According to a new paper from Byron Lutz, Raven Molloy, and Hui Shan from the Federal Reserve, the answer is “not as much as you might think”. They identify five channels through which low house prices can affect state and local government tax revenues:

1) property taxes

2) home sales transfer taxes

3) sales taxes via spending on construction materials

4) sales taxes via impact on consumption of lower housing wealth

5) personal income tax

Compared to the 1995-2002 trend, state tax revenues in 2009 were $31 billion below where they otherwise would be, which is 5% of total revenues. Looking at the short-run trend, the total 2005-2009 shortfall is only $15 billion.

Partly driving this result is that property taxes are based on assessments which are lagged, so that falling prices do not show up immediately. As a result, in 2008 and 2009 property taxes rose 5%. This can be seen clearly in the figure below.

This is helpful for local governments, because it means their tax base does not dry up during a recession. However, it does create something of a anti-Keynesian policy where property taxes continue to rise as prices plummet. A 5% increase in assessed value on top of a 15% decline in house prices means an $85,000 house is being taxes as a $105,000 house.