Paul L. Caron

Friday, February 3, 2023

Weekly SSRN Tax Article Review And Roundup: Layser Reviews Household Asymmetric Risk Of Foreclosure From Tax Assessment Limit

This week, Michelle Layser (San Diego) reviews Sebastien Bradley (Drexel; Google Scholar), Da Huang (Utah; Google Scholar), Nathan Seegert (Utah; Google Scholar), Household Asymmetric Risk of Foreclosure From Tax Assessment Limit (Jan. 21, 2023).

Michelle-layserDuring the pandemic, U.S. housing prices soared. In many cities, rising home prices can trigger higher assessed values for property taxation. But in California and 16 other states with assessment limits, laws limit how much appreciation cities can take into account for property tax purposes. That is good news for homeowners here in San Diego, where housing prices in March 2022 were up a whopping 29.9% from the previous year. Since California law caps the annual increase in assessed value at 2%, homeowners were protected from property tax spikes during that period.

Then came the fall. From April to September, prices in San Diego fell 5.2%, and they have continued to drop

The downward trends are tied to factors like rising mortgage interest rates and inflation, which create new financial burdens for many homeowners. And a new study by researchers at Drexel University and the University of Utah suggests that assessment limits may add to the strain if they allow assessed values to grow while market values are falling. Moreover, according to the study, new homeowners may be particularly vulnerable to property tax burdens during these periods, as they may face heightened risk of foreclosure.

The study begins by reviewing the logic behind property tax limits. By the authors’ count, all but three states have enacted laws to limit property taxation, including assessment limits, tax rate limits, and levy limits. These limits are politically popular because they protect “potentially illiquid homeowners from large increases in their property tax bills.” However, according to the authors, “these policies can also have the perverse effect of increasing homeowners’ exposure to systematic risk by allowing property tax liabilities to be higher than they would otherwise be during housing market contractions.”

The authors focus on assessment limits, which they say “decrease mortgage distress when housing prices are rising, and increase mortgage distress when housing prices are falling—precisely when households are otherwise likely subject to greater illiquidity and possible financial distress.” To demonstrate, the authors begin by explaining how assessed values may continue to rise even as market values are falling. They point to Michigan as an example. In Michigan, annual assessments are automatic but subject to a capped growth rate. Under the law, assessed values will increase as long as the assessed value remains below the current market value.

That means after “a period of sustained housing price growth in excess of the state’s capped growth rate,” assessed values may continue to rise even if market values are beginning to drop. Eventually, the assessed value and market value will converge, at which point any further declines in market value would be reflected in reduced assessed values. Still, this scenario “implies that reductions in tax liabilities are prone to occur with a lag (if at all) in states with assessment limits relative to states where taxable values rise and fall in direct proportion to market values, as in states with market value based assessments.”

To test this theory, the authors compare states with assessment limits to those with no limits, focusing on the relationship between tax liabilities and market prices during the years before, during, and after the Great Recession. Their analyses show that tax liabilities “remained relatively elevated in both groups of states . . . through the initial years of the market downturn,” but that “taxes adjusted faster and to a greater degree to declining prices in the set of states without assessment limits.”

Based on the foregoing, the authors predict that during down markets, homeowners in assessment limit states may, somewhat counterintuitively, experience greater mortgage distress than homeowners in states without assessment limits. To test this hypothesis, the authors perform a border study to compare nearby homes subject to different property tax regimes. The authors used regression models to analyze data about homes located close to borders that separate assessment-limit states from states without limits. In this way, the authors attempted to compare homes that “would face identical foreclosure probabilities on either side of the state boundary if not for differences in assessment limitation practices.”

The authors found that during downturns, “properties in assessment limitation states experience larger changes in annual property tax obligations . . . than their counterparts in adjacent no-limit states.” Next, the authors turn to the question of foreclosure. On the one hand, they find that, on average, “parcels in assessment limitation states are no more likely to experience mortgage distress” than parcels in no-limit states. However, they note that “this on-average result masks the fact that when property values are rising, the probability of entering into foreclosure is 0.183 percentage points lower in assessment limit states, while it is significantly higher when prices are falling.”

In other words, consistent with the discussion above, assessment limits may protect homeowners from foreclosure during periods of rising home prices, but they may place them at risk of foreclosure when home prices are falling. Moreover, the authors find that risk of foreclosure during downturns is highest for new homebuyers. Therefore, the authors conclude that “despite reducing property tax variance, assessment limitations increase risk for homeowners during market downturns” and that increased risk “constitutes a significant trigger for mortgage distress.”

This Article provided an interesting and nuanced account of the impact of assessment limits on homeowners. I would have been interested to know a bit more about other factors that could have affected results during the study period, such as differences in housing payment assistance across states. I also wondered how other kinds of limits (e.g., rate limits or levy limits) in the “no-limit” comparison states may affect the analysis. But overall, I thought this was an intriguing study, and I look forward to discussing it with my SALT students in a couple weeks.

I recommend this article to anyone interested in state and local taxation, property taxation, housing stability, or public finance.

Here’s the rest of this week’s roundup:

Michelle Layser, Scholarship, Tax, Tax Scholarship, Weekly SSRN Roundup, Weekly Tax Roundup | Permalink