Taxing for Progress
Two Rate Property Taxation
C. Lowell Harriss
Every community in the country uses property taxation. Schools,
policing, and the many elements of local government rely heavily on
property tax revenues. Typically, the tax (some hidden in prices)
averages around three percent of Personal Income.
Property Taxation differs greatly from one place to another. Real
estate makes up most--in some states, all-- of the tax base. And the
real estate base consists of two elements that differ
fundamentally--one is land, the other, man-made capital. This
distinction has economic reality of profound significance. The
quantity of land is fixed. The total space on the earth's surface
does not depend upon the rewards offered. Man-made capital, the
other part of the property tax base, does result from what human
beings do, their work and thrift. The quantity of man-made capital
to serve us will be influenced by the taxes on its creation and use.
The concern here today is not whether to use property taxes or
how heavily but rather on the structure of the tax. And
specifically, upon the relation to progress. The concept of "progress"?
For present purposes let us say "more of what people choose"--foolish
as some choices may be. The more the opportunities, the broader the
range of choices available, the greater the progress. The title I
chose should not mislead. Taxing will not make for progress. The way
taxes are imposed, the structure of the revenue system, can make a
Much of progress relates to, consists of, capital-- housing,
utilities, factories, equipment, planes, and other tangible items as
well as intangibles, notably human capital. Modern life calls for
much more than most of us realize. Yet supplies are limited.
Additions of new capital (the flows) reflect the prospect of net
benefit. Net, after tax.
Property taxation drives a wedge between the product of property,
the values it creates as measured by what the user will pay, and the
amount the supplier will retain. Local government services may be
directed to benefits associated with the buildings that are taxed.
Fire and police protection may be cited. Schooling presents more
complexities. How much of the benefit and how much of the cost of
government services should be associated with structures and how
much to land--location-- may not be clear. But more capital, whether
housing or business production capacity, means more net benefit.
Taxes that reduce additions of capital in a community impose burdens
beyond those measured by the revenue yield. Capital for new
investment flows in a world market. Some may be essentially local.
The "building and loan" associations of my youth
epitomized the accumulation of local saving to finance housing in
the community. Today's markets for new investment funds extend over
the world. They are competitive. Individuals or businesses seeking
funds for new investment projects face competition from many
sources. Their local governments can impose obstacles. Taxes.
Governments may also provide services that attract. Whether
hindrances or attractions, what counts will be the net effect. But
taxes are not all the same per dollar of revenue. And they are not
the same as prices.
Prices serve to get things produced and offered to users. And
prices help us allocate--one thing rather than another. We pay to
get things created--more for a four- than a three-bedroom residence
of similar construction. Payment induces the supply, the production,
of machinery or a consumer good.
Why state the obvious? Because of an important exception! Land.
What is paid for land does not create land. Markets have a crucial
role as regards land. But for land, prices play only one of the
central roles of price--not inducing production because the
production of land occurred in a past not being recreated. The role
of prices in land markets is the other function of price,
allocation. Guidance of choice.
Some land commands high price, others little. Some of the
difference grows out of investments present and prior owners have
made in sites. Such capital inputs get embodied with what nature
created. Market forces guide such new investment. Much of what is
paid today for urban sites exceeds, usually by far, what owners have
done to improve the land.
Differentials in land prices, some enormous, serve the highly
valuable function of guiding the allocation of land. Which of
possible uses. The function has greater importance in our lives than
we may realize.
The "where" of production and residency and recreation
(to say nothing of movement and the resources of time and money in
getting somewhere else)--location-- whether chosen well or poorly,
bear crucially on human life. Land prices are not a result of costs
incurred in production, but they do have a distinctive "time
dimension," perhaps a permanent or "forever" element,
sometimes for shorter periods.
Professor Gaffney has identified two dozen aspects of land and
land markets that make them somewhat unique. Classical economics
treated (pure) land rent as a residual. Correctly. Land rents in the
economic sense are much greater than amounts so labeled in the
national income accounts. For example, quite a bit of what is
economic rent of property used by businesses will be treated as
interest or profit. Moreover, the pure land rent element of housing
occupied by the owner will not be identified as such.
Today we hear of more types of rent and rent- seeking. Think of
rent as the payment in excess of what is needed to call the resource
into existence. The skill of an actor, athlete, or inventor may
yield rent-like return. And long-lived facilities may bring what are
sometimes called quasi-rents (in the time before new capital flows
add to the supply.) Mineral sources and the broadcast spectrum
certainly have elements that are properly treated as is land in
discussions such as this. Our concern is with the finance of (local)
Tax Something, There Will Be Less of It--Except Land
Taxes force people to do with less privately so that they can get
government services. Tax something, people will buy less. One can
quibble and try to think of exceptions. And there IS an
exception--land. The quantity of space on the earth's surface was
fixed by nature. The amount of housing in a community or the taxes
the locality imposes on factories or offices or trucks will affect
the amount available; most responses to any changes, of course, take
time. And the responses will reflect the estimated worth of the
fruits of the spending for those who have choice about paying tax or
Location has value. Some urban land commands very high rewards.
The worth of location depends upon what goes on around, upon the
community--including, but not limited to, things the (local)
government does--streets, policing, schools, and so on. The value of
buildings and machinery depends upon investment of present and prior
owners in creating the assets. The worth of location, in contrast,
depends upon what the community (broadly conceived) has done and
seems likely to do in the years ahead.
Sometimes tax laws are designed to reduce an activity--smoking
cigarettes or consuming alcohol. More typically, taxes, such as
those on housing, are imposed without an explicit desire to reduce
the activity. We know less than we would like about the results over
the years of a tax change now.
But we do know that water flows downhill.
Similarly, taxes will discourage.
Other things the same, a tax increase on housing will reduce
construction. A tax on machinery will reduce the attractiveness of
the area for new investment in machinery.
Mobility of Investment Funds
Local governments exist in a world in which investment funds are
mobile. The well-being of the people in any community reflects the
capital that has been invested in the past. And the future will
depend upon the new capital funds invested--in office-building,
utilities, factories, and other such production facilities
associated with employment and the creation of income--housing
included. Local officials recognize that the flow of dollars for new
investment will take account of the effect of taxes. To attract new
investment, local governments make tax deals of various types ("holidays,"
sometimes not disclosed with full clarity).
Competition among communities is real but quite unsystematic.
What one locality gets, others will lose.
Overall, net revenue will suffer. And the "system" does
not make up revenue losses by capturing more from land.
Owners and occupants of existing structures will be worse off
relative to what could be.
My advocacy of two-rate property taxes has emphasized the
desirability of encouraging capital investment--with higher tax
rates on land to keep the net revenue unchanged. But there are also
substantial merits in financing (local) government from land rents.
We pay for the use of land. But the space would be there even if
we made no payment. Over the sweep of history--and in some
localities, last week, even yesterday- -land prices have gone up.
Owners have benefited beyond any creative effort and investment they
People getting rich while they slept, perhaps with inherited
land! If such unearned increments could be captured to help pay for
(local) government, wonderful! Alas, however, there seems to me less
than slight prospect of any tax targeted on unearned increments
being crafted and administered on a scale that would do much to pay
for urban government. But increments become part of a broad property
tax base. The greater the land portion of tax revenue, the more
value increments would yield in revenue.
A central goal -- revenue from taxes that do not tend to reduce
and impair productive capacity, including housing. Less deadweight
loss. Less burden that does not yield revenue. More benefits that
are unseen, two kinds. One is the use of economic surpluses, pure
rents, to help pay for some of government. The other is a reduction
in deadweight burden, the adverse effects of taxation beyond revenue
Property taxation today does tap some of the values created by
community growth, including unearned increments. Here lies one
reason why the property tax can be called rightly (with qualifiers
and, of course, per dollar of revenue) "the best of taxes."
And I repeat the merit noted earlier, this tax to the extent that it
falls on land does not reduce the stock of productive capacity.
Allocation: The Use of Location
Human well-being depends not only upon the quantity and quality
of productive resources but also upon how they are used, allocated,
choice among alternatives. For land, one focuses on the location
element. (Agriculture differs.) Each location is unique. Machines
and houses and trucks can be duplicated. Not location. And what
happens on one spot has significance for neighbors. Moreover,
decisions as to use usually involve commitments for substantial
A property tax payable in cash creates incentive to get some
income. And normal market forces provide inducements for owners of
land to find and to utilize the best opportunities. What do
potential users desire? Market forces, however, may be inadequate.
Knowledge will be incomplete. The community (broadly conceived)
suffers when locations are not used to best advantage. The market
has rigidities, many imperfections; the real estate market can be
sticky. The general public has little way to express collective
demand (wishes and willingness to pay).
The two-rate system would enlarge the pressure of the land
portion for optimum use. This result increases the desirability of
the proposal. The general community, as well as the owner, has an
interest in "highest and best" use of locations. The
two-rate system would enlarge the forces of the market to make best
use of land. And by reducing the tax burden on new capital
investment, the two- rate tax would raise the demand for land.
Without knowing just what others on this program will say, I
conclude with an assertion: There are persuasive economic reasons to
increase the land portion of property taxation and reduce the
burdens on man-made capital. After these notes were prepared, I
received from Professor Steven Cord the draft of an impressive
study. He has searched for examples of the use of the two-rate
system. He reports that all the evidence, every case, gives
empirical confirmation that, in practice, the two- rate tax will be
associated with results that theorizing predicts.
Dr. Lowell Harriss is Professor Emeritus of Economics
of Columbia University.