The widespread reduction in property tax yields created by the real estate bust is grim news for local governments because this tax remains their major revenue source. It is our contention that reforming the property tax can set communities on a path that generates jobs, reduces sprawl, expands affordable housing, and attacks a root cause of boom-and-bust cycles.
Traditional property tax incentives are upside-down. They impose higher taxes on owners who construct or improve homes and commercial structures. They reduce taxes for owners whose buildings deteriorate. Owners of boarded-up buildings and vacant lots typically pay lower taxes than owners of well-maintained properties.
The tax penalty on buildings is easily underestimated. Property tax rates, typically set at 1 or 2 percent of value, seem modest. Unlike a one-time sales tax, however, the tax is levied year after year. Over the life of a building, the building tax can be equivalent to a whopping 10 to 20 percent sales tax.1 This cost barrier explains why many developers launch major projects only after first obtaining property tax abatements.
A number of Pennsylvania localities whose tax revenues declined as industries died, turned the perverse property tax incentives right-side-up. They put their treasuries back in the black, spurred economic activity, and revived their downtowns by adopting a two-rate tax, reducing tax rates on buildings and raising them on land values. This stimulated construction and rehab of homes and office buildings. 2
If taxing buildings makes buildings more expensive, don’t higher land taxes make land more expensive? The answer is “No.” Land taxes actually cause land prices to fall.3
To avoid high taxes on construction and to exploit relatively low taxes on land values, many owners take sites off the market, waiting for population growth, improved public infrastructure, or development subsidies to enhance the value of their land. This causes a scarcity of available development sites, pushing land prices up further. Expectations of gains from real estate speculation become a self-fulfilling prophecy—at least initially.
As more people pursue profits from land price appreciation rather than from productive enterprises, potential developers and home buyers get priced out of the market and the bubble collapses. Land speculation fuels the real estate boom-and-bust cycles that bring the economy and local governments to their knees.4
Higher land taxes discourage land speculation by making it less profitable. Prior to the Great Depression, there was a nationwide real estate boom and bust. Not surprisingly, land values in major U.S. cities declined drastically. Between 1930 and 1940, land values declined in New York, 21 percent; Milwaukee, 25 percent; Cincinnati, 26 percent; New Orleans, 27 percent; Cleveland, 46 percent; Los Angeles, 50 percent, and Detroit, 58 percent.
But Pittsburgh adopted a two-rate property tax in 1914. As evidence that this reform reduces speculation, Pittsburgh’s decline in total land values was only 11 precent between 1930 and 1940.5
The potency of the two-rate tax was also seen in Pennsylvania’s Monongahela Valley where adjacent Duquesne, Clairton, and McKeesport suffered from the steel recession of the 1970s and 1980s. New construction came to a standstill as plants closed and unemployment rose. McKeesport responded by adopting a two-rate tax. Building permits immediately began to increase. Would this have happened without the reform? Unlikely. Construction continued to decline in Clairton and Duquesne.6
High urban land costs after World War II began driving most new growth out of central cities to cheaper suburban sites. Yet Pittsburgh experienced downtown revitalization with dramatic new corporate headquarters along with a large increase in home and business structures throughout the city. After taxing land at six times the rate on buildings in the late 1970s, the increase in downtown development outpaced its suburbs.7
Pennsylvania’s capital city used this technique to regenerate its downtown after flooding from Hurricane Agnes in the 1970s left thousands of vacant properties. Harrisburg saw redevelopment of almost all idle central city lots over a 15-year period.8
Growth in the urban core instead of in surrounding farmland is what smart growth proponents urge but seldom achieve.9 Higher land taxes will create a strong economic impetus to develop high-value sites.
Such sites tend to be near existing urban infrastructure amenities. Growth on these infill sites avoids the costly duplication of facilities when growth occurs at the urban fringe. Reducing sprawl preserves rural land for agricultural, recreational, and conservation uses.
In 1913, Pittsburgh Mayor William Magee asked the state legislature to let the city gradually reduce property tax rates on buildings while increasing rates on land values. The legislature in Act No. 147 of that year passed an enabling law for “cities of the second class”—a population designation for Pittsburgh and Scranton. Major companies like Heinz and Westinghouse supported the measure.
The city became the poster child of the two-rate tax movement for three-quarters of a century. Its vitality inspired the national urban renewal program, though federal and local policymakers neither understood nor tried to replicate Pittsburgh’s property tax modernization.
In 1951, Act No. 299 enabled most other Pennsylvania cities to use this reform. Today, 13 cities, two school districts, one borough, and Pittsburgh’s downtown improvement district employ the reform. In each jurisdiction this led to an increase in urban development and renovation, with no adverse consequences reported.
Unfortunately, the city of Pittsburgh reverted to the conventional property tax in 2000 after an overdue but botched reassessment created widely irregular land assessments, underscoring the importance of fair and accurate assessments.
Modernizing the property tax is not magic. It requires extensive public education and careful administration. Features of an equitable property tax—in both the conventional and land tax form—include the following:15
Most states have a uniformity clause in their state constitution. Depending upon how it is written and interpreted, local governments might need either permissive state legislation or a constitutional amendment (or both) to implement this reform.
Land values stem in large part from public amenities—schools, roads, parks, fire and police protection, and the rest. Taxing those values serves as a value capture instrument.10 Like a user fee, owners pay in proportion to the advantages that public amenities bring to their sites.
Consider mass transit that boosts land values around transit stops.11 These publicly-created values could fund transit construction and operations12 but typically provide windfalls to a few private landholders instead. Failure to employ value capture techniques often requires fare hikes and service cuts that reduce transit ridership, 13 exacerbating the congestion and air pollution that transit is designed to mitigate.
A two-rate tax recaptures and recycles publicly-created land values to make transit and other infrastructure financially self-supporting. It also provides an incentive for transforming vacant lots and boarded-up buildings into more affordable housing or commercial space. It allows all property owners, large or small, to make improvements without incurring a tax penalty.
Joshua Vincent of the Center for the Study of Economics calls this reform a “universal abatement.” It lets a majority of homeowners enjoy lower taxes than under the conventional system.14
Ending the tax bias against both residential and commercial buildings opens the way to jobs in construction, energy conservation, home furnishings, and related fields.
With apologies to Shakespeare: To tax or not to tax, that is not the question. How to tax, that is the question. Officials need to minimize taxes that obstruct job creation, affordable housing, and wholesome urban growth, and to choose taxes that positively support these essential purposes or at least do not hinder them. Property tax reform meets this criterion and should be a high priority.
Localities are in a revenue bind. The federal government, stymied by dwindling resources and gridlock, cannot come to the rescue. Local and state governments must find their own solutions. By shifting taxes off buildings, jurisdictions in effect will advertise to residents and the business community: fix up your house, build a store, or put up a factory without fear of tax increases!
The resulting economic stimulation will help restore the local economy and boost the tax base. Localities that pioneered this reform reveal that it works. It offers local governments a way to overcome the hurdles imposed on them by the real estate market collapse and to reduce the severity of future boom-and-bust cycles.
A net present value calculation is used to collapse this stream of payments into a one-time payment.
2 Described in Public Management (PM) article, “Retooling the Property Tax,” March 2010. http://webapps.icma.org/pm/9202/public/cover.cfm?author=walter%20rybeck&title=retooling%20property%20taxes.
3 Paul A Samuelson, Economics, McGraw-Hill, 9th Edition, 1973, p 563. Taxes on goods of variable supply are a cost of production. (Land is not produced.). Because there will be no less land in existence after the tax is imposed, there is no economic impetus for its price to increase. Adam Smith in 1776 explained: The more taxes a buyer had to pay for a plot of land, “the less he would incline to pay for the ground.” The Wealth of Nations, Random House, New York, 1937, p.976.
4 “Affordable Housing as Infrastructure in the Time of Global Warming” by James A. Kushner, in The Urban Lawyer, Vol. 42 No. 4 / Vol. 43 No. 1, Fall 2010 Winter 2011, p 207, crediting real estate speculation as a significant cause of the 2007 financial melt-down.
5 “Pittsburgh’s Pioneering in Scientific Taxation,” Percy R. Williams (Pittsburgh’s Chief Assessor, 1934–1942), fn. 59. Republished as The Pittsburgh Graded Tax Plan: Its History and Experience, Robert Schalkenbach Foundation, New York, 1963. http://savingcommunities.org/docs/williams.percy/gradedtax.html. See also: “Why Pittsburgh Real Estate Never Crashes: The tax reform that stabilized a city’s economy” Dan Sullivan at http://savingcommunities.org/places/us/pa/al/pgh/nevercrashes.html.
6 Steven Cord, Incentive Taxation, Columbia, MD., October, 1995. Clairton and Duquesne adopted this reform after observing its benefits in McKeesport.
7 Wallace Oates and Robert M. Schwab, “The Impact of Urban Land Taxation: The Pittsburgh Experience,” National Tax Journal, Vol. 50, No. 1 (March 1997), pp 1–21. Appendix, Table 5, p 11. Pittsburgh’s tax system contributed to it being one of only two rust-belt cities out of 15 to experience increased development during the period studied. The other city, Columbus, Ohio, showed more in-city growth because it had annexed its suburbs. http://econweb.umd.edu/~oates/research/The%20Impact%20of%20Urban%20Land%20Taxation.pdf.
8 Harrisburg Mayor Stephen Reed, in May 1, 2003 letter to Philadelphia Controller Jonathan Saidel noted that vacant lots had been reduced by 85% since adoption of property tax reform. http://www.urbantoolsconsult.org/upload/City%20of%20Harrisburg%202%20tier%20tax%20rate.pdf Harrisburg illustrates that property tax reform is no cure-all. The city was in deep financial trouble after its failed waste-to-energy incinerator left the treasury unable to pay off its bonded debt—a problem unrelated to the city’s successful tax reform.
9 “Indicators of Smart Growth,” Jason Sartori, Terry Moore and Gerrit Knapp, National Center for Smart Growth Research and Education, University of Maryland, January 2011. Ten years of implementing Maryland’s smart growth program produced no statistically significant increases in infill development or reductions in suburban sprawl.
10 Rick Rybeck, “Using Value Capture to Finance Infrastructure and Encourage Compact Development,” Public Works Management and Policy Journal, Vol. 8, No. 4, April 2004, pp. 249–260. See Wikipedia at http://en.wikipedia.org/wiki/Value_capture.
11 “Metrorail Impacts on Washington Area Land Values,” Banking Finance and Urban Affairs Committee, House of Representatives, Washington, D.C., January 1981. The D.C. area Metro had generated $2 to $3.5 billion worth of new land values, more than Metro’s land acquisition, construction, and operation costs up to that time. Discussed in “Transit-Induced Land Values: Development and Revenue Implications,” Economic Development Commentary, Vol. 5, No. 4, CUED, October 1981.
“Applying Value Capture in the Seattle Region,” Thomas A. Gihring Journal of Planning Practice & Research, Vol. 16, Nos. 3–4 (Winter, 2001): 307–320. The study demonstrates how a city-wide land value tax (LVT) plus a gains tax within a transit zone to tap rising site values due to a proposed light rail line can raise $118 million, exceeding the $80 million estimated construction cost of the line.
12 “Financing Transit Systems through Value Capture: An Annotated Bibliography,” Jeffery J. Smith, Thomas A. Gihring, Todd Litman, and Victoria Transport Policy Institute, 27 May 2012. http://www.vtpi.org/smith.pdf.
13 “Transportation Elasticities: How Prices and Other Factors Affect Travel Behavior,” TDM Encyclopedia, Victoria Transport Policy Institute, Updated 16 March 2011, http://www.vtpi.org/tdm/tdm11.htm#_Toc161022586.
14 “Real Property Tax Rates for Tax Year 1992,” Pro-Housing Property Tax Coalition Council of the District of Columbia, June 21, 1991. Testimony compared a) existing D.C. property tax rates with b) rates that reduced taxes on buildings and increased taxes on land values while producing identical revenue. Homeowners in all residential neighborhoods paid less under option b.
15 Improving Real Property Assessment: A Reference Manual, International Association of Assessing Officers, Chicago, 1979. W. Rybeck was a project advisor for this work.
16 David Brunori and Jennifer Carr, “Valuing Land and Improvements: State Laws and Local Government,” State Tax Notes, 25(14) (2002).