Local Governments and Housing Prices: Capitalization of Property Taxes

This paper studies the capitalization of property taxes into housing prices by exploiting a unique institutional setting. We utilize a nationwide reform that raised the statutory base rate of the property tax by 80% while simultaneously restricting the fiscal instruments municipalities could use to mitigate the hike. Exploiting a population-based discontinuity in tax rates, we deploy a difference-in-discontinuities design to jointly identify municipal tax-setting behavior and asset price capitalization. We show that prior to the reform, municipalities aggressively used local coefficients to offset statutory rates. Following the reform, however, local governments failed to utilize their remaining discretionary tools to offset the tax increase, leaving residents with a higher effective tax burden. Despite this substantial fiscal shock, we find no evidence that the resulting tax wedge is capitalized into housing prices. Our findings demonstrate that accounting for endogenous municipal responses to nationwide policy shocks is vital for accurately evaluating the economic incidence of property taxation.