Opposites Attract: The Effect of the Federal Income Tax Code on Community Composition

Abstract

The federal income tax code provides an incentive for developers to organize homes for different types of families as a single heterogeneous community. The property tax deduction and a progressive rate structure cause the property tax to be subsidized at a rate which increases with family income. Since owners of high-income homes pay more property tax in a heterogeneous community than in a homogeneous community, ceteris paribus the establishment of a mixed-income community shifts the property tax towards families that are subsidized at a higher rate. This raises the overall federal subsidy of the property tax causing aggregate property values to increase. Similarly, restrictions on saving in tax-deferring assets imply that young and elderly families are likely to use different interest rates to capitalize future property taxes. In this case, the capitalized value of the property tax stream is lower in a mixed-age community which also causes aggregate property values to increase. In both cases, heterogeneous communities are established provided different family types desire similar levels of public service.

JEL Classification: D7, H1, H2, H7, R1, R5