The Impact of Fiscal Illusion on Housing Values: An Australian Test of the Debt Illusion Hypothesis
The debt illusion hypothesis holds that taxpayers may underestimate the present discounted value of future tax liabilities under debt finance. The empirical question arises as to whether debt illusion at the local government level can affect housing values. This proposition is evaluated by investigating whether local fiscal variables are fully capitalised into housing values by means of a pooled time-series, cross-sectional analysis of 27 metropolitan municipalities in Sydney, Australia, for the period 1989 to 1991. The results indicate that municipal debt is under-capitalised into housing values, and accordingly suggests that local government expenditure may be systematically biased upwards.
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