Association for Public Policy Analysis & Management

Managing fiscal health in cities presents an increasingly difficult challenge due to both adverse economic conditions and state imposed revenue limits. Municipalities relay heavily on property taxes to generate revenue. Yet in spite of its relative stability, state policies known as Tax Expenditure Limitations (TELs) seek to limit local revenues by restricting the assessment growth, the overall revenue growth, or setting a maximum tax rate. These limits, taken either together or separately, result in states stripping localities of their ability to raise funds.

TELs were first introduced during the reconstruction period of the United States. These tax limits were in large-part aimed at limiting large public investments in infrastructure, such as canals and railroads. The next wave of tax limitations came during the Great Depression when several states enacted assessment limitations in order to relieve property-owners who were facing property tax delinquency and risked default. Yet another surge came during what has come to be known as the “Taxpayers’ Revolts” beginning in the 1970s with California’s Prop 13. Citizens, burdened with increasing home values due to rapid inflation, sought to restrict localities’ taxing power via constitutional and statutory limits. In recent years, the burgeoning housing market and rising prices followed by the Great Recession of 2008 led to stricter limits.

Since the Taxpayers’ Revolts, 30 states have enacted limitations on local taxes. While TELs have become pervasive, limits are idiosyncratic to each state: some are constitutional, while others statutory; some apply to revenue, some to the tax base, and others to rate increases; some are introduced by legislatures, while others by voter referendum; some use population and inflation as growth targets, while others use a flat percentage increase. Nonetheless, the general goal of limits is the same—to restrain government growth and to insulate homeowners from spikes in property values.

How TELs reduce local spending is intuitive. By limiting the primary revenue source, limits effectively force local officials to cut services – often social and education services. The loss of these programs means a smaller government. Likewise, TELs seemingly accomplish their second goal. TELs protect property owners from a situation where property values would skyrocket and cause taxes property owners to be overburdening by limiting the amount of taxes localities may levy on homes or the growth in assessment. While they accomplish their two main goals, TELs may cause the unintended consequence of putting localities at risk of default during economic downturns such as the Great Recession.

Using panel data from New York’s Fiscal Stress Monitoring System, as well as a Tax and Expenditure Limitation rating index, this paper examines the impact of New York’s 2012 Property Tax Cap on local government finances. A difference-in-difference estimation is used to look at the effects of New York TELs on the fiscal health of localities during the economic decline of the Great Recession. The study demonstrates the effects of more stringent limitations on localities during times when the economy contracts rapidly.