The housing crisis, foreclosures, and local tax revenues

Abstract

The housing crisis that began with the “Great Recession” led to a dramatic increase in home foreclosures, and these foreclosures likely had subsequent impacts on local government tax revenues. We investigate the impacts of foreclosures on local government tax revenues, using a reduced form estimation approach that relates changes in foreclosures to changes in local government tax revenues. Unlike most previous work, we focus mainly on the nationwide revenue impacts of new foreclosures, using data across all local governments in the entire United States during the worst years of the Great Recession. We also use an instrumental variable approach that controls for possible endogeneity of foreclosures and housing prices. Overall, we find evidence that the new foreclosures had a direct, negative, but small effect on total tax revenues at the local level, although there is only weak evidence that this impact can be attributed to declines in local property taxes. However, we also find that foreclosures had an indirect and negative impact on local governments via declines in state government funding. We suggest that foreclosures may have affected the real economy, thereby reducing the state government revenues dependent on real economic activity that were used to finance transfers to local governments.