An Open Letter to the Mayors
of the Cities and Towns in the United States

Edward J. Dodson

[March 2001]

Governing a community, any community, presents tremendous challenges to elected officials, and the person who serves as mayor is very much in the spotlight. His or her decisions and policies are subject to constant scrutiny. Today, the challenges are as great or greater than ever before because many people and most businesses are apt not to have firm roots in any particular community. Businesses come in search of markets and stay when the effort proves profitable. People follow employment opportunities and -- when able to choose -- they look at the other attributes of the places where they might live, work and play.

As mayors working to retain existing residents and attract new people in, you are certainly aware of the importance of safe neighborhoods, good schools, useable parks, reliable mass transit, bearable taxation and a welcoming climate for businesses. To a very great extent, full employment results in these desired characteristics. At the same time, a community must find ways to fund all of the desired amenities when they are not now present. This has proven to be an elusive goals for many cities and towns.

Common Ground members live and work in many of the communities you serve. We want to stay and make our contribution to the quality of life for our neighbors and our families. That is why we urge you to think seriously about the way our municipal governments raise revenue to pay for the public goods and services we believe are necessary for our quality of life.

One perspective – the one that has driven public policy for a very long time – is that the least harmful way to raise public revenue is by taxing just about everything and everyone – but as moderately as possible. Over time, government has imposed taxes on the wages of every working person, on the homes and automobiles and other personal assets of every resident, on the assets and gross revenue and profits of every business, on every exchange of goods and services, and even penalizing visitors by taxing stays in hotel rooms. The result for many cities has been an ongoing loss of people and commerce.

In place of self-sufficiency has come a perpetual dependency on state and federal governments for revenue at a time when state and federal elected officials have adopted the tenets of “new federalism” that returns authority and responsibility to communities to solve their own social and financial problems. On the bright side, there is today a recognition that heavy taxation of businesses and working people only serves to drive them away. People who have options will not hesitate to abandon a city or region if government is not doing the right things from their perspective.

Taxes are only one contributing factor to a high cost of living or of doing business. With markets often global rather than national or regional, a location to be desirable must allow businesses the opportunity to compete internationally, absorb local costs of producing goods or offering services and still make a profit for the owners. The responsibility and challenge to our elected representatives is to strike the right balance between the need for revenue and the need for a healthy, nurturing economy.

A more deeply penetrating analysis than is the norm of how taxation affects markets, investment decisions and the migration of people is part of the educational mission of Common Ground U.S.A. and its membership. Our research leads us to rather striking conclusions of how the way we raise our public revenue drives economic and social outcomes. <br><br>

What cities have to offer most is location. Cities are where they are because at some time in the past the location was advantageous: an excellent harbor, a navigable river, rich farmland, mild weather, the crossroads of natural trade routes. With the increase in population coming to live in the same geography, locations come to have exchange value. In fact, every location has some annual rental value in the market place. This rental value is what people are willing to give up from what they produce as payment for control over a particular location.

In our cities the most valuable locations are usually in or near the central business districts. Values tend to decline the further away from the center one goes (until you get close to another business district or a riverfront or ocean beach or mountain vista). An important practical observation is that this location rental value grows or falls independent of what any individual does with a location. Location value is created by aggregate public and private investment. As such, this value ought to be – we would say “needs” to be -- fully captured by government to pay for public goods and services. When, as is largely the case, location rental values are only lightly taxed, the market recognizes the net rental value as “imputed income” to the holder of the land deed. This income stream is capitalized into a selling price. Here is a simple example. Say a parcel of land can be leased for $10,000 a year and a market rate of return on investments is 10%. The $10,000 in rental income is capitalized, at 10%, into a selling price of $100,000 for that parcel. However, if location rents are rising every year, the owner will try to capture this future increase in income by charging a price greater than “current value” would suggest.

The lower the annual tax in relation to location rental value, the greater is the imputed income to be capitalized. Thus, a city with a low effective tax rate on location rental values will experience high levels of land hoarding and speculation, as well as land markets with a strong tendency to spiral upwards rapidly, then crash when businesses can no longer afford to absorb the higher costs of doing business triggered by the speculative land market. Strangely, we have come to accept these dynamics as the unfortunate consequences of a market economy, of the business cycle, when rational public policy could attack the problem at its core.

Our mission to provide objective and thoughtful analysis to our mayors, urging you to take the lead in removing one of the most serious impediments to the economic health of our cities by looking to location rental values as the primary source of public revenue and removing the burden of taxation from the productive activities in which we engage. <br><br>

Taxing (i.e., collecting) location rental values brings in revenue, discourages land speculation and pressures those who own land parcels to improve them according to “highest and best use” as dictated by the market. Zoning and planning measures are important factors in these investment decisions, and current thinking is to encourage mixed-use development so that people can live, work and place in the same geography – reducing our dependency on the automobile and paving the way to a cleaner environment. When the land owner then makes an investment in a home or office building or store – improving the land parcel to its highest and best use – the best thing the city can do is exempt these assets from taxation. Selective and limited abatements have been employed for decades. Exempting all property improvements from taxation simply extends this wise policy to all property owners. Never again should anyone be penalized by an increase in their taxes as a result of constructing a new building or renovating an old one.

The same logic applies to taxes on the wages and salaries of working people and on the sales of goods. These forms of taxation started out at very low levels and have been increased over time, often in response to revenue shortfalls. The long-term impact of these measures has been to drive people and businesses to lower (or no) tax geographies. All across the United States, people live in one state because there are lower real estate taxes, work across a border because the wage taxes are lower and shop in another state because there are no sales taxes. People most behave rationally, even if our tax policies are not.

Every city or town would benefit, we believe, by the measures we have described. Perhaps more to the point, the people who work and produce and contribute to the economic and social health of our communities will be rewarded – as they should – for doing so. Those who enjoy the privilege of controlling the use of the most desirable and potentially profitable locations in our communities will, finally, pay for this privilege.