Property Tax Revolt

Arizona has been hit hard hit by the real-estate bust, with the average home value down 17% in a year and a record number of foreclosures. So Democratic Governor Janet Napolitano has devised a clever way to revive the housing market: Raise property taxes.

Last week Ms. Napolitano vetoed a bill that would have made a two-year suspension of the state property tax permanent. "It's untimely. It's untenable. It's unwise," she said of her untimely and unwise veto. So as housing values slide, Arizonans next year will get walloped with an extra $250 million property tax bill.

Arizona is one of a growing list of states and big cities looking to raise taxes on homes to close budget gaps in 2008 and 2009. Housing values are expected to decline by $1.2 trillion this year, according to Global Insight Inc., an economic consulting firm, and that means tens of billions of dollars in lost taxes.

In recent weeks, Fairfax County in northern Virginia, Washington state, Chicago and Memphis have announced proposals to increase residential property tax rates to offset declining revenues. So at the very time that states and cities are begging for money from Washington to help distressed homeowners pay their mortgages, property tax hikes could push hundreds of thousands of homeowners under water.

Higher property taxes impose a double whammy on those at risk of losing their homes. First, they act as a tax surcharge on homeownership. And second, when the tax hikes aren't tied to better public services, they reduce housing values, thus reducing owner equity.

The Center for Business and Economic Research at the University of Kentucky reviewed dozens of studies on real-estate prices and concluded that "the evidence from the most reliable estimates" is that between 60% and 90% of property taxes are capitalized into a reduced value of the home. So a permanent $200 a year increase in the property tax could reduce the sales value of the home by between $1,200 and $1,800.

Lawmakers mulling other revenue-raisers to close budget deficits need to know that these may also exacerbate the housing decline. Richard Vedder of Ohio University has found that, from 1980-90, the 10 states that increased their state and local tax burdens the most suffered a 12% decline in prices versus a 48% increase in housing values for states that reduced their tax burden the most. His study found that "while property tax changes have the biggest impact on housing price changes, other forms of taxation exhibit the same effect." Income taxes, for example, chase people out of the state, which reduces home values for those left behind. Think Michigan, or Ohio.

State and city governments lived well – too well – during the housing boom. From 2000-07 property tax collections climbed by 62%, two-and-a-half times faster than per capita incomes, according to Census Bureau data. Homeowners tolerated the tax hikes as long as the equity in their homes was rising. But voters may not be so forgiving when values tumble and assessments lag behind this fall in prices. One early sign of voter discontent came last year in Indiana, where 21 incumbent mayors lost re-election bids due to anger over taxes. Indianapolis Mayor Bart Peterson lost to underfinanced GOP challenger Greg Ballard, thanks in part to a doubling in property taxes and a 65% increase in the local income tax.

In Arizona, Florida, Georgia and Nevada – four states where property taxes soared during the boom – citizen revolts are also brewing. Steve Voeller of the Arizona Free Enterprise Club says his state's voters are already gathering signatures for a ballot initiative to overturn Ms. Napolitano's veto. Property tax relief could be the sleeper issue of 2008.