. Homeownership in California rises 4.6 percent overall and 7.4 percent among homeowners ages 25 to 44.
In this counterfactual scenario with higher property taxes, homeownership in California is higher than the status quo at every age until the late 50s. After this point, it falls below the baseline as higher ongoing expenses motivate more older adults to sell (Figure 3).
In the model, higher property taxes and lower housing prices in California also result in increased migration from Texas, especially among younger and more financially constrained people. And an increased number of older residents of California head the opposite direction, to Texas, though not enough to outweigh the younger inflow into California.
Benefits beyond housing
These migration flows have effects beyond the housing market, because more young households from Texas can now afford housing in higher-income California. “Financially constrained households are able, with higher property taxes, to own houses in California at a lower purchase price and thereby gain access to superior job markets,” the economists write. As a result of alleviating this “spatial mismatch,” the overall incomes of people in the model increase slightly.
Although more older homeowners choose to sell, the greater net number of homeowners means that housing wealth increases (as does overall wealth). The economists hypothesize that there may be further societal benefits far downstream via the children whose parents can now purchase a home at a younger age.
The economists perform various extensions of the base model to further simulate real-world circumstances. For example, with a lower downpayment requirement (such as access to downpayment assistance or Federal Housing Administration loans), they find that homeownership rates jump significantly more.
The base model also assumes that housing supply responds to demand. The reality of today’s supply-constrained housing markets—California being Exhibit A in the U.S.—is somewhat different. The economists adjust their model to an extreme scenario in which supply is fixed: No new housing comes online in California. In this alternate world, prices fall less than half as much as in the baseline model. But they still fall a significant 7.5 percent, with more homes in the hands of younger families.
Harmed in the transition
So far, this all sounds like a win-win-win—and it does appear to be, from a societal standpoint. But there are losers, of course, when property taxes go up.
One important effect is the shifting of welfare from later in the life cycle to earlier. While households are better off over their full lifetime, raising property taxes sacrifices well-being many years later (enjoying a spacious, paid-off house with low property taxes, and leaving this house to heirs) for well-being in the present day (affording a house for a young family, and enjoying this house for longer).
And there are existing homeowners to consider. Ndiaye emphasizes that the economists’ current model compares two alternate versions of the world, side by side—it does not model the one-time impacts of a transition from one to the other. “For the young to afford more housing, the older households have to downsize and lose,” Ndiaye said. He adds that this is a feature of many reforms that have varying effects for people at different phases of life.
The effects of higher property taxes on low-income households or older adults who want to age in place would be an inevitable part of any policy debate. In fact, while Ndiaye’s research highlights the potentially large affordability benefits that Texas’ high-property-tax regime has for young families, Texas lawmakers have been running hard in the other direction. A Texas Tribune analysis of 50 homeowners across the state found property tax bills plummeted an average of 28 percent in 2023 after massive property tax relief passed by lawmakers in 2022.
A proposal by elected officials or voters to deliberately hike property taxes for the sake of lower housing prices could be a tough sell. But for states where property taxes are already relatively high—or, in the case of California, held arbitrarily low—the research from Ndiaye and his co-authors highlights an essential connection with affordability.
Endnotes
1 Per a recent analysis of U.S. Census Bureau data by WalletHub, as of 2022 California had a median home price of $659,300 and the nation’s 16th-lowest property tax rate. Texas had a median home price of $238,000 and the seventh-highest property tax rate (out of 51, including Washington, D.C.). The country’s lowest property tax rate and highest home prices are in Hawaii.
2 The authors use proprietary property tax data from Verisk, a data analytics and marketing firm serving the insurance industry.
Jeff Horwich is the senior economics writer for the Minneapolis Fed. He has been an economic journalist with public radio, commissioned examiner for the Consumer Financial Protection Bureau, and director of policy and communications for the Minneapolis Public Housing Authority. He received his master’s degree in applied economics from the University of Minnesota.
