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    GSAM Connect

    THE GREAT STABILIZER: HOW MUNICIPALITIES DEPLOY PROPERTY TAXES

    August 17, 2023  |  4 Minute Read

    Michael Zinman

    Head of High Yield Municipal Bond Research

    Michael Zinman

    Making up nearly 40% of annual revenues on average, property taxes play a critical role in local government finance and tend to act as a stabilizing revenue source for municipalities during periods of fiscal stress. Property tax revenues generated in a particular fiscal year are based off valuations calculated one or two years prior to that budget cycle. This in effect, provides municipalities the luxury of weathering the fiscal storm created by near-term declines in more economically sensitive revenue streams such as income and sales taxes. In fact, it’s not uncommon for property taxes to increase during the first years of a recession while other revenues fall and then reverse the pattern during recovery (Exhibit 1). Consequently, the timing lag affords municipal management teams the flexibility to downwardly adjust expense budgets and/or potentially increase tax rates to offset upcoming tax base declines, provided the political will exists to do so.

     

     

    Exhibit 1: Property Tax Revenues Tend to Lag Economic Growth

     

    Source: U.S. Bureau of Economic Analysis (BEA), as of March 31, 2023.

     

     

    Limited Volatility During Periods of Economic Stress

    The relative stability of property tax revenues becomes more apparent when examining city-specific data. The top 10 most populous cities in the US saw their property tax levies decline, on average, just over 2 times over the 20-year period from 2003-2022. Furthermore, the severity of those declines was just -3.5% on average with only one city (Phoenix, -13.4%) experiencing double-digit average declines. As an aside, it’s worth noting that property taxes only accounted for 8% of Phoenix’s governmental activity revenues in fiscal year 2022. 

     

     

    Exhibit 2: Property Tax Data for 10 Largest Cities (by population)

     

    Source: Various City Comprehensive Annual Financial Reports (CAFR) (2002-2022). As of December 31, 2022.

     

     

    Chicago: Political Support → Revenue Increase → Financial Improvement

    Spurred in part by Moody’s downgrade to non-investment grade in 2015, Illinois’ legislature and Chicago’s City Council took various actions that culminated in a multi-year property tax hike including a ~38% property levy increase in 2016. Along with various other revenue increases, the jump in Chicago’s property taxes—roughly 85% of which went towards pension contributions last year—eventually led to a material improvement in the city’s finances and the return of its investment grade rating by Moody’s in late 2022. 

     

     

    Exhibit 3: Chicago Property Tax Related Data (2010-2020)

     

    Source: City of Chicago Comprehensive Annual Financial Reports (CAFR) (2010-2020). As of December 31, 2020.

     

     

    Office Headwinds Are More Manageable Than Advertised

    The impact that remote work arrangements has had on commercial real estate, particularly office buildings, has garnered significant headlines post-pandemic. While many office building appraisals have come under pressure as of late, we do not expect valuation declines to have a materially negative impact on property tax revenues or the fiscal health of municipalities. While property tax revenues generally make up the single largest revenue stream for local governments, municipal taxbases tend to be dominated by residential, not commercial property. Interestingly, the direct impact of office-generated property taxes tend to be relatively muted in some of the most business concentrated cities. Case in point, office buildings account for 18% and 21% of San Francisco and New York City tax bases, respectively. Given that property taxes make up roughly 28% of San Francisco’s total revenues and 25% of New York City’s, only ~5% of each city’s revenues are directly generated from office properties. In fact, the New York City Comptroller recently released a “doomsday” scenario for the Manhattan office market which concluded that a decline of -40% in the market value of office properties from pre-pandemic levels would result in a drop of just 3% of the city’s property tax levy in fiscal year 2027.

     

     

    Exhibit 4: NYC Comptroller - Property Tax Levy Scenarios

     

    Source: New York City Comptroller, "Spotlight: What Risks Does the Office Market Pose for the City's Finances?" As of June 13, 2023.

     

     

    Overall, municipal bond credit fundamentals remain strong. Between the financial flexibility that property tax revenues afford localities, manageable challenges related to office building valuation pressures and robust cash reserves bolstered by federal stimulus monies, we believe that localities remain well positioned from a credit perspective. 

     

     

     

     

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