Property taxes in most Canadian municipalities now constitute a significant part of home ownership costs. Normally, in assessment or appraisal theory, it is stated that home values or sales prices drive assessment values, which, in turn, drives the level of property taxes to be paid given various mill rates. But, is it possible that the inverse may exist and property taxes can affect the market prices paid on residential real estate?
Logically, purchasers take property taxes into account when making offers on a home, much as they consider other factors such as age and size of the home, location, maintenance and/or number of bathrooms. Property taxes may reduce the value of a property if the real or imputed net rental on the property would be reduced, or, as indicated by Oates in the The Effects of Property Taxes, they may increase real estate values if it is perceived that they pay for beneficial local public improvements.
In economic theory, this effect on value is supported by what is known as the Tiebout Hypothesis, which is a theory for local government expenditure. In the Tiebout Hypothesis, home buyers in urban areas with multi-jurisdictional governments choose to live in neighbourhoods that not only give them the house they desire, but also the property tax level with which they are comfortable in order to have the local public services they desire. In effect, home purchasers are choosing to buy goods (municipal government services) with various prices (property taxes) from different vendors (local governments) as in any market.
Local governments compete with each other by offering different services and property taxes to attract different home purchasers. Buyers maximize their utility or satisfaction by moving to the municipality that gives them the right mix of taxes and services. The Tiebout Hypothesis has a number of assumptions such as mobile consumers, buyers having complete information on taxes and public services, the buyer’s ability to choose between different communities, reasonable commuting costs, an inability of public services to be offered in different municipalities and that there are economies of scale at an optimal level in local government service provision.
Grande Prairie, Alberta has an urbanized area of approximately 80,000 people divided into two municipalities:
- The City of Grande Prairie makes up the central core area with a central business district, highway commercial areas, industrial areas and adjacent residential areas.
- The City can be considered a high service/high tax jurisdiction.
- The County of Grande Prairie surrounds the City with rural lands, country residential and residential areas as well as industrial subdivisions.
- The County can be considered a high service/low tax jurisdiction.
The following table shows local government expenditures, as a measure of service provision, in the two jurisdictions on a per capita basis over the last few years. The expenditures include both capital and operational expenditures. Note that education expenditures are not shown, which, in Alberta, are equalized between municipalities. In 2016, capital expenditures in the County were at 35% of all spending, while in the City they were at 30%.
LOCAL GOVERNMENT EXPENDITURES PER CAPITA GRANDE PRAIRIE
YEAR COUNTY CITY
2014 $5,368 $3,393
2015 $6,176 $2,831
2016 $6,242 $4,089
Even though the County spends over 50% more per capita than the City, its residential tax rates are approximately half the City’s. The County residential mill rate, including the education levy, is at 6.4884, versus the City equivalent residential mill rate at 12.6588 in 2017.
This expenditure pattern is possible given the high ratio of non-residential properties in the County’s assessment tax base compared to the City’s ratio; in 2016, the City’s residential assessment base was 68% of the total assessment base compared to a ratio of 44% in the County. The County benefits by having a large linear and non-residential assessment base. Newer industrial and warehouse projects prefer to locate in the County as there is a trend toward larger industrial lots compared to the smaller lots provided in the City’s older industrial parks. In summary, as the two municipalities provide high service levels, the major difference between the two is not services, but property tax levels.
Do home purchasers take account of the differential municipal service levels and taxes in the Grande Prairie urban area? Oates, in the The Effects of Property Taxes, found a negative relationship between property taxes and property values, if they were unaccompanied by an expanding program of public services. As well, Oates believed that, if two communities offered the same local government services, the one with higher property taxes would have depressed realty values relative to the other. Cebula, Foley and Houmes, in their tax study, found that property taxes are capitalized into a lower house price. In the Grande Prairie area, if purchasers do account for taxes, it would be expected that an increment would be paid for similar properties in the County due to their lower taxes. The lower annual property tax burden should be capitalized into an increment in sale price.
To examine this, a paired sales analysis was done on three newer upper-middle class neighbourhoods in the City versus equivalent neighbourhoods in the County. A paired sales analysis compares newly-built homes that are almost identical to each other except for the factor of interest and the residential property tax difference between the City and the County. Using newly-built homes is problematic, as some purchasers would have to estimate property taxes because the homes purchased may not be fully assessed at the time of purchase.
- The analysis used completed construction
assessment data was used.
- The land value of sales was subtracted based on bare lot sales to account for locational differences between neighbourhoods.
- On the paired house sales, the price paid minus land valuation was projected and then the difference in price paid between neighbourhoods was calculated.
- The annual property tax differential between the homes was divided by the differential in sales prices to give an implied capitalization rate of the property tax differential.
- The ability of taxpayers to consume local government services in adjacent communities was not considered in the analysis.
- It should be noted that projections of land value between the neighbourhoods significantly affect the differentials in value.
The results in the following table confirm that residential buyers take into account property tax differentials in the first two neighbourhood comparisons, but not in the third.
CITY COUNTY Mean Tax Diff/Price Diff Pairs
= Implied Capitalization
Arbor Hills Whispering Ridge .0655 3 pairs
Obrien Lake Whispering Ridge .0510 7 pairs
Grande Banks Whispering Ridge -.0860 7 pairs
The two pairings (Arbor Hills/Whispering Ridge and Obrien Lake/Whispering Ridge) where this effect occurred would support the theory of the Tiebout Hypothesis. They indicate a capitalization of the tax savings to property value of approximately 6%, or $17 in value for every $1 of tax savings.
The Grande Banks/Whispering Ridge paired sales indicate an increase in property values due to higher taxes. This neighbourhood is complicated in that Grande Banks is an upper class City subdivision in a preferred location that is close to a major park and other recreational facilities. Would this exemplary location overwhelm the higher tax differential?
The effect of property tax differential on price offerings in the Grande Prairie market is also supported by the fact that, in recent years, upper and upper-middle class neighbourhoods have developed outside the City in the County, in developments such as Whispering Ridge, Carriage Lane Estates, Maple Ridge Estates and Taylor Estates.
The above analysis indicates that property taxes not only reflect market prices, but can also impact market prices on residential real estate.
Tiebout Model, Wikipedia – The Free Encyclopedia, accessed August 8, 2017
Consolidated Financial Statements, 2014-2016, County of Grande Prairie
Executive Summary, 2014-2018, City of Grande Prairie
Budget Summary, 2015-2016, County of Grande Prairie
The Effects of Property Taxes and Local Public Spending on Property Values: An Empirical Study of Tax Capitalization and the Tiebout Hypothesis, W Oates, Journal of Political Economy, 1969
60 Years Later and Still Going Strong: The Continued Relevance of the Tiebout Hypothesis, Salz and Capener, The Journal of Regional Analysis and Policy, 2016
Property Tax Capitalization within a National Historic District versus Property Tax Capitalization outside that National Historic District: Another Application of the Tiebout Hypothesis, Cebula Foley Houmes, Jacksonville University, 2010