Federal Tax Policy and the Capitalization of Local Public Goods

Abstract

This study examines the connection between federal tax policies, particularly the deduction of State and Local Taxes (SALT), and the capitalization of local public goods into housing prices. In the United States, taxpayers can deduct taxes paid to local jurisdictions from their federal taxable incomes, effectively reducing the net cost of local public goods. We develop a theoretical model of local public goods capitalization that predicts a higher capitalization of public goods in jurisdictions with a greater share of residents who deduct taxes. We test this prediction using cross-sectional and temporal variations in deductions and school district spending and find empirical support that a higher share of residents deducting property taxes relates to a greater capitalization of local public spending. In particular, a one-standard deviation increase in school spending corresponds to a 3.7% decrease in house value in school districts where no resident deducts property taxes but to a 1.4% rise in values in districts where 25% % of the residents take advantage of the property tax deduction. Our results thus emphasize the importance of the interaction between local and national policies when evaluating the optimal level of local public good provisions.

Keywords: Capitalization of Public Goods, Local Public Finance, Fiscal Federalism, Fiscal Deductions, Property taxes, TCJA

JEL Classification: H71, H41, H21, R21