Controller's Report on New York State Property Taxes
a Heap of Distortions
H. William Batt
[Reprinted from
GroundSwell, May-June 2006]
As April 2006 ended, New York State Controller Alan Hevesi's
Division of Local Government Services and Economic Development
released a 22 page Report on Property Taxes in New York State. The
Report is singularly unhelpful and downright misleading.
Amid the pages of descriptive analysis, the Report makes
essentially three points of criticism: 1) it is burdensome to
homeowners, 2) it puts the state at a competitive disadvantage vis-à-vis
other states and localities, and 3), it is unfair. Each of these
arguments I will address here at length in hopes that it will edify
the debate and point to solutions for what is a growing problem for
both the state and its localities.
It is helpful first to understand that to an economist the real
property tax as we know it is really two taxes that each have very
different dynamics: a tax on the land value of a site and a tax on
its improvement value. Further one must understand that improvements
-- i.e., structures sited on the land -- depreciate in value over
time, just as do cars, computers and refrigerators. Only land values
increase, so that if a property parcel sees higher market value in
time, the increase in land accounts for it. The Controller's Report
makes no mention of this extremely important fact, leading to its
many subsequent failings.
Note was made in the Report, and picked up in the NY Times, that
in the last five years property tax bills increased statewide by 42
percent, compared with inflation of 13 percent. Yet the cost of
housing is no longer even included in today's consumer price index.
A far more accurate comparison would be the index of real estate
prices, which have quadrupled in some places over the past decade,
even though they have varied enormously statewide. Downstate New
York has shown robust growth, but the upstate economy is moribund.
Eliot Spitzer said it's "an economy that is devastated,"
and "looks like Appalachia." It is no wonder the tax rate
supporting schools and localities can be lowered downstate and still
provide the necessary finances.
An economy's vitality is reflected in its land values, and those
values have little to do with what any individual titleholder does
on a site. John Stuart Mill observed that, "landlords grow
richer in their sleep without working, risking or economizing. The
increase in the value of land, arising as it does from the efforts
of an entire community, should belong to the community and not to
the individual who might hold title." The values are reflected
in landsite locations because of what economists call economic rent.
If the economic rent were recovered for the community in the form of
taxes, land values would be stable, and housing -- as well as all
other real estate ventures -- would be more affordable. To jump
ahead, the solution to our tax dilemma rests, then, in a small
computer modification in the conventional property tax formula so
that only the economic rent from the land component is taxed.
The failure to collect land rent leads to the increase in market
values of property parcels and to the vicious circle of higher
property taxes. The burden grows according to the vicissitudes of
the economy, because locational sites have a fixed supply and
therefore amplify what scarcities might normally exist. Land
speculators feed the frenzy, and every homeowner gets caught up in
the game of rejoicing in growing property values. But the burdens of
those higher values are reflected in higher taxes. Owners often shed
wolves' tears, even while they look to "cashing out" their
increased holdings down the road. One answer to these plaints might
be to defer the tax burden borne until such time as owners sell and
those inflated home values allow what is due to be paid off more
easily. The deferral provision is already available in some
twenty-four states, letting owners continue living in their homes as
long as they can or wish to.
The Controller's Report could have offered these thoughts for
perspective and as a way of helping the public understand the
genesis of the problems it enumerated. It did not.
Part II
The recently released Report on Property Taxes in New York State
issued by the Office of State Controller suggested that its design
puts the State at a competitive disadvantage. Yet it gave no
explanation of the economic dynamics or its impact. The truth is
that the land component constitutes the most perfect tax that could
be. This is because it is based on a resource of fixed supply --
land -- absorbing in its market price whatever tax or other
encumbrance is imposed upon it. It is not passed forward, imposes no
"excess burden" (a fancy economic word for friction) on
the economy, and complies with all the other textbook principles of
sound tax theory. In fact the higher the tax on locations is, the
greater it fosters economic vitality in a region. It's the tax on
improvements that is so problematic.
The real property tax as it is understood in the US penalizes the
titleholder who keeps his property in good order, and rewards the
property owner who lets its condition decline and then be assessed
at a lower rate. Although structures depreciate while land
appreciates, our tax structure promotes this tendency even further.
Land rent that comes to rest on locations raises the market value of
parcels, and the structure gradually becomes a smaller proportion of
its total worth. Given our present tax incentive system, a newly
built-on parcel that might have an initial improvement value of 70
percent and a land value of 30 percent will see those proportions
reversed over the course of two generations. So it is that older
neighborhoods often become slums when they never need to have been.
Another solution is to collect the economic rent as it is
reflected in site values. The more rent recovered, the more stable
the land values become and the greater the incentive to maintain a
structure on it worthy of its carrying costs. Whatever increases
arise by taxing the rent accreting to landsites can be ameliorated
by a reduction in the tax on the improvement component. This is
phased in according to schedule in what has come to be called a "two-rate"
tax. Some twenty municipalities in Pennsylvania now employ such a
design, and it is catching on worldwide in many other forms.
Homeowners typically pay less in taxes because their houses are no
longer subject to levy. In fact all structures worthy of sites on
which they sit will pay less; sites or vacant lots under-used
relative to their locational value will pay more, just as the
incentives should be. Harrisburg PA has seen the restoration of some
5,000 previously boarded up brownstones since the inception of its
two-rate tax in 1982.
The conventional property tax contains within it what economists
have come to call "perverse incentives." Its
inefficiencies are rife, and its distortions impose heavy impacts on
environmental decisions, especially in locational choices and land
use configurations. To be sure the impact of the usually mentioned
alternatives -taxes on sales or income -- are even worse, but this
is all the more reason it's important to think outside the framework
of neoclassical economic theory and recognize land as a distinct
factor.
Part III
The Office of State Controller's Report on the Property Tax in New
York claims that the tax is egregious because it is unfair. But its
analysis of that unfairness is loose if not erroneous. Most of the
argument is based on a comparison of the different tax rates among
the various jurisdictions statewide. Additional criticism is leveled
on the poor quality of the assessments from place to place.
The fairness argument needs special explication, as "ability
to pay" has come to be the measure of its acceptability. But as
a start, one needs to recall that the property tax is really two
taxes, each with its own economic dynamic. The tax on the land
component is absorbed -- economists say "capitalized" --
in the market value of the property parcel and is never passed
forward to its tenant. The tax on the improvement portion is partly
shifted to the tenant. One way to bring the tax into greater
conformity with ability to pay is to relieve tenants of any tax
burden that has been passed forward -- the improvement part. Taxing
only the land component relieves everyone who owns no land --
typically poor people -- of all such tax burdens. The burden is then
carried solely by residential and non-residential landowners,
usually about half each. (Farmers' land is usually so geographically
remote that its value is inconsequential relative to that in the
cities.)
Moreover, the fairness of a tax on the land component is arguably
based on the use of a location, and those who avail themselves of
high value sites should pay accordingly. The highest value sites are
downtowns, and site values fall quickly as one leaves an urban
center. Homes are typically on sites a fraction of the value of
urban centers. Paying for locational advantage is not only fair but
fosters spatial configurations in accord with what planners most
advise. "Tax what you take, not what you make," is one way
to say it. "Tax waste, not work," is another way. What
could be fairer?
The Report takes special note of the poor assessment practices
that prevail among the hundreds of districts statewide. But this is
to conflate and confuse criticism of the administration of a tax
with the design of the tax itself. To be sure, the tax is poorly
administered, but the answer to that is to correct those problems,
not to scuttle the tax. Technology exists that make valuation very
simple and feasible, especially since the advent of computer mapping
applications. In fact taxing the land component is far easier than
taxing improvements, and far less intrusive, so that the promise of
taxing land value by itself would reduce the costs of
administration, litigation, and other management to a fraction of
those today.
The Report made no mention of the distortion typically created by
assessors' tendency to first value structures and then treat land
components as residuals. Elsewhere in the world, land is valued
first and any improvements are residuals. The failure to conform to
standard practices elsewhere in the world is probably due to the
advantage over-valuing structures gives for depreciation on
corporate tax schedules. To this extent, assessors serve the
interests of the finance, insurance, and real-estate industries. The
distortion can be seen in the fact that the aggregate land value
proportion in a typical American city is 1/4 to 1/3 of the total tax
base, far less than in municipalities elsewhere. Greenwich,
Connecticut, a city that employs the building residual method, has a
land value proportion of 71 percent. This dimension of fairness was
never touched by the Report at all.
A last issue involving the fairness of the New York State property
tax involves the balkanization of taxing districts. There exist some
1,300 assessment districts in New York, and an even larger number of
overlapping jurisdictions for purposes of water and sewer service,
fire departments, libraries, school districts, and so on. The result
is that there are enclaves of poverty bordering pockets of
affluence. The Report attempts an exploration of this problem in a
cursory way. But its solution is to rely for correction on other
state-level taxes, mainly the income and sales taxes. A statewide
property tax would ameliorate this significantly, and would likely
see some of the high-land-value localities raising more revenue for
some of the poorer districts upstate. In fact, a land value tax
imposed statewide would go far toward not only relieving upstate
financial stress, but also relieve downstate communities of the
impediments they face to improve and restore some of their real
estate investments. This is because, unlike other taxes, increasing
the tax on any base with a fixed (inelastic) supply engenders more
economic vitality the higher it is. As it is, attempts to redress
present statewide inequities in public school finance are now
focused on transferring more revenue downstate -- some $4 billion --
from upstate regions that are economically flat on their backs
already.
In all, the Office of State Controller's recent Report on Property
Taxes in New York State is revealing as much for what it does not
address as for what it does. Never once does it mention that the two
studies done in the early 1970s on the property tax by recognized
national scholars concluded that the property tax is marginally
progressive, more so for the land component. In what every graduate
textbook in public finance refers to as the "new view,"
this is explained in detail. Apparently, the authors of the Report
never took a graduate course in public finance.