City Finances and the Property Tax
C. Lowell Harriss
[Reprinted from the MGIC Newsletter, exact
date not known,
but sometime during the early 1980s]
The total property tax is often over one-fourth of gross income from
the property - or 30 to 35% when expressed on the same basis as a
retail sales tax, as a percentage of the cost of occupancy excluding
tax. When rates of tax are so high, and when differences in tax
burdens are appreciable (e.g., from one location, type of property, or
activity to another), the indirect results can be substantial. Today,
they influence cities profoundly and are needlessly bad. The same
amount of revenue could be raised with significantly different, and
better (or less bad) results.
Progress will come from redesigning property taxation, not lo reduce
total yield (for needs seem too great), but to take account of the
essential differences between land and structures.
LAND VERSUS BUILDINGS
Land cannot move. The quantity is fixed. Rarely will the amount in
existence in an area be subject to more than tiny change by actions
under the control of man. The space will be there, regardless of
almost anything governments do by taxation. This space commands prices
which are often "high." To a large extent these prices
result from investments by the general body of taxpayers - government
provision of streets and schools and other facilities - and demands of
a growing public. A tax on land, a heavy one, will not reduce the
supply -a merit which no other tax can claim. And such a tax can
recapture for public uses much of the annual rental value or worth of
what the public itself, as distinguished from the landowner, has
Buildings and other improvements present a striking contrast. Taxes
on buildings at today's rates produce several kinds of bad results and
help to account for some of the deplorable features of our cities.
The property tax on structures hits well-constructed, high-quality,
buildings far more heavily per unit of space than slums and "junk."
What perversity! The tax on buildings creates an incentive against
upgrading of quality, especially in those parts of older cities with
most urgent needs and high tax rates. To say the least, such
discouraging of private effort to raise quality serves no useful
When the tax bill goes up because the owner has constructed a better
building, he does not get correspondingly more or better governmental
services. But his investment has advantages for others around. As
compared with the old, decrepit, and low-tax property, the new,
high-quality building will bring the general public positive and
desirable "neighborhood benefits."
Wise public policy would encourage better structures. The present
tax, however, favors buildings which produce bad neighborhood effects.
The owner of dilapidated structures - of residential, commercial, and
industrial slums - will be freer from economic pressure to replace
with something better if his tax goes down because the building gets
worse. Any individual or business wishing to shift to use of a higher
quality structure must also pay more toward the costs of government -
$1 more of taxes for each $3 (or even $2) of annual payment for the
Cities which urgently need to replace obsolete, decayed, degrading,
buildings rely heavily on a tax which creates a substantial bias
against replacement. Nobody "planned" to set up a tax system
with such deleterious influence.
TAXES AND MAINTENANCE
The quality of space available for work and living will depend
greatly upon the maintenance of the stock of older buildings.
Undermaintenance forms one way by which an owner can reduce his net
investment in a building, and eventually the tax. His actions in
letting a building run down will affect others, the larger
neighborhood^ Deterioration of a minority of buildings can hurt a
considerable area. Good maintenance can be combined with spending for
improvements which have "spill over" benefits for the whole
The property tax adversely influences maintenance. The tax reduces
the net return from the structures and thus the attractiveness of
investing more in such properties. Tax dollars are not available to
finance maintenance. And with or without good reason, the owner may
fear that a "repair and maintenance" job having visible
results will bring an assessment increase.
EFFECT ON PRICE
The higher the price of housing, the smaller the quantity and the
lower the quality purchased. The tax on buildings adds to price and
thus reduces the amount demanded. One bad effect is a hidden, or what
economists call an "excess" burden. It deprives the consumer
of more real benefit than the dollars paid to government. For example,
the cost per cubic foot of construction often declines as the size of
the house, apartment, office, or other unit increases. The tax on
buildings, however, creates pressure for constructing smaller units
and thus deprives the occupant of potential benefits for which
government treasuries get no dollars.
OTHER UNDESIRABLE EFFECTS
High tax rates on buildings re-enforce incentives for creating "islands"
of relatively low tax rates. A few of the localities which make up
most metropolitan areas have tax resources which are above average in
relation to service obligations. With lower tax rates they can have
above average quality of services, attracting still more investment.
Some communities use zoning power to exclude types of property
associated with high governmental expense - the high-density housing
which requires heavy school costs. Other parts of the metropolitan
area however, must pay higher taxes; elements of a vicious circle gain
"Lower" taxes in the fringes encourage dispersal and the
development "far out" of activities (including housing)
which "ought not" to be so distant. Each increase in tax
rate near the center will reduce the value of the property and the tax
base. Many buildings in the older section will have deteriorated but
yet have some "useful" life and a potential of prolonged
decline before replacement. Owners of land with obsolete buildings
delay replacement, in part because the speculative holding of the land
involves little out-of-pocket tax costs. The tax base tends to go
down, aggravating the need for higher tax rates. Businesses become
vulnerable to competition from outlying neighborhoods.
People who wish to escape the urban center must leapfrog over the "islands."
Such land use imposes higher costs than if population were spread more
in accord with factors free from the influence of tax on buildings.
The disadvantages take the form of: (1), costs in time and money of
traveling greater distances from home to work; (2), higher expense of
supplying water, sewer, and utility services over the far larger area;
and (3), reduction in economic and social benefits which concentration
of population facilitates.
WHAT CAN BE DONE?
The adverse nonrevenue effects of high tax rates on buildings are
more serious and more pervasive than generally recognized. Can we
reduce them? Yes. How? By cutting local expenditures? Not much
prospect here. By greater use of other local revenue sources or funds
from state taxes? Possibly. The hope in this line offers some basis
for optimism - but not enough.
Another opportunity deserves a try - raising the tax on land and
reducing the burden on structures. An old idea - and yet one whose
merits grow with every increase in local tax bills. To produce the
same total revenue, the rate on land might be three, or even more,
times that on improvements. For most property owners the tax bill
would not change appreciably. Those with the worst buildings, or with
land vacant, would have to pay more. They would face pressure from the
land tax to construct new buildings, knowing that the tax on new
structures would be much lower than under the present system.
A tax increase on land would have important effects other than the
revenue yield which would "finance" a big cut in the burden
on buildings. The new purchaser of land would pay less in price per
square foot But he would pay more each year as tax. Such change would
favor the person with less capital, without making financing harder
for persons more amply supplied with cash (and borrowing power). A
buyer could acquire a plot with smaller initial outlay and with lower
annual financing charge (interest plus amortization). Each year's tax
payment to government on land would be higher.
More land would be offered for sale or for use in new ways. Higher
tax on land would force some owners to put land to more effective use.
A heavier tax on inefficiently used land would add inducement to put
into effect a type of use which would bring more income. Speculative
withholding of land from better use would become more obviously
expensive. The usable supply of land would rise, leading to more
efficient use of a community's space - and reducing "urban sprawl"
along with substantial cut in the rate of tax on improvements.
The practical possibilities? Given the will and the determination,
quite a bit could be achieved soon under some state constitutions. In
other cases, more time would be needed for reasonably broad
One immediate step in many communities would be to raise assessments
on land while reducing, relatively, those on buildings. Huge increases
in land prices have by no means been fully reflected in assessments.
Local taxes have not siphoned off for the financing of local
government more than a fraction of the increases in land prices,
increases resulting significantly from expenditures by local
The National (Douglas) Commission on. Urban Problems estimated that
in the decade to 1966 land prices in this country rose by around $240
billion. An annual average increase of $25 billion in a period when
both tax and interest rates were rising testifies to powerful
underlying forces raising land prices. A special tax on increments as
such, often recommended, is not what is proposed here. But high and
rising land prices do provide a base for collecting more local tax
revenue based on land values in order to permit a desperately needed
reduction in the tax on new and good buildings.