To get the housing market moving, raise property taxes

Young American families chasing the dream of homeownership have found conditions increasingly difficult in recent years, with affordability challenges spreading from always-expensive cities such as San Francisco to previously affordable places such as Orlando. A number of these cities face a budgeting problem of their own, with public spending outpacing revenues and painful cuts on the horizon as federal COVID aid runs out.

A recent working paper from the Federal Reserve Bank of Minneapolis’ Opportunity & Inclusive Growth Institute offers an unusual solution to runaway house prices that would also generate much-needed income for local authorities: higher property taxes. This is no doubt an unpopular idea for homeowning voters, still it is worth considering as the dysfunction in the housing market stretches into another year.

Buyer affordability across much of the U.S. is poor due to a combination of years of rapid price escalation and stubbornly high mortgage rates. The low inventory of homes for sale is keeping prices elevated and resale housing activity stuck near generational lows. People who can afford to purchase in this market are likely to be older and repeat buyers, while the share of buyers with school-age children has shrunk to a record low, according the National Association of Realtors’ 2024 Profile of Home Buyers and Sellers.

The paper (highlighted in a Minneapolis Fed article recently) examines the relationship between property taxes and house prices by comparing the markets of Texas and California. Texas levies relatively high property tax rates on owners but offers more affordable homes, while homes are out of reach for many in California though the average tax paid on property has been kept low in part by a 1978 amendment to the state constitution that limits annual increases. Essentially, property tax rates flow through into home values. Higher rates "act as a ‘forced mortgage,’ reducing up-front down payments and enabling greater homeownership among younger households," contend the researchers from New York University’s Stern School of Business and the University of Hamburg.

As a homeowner in Georgia, a state that prides itself on low taxes, I am not naive about the politics of raising property taxes or the burden it places on those on lower or fixed incomes. Still, the dire state of the housing market requires us to weigh policy ideas that wouldn’t be considered in normal times.

When mortgage rates soared in the first half of 2022, the root of the housing market’s current woes, the argument was that the Federal Reserve would get inflation under control and then cut its key interest rate. Mortgage costs would fall too, the thinking went, moving us in the direction of normalcy even if housing affordability wasn’t immediately restored. Two and a half years on, inflation has mostly been brought under control and the fed funds rate has been cut by 0.75 percentage point, yet mortgage rates are above 7% and resale transactions on a population-adjusted basis are the lowest in history. Things feel stuck, and it’s not clear what will unstick them outside of a recession, which isn’t something anyone should root for.

Increasing property taxes, while painful for local politicians and homeowners, would improve the structural dynamics of the housing market. It would raise carrying costs for people who own multiple homes, for instance, incentivizing them to sell one of them. It would also incentivize downsizing among empty nesters living in huge single-family homes, freeing those up for young families who need the space. It would encourage lot splitting and other development that puts more housing units on underutilized land. Importantly, it would limit home price appreciation at a time when the ratio of home values to incomes is high.

Stressed municipal budgets and the post-COVID decline in commercial property values may be changing the political calculus around this issue as we’ve seen in Chicago with Mayor Brandon Johnson’s efforts to force through a property tax increase. Johnson has so far been rebuffed by Chicago’s city council, but spending cuts are equally unpopular. The mayor of Oakland, California, was recalled in this month’s elections in large part due to the city’s budget deficit, with unions protesting potential cuts to police and fire services.

Higher property taxes have the potential to raise revenue in a couple of ways -- by mechanically increasing income due to the higher millage rate on property, and by incentivizing turnover, which matters in jurisdictions such as California where the tax dollars paid on a parcel of land are often a function of when a home was purchased and for how much, and where assessments often lag market values.

This is an idea that is certain to draw a backlash, particularly when changes don’t provide relief for older homeowners and those on lower incomes. But the question for critics who want to see housing affordability improve is how that happens through business-as-usual policies. A decade of underbuilding has left the U.S. chronically undersupplied, while local opposition frequently hampers efforts to increase density in cities and their near suburbs.

We can’t count on mortgage rates dropping back below 6%, to say nothing of the 3% rates where transactions took place from 2020 through the early part of 2022. High borrowing costs make both housing construction and home buying challenging, and construction costs don’t seem to be falling anymore. Turnover should increase gradually over time as life events lead to forced moves, but tens of millions of homeowners either own their homes free and clear or have mortgage rates that it will never make financial sense to give up. Heading into 2025, we either become more open-minded about politically contentious policy ideas or accept that improving housing affordability isn’t a goal that government is committed to.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners. Conor Sen is a Bloomberg Opinion columnist. He is founder of Peachtree Creek Investments.