Land Supply, House Price Capitalization, and Local Spending on Schools

Many researchers have noted that house prices reflect the capitalized value of local public services and amenities on house prices, but few empirical papers link the extent of house price capitalization to local spending decisions. In this paper we show that the causality indeed runs in both directions; in particular, local spending is higher in places with a greater degree of capitalization. To begin we make a simple observation; the degree to which house prices capitalize local amenities can vary substantially depending on the supply of land for new housing. In response to demand shocks, locations with more available land will have a larger adjustment in quantity, but a smaller adjustment in price and vice versa. We examine these predictions using a unique data set for Massachusetts that includes a measure of available land that varies by community and takes advantage of a property tax limit (Proposition 2½) that provides instruments for local changes in spending. Indeed, we find that fiscal variables and amenities are capitalized to a much greater extent in cities and towns with little available land, and confirm that these locations have a lower elasticity of land supply. We then show that localities with little available land spend more on schools, even after controlling for other factors that might affect demand for education. These results provide an alternative explanation for why suburban locations with little available land have relatively high spending on local schools.