Lincoln Institute of Land Policy

Report Part Title: Literature Review and Theoretical Framework

Report Title: Assessment of Property Tax Reductions on Tax Delinquency, Tax Foreclosure,
and Home Ownership
Report Author(s): Fernanda Alfaro, Dusan Paredes and Mark Skidmore
Published by: Lincoln Institute of Land Policy (2021)
Stable URL: https://www.jstor.org/stable/resrep43187.4

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assessed values, and other parcel characteristics for years 2011 through 2019. During this period,
there were significant changes in property assessment that lowered assessed values and tax
burdens for many residential properties.

For residential parcels, we have two potential routes by which a split-rate tax is expected to
reduce tax delinquency/foreclosure and influence homeownership decisions. First, there will be a
reduction in tax burden as shown by Allen (2019), which improves perceptions of fairness and
makes taxes more affordable for property owners. This first route is anticipated to reduce tax
delinquency and/or tax foreclosure. Second, anticipated increases in property values resulting
from the tax regime change (Yang 2018) increase the costs of failing to make tax payments
(property forfeiture). If home values rise as a result of lower taxes, property owners have a
stronger incentive to pay taxes. We examine these impacts in a dynamic framework to determine
the length of time for new equilibrium conditions to emerge.

The impact of a significant and permanent tax reduction on the rate of homeownership depends
in part on the relative responsiveness of potential buyers of rental properties versus potential
buyers of property to be used as principle residences. It may also depend on incumbent property
owners’ decisions to maintain tenure as the tax environment changes. As discussed in the
literature review, we consider the relative benefit of a tax reduction for homeowners and rental
properties in the context of the mortgage interest and property tax deduction on the income tax.
Because of the complex tax advantages for homeowner-occupied property, we are not able to
predict whether a tax reduction will increase or reduce homeownership in Detroit. We rely on the
empirical analysis for insight.

This technical report is one of three commissioned studies, all of which offer an assessment of
how the split-rate tax might affect different aspects of Detroit’s economy. In the next section, we
offer a brief review of the most relevant literature that includes a discussion of the research on
land taxation as well as research on Detroit’s property tax environment. This review is not meant
to be comprehensive because other relevant research is discussed in more detail in other parts of
the broader project that includes this report. We also offer a discussion of Detroit’s real estate
market as well as property tax policies and challenges. The literature review provides conceptual
frameworks that serve as a basis for the empirical evaluation. This review is followed by the
empirical analyses, which include simulations of the anticipated magnitudes of the effects on tax
delinquency, tax foreclosure, and homeownership. The report concludes with a summary
discussion and implications of the findings.

Literature Review and Theoretical Framework

This discussion begins with a brief overview of the research on the potential benefits of land
taxation relative to the traditional property tax. From this body of research, we draw inferences
regarding the anticipated effects of implementing a split-rate tax in Detroit. We then discuss
recent research on Detroit’s property tax environment, focusing on tax delinquency and
assessment practices. The discussion of the Detroit property tax environment is followed by a
review of several articles on the relationship between property taxation and homeownership. We
begin with a discussion of the research on land taxation.

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Land Taxation

Many economists favor a land tax or split-rate tax wherein land is taxed at a higher rate than
improvements relative to a traditional property tax. The primary arguments are that land value
taxation is efficient and may increase the speed and intensity of capital development (Anderson
1999; Banzhaf 2010). Eliminating or reducing the tax on structures may encourage development
by eliminating or reducing the property tax penalty associated with improving property. A land
tax also tends to increase the cost of holding land in an undeveloped state, thereby moving the
optimal time of development forward (Shoup 1970; Zax and Skidmore 1994). 1 Yang (2018)
conducted an empirical examination of the impacts of increasing the tax rate on land and
lowering the tax rate on improvements using municipal-level panel data from Pennsylvania. Her
findings suggest that land values tend to rise following the implementation of the split-rate tax. 2
These ideas have served to motivate the inquiry about how the implementation of a split-rate tax
would affect economic activity in Detroit. As outlined in the introduction, we examine how the
adoption of a split-rate tax would affect tax delinquency, tax foreclosure, and homeownership.
We now turn our attention to recent research on the Detroit property tax environment, beginning
with a review of Michigan property tax policy.

Michigan and Detroit Property Tax Environment

Prior to 1994, Michigan public schools were financed primarily through local property taxes.
The substantial variation among school districts in the tax base due to differences in property
values resulted in large differences in expenditure per student. In addition, the property tax
burden was well above the national average.3 These features prompted voters and policymakers
to implement a series of reform measures (Feldman et al. 2003).

In 1994, Michigan voters adopted Proposal A, which shifted a significant share of school
financing to state sales and property taxes. First, the reform resulted in the imposition of the
taxable value cap, which restricted the growth at the parcel-level in property value for tax
purposes to the rate of inflation or 5 percent, whichever is lower. 4 Up to the 2008–2009 real
estate crisis, the taxable value cap resulted in significant differentials between longtime and new
property owners (Skidmore et al. 2010), but those differentials diminished when property values
slumped in the wake of the real estate crisis. Proposal A has also had substantial post-recession
effects on local government revenue capacity: when assessed values fall substantially, the
taxable value cap dampens revenue recovery in a rising-value market. Second, Proposal A
implemented the “homestead exemption,” a limitation on the statutory millage rate that could be
used for public school operating expenses, but the exemption only applied to owner-occupied

1
Shoup (1970) and Zax and Skidmore (1994) do not consider the land tax specifically, but rather the development
implications of increasing the cost of holding land in an undeveloped state.
2
Also, see Yang (2018) for a comprehensive review of the literature on land taxation and the split-rate tax.
3
Data from the U.S. Census Bureau for state and local government finances are available online at
https://www.census.gov/programs-surveys/gov-finances.html. Before Proposal A, property taxes accounted for
about 41 percent of state and local tax revenues in Michigan, which was above the national average of about 30
percent. After Proposal A, property taxes as a percentage of Michigan revenues were close to the national average.
4
Prior to Proposal A, aggregate local property tax revenues were limited by the Headlee Amendment (1978). The
Headlee Amendment was an earlier attempt at property tax reform. See Skidmore et al. (2010) for further
discussion.

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principal residences. For most school districts including Detroit, this resulted in a full exemption
of the millage used for school operating expenses. This change reduced the average statutory
millage rates by about one-third for owner-occupied (or homestead) properties. 5 However, there
was significant variation in homestead millage rate reductions across jurisdictions; in 2019,
owner-occupied properties in the City of Detroit received a 17.83-mill reduction in their statutory
rate relative to non-homestead properties due to the homestead exemption. 6 Finally, Proposal A
added a 6-mill “state education tax” which was imposed by state government, and increased
sales and cigarette taxes to support the financing of elementary and secondary public education.

Given the imposition of the taxable value growth cap, it is useful to make a distinction between
the statutory property tax rate and the effective tax rate. The statutory tax rate is the millage rate
applied to the tax base, or a locality’s aggregate taxable value. Detroit property owners pay
statutory millage rates that are much higher than the statewide average; in 2019, the millage rate
for owner-occupied properties was 68.7 mills per $1,000 of taxable value (TV). 7 These millage
rates are consistent with several other Wayne County jurisdictions—such as Inkster and
Highland Park—but higher than average for the Detroit metropolitan area and other Michigan
metropolitan areas. Note that state equalized value (SEV) is supposed to reflect 50 percent of
market value (MV).8 During periods of property value growth greater than the rate of inflation, a
gap emerges between a property’s TV (which grows at the rate of inflation or 5 percent,
whichever is lower) and SEV (which can grow at a rate faster than inflation). However,
whenever a property is sold, TV is reset to reflect market value so that TV and SEV are equal.
The taxable value cap is therefore a major source of inequality in tax burden across otherwise
similar properties.

In the years after the real estate crisis, 2010–2014, major differences emerged between SEV and
market value; market value had collapsed but SEV had not declined enough to reflect changing
market conditions (Hodge et al. 2016). A decision to implement a citywide reassessment was
prompted by the precipitous drop in market values. This resulted in a full reassessment of the
city’s property to bring SEV back in line with market values over the 2014–2016 period. We
exploit this reassessment to determine the degree to which reductions in effective tax rates
generate behavioral responses to tax compliance and homeownership decisions.

Due to the imposition of Proposal A and challenges in accurately assessing property after the
financial crisis, the effective tax rate is a more meaningful measure of tax burden than the
statutory tax rate. We define the Effective Tax Rate for residential property i using the following
equation:

= [( )/( )] = f[ , , , , ,A ] (2)

5
The homestead exemption effectively equalized the statutory property tax millage rates for local school operating
expenses on owner-occupied properties across the state. This reduced disparities in overall statutory millage rates
across jurisdictions, but it did not eliminate them.
6
From this point forward, we refer to “homestead” property as owner-occupied property.
7
One mill is defined as $1 per $1,000 of taxable value (TV).
8
The Michigan Assessor’s Manual provides a precise definition for the “true cash value” of property, which is
reasonably consistent with the conceptual “market value” of property. We use the term “market value” to refer to
both concepts.

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Equation (2) shows that the Effective Tax Rate for property i is determined by the tax payment
(TPi) and the market value (MV) per $1,000, where TP is equal to the millage rate multiplied by
TV. Note that when assessments are accurate, SEV is equal to 0.5*MV. 9 Whenever a property is
sold or transferred, TV is reset to equal SEV, and thus the effective tax rate equals the statutory
rate provided SEV reflects market value. Over time, however, effective tax rates for owner-
occupied properties generally become lower than the statutory rate and differ considerably across
these properties, depending on the degree to which the property is protected by the taxable value
cap. Generally, the effective tax rate depends on the length of time an individual has owned the
property (Ti), the rate of inflation multiplier (r), the appreciation (or depreciation) of property
value (Vi), 10 the characteristics of the property (Ci),11 the location of the property (Li),12 and the
accuracy of the assessment (Ai).13 The less a property owner benefits from the taxable value
growth cap, the closer the effective rate will be to the full statutory rate. Of relevance to the
present study, the closer the SEV is to 0.5*MV, the closer the effective rate will be to the
statutory rate.

As documented by Hodge et al. (2016), in the wake of the financial crisis SEV’s did not initially
fall with market value; the result was that effective tax rates for most residential properties
increased dramatically. However, for many parcels the reassessment brought both SEV and TV
down and more in line with market values, resulting in significant declines in effective tax rates.
We rely on the reassessment and corresponding declines in effective tax rates to examine how
tax delinquency/foreclosure and homeownership responded to the change.

Several studies provide the basis for our empirical analysis. The following three studies provide
useful strategies to evaluate the determinants of tax delinquency and tax foreclosure in Detroit.
Alm et al. (2014) examine the determinants of Detroit tax delinquency in a single year cross
section of parcels, finding that higher property tax burdens and overassessment increase tax
delinquency. Though this study is very useful, the cross-sectional analysis does not allow for a
dynamic evaluation. Alfaro et al. (2020) use parcel-level panel data for years 2011–2016 to
examine how tax delinquency changed for owners of property following the announcement of
Detroit’s new QLine, a local streetcar system. Importantly, the examination includes an
evaluation of how tax delinquency changes over time—a dynamic impact analysis. Specifically,
they find a reduction in tax delinquency among owners of property near the new line following
the project announcement; the impact was fully realized within three years. Hodge (2019) also
used parcel-level data from Detroit for years 2013 through 2016 to show that reductions in
assessed values and associated tax burdens reduced residential tax delinquency, especially
among owners of rental property. However, the limited timeframe in his evaluation did not allow

9
According to Michigan assessment guidelines, state equalized value (SEV) should reflect 50 percent of market
value.
10
During periods of housing price growth, the taxable value cap results in declining effective tax rates for longtime
property owners when property values and thus SEV are rising faster than the rate of inflation.
11
Characteristics such as age of the house, lot size, house size, homestead, etc. are important determinants of the
sale price, which are related to SEV and TV.
12
Location is also important because (1) SEVs are adjusted by a neighborhood-level Economic Condition Factor;
and (2) market values are always partially interpolated from nearby transactions.
13
Location may influence changes in SEV over time since properties in desirable locations may experience larger
growth (or smaller declines) in market values relative to properties in less desirable neighborhoods.

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for an examination of dynamic impacts. Taken together, the three studies provide a foundation
for modelling how reductions in tax burden might decrease tax delinquency and tax foreclosure
in a dynamic context.

Homeownership

Much of the research on the impacts of taxation on homeownership centers on favorable tax
treatment of homeownership in the United States income tax code (Poterba and Sinai 2008).
While there is much debate about the usefulness of deductions for property taxes and mortgage
interest payments on federal and state income taxes, these deductions offer tax savings for
homeownership over renting, more so for middle and high-income households. Rosen and Rosen
(1980) present evidence from a time-series analysis indicating that such favorable treatment
encouraged homeownership over renting. However, Bourassa and Yin (2008) focused on young
households, concluding that favorable tax treatment raises housing values so much that it reduces
the homeownership rate among younger households who are on the margin between owning and
renting. Similarly, Hanson (2012) finds that the mortgage interest deduction did not encourage
homeownership. While one may be able to draw some inferences from this work on the potential
impacts of a reduction in property tax burdens resulting from the imposition of a split-rate tax,
these studies are somewhat ancillary to the question of how reduced property tax burdens would
affect homeownership across Detroit.

Of more direct relevance is the work of Ihlanfeldt and Bohm (1983), who examine the
relationship between property taxation and the demand for homeownership. In their framework,
due to the property tax deduction on income taxes, a reduction in the property tax rate increases
the price of homeownership relative to renting, and thus homeownership is discouraged relative
to renting. However, there is an opposing effect in that the overall price of housing declines
relative to the cost of non-housing goods; thus, homeownership is encouraged. Their empirical
evaluation suggests that the opposing effect dominates, such that a property tax rate reduction
increases the probability of homeownership.

In the context of Detroit, prices are so low that mortgages are unavailable for many residential
properties and thus any impacts associated with favorable income tax treatment are inapplicable
for many potential homeowners. Just 21 percent of residential sales in 2017 had mortgages in
Detroit (Runyon and Mondry 2020). According to the Urban Institute, as few as 7 percent of all
residents have a mortgage in Detroit (Ratcliffe and Kalish 2016). In addition, many Detroiters
fall into lower income categories where it is not advantageous to include itemized deductions on
their income tax returns. Thus, the associated negative homeownership effect described by
Ihlanfeldt and Bohm (1983) is not likely to be dominant in Detroit. Also, potential rental
property owners may be more responsive to tax reductions because they have greater access to
financial resources than do typical potential Detroit homeowners. Thus, they are better
positioned to purchase property than potential buyers of a principle residence. In addition, due to
the principal residence exemption, rental property owners will receive relatively larger tax
reductions from the reassessment than homeowners. Given these offsetting considerations, a
priori we are not able to predict whether the introduction of a split-rate tax and associated
reductions in residential property taxes will increase or reduce homeownership in Detroit. We
rely on the empirical analysis to offer insight.

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