Retooling Property Taxes: How Re-Engineering the Property Tax Can Be Successful
How did some local governments generate adequate revenue during a failing economy, reduce property taxes for most homeowners, entice new private development without subsides, retard sprawl, and keep housing affordable? Certainly a timely question. During this prolonged recession, shrinking funds are forcing localities to cut back on services when they are most needed by people suffering from loss of homes and jobs.
Several dozen cities dug themselves out of a hole by re-engineering their property tax. They reduced taxes on homes and other buildings and raised taxes on land. Pennsylvania's capital city demonstrates the potency of this medicine.
In 1980, Harrisburg, Pennsylvania, was cited by HUD as one of the nation's most distressed cities. It had lost 800 businesses and a third of its population in 20 years. Mayor Stephen Reed initiated the two-rate tax in that era, reducing the tax rate on buildings to one-half the rate on land.
Reed, who continued as mayor until January 2010, credits the reform with playing a major part in reversing the city's downward slide. Most of the 5,200 stores and housing units that were boarded-up when he took office are replaced or back in use. Since then, new construction and rehabilitation of existing structures increased the city's taxable real estate from $212 million to over $1.6 billion. Businesses on the tax rolls rose from 1,908 to more than 9,100 by the start of 2009. Seeing these positive effects, Harrisburg reduced its tax rate on improvements to one-sixth the rate on land.
Tax hikes on idle sites induced owners to put them to use, discouraging sprawl. Reed said, "Unused urban land is what pushes development into open spaces. Many states try to save farmland by buying development rights. That's expensive. Without spending a dime, we achieved the same goal with our two-tier tax."
Upside-Down Property Tax. The conventional property tax combines two distinct taxes, one on land and one on improvements. Taxpayers dislike the tax on buildingsâ€”for good reason. The more they invest, the higher their tax. In contrast, owners who let structures deteriorate are rewarded with lower taxes. Taxing good buildings heavily and poor buildings lightly is like giving blight and slums an engraved invitation to invade a city.
That's only the half of it. The good part of the tax, on land values, generally is too low, especially on vacant sites. Assessors look at the non-existent income streams of bare lots and mistakenly assign low values to them, ignoring their potential. This promotes land speculation, a prime cause of runaway housing prices, sprawl, and recessions.
How so? Speculators hold prime sites vacant, waiting for population growth and local government services to make these sites more valuable. Plots kept in cold storage create an artificial shortage of developable sites. This drives urban land prices up, drives growth to the outskirts, and fuels more speculation until a boom, based largely on thin air, goes bust.
Virtues of Taxing Land. Taxing land more and buildings less takes the profit out of speculation, putting land users rather than land holders in the driver's seat. Unlike taxes on most anything else, taxes on site values reduce land prices. Good things flow from this remarkable fact, as these examples show.
Aliquippa, Pennsylvania, not only lost jobs when LTV's steel mill closed 20 years ago, a court order reduced LTV's property tax from $1 million to $200,000. The city reduced tax rates on buildings, making the tax rate on land 16 times higher than on improvements. This enabled Aliquippa to collect $450,000 from LTV's valuable site, and it nudged LTV to promptly find new occupants for its plant. Within a few years, the city treasury had a surplus. City Administrator Thomas Stoner says the two-rate tax "favors residences and puts more weight on industrial properties." This Rust Belt city still struggles economically but its housing costs remain affordable.
Peoria, Illinois, adopted tax reform under an enterprise zone law to revive a seven-mile strip of obsolete factories and blighted warehouses. This area along the Illinois River employed 2,000 people in 1980, down from 50,000 in its heyday. Taxes on new or renovated buildings were reduced 75 percent for five years, 50 percent for the next five. Reductions did not apply to land values. The city offered no subsidies to entice new firms. Building activity mushroomed, land values rose, and so did tax revenues. The dollar value of industrial and commercial building permits quickly rose from 8 percent to 29 percent of the citywide total. Tax incentives favoring instead of discouraging growth worked their magic.
Southfield, Michigan, attracted impressive growth after Mayor James Clarkson and assessor Ted Gwartney in the 1960s corrected the city's under-assessment of land. Land was assessed too low at 10 percent of value and buildings too high at more than 70 percent of value. Assessing both at market value touched off dramatic expansion. Average homeowners won a 22 percent tax reduction. Detroit, literally across the street, failed to follow Southfield's lead and was in decline long before the fall of its auto industry. Note that Southfield did not adopt a land tax. Its turnaround came from simply obeying the law of the conventional property tax and assessing both land and improvements at current value.