Working Paper No. 07-12

The Effect of Property Taxes on Location Decisions:
Evidence From the Market for Second Homes

Erik Johnson and Randall Walsh

November 2, 2007

ABSTRACT

While there exists a large empirical literature on the capitalization of property taxes into home prices, very little work has been done to identify the effect of differences in property taxes on location choices. Further, what empirical work has been done typical suffers from identification problems due to aggregation bias, tax endogeneity, and confounding influences from the link between tax rates and the provision of public goods that are funded by these tax rates. In this paper, we identify the effect of differential school tax rates on location choices in the second home market. We are able to overcome the typical identification problems by: 1) focusing on purchasers of second homes who arguably receive no benefits from school expenditures in their second home locations; 2) using a unique tax data base with a high degree of spatial resolution; and, 3) identifying the effects of differential tax rates using an exogenous change in the distribution of school tax rates in Michigan that arose as a result of the passage of ‘Proposal A’ in 1994. Our results provide some of the clearest evidence to date on the impact of property tax differences on housing location choices.

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