Property Tax -- Cause of Unemployment
Herbert J. G. Bab
[A paper presented to the staff of the Center for the
Study of Democratic Institutions, Santa Barbara, California; excerpted
from a manuscript with the title Three Million Jobs; undated,
but probably written during 1964]
Dr. Herbert Bab was born
in Vienna and received his Ph.D. in Political Economy at the
University of Vienna in 1936. A specialist in interest theory, he
was granted a Research Fellowship to King's College, Cambridge by
the famous economist, J. M. Keynes. At Cambridge began his special
interest in the problems of housing. He came to the U.S. in 1938 and
settled in California. He is the author of a number of papers on
various aspects of housing, property taxation and interest theory.
Some time ago Soviet Premier Nikita Krushchev prophesied that
Communist Russia will bury the capitalist system. Yet, it is likely
that historians will come to the opposite conclusion, namely, that the
cold war has saved the American economy from another Great Depression,
if not from collapse.
We have lived in a defense economy for almost 20 years and most of us
take it for granted that it will continue indefinitely. Yet it is
becoming more and more obvious that it will not last forever.
Moreover, even the tremendous defense outlays have not secured full
employment and have not allowed our economy to grow fast enough. Under
the impact of spectacular advances in technology the actual level of
employment and production falls short of the full use of our manpower
and industrial capacity.
And this gap is widening. According to Leo Keyserling it rose from
$1.5 billions in 1953 to a seasonally adjusted figure of $76 billions
in the 3rd quarter of 1963.
In view of this it would be difficult to contend that we have solved
the twin problems of full employment and economic growth. The truth is
that we have lived all these postwar years on borrowed time.
What have these considerations to do with property taxation? The
purpose of my talk is to show that the relation of property taxation
to unemployment and lack of economic growth is that of cause to
effect. I shall try to explain why I believe that property taxation is
one of the two chief villains in the drama we are witnessing today in
these United States. The other villain is the monetary policy pursued
by the government, which has increased the cost of borrowing to a
point where it stifles the growth of the economy. In this context
however I shall be concerned only with property taxation.
"Supported by a defense outlay of
between $45 to 50 billions the U.S. economy has been fairly
prosperous in these last years. Anybody who would have advocated
a public works program of that size for peaceful purposes would
have been branded as fiscally irresponsible. And bankers and
businessmen alike would have warned us that such a program must
necessarily lead to a disastrous inflation and would undermine
the stability of the dollar."
Two schools of thought have emerged as to the merits or defects of
property taxation: one school condemns the American system of property
taxation in every conceivable way. The other school underscores the
advantages of taxing land and untaxing improvements.
Professor Harold Groves in his book Financing Government
stated that "it has been said that the general property tax has
only two faults: first it is wrong in theory and second it does not
work in practice. Others have said, that the administrative defects of
the tax somewhat compensate for its conceptual shortcomings."
Professor Seligman stated "that the general property taxes as
actually administered are beyond doubt one of the worst taxes in the
civilized world." John Maynard Keynes in a letter written to me
in 1941 said "that in this country we may have to consider
seriously after the war the whole question of the part played by local
rates and local taxation. No one defends the existing system, but it
is not easy to find an alternative."
The other school of thought emphasizes the justification for and the
great advantages of taxing land.
Ricardo believed that ground rents and the value of land have a
tendency to rise continuously and that this benefits solely the
landowners. The progress of industrialization and urbanization in the
second half of the 19th century resulted in a rapid increase in the
value of urban land and the owners of such land reaped tremendous
profits. This led John Stuart Mill to observe, that "Only the
landowners grow richer, as it were in their sleep without working,
risking and economizing". He called for the taxation of land in
order to recapture the unearned increment accruing to the land owners.
The apostle of land taxation is Henry George. In his famous book Progress
and Poverty he develops his single tax theory. He tries to show
that poverty and unemployment and other evils are caused by the land
monopolists. Henry George's theory is similar to that developed by
John Stuart Mill. Land values are based on ground rents which are
created by the community and not by the land owners. Therefore the
community is justified in recapturing these rents by a single tax on
Land taxation has found widespread acceptance in many countries
especially in France, Germany, Denmark, Australia, New Zealand and in
certain parts of Canada. It has made no headway in the U.S. except in
Pennsylvania, where the cities of Pittsburgh and Scranton introduced
in 1913 a graded tax plan and in Hawaii where a similar tax plan was
adopted in 1963.
If John Stuart Mill or Henry George would be alive today, they would
be disappointed that the taxation of the unearned increment in land
values has not made more progress. They would be surprised that the
rise in urban land values has not been as steep as they had expected.
Yet the universal use of automobiles has in an unforeseeable way
multiplied the land available for residential use. It has made
possible the exodus of a large pan of the middle class out of our
towns into suburban areas. Thus the invention of the automobile has
upset the dire predictions and expectations of the economists who
advocated the taxation of land.
However, there is increasing evidence that the advantages which we
have gained by the universal use of the automobile are coming to an
end. Suburban areas within the range of the automobile are rapidly
being built up. There is a definite limit to the distance a person is
willing to travel or the time he is willing to spend to reach the
place of his work. Moreover, the use of the automobile is more and
more hampered by traffic congestion and parking problems. Thus the
further expansion of suburban areas is likely to slow down and the
upward pressure on land values in the central areas of our cities is
likely to increase.
Three criteria are generally used to judge the merits of a tax.
First, it must be satisfactory as a revenue producer, second it must
be equitable and third its economic effects should not collide with
the public interest. For instance if full employment and economic
growth are regarded as desirable, the question to be examined is what
effects will this tax have on achieving these objectives?
The shortcomings of property taxes as revenue producers have been
obvious for a long time and are widely known. The main difficulty is
that revenues from property taxation do not keep pace with the
ever-increasing requirements of local governments. Every county, every
city official and every school administrator will testify, that there
are not enough funds available to meet the requirements of local
The inability of local government to raise enough revenues from
property taxation has forced them to borrow at an ever-increasing
rate. The debts of local governments have increased from about $16
billions in 1947 to over $61 billions in 1963, an increase of about
382%. During the same period private debt increased by 279% and
federal debt by only 26%.
To satisfy the second criterion, a tax must be equitable. It must be
either based on the ability to pay principle or on the benefit
principle. The Federal income tax for instance is based on the ability
to pay principle. Gasoline taxes used exclusively for the construction
of roads are benefit taxes. The property tax cannot be justified by
either of these principles. The ownership of property is not a
yardstick of ability to pay, though this was probably true before the
industrial revolution. In that age land was the main, if not the only,
form of wealth and intangible forms of wealth did not exist. As to the
benefit principle most of the services rendered by local governments
benefit the community as a whole rather than property owners. This is
especially true of schools, police protection, welfare expenses and
An analysis of the social and economic effects of a particular tax
system would indicate the third criterion.
When analysing property taxes we shall distinguish between that part
of the tax which is assessed on improvements and that part which is
assessed on land.
"A survey made by the editors of Fortune
found that during the 1950's the population in metropolitan
areas increased by about 400,000 persons annually. About 250,000
housing units were built yearly in these areas, but almost the
same number were lost by demolition, condemnation or conversion
into industrial use. Thus the housing shortage increased by
about 400,000 persons each year. The editors of Fortune
concluded that the battle against slums will be decided by the
simple arithmetic of new buildings versus immigration to the
That part of the tax that is assessed on buildings penalizes
everybody who improves his land, his buildings or intends to construct
residential, commercial or industrial property. The most serious
incidence of property taxes is on new housing. When rental property or
houses are newly constructed these taxes add 15 to 20% to the annual
cost depending on assessment practices and tax rates.
"In 1962 property taxes on new F.H.A. insured houses averaged
$14.30 per month, or $171.60 per year, excluding that part of the tax
that was assessed on the land. Assuming that a family spends 20% of
its income on housing, the income of a family must increase by $858
per year in order to afford the purchase of a home. In this way many
families in the lower income group are priced, or taxed, out of the
market. And residential construction, a mainstay of our economy, is
"In 1963 HOUSING STARTS reached a level of 1.6 million units,
representing a value of about $20 billions. Yet very few houses were
built in the central areas of our cities and a large part of these
houses were built for families in the middle or upper income group. Of
these single-family homes, only 15% were sold for less than $12,500.
Another 15% sold for between $12,500 and $15,000. Thus 70% of these
homes cost $15,000 or morel This is so because under our income tax
laws property taxes and interest charges are deductible items. A
person in the 75% bracket pays only 25% of these costs and a person in
the 50% bracket pays only half the property taxes and half the
The steep increase in the level of rentals represents a true and
accurate yardstick of our housing shortage. During the period 1950 to
1961 the average rental rose from $71.13 per month to $186.79 or by
160%. During the same period median urban family income rose from
$3,497 to $5,924 or by only 69%. Construction costs per square foot
rose from $8.68 in 1950 to $11.32 in 1961 or by only 30.4%.
The ever widening gap between the level of rentals and the urban
family income constitutes a rental squeeze, which has brought untold
misery and hardship to families in the lower income group, especially
to those belonging to minority groups. The rental squeeze has also
aggravated overcrowding and slum conditions.
In the press, on the radio and on television we are often warned
about the threat of inflation. Hardly ever are we told, that the
increase in the cost of living is to a large extent due to the
increase in housing costs brought about by the housing shortage. The
inflationary effects of property taxation are reinforced by the fact
that property taxes themselves are included in the cost of living
index and that property tax rates have the tendency to rise.
To the extent that property taxes discourage residential construction
and the improvement and modernization of homes they create
unemployment. The housing construction industry employed about
2,200,000 people in 1962, that is about 1.4 persons per housing unit.
Any change in the direction of home building employment is multiplied
2.57 times. Thus an increase in housing starts by 50% would give
employment to 2.8 million persons. An increase by about 66.6% or by
2/3 would create about 3.6 million jobs. These figures do not take
into consideration the investment in public utilities, streets,
schools etc., that would be required to service these additional
Under our property tax system wealthy communities with expensive
homes or with heavy concentration of industry will have a large tax
basis and low tax rates. Schools will be good and public services will
be adequate. Yet in a poor community the tax base will be much
smaller, tax rates will be much higher and still it will be found
impossible to provide for good schools and adequate public services.
In a pamphlet entitled Paying for better schools the
Committee for Economic Development came to the conclusion that "where
a child happens to live is likely to be important in determining the
quality of his education. In some areas children are taught by
meagerly qualified teachers in substandard schools with inadequate
equipment. The school session is shorter and the school leaving age is
lower than the national average."
A defect of our property tax system that is seldom mentioned is that
it puts a premium on obsolescence and penalizes new housing. This is
so because property taxes are ad valorem taxes. Every piece of real
estate except land is subject to depreciation. Thus the owners of old
and obsolete real estate will pay little in taxes, while newly
constructed buildings will bear the brunt of the tax.
This characteristic of the property tax is obscured by the rising
trends of land values, which in many cases offset the loss in value of
the improvement. Increases in tax rates and differences in assessment
procedures and practices further hide the fact that ad valorem taxes
favor obsolete real property.
Let us now turn to that part of the tax that is assessed on land.
Increases in population, immigration from the farms and other forces
have led to a rapid increase in the population of our large cities and
metropolitan areas. Population pressure is bound to increase the value
of urban land. Yet an adequate system of land taxation could have
prevented the steep rise in urban land values.
Economists agree that taxes on land can not be shifted but are
capitalized. For instance a lot having a value of $10,000 -- will have
an imputed or expected income of $500 -- assuming a 5% rate of
capitalization. A 2-1/2% yearly "ad valorem" tax would
reduce the imputed income by $250 -- or 50%. Such a tax would
naturally reduce the value of the land by the same percentage.
"Sir Winston Churchill has been most
of his life an advocate of land taxation. He stated on one
occasion that 'Land monopoly is not the only monopoly, but ...
it is the mother of all other forms of monopoly' ".
For these reasons increases in land values can be prevented by taxing
land at an appropriate rate. Yet urban land values have increased
tremendously during recent years. For instance in Los Angeles county
the assessed value of land increased from $1,972 millions in 1952 to
$4,002 millions in 1962, an increase of a little over 100%. The
assessed values, are supposed to represent 25% of the market value.
Thus the unearned increment in land values during this period amounted
to not less than $8 billions. Even this figure is an understatement
because it is based on assessed values and land is greatly
underassessed. While land values have risen by about 10% yearly,
property taxes assessed on land averaged about 1.5%. Thus a person
owning vacant or underimproved land would have earned about 8!/2% per
year just by withholding land from its proper use.
A higher tax on vacant or unimproved land would make it unprofitable
to hold such lands. It will tax land into better use and it will lead
to a spurt in construction activity. While all other taxes are
deterrents to employment and economic growth, though to a varying
extent, land taxes are the only genuine incentive taxes.
Inflated land values must necessarily increase the cost of new homes,
the cost of home-ownership and rentals. It discourages residential
construction, prices many families out of the housing market and
aggravates the housing shortage.
The average price of the site of F.H.A. insured newly built one
family homes increased from $1,035 in 1950 to $2,715 in 1962. The
site-value to building value ratio increased from 12% to 17-1/2%
during the same period.
Homeowners who bought their homes some time in the past can reap
large profits when selling them. Old homes should sell at a lower
price, because of the depreciation of the building, but in most cases
the depreciation of the building is more than offset by the increased
value of the lot. This increased value forces buyers to increase their
down payments or to increase their loan are higher, many families are
priced out of the market.
"The tremendous rise in the
expenditures of local governments confirms the excessive cost of
the exodus into the suburbs. Expenditures of local governments
increased from $9.1 billions in 1946 to $30.6 billions in 1957
or by 21.5 billions. A considerable part of this increase --
maybe one-third or more -- could have been avoided by a tax
system that would insure, not only a more rational use of land,
but also sound economy in our urban affairs."
We have discussed the sharp increase in the level of rents that has
taken place during these last years. These increases reflect the steep
rise in land values that have taken place in almost all sections of
our cities. The tax assessed on the improvements has discouraged the
construction of more and better housing. At the same time, the tax
assessed on land has been too low to induce owners to sell, improve,
or replace their rental properties.
Property taxes shape the pattern of our cities. If taxes on
improvements are low or non-existing and taxes on land are high, the
cities are bound to grow vertically and at a fast rate. If taxes on
improvements are high and taxes on land are low, our cities will
spread over larger and larger areas. They will become metropolitan
areas and they will grow at a much slower rate.
Relatively low taxes on land and high taxes on improvements will
discourage the owners of vacant lots or underdeveloped land, such as
that used for parking lots, gas stations, hamburger stands, etc., from
improving their land. It will encourage them to keep the land out of
use and to sell later at a profit. This will create an artificial
shortage of land, which in turn will lead to urban blight and
irregular, leapfrog city growth.
This urban sprawl makes our cities look ugly, but it has many
disadvantages besides: It gobbles up a tremendous amount of farm land;
the farmers have to give up their land before it is really needed; the
building developer has to go far out to find available land; the
prospective home-owner has to travel farther; traffic on congested
roads will increase and new roads and schools will have to be built.
It is generally believed that zoning laws are a very effective tool
to control the growth of our cities. Zoning laws determine the best
possible use of urban land. Yet nobody can be forced to improve his
land and to build unless there is an incentive. This can be achieved
by taxing land at a rate that will make it unprofitable to hold it
without improving it.
The city planner needs land taxation just as he needs zoning laws.
With both these tools the orderly growth of our cities will be
assured, but -- as experience has shown -- without land taxation
rational and efficient land usage becomes impossible.
Professor Galbraith and others have expressed concern about the
poverty of the public sector of our economy as compared to the
affluence of the private sector. The appearance of our cities, the
inadequate financial support we give our schools and poor public
services seem to support this view. Yet, I can not agree with
Professor Galbraith's conclusion that we need more public revenues to
meet these needs. It seems to me that the spreading out of our cities
over wider and wider metropolitan areas has immeasurably increased the
financial burden of local governments. In other words, wasteful use of
land caused by our property tax system is the real reason of the
poverty of the public sector.
It stands to reason that the spreading out of our cities into wider
and wider metropolitan areas is a very costly venture. For instance it
was found that in the New York region suburbs have to make capital
outlays of $68 per capita for new housing, while only $44 was required
for new housing in the central cities and only $38 in the
non-metropolitan area. Another survey found that it costs $80 per
household to provide water in the outlying suburbs against $30 in the
The administration of the property tax leaves very much to be
desired. Assessment procedures and practices are in many cases
erroneous, arbitrary and widely variant. So is the ratio of assessed
value to full market or cash value. In many states no public records
are available indicating assessed values and the taxpayer has no of
knowing what his tax bill will be.
The most serious defect in the administration of property taxation is
the continuous, widespread and enormous underassessment of land. A
survey made recently found that in 9 California counties, vacant lots
and acreage were assessed at only 5.3% of the cash value, while
residential property was assessed at 19.3% of its value. The illegal
underassessment of land deprives local governments of millions of
dollars of revenues. Moreover, it further aggravates the serious
defects of property taxation.
We have analyzed the effects of property taxation on improvements as
distinguished from those caused by the incidence of these taxes on
land. We have found that a high and burdensome tax rate on
improvements will discourage residential construction, create
unemployment, penalize home-ownership, aggravate the housing shortage
and force up rents. Yet a low tax rate on land will have similar if
not identical effects: it will lead to a rise in urban land values,
which in turn will discourage residential construction, create
unemployment, penalize home-ownership, aggravate the housing shortage
and force up rents. The paradox of property taxation consists in the
fact that lower rates on improvements produce the same results as
higher rates on land and conversely higher rates on improvements
produce the same results as lower rates on land.
The reform of our property tax system must be regarded as one of the
most urgent and important task we face today. It cannot be any further
postponed without risking grave consequences. Yet this reform will
prove to be a formidable task. There is very little understanding of
the problems by the public. Moreover, there exists a great number of
local governments levying property taxes and it is almost impossible
to coordinate and direct the policy of over 80,000 local governments
towards the same goals or objectives -- except by action of State or
Federal government. The States will have to find the permanent long
term solution of the problems of property taxation while the Federal
government will have to come forward with measures that will provide
There can be little doubt that the shifting of the tax burden from
improvements to the land is the appropriate remedy. I shall try to
outline a few ground rules for the procedure which should be followed:
- The shifting of the tax burden should be achieved gradually
over a period of years.
- A predetermined yearly reduction in property tax rates on
improvements should be enacted by each State and should be
imposed on all local governments without exception. At the same
time the tax rate on urban land should be increased to make up
for the loss in revenues.
- A State agency or State Tax commission should, be set up to
supervise and administer the shifting of the tax burden with the
a. To break up the property tax into its constituent parts:
taxes on urban improvements, urban land, farm land and property
other than real estate.
b. To enforce the yearly reduction in tax rates on urban
improvements and to see to it that taxes on urban land areraised
to make up for the loss in revenues.
c. To supervise assessment procedures and practices and enforce
the equal assessment of all classes of property.
d. To enforce the pooling of revenue derived from school taxes
and to equalize school standards on a state-wide basis.
e. To examine the merits and effects of the taxes assessed on
tangible and intangible property other than real estate and to
recommend the retention or discontinuation of these taxes.
f. To consider the merits of granting immediate tax relief on
the first $3,000 of all newly constructed housing in order to
stimulate the improvements and modernization of homes.
This long-range program which I have outlined will have to be
supplemented by a Federal program. The States will require many years
to develop and enact a program of property tax reform, yet immediate
relief is badly needed to encourage residential construction, create
employment, lessen the housing shortage and arrest a further rise in
rents. This relief can only come from the Federal Government.
As has been mentioned before, ad valorem taxes by their very nature
put a premium on obsolescence. It is in the power of the Federal
Government to convert the ad valorem tax into an incentive tax, a tax
Instead of taxing improvements at cost when they are new and at cost
less depreciation when they are old, the Federal Government could
change the tax so that new buildings are not taxed and old buildings
are more heavily taxed than at present. This can be done by
establishing age brackets and by taxing all improvements according to
The first step would be to exempt all new residential construction
from property taxation for a period of 10 years. This would represent
the first bracket of the graduated tax. It could be administered in a
very simple way. Our income tax laws allow property taxes as a
deductible item. Property tax relief would be made effective by
allowing property tax payments to be deductible from a taxpayer's tax
liability and recognize them as a part of income tax payments. A
second bracket could be established for housing when it becomes 10
years old and until it reaches 20 years by granting a tax exemption of
50% in the manner described before. The third tax bracket would
consist of all housing over 20 years old. No property tax relief would
be granted to this age group. Finally a fourth bracket could be
established for obsolete rental property. When a building becomes
older, it becomes more and more difficult to correlate age and
obsolescence. Thus this tax should only be assessed on buildings
declared substandard by the F.H.A. Moreover, instead of relying on
assessed values, this tax should be based on rentals.
A precondition for establishing this fourth bracket is a high and
increasing vacancy factor. As long as the vacancy factor is low, there
is a danger that some landlords may try to increase rents and to shift
the tax to the tenants. Yet, when vacancies are increasing, the
landlord will have to absorb this tax. It will encourage the landlord
to sell his property or to pull it down and construct a new building.
I have tried to show the relation between property taxation and
residential construction, the housing shortage, the steady increase in
rents, the inequality in school standards, inflated land values, urban
blight and sprawl and finally the financial burden of local
governments. I can not help but agree with the findings of a committee
of the California State Legislature stating "that the problem of
financing local government is the major domestic problem facing our