Higher Taxes That Promote Development
Gurney Breckenfeld
[Reprinted from Fortune, 8 August, 1983]
A venerable but controversial reform idea in real estate taxation --
taxing land much more heavily than buildings -- is undergoing a
portentous test in Pennsylvania. Five cities have increased their tax
rates on land to as much as five times those on structures, a striking
contrast with the customary 1-to-1 ratio. The results so far are
promising enough to raise hope that more localities will use similar
antidotes for the economic poison hidden in conventional property
taxation.
The Pennsylvania phenomenon bears witness to a durable condition in
democracies: the slow contagion of good ideas. The five cities --
Pittsburgh, Scranton, Harrisburg, McKeesport, and New Castle-are
engaged in the largest U.S. effort yet to take advantage of a
proposition advanced 104 years ago by Henry George, the
Philadelphia-born economist and land reformer (see box, page 70).
Analyzing why the greatly increasing wealth spawned by the Industrial
Revolution had failed to eradicate poverty, George argued that the
main reason was undertaxation of land, which enabled landowners to
pocket vast unearned income at the expense of both capital and labor.
He won a legion of ardent followers by proposing that governments
raise their entire revenues by increasing taxes on land and abolishing
all other taxes.
Now that federal, state, and local governments consume around 40% of
GNP, as corn-pared with about 8% at the turn of the century, George's
single tax is plainly unfeasible. But the conviction has been
spreading among economists and urban experts that a diluted form of
George's medicine could help spur the redevelopment of ailing cities
and minimize suburban sprawl. As these modern Georgists view things,
boosting the levies on land while cutting them on structures would
discourage land speculation, promote job-creating investment in new
factories and offices, and encourage proper upkeep of buildings in
aging neighborhoods.
The economic rationale behind loading the tax burden on landowners is
that most of the profits they reap -- in the form of rising values for
their holdings -- are pure windfalls that result from the economic
activity around them. Taxing away those windfalls doesn't penalize
initiative because landowners didn't do anything to earn them in the
first place. On the other band, taxing investments in buildings and
factories does discourage productive endeavor and impedes economic
growth.
IN OTHER WORDS, the Georgist formula is a sort of supply-side
approach to real estate taxation. By taxing land heavily and buildings
lightly, it would press landowners to develop their properties to the
fullest. Taxes on bare land and dilapidated buildings would in theory
be nearly as high as the ones on the new office building next door,
making it much more costly for speculators to keep property off the
market. The scheme even has something for homeowners. Since their
houses generally are worth a great deal more than the land under them,
shifting more of the tax burden to land values would reduce their
total property-tax bills.
The impact of higher land taxes-now dubbed incentive taxation by
supporters-has varied somewhat in each Pennsylvania city that has
adopted them. Higher land taxes have enabled some cities to balance
strained budgets without soaking homeowners or increasing local income
taxes (which are common and arguably too high already in several
Pennsylvania communities). In some cases, higher land taxes have been
accompanied by small reductions in taxes on structures.
It is no happenstance that Georgist tax ideas are gaining popularity
in Pennsylvania. There, more than in other states, those ideas have
historic roots and have been kept alive, though sometimes just barely,
by a band of organized and dedicated advocates. One particularly
effective campaigner is Steven Cord, a peppery professor of history at
Indiana University of Pennsylvania who has become the state's
self-appointed Johnny Appleseed of higher land taxes. At numerous
meetings with city councils and local officials, he helped persuade
Pittsburgh, McKeesport, and New Castle to change their tax systems.
Cord spends more than half his spare time editing a Georgist
newsletter, Incentive Taxation, and appearing before officials
in cities contemplating higher taxes on land as a tonic for flagging
economies. Some, including York, Erie, and Allentown, are considering
the change. Today, says Cord, the land-tax idea "has moved out of
the hands of aficionados and into the mainstream of local politics"
in western Pennsylvania.
Two leaders of the Georgist movement in Pittsburgh are Dan Sullivan,
western regional director of the Incentive Tax League of Pennsylvania,
and Democratic Congressman William J. Coyne. Sullivan has made several
studies of the financial impact of higher land taxes on property
owners, and speaks at meetings of Pittsburgh neighborhood and business
groups to spread the incentive-tax doctrine. Such efforts are crucial.
Few people, even among public officials and real estate executives,
understand the nature of the tax and its economic ripples. Coyne, who
as a member of Pittsburgh's city council played a pivotal role in
persuading the city to raise taxes on land sharply in 1979 and 1980,
notes that ignorance hasn't prevented the system from working. "I
believe we are onto something exciting," he says. "I do not
want to claim too much for it, but we may discover that our form of
property-tax modernization is a hidden treasure-like finding gold in
our own backyard."
PITTSBURGH AND SCRANTON have been enjoying at least a few nuggets for
nearly 70 years. In 1913 Pennsylvania passed a split-rate tax law at
the behest of a bipartisan civic reform movement in Pittsburgh that
required the two cities to phase in a tax rate on land double the rate
on buildings. Along with companion legislation adopted in 1911, the
split-tax law ended a notorious tax rip-off in Pittsburgh. Land
classified "urban" was assessed at 100% of market value,
while land classified "rural" was assessed at two-thirds of
market value and land classified "agricultural" was half its
real worth. The arrangement enabled wealthy owners of large estates to
keep most of the city's idle acreage off the market, creating an
artificial shortage of land and inflating rents for workers and
business alike. Reflecting a durable consensus view, David L.
Lawrence, long Pittsburgh's mayor and later governor of Pennsylvania,
said of the split-rate tax: "There is no doubt that the tax law
has been a good thing for Pittsburgh. It has discouraged holding
vacant land for speculation and provides an incentive for building
improvements."
Still, that 2-to-1 ratio was only a timid dose of George's
prescription that all real estate taxes be levied against the value of
the land. Moreover, the state's split-tax law applies only to the city
share of real estate taxes. School districts and counties continue to
tax land and buildings at a 1-to-1 rate. The impact of the split-tax
law has become increasingly diluted as schools have grabbed a larger
and larger share of total property taxes. In Scranton, for example,
schools today get 58 cents of every real-estate-tax dollar collected
inside the city. In recent years the city has raised land taxes so
high that they amount to $3.76 for each $1 of taxes on buildings. But
school and county taxes reduce the overall ratio to only $1.77 of land
taxes for each $1 of building taxes.
A few Pennsylvania lawmakers have been struggling unsuccessfully for
several years to get the legislature to broaden the split-tax law to
include counties and school districts. Of this impasse, John M. Kelly,
a lanky, white-thatched Scranton real estate broker who is among his
area's most effective advocates of higher land taxes, observes wryly:
"The more logical an idea, the less likely it is to survive in a
U.S. legislature."
The current phase of rising land taxes began after Pittsburgh,
Scranton, and McKeesport got home-rule charters in the early 1970s
enabling them to set any mix of tax rates they liked. Harrisburg and
New Castle acted under another state law. The differential tax rates
helped foster a spurt in construction and development or, as in New
Castle (pop. 33,400), helped minimize a decline in such activity. Most
cities in western Pennsylvania have been clobbered by the depression
in the steel industry, but construction hasn't declined nearly as much
in New Castle as it has in neighboring Sharon and Butler.
Pittsburgh raised its tax rate on land from 4.95% to 9.85% of
assessed valuation in 1979, while leaving the rate on buildings at
2.475%. New construction, measured by the dollar value of building
permits issued, rose 14% as compared with the 1977-78 average. In 1980
the city widened the differential still more, to a tax rate of 12.55%
on land vs. the 2.475% building rate, a ratio of 5.07 to (With
Allegheny County and school tax added in, the final ratio was 2.99 to
1.) Construction in 1980 leaped 212% above t 1977-78 average,
reflecting groundbreaking for a new crop of office skyscrapers that
giving the city its so-called second renaissance (the first came in
the 1950s with t redevelopment of the Golden Triangle). The adoption
in 1980 of three-year tax exemptions on all new buildings -- but not
the land -- also boosted construction. In 1981 construction peaked at
nearly six times the 1977-78 rate.
Some of the dozen new office towers that have gone up in Pittsburgh
would have been built with or without tax concessions; downtown office
space had been growing scarce. But the widening differential between
the taxes on buildings and land undoubtedly helped. It cut the annual
bill for owners of some skyscrapers by more than $500,000 year when
compared with conventional 1-to-1 ratio taxation.
THE INCREASES in land taxes have drawn some opposition in Pittsburgh.
Mayor Richard S. Caliguiri, Democrat who took office in 1977 has
declared himself a foe of the higher levies. "I don't see where
they help all," he says. For 1979 and 1980 he proposed raising
the city's tax on wages instead of boosting land taxes, but was
overridden by the city council. The tax rates for 1982 rose to 13.3%
on land and 3.2% on buildings. Last year Caliguiri allowed a further
increase the land tax to 15.15%, accompanied by small decrease in the
building tax to 2.7%.
In contrast, the mayor of Scranton, rotund James B. McNulty, proposed
last fall that his city move all the way to full land-value taxation
and eliminate taxes on buildings altogether. Scranton's tax rates have
been 9.6% on land and 2.55% on buildings since 1980. Despite his
conviction that taxing building at the present rate deters development
and redevelopment, McNulty quickly put his proposal on hold. Downtown
merchants angrily complained that the change would be unfair because
of the real estate assessments on which property taxes are calculated.
The assessments, set by Lackawanna County, are decades out of date. As
a result, the City's only surviving downtown department store, The
Globe, pays 222 times as much tax per square foot of land as the newer
Viewmont Mall, which straddles the City border on the northwest edge
of town. The Globe's downtown land has an assessed value of $26.66 per
square foot, while city land beneath mall, which includes Sears and
J.C. Penney stores, has an assessed value of just 12 cents per square
foot.
ERRATIC AND UNFAIR property assessments, endemic across the U.S., are
particularly egregious in the Keystone State. The U.S. Census Bureau
ranks Pennsylvania 49th in assessment accuracy among the 50 states
(ahead of Montana). Scranton's assessments are even poorer than most
in Pennsylvania. Calculations by researcher Roger Downing at
Pennsylvania State University show that in 1981 the average assessment
in Lackawanna County missed the intended percentage of market value by
49.9%.
McKeesport (pop. 31,000), 12 miles up the Monongahela River from
Pittsburgh, was on the verge of municipal bankruptcy in 1980 when it
switched to split-rate real estate taxation and increased its
property-tax revenues by more than 50%. The city raised taxes on land
from 2.45% to 9% of assessed value, but cut taxes on existing
buildings from 2.45% to 2% and granted a three-year tax exemption to
all new construction. Neighboring Clairton (pop. 12,200) and Duquesne
(pop. 10,100), where steel is also the main industry, left their
1-to-1 real estate tax alone. Compared with the annual average for
1977-79, the dollar value of construction in McKeesport rose by 38% in
1980-82. Clairton suffered a 28% decline, Duquesne a 22% decline.
Steven Cord argues that the Pennsylvania statistics make a compelling
case for Georgist tax theory. And they are bolstered says, by studies
that found similar increases in construction and jobs after more 1,000
localities in Australia and 300 in South Africa lifted taxes on land.
Adds Congressman Coyne: "Our differential tax may provide a vital
key to the paramount issue of day: how to put idle people and idle
plants back to work."
Businessmen understandably recoil at suggestion of tax reform. At the
state and local level, "reform" has become virtually
synonymous with tax increases. Real estate taxes in particular have
grown increasingly unpopular in recent years, and genuine reform
remains elusive because people prefer the devil they know to the devil
they do understand. But higher land taxes, especially when accompanied
by reduced taxes structures, look like an idea businessmen ought to
embrace and promote. The benefits in the form of more jobs and
increasingly compact development are not only lasting but flow to the
whole community.
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