We use a novel dataset on effective property tax rates in U.S. states and metropolitan statistical areas (MSAs) over the 2005–2014 period to analyze the relationship between property tax rates and house price volatility. We find that property tax rates have a negative impact on house price volatility. The impact is causal, with increases in property tax rates leading to a reduction in house price volatility. The results are robust to different measures of house price volatility, estimation methodologies, and additional controls for housing demand and supply. The outcomes of the analysis have important policy implications and suggest that property taxation could be used as an important tool to dampen house price volatility.

The housing market has important implications for macroeconomic stability through its impact on aggregate demand and supply (OECD, 2011). 2 On the demand side, housing wealth is an important part of the net worth of the private sector and housing-related expenses (e.g., mortgage payments, rents) represent a major part of household expenditure. Hence, changes in house prices may affect aggregate demand through various channels, including spending on residential construction and spending on nonresidential consumption (wealth effect). On the supply side, house prices have implications for labor mobility and property assets of businesses contribute to the production process. The volatile housing market can also raise systemic risks due to the high mortgage exposure of the banking sector. Developments in the housing market have been at the heart of the global crisis, prompting a debate on alternative policy responses.

The discussion so far has mainly focused on employing monetary policy tools and macro-prudential regulation to dampen house price volatility and prevent the buildup of housing bubbles. However, both have drawbacks (Crowe et al., 2013). Monetary policy is considered a too blunt instrument, as it affects the entire economy and may be too costly if the boom is limited to the housing market. Moreover, this tool is not available for members of a monetary union. Macroprudential regulation is more targeted and relatively more flexible, 3 but it may be too invasive to the operation of markets and market participants may find ways to circumvent them. A natural question arises can tax policy help? In recent years, a number of countries used tax instruments to curb excessive house price fluctuations (Lim et al., 2011; He, 2014; Darbar and Wu, 2015). There has been also increased interest in using property taxation as an efficient tool to bolster public revenues (IMF, 2013; Norregaard, 2015). While there is large literature assessing the impact of prudential macro regulation on house prices (Kuttner and Shim, 2013; Claessens, 2014; Ceruttital., 2016), evidence on the impact of property taxes is scant.