Declining House Prices and Property Taxes in Illinois - What is the effect of rapid increases and large drops in house prices on property taxes?

Declining House Prices and Property Taxes in Illinois
Declining House Prices and
Property Taxes in Illinois
What is the effect of rapid increases and large drops in
house prices on property taxes?

Declining House Prices and Property Taxes
                          in Illinois

                          By Daniel P. McMillen

                              he past decade has been an extraordi-       Even if total tax revenue did, in fact, remain
                              nary time for the housing market in         constant as house prices change, there still
                          the United States. According to data from       may be significant changes in individual tax
                          the Federal Housing Finance Agency              bills. Taxes go up in places where house
                          (FHFA), from the first quarter of 2000 to       prices increase unusually rapidly, and all
                          the peak of the housing market in the first     residential tax payments may increase if the
                          quarter of 2007 the average American            rate of appreciation of commercial and
                          home increased in value by 67 percent, or       industrial properties does not keep pace
                                                                          with residential appreciation rates. More-
    The data on house

                          an average annual rate of approximately
    prices are drawn

                          7.6 percent. The price declines since then      over, changes in property values directly
    from the Federal

                          have also been dramatic. From the first         affect homeowners’ wealth, and significant
    Housing Finance

                                                                          declines in property values may force local
    Agency’s web site,

                          quarter of 2007 to the second quarter of

                          2010, the price of an average American          jurisdictions to reduce their expenditures.

                          home fell by 11.2 percent, which translates     Other changes are even more indirect—if
    Page=87. The price

                          into an average annual rate of about 3.6        consumers feel less wealthy when property
    indices are based
    on a combination

                          percent. Although the rate of decline has       values decline, then revenue from the sales
    of sales and

                          slowed, it is not yet clear whether the         tax may decline when consumers spend less
    appraisal data. The

                          housing market has truly reached bottom,        than before, and income tax revenue may be
    FHFA data are
    unique in the

                          and it may be some time before prices           affected if lower property values lead to less
    breadth of

                          return to the heights reached in 2007.1         building and thus to lower employment in
    geography and

                                                                          the construction industry. But the sum of all
    time covered by

                                                                          such indirect changes is likely to be far less
    the price indices.

                          What is the effect of rapid increases and
                          large drops in house prices on property         than the direct change that would result if
                          taxes? To a first approximation, it might be    property taxes were, in fact, proportional to
                          expected that there is a simple propor-         property values.
                          tional relationship between house prices
                          and property taxes—taxes rise when house        In this chapter, I review some of the evi-
                          prices increase and taxes fall when prices      dence about the relationship between prop-
                          decline. This simple relationship would         erty values and taxes with an emphasis on
                          hold if taxes were a constant percentage of     Illinois generally and the Cook County pro-
                          property value, assessments were accurate       portion of the Chicago metropolitan area in
                          and timely, and all property values             particular. The main conclusion is simple:
                          increased at the same rate. Because the         falling property values do not necessarily
                          actual tax system is much more compli-          lead to declines in property taxes because
                          cated than this, it turns out to be very hard   tax rates increase when assessments decline.
                          to predict how taxes will react to changes      However, the distribution of tax payments
                          in property values. In fact, a much better      across households can vary greatly. House-
                          first approximation to the effect of house      holds in places with relatively small declines
                          price changes on property taxes is that         in house values may see their tax payment
                          there simply is no relationship: taxes are      increase even if their assessments have been
                          determined independently of property val-       reduced. The main effect of house price
                          ues, with the tax rate adjusting to keep rev-   declines on property taxes is much less
                          enue constant even in times when prices         direct: if homeowners feel less wealthy, they
                        are changing dramatically.                      are less inclined to support tax increases.
Figure 1
                                                                                                                                          House Price Indices
House Price Volatility

Figure 1 shows the path of house prices for

the United States, the Chicago-Joliet-

                                                                                                                                          Index, 1995:1 = 100
Naperville metropolitan area (not includ-

ing Lake County), the full state of Illinois,
and the parts of Illinois that are not in met-

ropolitan areas. After a period of moderate

growth in the late 1990s, prices began to
rise rapidly in the U.S. beginning about

2001, and a period of extraordinary appre-

ciation began around 2003. Price began to
fall sharply in 2007. The Chicago metro
                                                                                                                                                                                                     US                                                       Chicago-Joliet-Naperville

area’s experience is nearly identical to the
national average through 2007, but the rate
                                                                                                                                                                                                     Illinois                                                 Illinois, Non-Metro

of decline since then has been greater. The
full state of Illinois has had more moderate
                                                                                                                                 Source: Federal Housing Finance Agency

price growth and more moderate declines.
Non-metro Illinois neither shared in the                                                                                   It is clear from Figure 1 that 2003-2007 was
                                                                                                                           a unique period of extraordinary apprecia-
                                                                                                                                                                                                                                                                                      The Chicago
rapid price appreciation of the early part of
                                                                                                                           tion in house prices for Chicago, Illinois,
                                                                                                                                                                                                                                                                                      metro area’s
the decade nor suffered any significant
price declines.                                                                                                            and the U.S. How has the rest of metro-
                                                                                                                                                                                                                                                                                      experience is
                                                                                                                                                                                                                                                                                      nearly identical
                                                                                                                                                                                                                                                                                      to the national
                                                                                                                                                                                                                                                                                      through 27,
  Figure 2
                                                                                                                                                                                                                                                                                      but the rate of
  Average Annual Changes in House Prices
                                                                                                                                                                                                                                                                                      decline since
            10                                                                                                                                                                                                                                                                        then has been








                                                                                                                            Lake County




                                                                                                                                                                                                                          Illinois, Non-Metro



                                                                                                 2003:1 - 2007:1                                                2007:1 - 2010:1

        Source: Federal Housing Finance Agency

The Illinois Report 2011

                                     Illinois fared over the last decade? Figure 2
                                     compares annual average house price
                                                                                                      Trends in Property Taxes

                                     changes for the first quarter of 2003 to the                     The path of house prices over the last
                                     first quarter of 2007 and from 2007:1 to                         decade might lead one to expect that prop-
                                     2010:2 across all of Illinois’ metropolitan                      erty tax revenue would have increased
                                     areas, along with non-metro Illinois and                         dramatically up to 2007 and then fallen
                                     the nation. Chicago and Lake County had                          significantly since then. The relationship
                                     very high growth followed by sharp                               between house prices and property tax
                                     declines. Danville, Kankakee, and                                payments is far from mechanical, however.
                                     Rockford had more moderate declines                              For example, if property taxes increased in
    Lutz, Byron F., “The

                                     after periods of growth. The price indices                       proportion to house prices when terms like

                                                                                                      “bubble” are used to describe the state of
    Between House

                                     have not declined since 2007 in
    Price Appreciation

                                     Bloomington-Normal, Champaign-                                   the housing market, it is reasonable to
    and Property Tax

                                     Urbana, Decatur, Peoria, and Springfield.                        expect that property taxes would account
    Revenues,” National

                                                                                                      for a larger share of total state and local tax
    Tax Journal 61
    (2008), 555-572.

                                                                                                      revenue. Figure 3 shows the trend for the
                                                                                                      entire U.S. for property tax revenue as a
                                                                                                      percentage of total state and local tax rev-
                                                                                                      enue for 1998-2008. The percentage hardly
                                                                                                      changed between 2003 and 2007, and only
      Figure 3

                                                                                                      began to rise significantly as house prices
      Property Tax as a Percentage of Total State and Local Tax

                                                                                                      fell sharply in 2009.

                                                                                                      Similar trends were evident in Illinois.

                                                                                                      Figure 4 shows the trend for the state

                                                                                                      budget for 2000-2009. Despite the huge

                                                                                                      growth in house prices, the property tax

                                                                                                      accounted for a lower share of total tax

                                                                                                      revenue for the state in 2007 than it had

                                                                                                      earlier in the decade. However, the prop-










                                                                                                      erty tax accounts for only a trivial percent-
                                                                                                      age of the state government’s
                                                                                                      budget—well under one-half percentage
      Source: U.S. Census Bureau, Quarterly Summary of State and Local Tax Revenue

                                                                                                      point in each year over the past decade.

                                                                                                      In contrast to the state, Illinois’ local gov-
                                                                                                      ernments rely heavily on the property tax.
                                                                                                      As can be seen in Figure 5, the property tax
      Figure 4

                                                                                                      accounted for more than 71 percent of local
      Property Tax as a Percentage of State Tax Revenue in Illinois

                                                                                                      governments’ general own-source revenue

                                                                                                      in 1997 in Illinois. This figure fell over the
                                                                                                      course of the last decade to just over 68


                                                                                                      percent in 2007—even as property values
                                                                                                      were increasing significantly.











                                                                                                      Empirical Studies

                                                                                                      A study by Byron Lutz was the first to use
                                                                                                      national data to estimate the elasticity of
      Source: U.S. Census Bureau, Quarterly Summary of State and Local Tax Revenue

                                                                                                      property tax revenue with respect to house
                                                                                                                  Lutz, Byron, Raven
                                                                                                                  Molloy, and Hui
                                                                                                                  Shan, “The Housing
   Figure 5                                                                                                       Crisis and Local
   Property Tax as a Percentage of                                                                                Government Tax

                                                              both V and t change, then the full change
                                                                                                                  Revenues: Five
   General Own-Source Revenue, Local

                                                              in revenue is T2-T1 = t(V2-V1) + (t2-t1)V1.
                                                                                                                  Channels,” working
   Governments                                                                                                    paper, Federal
                                                                                                                  Reserve Board of

                                                              Other channels by which changes in house
             72                                                                                                   Governors (2010).

                                                              prices affect tax revenue are less direct.

                                                              Declining house prices may reduce con-
                                                                                                                  Recent studies
                                                                                                                  include Attanasio,

                                                              struction, which reduces sales tax revenue
             69                                                                                                   Orazio, Laura Blow,

                                                              from construction materials and perhaps
             68                                                                                                   Robert Hamilton,

                                                              income taxes from construction workers. A
                                                                                                                  and Andrew
             67                                                                                                   Leicester, “Booms

                                                              growing recent literature suggests that ris-
             66                                                                                                   and Busts: Con-

                                                              ing house prices increase consumption
                                                                                                                  sumption, House
                   1997             2002               2007

                                                              expenditures by making consumers feel
                                                                                                                  Prices and Expecta-
                                                                                                                  tions,” Economica

                                                              wealthier.4 Thus, declines in house prices
   Source: U.S. Census Bureau, Census of Governments
                                                                                                                  76 (2009), 20-50;

                                                              may lead to lower sales tax collections.
                                                                                                                  Bostic, Raphael,

prices.2 Lutz conducts the analysis using                     Similarly, voters will be less inclined to
                                                                                                                  and Gary Painter,
                                                                                                                  “Housing Wealth,

two data sets—aggregate national data for                     support expenditure bills when their prop-
                                                                                                                  Financial Wealth,

1976-2007 on property tax revenue and                         erty values fall.
                                                                                                                  and Consumption:

house prices, and a comparable data set
                                                                                                                  New Evidence from
                                                                                                                  Micro Data,”

covering all local governments in the U.S.                    The study by Lutz, Molloy, and Shan sug-
                                                                                                                  Regional Science

for 1985-2005. Both of these periods are                      gests that the direct channels are much
                                                                                                                  and Urban Eco-

times when house prices were rising                           stronger than the indirect ones. However,
                                                                                                                  nomics 39 (2009),
                                                                                                                  79-89; Campbell,

throughout most of the nation. In contrast                    both this study and the earlier one by
                                                                                                                  John Y. and João F.

to the evidence presented in Figures 3-5,                     Byron Lutz suggest that there are long lags
                                                                                                                  Cocco, “How Do

he concludes that:                                            between house price changes and their
                                                                                                                  House Prices Affect

   “The evidence suggests property tax rev-                   effects on tax revenue. Recent declines in
                                                                                                                  Evidence from

   enues are quite responsive to changes in                   house prices may affect revenue sometime
                                                                                                                  Micro Data,” Journal

   house prices. Although it takes several years              in the future, but it could easily take 5-10
                                                                                                                  of Monetary
                                                                                                                  Economics 54

   for house price appreciation to feed through               years until their effect becomes pro-
                                                                                                                  (2007), 591-621;

   to property tax revenues, the long-run elas-               nounced. These long lags may help explain
                                                                                                                  and Case, Karl E.,

   ticity is on the order of 0.4. On average,                 why Figures 3-5 show little response of
                                                                                                                  John M. Quigley,

   policymakers are estimated to respond to                   property taxes to rising house prices. The
                                                                                                                  and Robert J.
                                                                                                                  Shiller, “Comparing

   increasing home prices by 60 percent of the                lags may also explain why recent studies
                                                                                                                  Wealth Effects: The

   increase in tax revenue that would have                    show little response in property tax rev-
                                                                                                                  Stock Market ver-

   occurred in the absence of a change in the                 enue to the recent declines in house prices.5
                                                                                                                  sus the Housing
                                                                                                                  Market,” Advances

   effective tax rate.” (Lutz, 2008, p. 566)
                                                                                                                  in Macroeconomics

                                                              Several factors account for these long lags.
                                                                                                                  5 (2005).

In a subsequent paper, Lutz, Molloy, and                      Assessments may take quite some time to
                                                                                                                  Alm, James, Robert

Shan analyze the channels by which the                        respond to price changes, in part because
                                                                                                                  D. Buschman, and

housing market affects state and local tax                    assessors may not respond immediately to
                                                                                                                  David L. Sjoquist,

revenue.3 At its most basic level, a jurisdic-                the price changes and in part because
                                                                                                                  “Rethinking Local

tion’s property tax revenue (T) is simply                     many jurisdictions assess property rela-
                                                                                                                  Reliance on the

the product of its effective tax rate (t) and                 tively infrequently. In Illinois, Cook
                                                                                                                  Property Tax,” work-

the market value of its taxable property                      County assesses properties every three
                                                                                                                  ing paper, Georgia
                                                                                                                  State University

(V): T = tV. The first channel by which                       years while other counties in the state have
                                                                                                                  (2010), and

changes in house prices affect revenue is                     a four-year assessment cycle. Thus, it can
                                                                                                                  Doerner, William M.

entirely mechanical: if the tax rate is con-                  easily take five years or more for assess-
                                                                                                                  and Keith R.
                                                                                                                  Ihlanfeldt, “House

stant and the market value of taxable prop-                   ments to catch up to market trends. In
                                                                                                                  Prices and City

erty changes from V1 to V2, then revenue                      addition, nearly all states have adopted
                                                                                                                  Revenues,” working

rises by t(V2-V1). However, tax rates may                     some form of property tax limitation meas-
                                                                                                                  paper, Florida State

change when property values increase. If
                                                                                                                  University (2010).

                                                              ure which restricts jurisdictions’ ability to                       
The Illinois Report 2011

                            raise revenue when prices increase.6 In                         The Assessor’s Office is in charge of esti-
                            many cases, these limits on the response of                     mating market values every three years in
                            property tax revenue when prices rise also                      Cook County. By statute, residential assess-
                            lead to some catch-up when prices fall,                         ments are supposed to be set at 16 percent
                            which has an ameliorative effect on rev-                        of market value in Cook County, but in
                            enue responses to price declines.                               2009 the Assessor’s Office recently
                                                                                            announced a “recalibration” of the assess-
                            The most important source of lags is often                      ment process and now announces a target
                            overlooked: in many jurisdictions, tax rates                    of 10 percent for the assessment ratio rather
                            respond more mechanically than tax pay-                         than 16 percent. Similarly, commercial and
    Anderson, Nathan

                            ments to changes in house prices. If T = tV                     industrial assessment levels have been re-
    B., “Property Tax
    Limitations: An

                            and V is an accurate and timely measure of                      calibrated to 25 percent rather than their

                            house prices, then either T or t can respond                    statutory 38 percent and 36 percent rates.
    Review,” National

                            to maintain the equality when V changes.                        Assessment levels are 1/3 of all property
    Tax Journal 59
    (2006), 685-694.

                            In many—perhaps most—jurisdictions, T                           classes in the other counties in state.
                            is determined in local elections, while V is
    According to data

                            determined by local assessment practices.                       Although Cook County is allowed to have
    from the Illinois

                            The tax rate then responds mechanically to                      different assessment levels for different
    Department of
    Revenue, all but 19

                            ensure that the equality holds. It should                       property classes, the total of all assess-
    of the 101 other

                            hardly be surprising, then, to find that                        ments must end up being 1/3 of property
    counties in the

                            property tax revenue bears little or no rela-                   value for all counties in the state, including
    state had multi-
    pliers of 1 in 2007

                            tionship to house prices; it is t that                          Cook. In Cook County, each property’s

                            responds, not T.                                                proposed assessed valuation in 2007 was

                                                                                            multiplied by the state equalizer—the

                                                                                            “multiplier”—of 2.8439 to ensure that total
    multipliers.pdf ),

                                                                                            assessment averaged 1/3 of property
    meaning that their      Property Tax Administration in Illinois

                            Illinois is part of a group of states in which                  value, i.e., the average assessment across
    assessments were
    accurate on aver-

                            property tax rates bear a more mechanical                       all property classes was .33/2.8439 = 11.6
    age. The average

                            relationship to property values than is the                     percent of market value in 2007. Multipli-
    multiplier for these

                            case for revenue. Consider the following                        ers hover near 1 in all other counties in the
    19 states was 1.026,
    with a range of .960

                            table that the Cook County Assessor’s                           state, which implies that assessment levels
    to 1.131.

                            Office website uses to illustrate how to cal-                   are close to their statutory 1/3 rate.7
                            culate an estimated tax bill (http://cook
    A full list of exemp-

    tions is available on

                                                                                            The final step in the transition from market
    the Illinois

                                                                                            value to the property tax base is the home-
    Department of

                                                                                            owner exemption.8 The basic homestead
    Revenue’s web site:

                                                                                            exemption was increased to $6,000 in 2009.

                                                                                            Other special exemptions are available for

                                                                                            favored groups such as senior citizens, vet-
    propertytax/tax           Table 1

                                                                                            erans, and people with disabilities. Cook
                              How to Calculate an Estimated

                                                                                            County has some additional exemptions
                              Residential Tax Bill in Cook County

                                                                                            for people who have lived in their home
                              $ 100,000      Estimated Market Value
                                                                                            for 10 years and have household incomes
                                      .10    Assessment Level (10 percent)

                                                                                            of less than $100,000, as well as an alterna-
                              $  10,000      Proposed Assessed Valuation
                              ×  2.8439      2007 State Equalizer

                                                                                            tive general homestead exemption for
                              $  28,439      Equalized Assessed Value (EAV)

                                                                                            homes with assessed values that have
                                 – 5,500     Homeowner Exemption

                                                                                            increased by more than 7 percent.
                              $ 22,939       Adjusted Equalized Value (AEAV)
                              ×       .10    Sample Tax Rate (your tax rate
                                             could vary)

                                                                                            The Illinois Department of Revenue calcu-
                              $    2,293     Estimated Tax Bill in Dollars

                                                                                            lates equalization factors by comparing

Institute of Government & Public Affairs

each county’s assessments to actual sales         properties are re-assessed, tax rates will
prices. Equalization factors are calculated       rise unless voters agree to reduce expendi-
with some lag because the Department of           ture levels.
Revenue compares a year’s assessments to
sales prices from the previous year, and
assessments themselves take place on a
                                                  The Distribution of Taxes

rotating three-year cycle within Cook             The way tax rates are calculated in Illinois
County and on a four-year cycle elsewhere.        means that an individual’s property tax
These lags mean that equalized assess-            bill will be unchanged if all prices rise or
ments can easily take four to five years to       fall by the same percentage and the num-
                                                                                                                  Unlike the

fully react to changes in market values.          ber of properties does not change over
                                                                                                                  other counties
                                                  time. This unrealistic scenario does not
                                                                                                                  in the state,
Apart from these lags and the panoply of          take into account the fact that new proper-
                                                                                                                  Cook County’s
exemptions, the assessment process is             ties are added over time and others are
                                                                                                                  classified tax
designed to produce assessments that              demolished or are converted to alternative                      system makes
closely track market values. A jurisdic-          uses. It also involves an unrealistic                           residential
tion’s property tax base is the sum of the        assumption that all properties appreciate
                                                  or decline in value at the same rate.
                                                                                                                  properties a
adjusted assessed values, i.e.,                                                                                   favored class

                                                  These issues are particularly relevant in
                                                                                                                  with lower

                                                  Cook County. Unlike the other counties in
   B = ∑tn=  AEAVi                                                                                               effective rates

where B is the tax base and AEAVi is the          the state, Cook County’s classified tax sys-
                                                                                                                  than other
adjusted equalized assessed valuation for         tem makes residential properties a favored
the ith property in the jurisdiction. Once        class with lower effective rates than other
this base is determined, all properties in        property classes. Non-residential proper-
the jurisdictions are taxed at the same rate,     ties are not the beneficiaries of exemptions
t. The total tax revenue for the jurisdictions    and are subject to higher property assess-
is thus T = tB.                                   ment levels. Table 2 shows the calculation
                                                  of the tax bill for a representative commer-
Given this reasonably straightforward rela-       cial or industrial property in Cook County
tionship between assessed values and tax          if the recent recalibration for non-residen-
revenue, changes in actual property values        tial assessments to 25 percent of property
would lead in time to proportionate               value had been applied in 2007.
changes in tax revenue if the tax rate were
constant. In Illinois, as in most states, it is
the tax rate that adjusts when the tax base
changes, not revenue. In other words, the
simple identity should be re-written as t =
                                                    Table 2

B/T to reflect the actual direction of causa-
                                                    How to Calculate an Estimated Tax Bill

tion: each jurisdiction’s tax base and total
                                                    for a Commercial or Industrial

tax extension interact to determine its tax
                                                    Property in Cook County

rate. The tax rate falls when assessed val-
                                                    $ 100,000      Estimated Market Value
ues rise in response to rising property val-
                                                           .25     Assessment Level (25 percent)

ues, and it rises when assessed values fall
                                                    $  25,000      Proposed Assessed Valuation
                                                    ×  2.8439      2007 State Equalizer

in response to declining property values.
                                                    $  71,098      Equalized Assessed Value (EAV)

However, the change does not come
                                                           –0      (No Exemption)

overnight. Property values began to
                                                    $ 71,098       Adjusted Equalized Value (AEAV)
                                                    ×      .10     Sample Tax Rate (your tax rate

decline in 2007 and many properties are
                                                                   could vary)

only now being re-assessed to reflect the
                                                    $    7,110     Estimated Tax Bill in Dollars

changing market conditions. Once the

The Illinois Report 2011

                                     The total tax bill for a commercial or                          to be replaced with a $269,340 home to
                                     industrial property with a market value of                      keep taxes the same in Cook County. This
    Note that these cal-

                                     $100,000 in this example is 7,110; it would                     situation provides a huge disincentive for
    culations use the
    same $5,500 home-

                                     be $2,293 for a residential property with                       commercial property owners to locate in
    stead exemption

                                     the identical market value. The effective                       Cook County, and also means that any loss
    that was used in

                                     tax rate is 7,110/100,000 = 7.11 percent,                       of non-residential property is likely to pro-
    the table from the
    Cook County

                                     compared with 2.29 percent for the resi-                        duce increases in residential tax bills even
    Assessor’s Office.

                                     dential property. The tax bill is more than                     as homes drop in value.
    When the figure is

                                     three times higher for commercial property
    raised to $6,000 to
    be consistent with

                                     than for a residential property that has the                    Unfortunately for Cook County, the num-
    the current exemp-

                                     very same market value.                                         ber of commercial and industrial proper-
    tion, the value of

                                                                                                     ties has been falling over time. Data
    $116,667 rises to
    $118,000 for coun-

                                     In any county in the state, a loss of com-                      presented in the Cook County Assessor’s
    ties other than

                                     mercial or industrial property will neces-                      Office Final Assessment Abstracts show that
    Cook and the value

                                     sarily lead to higher taxes on residential                      the total number of commercial properties
    rises from $269,340
    to $271,107 in Cook

                                     property owners unless the tax extension                        in the county fell from 73,002 to 69,263 in

                                     changes. In other counties, each $100,000                       2008, and the total number of industrial
                                     of market value that is lost in commercial                      properties declined from 27,879 to 25,110.
     The exact calcula-
    tions are 2.69 ×

                                     or industrial property value only needs to                      The average commercial assessment was
    1,040,964 × (73,002

                                     be replaced with $116,667 in residential                        $262,491 in 2008 and the average industrial
    – 69,262) =

                                     property to keep taxes the same as before.                      assessment was $171,480; these figures
    104,772,722,420 for
    commercial and

                                     The additional $16,667 is needed to com-                        translate into market values of $1,049,964
    2.69 × 685,920 ×

                                     pensate for the exemption that is provided                      and $685,920 at the re-calibrated 25 percent
    (27,879 – 25,100) =

                                     to residential property owners. These cal-                      assessment level. Because each property
    5,127,601,819 for

                                     culations are shown in the first two                            needs to be replaced by a residential prop-
                                     columns of the tables below, which show                         erty with a value that is 2.69 times as
                                     that representative $100,000 commercial                         expensive to keep property value
                                     industrial properties produce the same tax                      unchanged, the commercial properties
                                     revenue as a $116,667 residential property                      would need to be replaced by more than
                                     in 101 of the state’s 102 counties.9 Similar                    $100 billion in residential homes to keep
                                     calculations in columns 3 and 4 show that                       the property tax bill constant, and another
                                     the $100,000 non-residential property has                       $5 billion would be needed to compensate
                                                                                                     for the loss of commercial property.10

                                                                                                     These calculations show that a loss of non-
                                                                                                     residential property in a jurisdiction can
                                                                                                     lead to increases in homeowners’ property
     Table 3

                                                                                                     tax bills even if all residential assessments
     Comparison of Residential and Commercial Property Tax

                                                                                                     remain constant over time. Tax bills will
     Rates and Their Influence on Each Other

                                                                                                     also change when property values change
                                                                                                     at different rates in different area within a
        Other Counties                   Cook County
     Res.       Com. or                Res.     Com. or

                                                                                                     jurisdiction. For example, suppose a juris-
                  Ind.                            Ind.

                                                                                                     diction’s entire tax base is residential, with
     $116,667 $100,000              $269,340    $100,000           Estimated Market Value
     ×      .33 ×     .33           ×      .10  ×     .25          Assessment Level (33 percent)

                                                                                                     1,000 properties that initially all have
     $ 38,500 $ 33,000              $ 26,934    $ 25,000           Proposed Assessed Valuation
     ×        1 ×                   × 2.8439    × 2.8439
                                                                                                     adjusted equalized assessed values of
                        1                                          2007 State Equalizer

                                                                                                     $50,000. The tax base is $50 million. If vot-
     $ 38,500 $ 33,000              $ 76,598    $ 71,098           Equalized Assessed Value (EAV)
      – $5,500        –0             – $5,500         –0           (Exemption)

                                                                                                     ers in the jurisdiction have authorized
     $ 33,000 $ 33,000              $ 71,098    $ 71,098           Adjusted Equalized Value (AEAV)
     ×      .10 ×                   ×           ×
                                                                                                     property tax extensions of $10 million,
                      .10                  .10        .10          Sample Tax Rate

                                                                                                     then the tax rate is .20, and each home-
     $ 3,300 $ 3,300                $ 7,110     $ 7,110            Estimated Tax Bill in Dollars

                                                                                                     owner pays $10,000 in property tax. Now

Figure 6
  Appreciate Rates for Residential Properties in Chicago, 1995-2005


                                                                                                                          1.1     calculations
                                                                                                                                  show that a
                                                                                                                                  loss of non-
                                                                                                                                  property in a
                                                                                                                                  jurisdiction can
                                                                                                                                  lead to
                                                                                                                                  increases in
                                                                                                                                  property tax
                                                                                                                                  bills even if all
                                                                                                                                  constant over

  Source: Author’s calculations using data obtained from the Illinois Department of Revenue

suppose that the market value of half of                                        10 percent. Though this result may lead to
these properties falls by 10 percent, while                                     some complaining, it is a mathematical
the others are fortunate enough to remain                                       necessity if tax extensions are not included.
unchanged. For simplicity, ignore the effect
of exemptions, and assume that the                                              Although we do not yet have sufficient
adjusted EAV declines by 10 percent to                                          data to observe variations within jurisdic-
$45,000. The tax base is now 500 × $45,000                                      tions in the decline in property values
+ 500 × $50,000 = $47.5 million, and the tax                                    since 2007, it is clear that appreciation rates
rate must rise to .2105 to raise the required                                   varied markedly during the boom time
revenue. The tax bill for the properties that                                   preceding the decline. Figure 6 shows
have declined in value falls to $9,474, but                                     average appreciation rates for residential
the tax bill for the houses that have not                                       properties for census tracts in the City of
changed in value rises to $10,526. Thus,                                        Chicago for 1995-2005. During this time,
half the homeowners in the jurisdiction get                                     sales prices increased markedly through-
higher tax bills even though their property                                     out Chicago. Appreciation rates were
value has not increased. The other half gets                                    much higher in areas near the city center
only a 5.26 percent decline in their tax bills                                  on the north side of the city. Property val-
even though their property values fell by                                       ues grew at much lower rates on the south                       7
The Illinois Report 2011

                              side of the city. If tax extensions remained     Merriman study captures the essence of
                              constant during time and there were no           the rate setting process. The maximum tax
                              change in the number of properties or the        rate imposed by PTELL can be written as
                              mix of residential and non-residential           follows:
                              properties and assessments accurately               Maximum tax rate = {(prior extensions)
                              reflect changes in market value, then tax           × (1 + inflation factor)}/(new total tax
                              payments would increase in the areas of             base), or
                              the city that are in red relative to the areas
                              shaded in blue. If the red areas also experi-
                              enced greater declines in property values
                                                                                  tptell = ( last year) * (1+p)
     Dye, Richard F.,

                              after prices began to decline in 2007, then
     Daniel P. McMillen,                                                                       Bthis year
     and David F.

                              these areas will eventually come to be the          where, as before, T represents total tax
     Merriman, “The

                              beneficiaries of lower tax payments while           extensions, B represents the total assess-
     Effect of Declining

                              the blue areas may make higher tax pay-             ment base, and t represents the tax rate.
     House Prices on
     School Property

                              ments even as their homes drop in value.            The new variable is p, which represents
     Taxes and School

                                                                                  the inflation factor—the less of the rate
     Aid in Illinois,”

                                                                                  of inflation or 5 percent.
     University of Illinois
     Institute of
     Government and
                              The Illinois Property Tax Extension

                                                                               In times when assessments are rising,
     Public Affairs           Limitation Law (PTELL)

                              PTELL was first adopted in 1991 by the           PTELL is implemented by imposing a

                              five collar counties of suburban Chicago. It     limit on the tax rate. An example based on
                              was extended to Cook County in 1994, and         one presented in the Dye, McMillen, and
                              has since been adopted by another 33             Merriman study illustrates how PTELL
                              counties in the state. PTELL limits the          affects total tax extensions for a
                              growth rate in total property tax to the         representative school district in a time
                              lesser of the rate of inflation and 5 percent.   when assessments are falling. The
                              The limits are implemented by imposing a         representative district starts with total
                              maximum tax rate for jurisdictions in            EAV (B) of $100 million and a tax rate (t)
                              PTELL areas. Because declining assess-           of 2.5 percent, a combination that provides
                              ments must be accompanied by higher tax          $2.5 million in total tax extensions (T).
                              rates to keep extensions at their target lev-    Suppose that assessments fall by 10
                              els and PTELL imposes maximum tax rates          percent so that the new tax base is $90
                              on jurisdictions, do falling house prices        million instead of $100 million. Also,
                              necessarily lead to lower property tax           suppose that the overall inflation rate is
                              extensions in PTELL jurisdictions?               zero, and the district therefore decides to
                                                                               leave tax extensions unchanged from the
                              This question is addressed in a recent study     previous period. The tax rate then must
                              by Dye, McMillen, and Merriman.11 The            rise by exactly the amount that assures
                              answer to the question is no; although           that the $90 million tax base produces $2.5
                              PTELL imposes limits on increases in prop-       million in taxes. Thus, the new tax rate in
                              erty tax extensions, the interaction between     this non-PTELL district is simply 2.5/90 =
                              falling assessments and the maximum tax          2.78 percent, or an increase of 0.28
                              rate imposes no additional constraints on        percentage points.
                              tax extensions. The reason for this some-
                              what counter-intuitive result is that the        Suppose that an identical district that is
                              maximum tax rate is not set by law;              subject to PTELL also began with a $100
                              instead, it varies to allow extensions to        million tax base, a tax rate of 2.5 percent,
                              reach the same level that would have been        and total tax extensions of $2.5 million. If
                              reached if assessments had not changed.          the district’s maximum rate remained at
                              An example from the Dye, McMillen, and           2.5 percent, then tax revenue would fall to

Institute of Government & Public Affairs

.025 × 90 = $2.25 million. But the
maximum tax rate adjusts to allow the
district’s expenditures to keep up with the
less of 5 percent or the inflation rate,
which in this case is simply zero. So the
new maximum tax rate is 2.5/90 = 2.78
percent, which is exactly the same as in
the otherwise identical non-PTELL district.

The general point is quite simple: property

tax rates are not constant over time in
Illinois. Rather, the tax rate changes to
                                                                                               values do not
keep ensure that the tax base provides the
amount of revenue agreed upon by voters.
                                                      Daniel P. McMillen has a joint
                                                                                               impose fiscal
Though PTELL places limits on total
                                                      appointment in the Department
                                                                                               stress on state
increases in tax extensions, it places no
                                                      of Economics and the Institute of
                                                      Government and Public Affairs. He        and local
limits on how much tax rates can change
                                                      also is a visiting fellow at the
in response to changing assessments.
                                                      Lincoln Institute of Land Policy
                                                      and a consultant at the Federal          In the short
                                                      Reserve Bank of Chicago. He              run, assess-
                                                      served as the Director of the
                                                      Center for Urban Real Estate at the
                                                                                               ments do not

Falling property values do not
                                                      University of Illinois at Chicago        change and
automatically impose fiscal stress on state
                                                      from 1999-2005, and has been a           tax rates stay
and local governments. In the short run,
                                                      member of the economics
                                                                                               the same
assessments do not change and tax rates
                                                      departments at the University of
                                                      Oregon, Santa Clara University,          unless tax
stay the same unless tax extensions
                                                      Tulane University, and the               extensions
change. Although assessments eventually
                                                      University of Illinois at Chicago.
will fall to reflect changing market
                                                      McMillen received his Ph.D. in

conditions, homeowners’ tax payments
                                                      Economics from Northwestern

may stay the same as before. In Illinois, as
                                                      University in 1987. His
                                                      publications have appeared in

in most of the country, tax extensions do
                                                      such academic journals as the

not adjust passively to changes in
                                                      Journal of Urban Economics,

assessments: increases in assessments do
                                                      Regional Science and Urban

not automatically produce increases in
                                                      Economics, the Review of
                                                      Economics and Statistics, Real

property taxes, and declines in
                                                      Estate Economics, and the Journal

assessments do not automatically produce
                                                      of Business and Economic Statistics.

decreases in property taxes. Instead, it is
                                                      He has been co-editor of Regional

tax rates that adjust to changing
                                                      Science and Urban Economics since


The distribution of assessment changes
can have a significant effect on a             most fundamental effect of declining
homeowner’s tax bill, however. Areas           house prices on property taxes is much
with smaller declines in assessments may       less direct: if voters turn down tax
end up having higher tax bills even            requests when property values fall, then
though their homes have decreased in           taxes will eventually fall. In the end, it is
value. Declines in the non-residential tax     voters who determine the overall size of
base can lead to large increases in            property tax extensions, not house prices.
residential tax bills irrespective of the
direction of change in home prices. But the                                                                 
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