Property
Taxes and The Frequency Of Urban Renewal
Members of this Association do not
need very long memories to recall several sessions at which the
property tax was buried, usually with more relish than eulogy, and
it was forecast that any respect shown the subject by as late as
1964 would only be necrolatry. But like Mark Twain's, the reports
of its death were greatly exaggerated; and I, unlike Marc Antony,
come not to bury the corpse, nor yet to raise it, for history has
already done that without my help, but to face up to how to live
with this Presence that refuses to lie down and die.
The property tax has grown large,
and is destined to grow larger as municipal debt expansion evolves
into debt service and retirement. The tax burden and rate have by
no means been increasing as fast as the levy because of the long
rise of real estate values, both unit values and number of buildings,
over a whole generation. Indeed, for a long time tax levies lagged
behind rising real estate values. Now, however, real tax rates have
risen, too. In Milwaukee city, for example, we are up to 3% of true
market value. And these real tax rates are destined to rise farther
because the real estate market has clearly lost its inflationary
zing in most areas. If real estate values should drop sharply—an
event not unknown to history—real estate taxes in some jurisdictions
would reach crisis levels. Indeed, it is the increasingly evident
impotence of market inflation and new building to offset building
depreciation that helps account for the high rates already reached
in many older central cities.
At 3% the property tax is consequential.
Some housing economists used to shrug it off with a de minimis non
curat lex. But a 3% property levy might take 30% of the gross income
of a new apartment building, or of the imputed income of a residence.
Top of page
To help appraise the effect of real
estate taxes on construction, let us compare the building tax with
an excise levied once, at the time of construction. To be of comparable
impact, the one-shot excise would have to equal the present value
of the stream of yearly real estate tax payments anticipated over
the life of the building. Using a standard table showing the present
value of annuities, it is no trick to see that an annual tax payment
of $1, continued for 60 years, has a present value (discounted at
5%) of about $19, [of which $12.50, or 66%, represents the first
20 years, $4.70 or 25% the second 20 years, and $1.70 or 9% the
last 20 years]. As a rough first approximation, then, a yearly real
estate tax of l%, or $1 on $100, is comparable to an excise tax
of 19% levied on new construction.
Of course, most buildings outlive
60 years, but on the other hand they are reassessed downwards well
before 60 years, so one might argue for more or less than l9% as
the proper figure, but 19% is a workable approximation. Each 1%
of real estate tax rate is equivalent to a 19% tax levied as a lump
sum payable at time of building. A 3% tax, such as Milwaukee and
many other cities now impose, equals a 57% present lump sum tax,
or let us just say about 50% as a good round figure.
That is quite a lump for a supposed
corpse to hang on a new building. We have heard a good deal recently,
from myself too, about high asking prices for land as a deterrent
to new building, but rarely does the price of land reach 50% of
the value of a new building. The present value of anticipated building
taxes must now be counted as the larger deterrent in those jurisdictions
where the rate exceeds 1.5%.
Such a level of taxation breathes
new meaning into the old saw about the power to destroy. But hereby
hangs a paradox, one which the worthy Justice foresaw when he went
on to observe that the power to tax is also the power to keep alive,
and he might have added "bring to life." The upward assessment
of undeveloped land in suburban fringes, and resulting higher taxes,
is a prime force prompting the land's development! So the property
tax is not only potent, it is potent to different effects, depending
on whether buildings or site-potentials constitute the base.
This paradox may bear the clue
of how we might recivilize this reluctant corpse with which we must
live. If the real estate tax as it continues to grow is not to scorch
the earth, it must be modified to exempt improvements. That can
be done by focusing it on the base of land value or site-capability,
which not only permits improvement but positively prompts it.
Top of page
Few people take real pleasure in
being fiscal surplus generators, that is of paying more in taxes
than they receive back in services. New buildings, vis-d-vis old
ones, under the property tax do enjoy that unenviable status. The
tax base erodes as real estate owners develop a fiscally motivated
preference for old age.
We often hear that heavy taxes
stifle enterprise, but that is an artless slogan. It is not the
mere weight of a tax that stifles enterprise. What matters is how
the tax varies when the taxpayer acts enterprising. A non-erosive
tax base must be one whose value derives from forces outside the
control of the individual taxpayer, and which the taxpayer cannot
therefore alter, with a view to tax- avoidance, by checking his
enterprise.
The welfare economists have told
us that an ideal tax base (in respect to incentives at least) would
be some sort of faculty, capacity, or potentiality on which we might
levy a tax not contingent or conditioned on the taxpayer's productive
activity or allocative decisions, but purely on the exogenously
determined capability of the base to earn income. Most of these
same welfare economists have delicately declined to descend into
the biosphere where the rest of us move and breathe and have our
being, and have contented themselves with sighing that it would
be intellectually gratifying if such a base might be conceived of.
But we cannot tax a disembodied spirit. We need some object corresponding
to the concept.
Capital will not do—it is
migratory, and destructible as well (via consumption). It requires
maintenance and replacement, and it can be replaced outside the
jurisdiction that taxes it. One of Milwaukee's major industries,
for example, is exporting capital to feed the growth of other regions
as our own buildings depreciate without adequate replacement. Our
nation as a whole has bumped into a serious balance of payments
problem as capital leaks out seeking higher returns abroad.
Labor will not do, either. It is
migratory, like capital, and its capacity to earn income is now
generally regarded, I think rightly, as itself a species of capital,
in whole or part, more than as an unearned genetic capacity that
might be appraised and taxed as a "rent."
Land, however, does nicely as a
tax base corresponding to the idealists' concept. Its value is determined
largely by forces exogenous to the owner. It is appraisable, and
is appraised, constantly, separate from buildings, for several purposes:
setting ground rents; buying real estate on the eve of demolition;
right of way acquisition; and allocation of real estate value between
depreciable and non-depreciable components for income tax accounting,
fire insurance, etc. I do not vouch for the accuracy of appraisals
often used.
The land-building allocations commonly
reported for property tax assessments are often arbitrary and meaningless;
the allocations used for income-tax purposes systematically overstate
the depreciable component; appraisals used by borrowers these days
are tending to overstate all components. But for all that, land
appraisal is an established art that was already as old as history
when William the Conqueror ordered the Domesday Books. When the
intent is to appraise accurately, we can do it.
Top of page
Land is not migratory. Some theorists
have alleged that the old distinction between "immobile"
land and "mobile" labor and capital is passé, because
land is economically "mobile" among different uses. But
redefinition of a word is a pretty weak substitute for substantive
new thought. In tax matters, the older physical concept of mobility
is the relevant one. Land is immobile among taxing jurisdictions—that
is the point. You can tax the living daylights out of it, and not
one square foot will get up and walk out of town. Milwaukee keeps
losing people to Los Angeles, and capital (and an occasional ball
game), but so far it has not lost any land, regardless of taxes.
For all the wonders of modern science, I doubt if it ever will.
A jurisdiction can gain or lose chunks of land only by moving its
boundaries, but that gets beyond our scope this morning.
It is true, of course, that increased
land taxes, if unaccompanied by increased public services or reduced
building taxes, would in a special sense "erode" their
base by capitalization. But that is neither an insoluble problem
where relevant, nor a relevant one this morning, for we are concerned
today with the effects of a given real estate tax levy, financing
given public services. We only ask how the effects might differ
if the base were redefined to exempt buildings. The building exemption
would tend to increase land values and offset the capitalization
of increased land taxes. The same collection of real estate would
bear the same tax levy—it would simply pay in a different
way.
It is a remarkable quality in a
tax base that its response to being taxed is not to flee, nor yet
to shrivel up, but to offer itself like the fabled shmoo for the
full accommodation of its human masters. Surely such a base is devoutly
to be desired, and its possible use to be seriously considered by
responsible fiscal authorities.
Top of page
Once it is accepted that land possesses
unique and desirable attributes as a tax base, there are several
alternative ways to get at it. The base might be the realized net
income from land, net of costs of improvement. That would differ
from present income taxation in deducting imputed interest on equity
investment, and wages of management. Or, if we want to exert more
fiscal leverage, the base might be the imputed net land income in
the highest and best use, or a market value capitalized from that.
I will discuss the last, since that is in form closest to the property
tax whose reform we are now considering. Those who think the property
tax exerts too much leverage may prefer later to go back and consider
the first, the realized net income of land, which has a tempering
element of fiscal profit-sharing and risk-sharing that many find
attractive. Meantime, however, I will have suggested that the excessive
leverage that is objectionable in property taxation derives from
the building tax more than the land tax.
We may also sneak up on the land
tax base by various halfway measures. Professor Richman has discussed
the Pittsburgh plan, now inaugurated in Hawaii. There are countless
more: frontage assessments, flat acreage assessments levied by various
special service districts, land taxes levied by California Irrigation
Districts, and discrimination within the latitude customarily given
assessors—although, as we know, that usually works the other
way.
There are in some states special
tax abatement laws, like the Missouri Urban Redevelopment Corporations
Law which exempts improvements in renewal areas from real estate
taxes for 10 years entirely and the following 15 years 50%. In Wisconsin
we call it a "freeze"—an allusion to our climate
no doubt. It is the assessment that is frozen, for up to 20 years
under certain quite limiting conditions. Milwaukee has two new buildings
under the law, with seven-year freezes. Going back to my interest
tables, assuming 60 year life and 5% interest, a 7 year freeze is
as good as a 30% tax cut over full life; a 20 year freeze as good
as a 66% cut. So these laws have already moved quite far towards
full building exemption. And they have produced some outstanding
buildings. Quality Hill in Kansas City; Marine Plaza and Cutler-Hammer
headquarters in Milwaukee.
Top of page
Some jurisdictions allow informal
assessment freezes without benefit of law. By their nature, such
cases are hard to document, but it is widely alleged that the assessor
of one Milwaukee industrial suburb forgets to assess new factories
for their first several years, and it is easily observed that this
informal suburb contains several unusually handsome new factory
buildings.
The land tax which I now propose
to you resembles the assessment freeze, but differs in these important
ways:
a. It would apply generally, rather
than being granted to some and denied to others by the City Council.
b. The freeze under the land-base system would be permanent, but
I hasten to qualify "permanent." The land value base remains
unmoved by any building done by the landowner himself, but the base
does move up or down as environmental forces make the site worth
more or less. Thus a man is not taxed more as he improves his property,
but as his neighbors and his city improve his opportunities by improving
their property. And if public works should divert demand away from
him, he is taxed less by way of compensation. c. With a freeze,
the assessment is based on the pre-freeze buildings. Under the land-value
system, the assessment looks entirely to the future. It is based
on the best future use of the site. Those might be the same at first,
if the old buildings were worthless, and the land was properly assessed.
But in general the assessments
would differ under the two systems. The land basis seems preferable
because a) the freeze system creates an incentive to let buildings
become blighted before applying for a freeze; b) the land basis
lets assessments change later as the neighborhood changes, and lets
the city maintain revenues without coming under pressure to terminate
the freeze and tax the building; c) the land basis lets the city
assess the increment of land re-use value, which the city creates
by the very act of untaxing new buildings.
The last might seem to negate the
whole tax benefit, and it does maintain city revenues, but it does
so without taxing new buildings. Higher taxes from land recoup the
revenues lost by exempting buildings, but do not impair the constructive
incentives thereby unchained.
Top of page
Property taxation has profound
effects on land use, most of which may be summed up in one general
principle: if the tax base is defined so that the tax depends on
the use to which land is put, then the tax biases the landowner
against the heavier taxed use. The fisc is interposing itself in
the competition of the market in favor of the lighter taxed use.
This morning we are concerned with
one application of the principle as it bears on the timing of urban
renewal. Every parcel of land is in constant press or competition
between the extant improvement and its prospective successors. Let
us call the first the "defender," and the second the "challengers."
In this contest, the fisc is not
a neutral party. The fisc, under prevailing tax policies, is interested
to have the challenger unseat the defender, because the challenger
will bear a higher assessment and pay several times as much in real
estate taxes. That consideration is of great fiscal value, so much
so that the fisc is often willing to subsidize urban renewal (although
it is a peculiar logic to subsidize people to pay their taxes!).
But, as each man kills the thing
he loves, so the fisc in its passion for new buildings tends to
smother them. For that anticipated flow of taxes, which is of positive
value to the fisc, is of an equal and opposite or negative value
to the taxpayer. He can avoid it by avoiding renewal, and defer
it by deferring renewal, and shrink it, when he does renew, by shriveling
his renewal plans. And that is what he does, with the results that
we continually deplore, but just as continually impose on ourselves
by continuing to tax new buildings.
Top of page
Let us put the point more generally
by asking "when is the economic time to renew a site?"
The answer, ably expounded by Professor Ratcliff in his Urban Land
Economics (pp. 403-05), is plausible enough: when the defender ceases
to earn a return on the value of the site in its highest prospective
alternative use. After then, the bare land outvalues the land-and-defender
combination. It is time to salvage the land by demolishing the defender.
The defender, even if still sound and usable, has become absolutely
worthless—a point that outrages the instincts of so many influential
people that economists should try to preach on it every Sunday.
We can reduce that to yet simpler
terms by expressing the challenge and defense in the form of annual
rather than capitalized values. The defense comprises the current
net revenue, Rd, yielded up by the defender. Rd is net of current
costs, but gross of historical sunk capital costs, even if embodied
in outstanding debt. That is a privilege we cannot accord the challenger,
for his capital costs are as yet unsunk and must be netted out to
compute the corresponding challenge. Thus we are biassed for the
defender, but properly so because historical costs are irrelevant
to current decisions.
The challenge may also be annualized
to a unitary value. The process is more complex, but not forbidding.
We must enter all anticipated costs and revenues over life, carefully
dated, and then reduce them to an annual equivalent, Ac, using standard
financial formulas and our friendly interest tables.
(1) Ac = iSot [Rn (l + i)i-n]/[(1
+ i)i –1]
where i = interest rate t = terminal
year of life R = revenues (and costs, where negative) n = date of
R in years from present Ac is that annuity whose regular receipt
is equivalent to the irregular outlays and receipts we actually
expect. It is the challenge, expressed as a yearly net income. It
is the ground rent expected from the best future use. It is the
opportunity cost of the land. Let us not quail from such superficial
complexity as it may present, for there is no simpler way to compute
any of those three essential economic concepts whenever outlays
and receipts are irregular and separated over time. Neither is there
any simpler way to compute site value, which is Ac capitalized (simply
by plucking i from the numerator).
Once having annualized SRn, with
equation (1) we can revert to our more comfortable accustomed level
of mathematical simplicity and declare that renewal must occur when
the defender yields us less than the challenger will:
(2) Rd < Ac
We have said nothing about taxes.
Let us separate them out for observation. Land taxes, to begin,
have no effect on the decision. They are the same before renewal
as after. They appear on both sides of the inequality (2), cancel
out, and disappear again. They are largely neutral in the renewal
decision, at least at our present level of analysis. In practice
they even tend to accelerate renewal by arousing sleeping landowners,
bypassing credit rationing, substituting a visible explicit cost
for an invisible implicit one, reducing the liquidity of slow landowners,
compelling a more rational attitude toward "heirloom"
land, and in general needling landowners to do what their self-interest
would seem to have dictated anyway.
Top of page
Building taxes are another matter.
They hardly appear on the left side of (2) because there is hardly
any building value remaining as we approach demolitions. Building
taxes on the challenger, Tc, appear in full force on the right side,
however.
(3) Rd < Ac - Tc,
Tc should properly be taken as
an annualized figure, computed like Ac, but we are not too far off
to take it simply as the initial tax level, T1. Equation (3) tells
us that the challenge, Ac, must now outweigh not only the defense,
Rd, but also the building tax, Tc, before private renewal will normally
occur. There is a fiscal deterrent reinforcing the free market deterrent
to renewal.
Of the two deterrents, the fiscal
one is in fact the larger. Let us take a not uncommon case where
a prospective new apartment building costing $300,000 challenges
two old houses priced at $30,000 for the pair. At 3%, Tc would be
$9,000. Rd, if it is 10% of the price, is $3,000. Ac must exceed
$12,000 to overcome the defense (Rd + Tc or $3,000 + $9,000). In
the absence of building taxes (Tc), $3,000 would be enough.
Thus the fiscal deterrent assumes
not just a supplemental, but the primary, role in blocking urban
renewal. It may defer private renewal not just for decades but indefinitely,
because there are reverberating neighborhood effects, from deterioration
of old buildings, which progressively rob sites of their renewability.
There are large areas in our central
cities which would be renewed forthwith in the absence of the fiscal
deterrent. My student, Paul Downing, is just completing an isovalic
cadastral contour map of Milwaukee County land values, based on
several thousand actual sales either of vacant land or of land with
old buildings on the eve of demolition. Comparing the bare land
values with the combined values of land and old buildings, it is
clear that in 10% or more of the city the bare or renewal value
of land already nearly equals the defender values. Remove the fiscal
deterrent and the challenge values would move well above the defense
values, bringing prompt private renewal.
Some wealthy Milwaukee suburbs,
notably Whitefish Bay, recognizing their fiscal and neighborhood
interest in site renewal, have quietly entered the real estate market,
bid on older houses, and actually absorbed demolition losses of
$6,000-$8,000, without Federal subsidy, in order to accelerate renewal.
They buy for about $16,000, demolish, and resell land for about
$9,000. They reckon that the present value of the augmented future
tax stream is worth to them as tax collector at least $7,000, even
though they receive only part of the increased property taxes. Recalling
that the tax collector's meat is the taxpayer's poison, that suggests
that the removal of fiscal deterrence might push the threshold of
renewal clear out into high income suburbs, [not in blanket fashion
of course, but selectively]. That is, the prospective future tax
stream has to the challenger a deterrent value of $7,000. If taxes
were unmoved by renewal, the bidding power of challengers vis-a-vis
defenders would rise by $7,000 or more (whether by a rise in the
former or a fall in the latter, or both) and renewal would occur
without any subsidy of write-down.
Top of page
Another important benefit in replacing
building taxes by land taxes has to do with credit rationing.
Land taxes differ from building
taxes, among other ways, in their time-distribution. Building taxes
are highest when a building is new, then taper off with age. Land
taxes should usually remain constant or rise over time.
The replacement of building taxes
by land taxes therefore constitutes a species of extension of credit
from the municipality to the builder—more strictly, it is
the present system of taxing buildings that constitutes a forced
loan from builders to the fisc. A new building yields a fiscal surplus
over public costs, as a rule, and often a deficit to the owner for
some initial period. Old buildings constitute fiscal deficits, by
which the owner tends in a sense to recover his earlier loan to
the fisc.
Shifting to the land tax system
would not, in general, detract from public revenues, because at
any given time there are buildings in every stage of the life cycle.
Lower taxes from newly improved sites would be compensated by higher
taxes on sites under old buildings. In older central cities, indeed,
the old buildings are the majority. Nor would the change discriminate
against the older places, for in due time they will be renewed and
enjoy the new policy of impartiality towards youth.
The uneven impact of the change
is largely among personsthose benefit most who are most in need
of credit. That is in harrnony with accepted public policy, but
it achieves the end without subsidy or public assumption of large
contingent liabilities, and without the double incubus of combined
bureaucratic and lender conservatism and routinization.
The uneven impact of the shift
may be seen by comparing the present values of the streams of future
taxes to two taxpayers under the two systems. Let us name the affluent
taxpayer, Mr. In, and the hard-pressed borrower, Mr. Out. Mr. Out
discounts future values at a higher rate per annum than Mr. In,
because his friendly local loan company does not extend him the
same terms as Mr. In, with his credit rating. An ironic benefit
of Out's position is that the present value of a stream of future
taxes appears lower to him than to In.
Top of page
The more remote the future taxes,
the greater the relative difference of their present valuation by
In and Out. Since land taxes tend to rise over time, while building
taxes tend to fall, the impact of land taxes is much heavier on
In than Out, while the impact of building taxes is only slightly
heavier. So a shift from building taxes to land taxes favors Out
to the discomfort of In.
Let us take a simplified numerical
example. Suppose land values, and therefore taxes, are expected
to rise by g% per annum indefinitely. Then the present value, PL,
of the land tax stream is:
(4) PL = a/ (i – g)
where a is the tax in year one.
Suppose building taxes fall by
d% per annum, then their present value, PB, is:
(5) PB = a/ (i+d)
Now let "In" discount
future values at 5%, and "Out" at 10%. Let g =: 1%, and
d = 5%. The table below shows the present values of the tax streams
to Out and In.
Land Tax Building Tax PL/PB PL
PB
Out a/.09 = 11a a/.15 = 6.7a 1.64
. In a/.04 = 25a a/.10 = 10a 2.50 In/Out 2.25 1.50 --
The land tax looms 2.25 times larger
to In than to Out. The building tax looms only 1.5 times larger
to In. Again, that is essentially because the land tax is deferred
farther into the remote future.
The building tax not only increases
the capital requirements of builders, but throws on them a great
deal of risk. The income tax, whatever its failings, has the virtue
of falling off when evil days betide so that the fisc shares some
risk with the builder. The building tax is not based on income but
on an initial capital outlay. It is at its maximum before there
is much income, and it continues at a level based on gross outlay,
regardless of income. It would be hard to contrive a tax calculated
to throw more risk onto the builder in proportion to the revenues
raised. It tends to make Messrs. Out poorer credit risks than they
would be under another system of taxation, and beset with added
difficulties the essential economic problem of putting capital in
the hands of enterprising people.
Top of page
Leon Hickman, writing in Urban
Land (May 1964), puts the point thus: ". . . the early and
heavy imposition of property taxes will in the long run defeat this
urban renewal concept and the hoped for improvement of the municipal
tax base. If taxes could be imposed at lesser rates in the earlier
and more difficult years ... urban renewal would have a much more
certain future than is the case today."
Mr. Hickman's company (Alcoa) does
not qualify as a poor credit risk, which doubtless helps explain
why they have survived the difficult early years. But there are
others who have not made it, and countless more who can never try
it, because of the perverse timing of our real estate taxes. One
of the advantages of the land tax base is its easy starting level,
and its consonance with Hickman's principle of deferred impact.
In conclusion, the property tax
need not be a Frankenstein. In its present form it belongs back
in the grave whence it so recently lurched, for it is grisly with
the gore of aborted buildings and guilty with the breath of suffocated
communities and the stifled lives of those who suffer from inadequate
housing, from unemployment in the building trades and building material
industries, and the host of related problems. But if it were converted
to a tax on the base of site values it would become a perfectly
respectable member of the tax family. In a family with so few of
the description, it is an opportunity not to be lightly dismissed.
Certainly it is not to be dismissed
with the hackneyed inanity that "it is no panacea." It
is not competing with any panacea. History has imposed a curious
double standard on deliberations of tax alternatives. Most taxes
are adopted because they raise revenue. Land taxes are rejected
because they are no panacea. If they simply raise revenue without
doing much damage they are a great improvement over what we have
now. If they offer additional benefits, so much the better, but
let us not be so enamored of the results of taxing buildings that
we will consider no alternative except a panacea. The land tax is
a good tax, on a non-erosive base. It lets us escape from the folly
of taxing improvements. That is a sufficient character reference.
^^^^^^^^^^^^^^^
|
