Reviving Our Cities,
A Market Driven Perspective

Edward J. Dodson and Walter Rybeck

[1991]

Walter Rybeck is President of the Center for Public Dialogue, Kensington, Maryland. Edward J. Dodson is Director of the School of Cooperative Individualism

INTRODUCTION

Many of our nation's cities are plagued, despite major government and private reinvestment programs undertaken, with continuing urban decay, the loss of commerce and employment opportunities and a shrinking tax base. These problems stretch from one end of the country to the other and involve communities of all sizes. Everywhere, municipal governments search for ways to reduce expenditures. In some cases, even the most basic services such as police and fire protection have been severely reduced or even eliminated. This is clearly a catastrophe in the making.

Until recently, our cities have been thought of as islands of problems in a sea of prosperity. Even within the islands themselves there were pockets of prosperity. Urban centers experienced rebirths and revitalization. Corporations built impressive headquarters in the downtown areas. Aged residential neighborhoods within walking distance of the city centers attracted, first, urban pioneers, then real estate developers and higher income households. Many neighborhoods were left out of this turn-around, however. Critics have looked to the financial services industry as an important factor in this anomaly.

Despite what amounts to a prolonged period of disinvestment by most regional and even local financial institutions, the evidence suggests that there was no conscious strategy adopted by these institutions to eliminate their presence in certain neighborhoods. Rather, a process of unconscious redlining resulted in areas where economic conditions discouraged private investment. Many urban neighborhoods have, over a span of several decades, become centers of blighted housing, abandoned structures, business flight, joblessness and public disinvestment. Consequently, within these areas a diminishing number of business and consumer applicants for loans possess acceptable collateral or credit histories to meet normal underwriting criteria. Yet, what is almost universally recognized is that a failure to invest dooms such areas to even further decline.

The question we have grappled with is how this cycle of decay be broken. What public policies would lead to a healthier investment climate in our inner-city neighborhoods while resolving the fiscal crises now faced by nearly every community? This paper analyzes the root causes of these problems and argues for specific changes in tax policy as an essential element for the cure.

CITIES AS MAGNETS FOR THE POOR

The Great Depression touched off a massive migration of unskilled rural workers into the nation's industrial centers. City governments became overwhelmed by the problems of overcrowding and the ever-growing demand for public services. Not until the late 1960s did federal spending in the cities bring a real measure of external financial support for the development of both physical and social welfare infrastructure. At the same time, the nation experienced significant population shifts and the influx of large number of immigrants from other countries. The pressure on municipal and state governments to fill the revenue and services gap increased enormously, as did the pressure on taxpayers and property owners to absorb the escalating cost of government.

While the cost of municipal government escalated, a counter-migration from the cities to the suburbs was underway. Federal programs for housing and highway construction stimulated suburban sprawl. Private and public investment reserves where siphoned from the older cities into new and more land extensive communities. Those who left the central cities also tended to be the more higher educated and more technically skilled, taking with them their potential for higher earnings. Industry was quick to recognize the reduced cost of doing business in the suburbs, and many corporate executives saw an opportunity to relocate to what at the time were less congested areas. New technologies reduced the demand for unskilled and semi-skilled labor, and the interstate highway system turned the central cities into transportation obstacles to be circumvented rather than destinations. As office and industrial parks flourished in the suburbs, the out-migration intensified. Major retailers and other employers began abandoning the central city in favor of suburban malls and shopping strips. For those at the lower end of the socio-economic ladder, the opportunity to improve their circumstance was rapidly disappearing.

One result of this pattern of disinvestment has been a continued deterioration of the housing stock in the nation's older cities. Most dwellings in the inner-city neighborhoods are more than fifty years old and require substantial modernization of heating, plumbing and electrical systems to bring them close to modern standards of decency and efficiency. As out-migration occurred, large urban homes were often purchased by investors and divided into apartment units or were occupied by families whose lower incomes prevented them from properly maintaining these aging structures. And, as low income renters replaced owner-occupants, housing maintenance declined. Accelerated depreciation and tax penalties imposed on owners for capital improvements permitted (and even encouraged) investors to gain maximum income while their properties deteriorated in physical condition. Declines in market values occurred as the median household income fell in these neighborhoods, adding to the disincentives for adequate maintenance or rehabilitation by property owners. A large number of absentee owners simply filled their properties with as many tenants as possible at whatever rents they could obtain, discontinued paying property taxes and allowed their properties to deteriorate until condemned by city authorities. Once the properties were acquired by the city at tax sale, the tenants were evicted and the property boarded up or demolished. The tenants were then forced into public housing, where available, or had to compete for the limited supply of other rental units.

NATIONAL AND INTERNATIONAL FACTORS

The post-Second World War resurgence of European and Asian economies, as well as the industrialization of certain developing nations confronted the United States with a degree of competition in domestic and global markets for which our industries and labor force were ill-prepared. Technology transfers and the proliferation of multinational corporations have all but obviated traditional policy making as a tool for protecting domestic economies from external competition.

Massive deficit spending during the U.S. military action in southeast Asia, exacerbated by the market penetration of O.P.E.C., resulted in a soaring national debt. We went through a prolonged period of stagflation at home while other countries suffered various degrees of recession and depression. As we have seen, a large number of the countries described as less developed have continued to live with hyperinflation and reduced standards of well-being for the majority of citizens. In the United States, the response of middle and upper income voters to ever higher taxes and erosion in purchasing power was a political backlash against runaway government spending. This resulted in Proposition 13 in California and other tax limitation measures across the country. Ronald Reagan was also elected President on the promise to reduce the size of the federal government, return authority to the states and hold the line on taxes.

During this same period, the economy of the United States was in the final stages of a dramatic transition from one that employed most of its labor force in heavy industry to an information and service-oriented economy. By the beginning of the 1980s most corporations had positioned themselves to move production around the globe to where costs were lowest. The initial impact was to shift the equilibrium against blue collar workers, applying downward pressure on incomes and weakening unions. Millions of workers nationwide entered the group of marginally employed or long-term unemployed, placing additional demands on city government services while simultaneously eroding the tax base at a time of reduced federal support. Today, even the highly educated and professional groups are subject to the same pressures that blue collar workers first felt a decade ago.

A CHANGE IN FOCUS

Under conditions that demand self-sufficiency, city officials and community leaders must focus on what can be done locally to resolve financial and social problems. Economic growth is clearly critical. In the case of housing, for example, the availability of residential mortgage loans is directly linked with the expansion of full-time, steady employment opportunities for those now left out of the mainstream economy. The construction and rehabilitation of units as rental housing is also a profitable investment opportunity only if neighborhoods provide employment for potential tenants. Too often down played by policy analysts is the fact that job-creating economic growth is the cornerstone to revitalization of blighted neighborhoods in our cities and fiscal solvency. Gentrification of historically significant areas brings some professional households back to the urban tax base; however, unless the housing stock and employment opportunities are expanded for those now dependent upon government programs for support the net gain is insignificant.

EXISTING PUBLIC STRATEGIES
Site Acquisitions and Tax Abatement

Many cities have created public development corporations that attempt to attract new industry, especially high technology businesses. One of the primary elements in this strategy has been a site acquisition program. Land suitable for commercial or industrial development is purchased by the city (funded by the sale of tax-free municipal / industrial development bonds), then resold to businesses agreeing to locate in the city. The price paid for land offered under these programs is often less than 25 percent of market value. Additionally, new firms are normally exempted from city real estate taxes for a stated period of time.

Such land cost write-downs and tax abatements are undoubtedly attractive to new firms. However, these new businesses require local services and facilities. The increased economic activity generated by the new firms must be sufficient to pay for such services as well as the subsidies given. In many instances, the land and tax bait may cost the city more than the catch is worth. An important point to remember is that the costs of attracting new businesses are borne largely by older, existing businesses, which must then compete on unequal terms (including, for example, the payment of higher taxes) with the newcomers. One consequence is that older and often marginally-profitable firms may be forced out of business, leaving their employees without employment and the city with a zero sum result.

Ways must be found for bringing down land costs and tax costs for all producers in the community -- older firms as well as the new. Helping existing firms in a city to thrive and expand is often more cost effective than trying to lure new firms from other places. Companies being sought after by competing cities sometimes put extravagant prices on their locational decisions. A vital and growing economy, on the other hand, acts as a magnet for business. When the environment is right, commerce does not need to be subsidized in order to thrive.

THE CRUCIAL ROLE OF TAXES

Economists, as a group, are uniform in agreement that the greater the tax burden on production the less production there will be. Taxation at the federal level presents a serious competitive disadvantage for many businesses who must compete with foreign producers. Overtaxing production is, however, an equally serious problem at the local level.

Local revenue is raised primarily from taxes on individual and business income, on retail sales and on real estate. Income and sales taxes are large burdens on production. The real estate tax also hampers production insofar as it falls on improvements such as homes, office buildings, factories and equipment. Conversely, insofar as the real estate tax falls on land, it is not a tax on production. The quantity of land in existence is fixed and is not produced by people. A change in tax policy has no effect on the amount of land in a city. Whether or not land is taxed and how heavily does have a direct effect on the availability of land and its price to potential users.

Land is unique as a commodity because of two characteristics: it is both fixed in total supply and in location. An individual or business can leave an area, can take possessions, equipment (and, occasionally, even a home or factory) with them, but not the land they occupy. Labor and capital are mobile, while land is not. A pro-employment and pro-production tax structure must be fashioned to recognize this distinction by collecting a much greater proportion of local taxes from land values than any other source (i.e., sources that can leave).

A CLOSER LOOK AT LAND TAXES

To suggest that a tax increase would reduce the price of a commodity runs counter to conventional wisdom and, most would respond, to common sense. Nevertheless, if taxation could be used as a means to bring more land onto the market at reasonable prices, to encourage the production of more and better housing, and to reduce construction costs while generating more jobs, such a tax policy should stir excitement and support among economists, policy makers, officials and all citizens concerns with the social and economic climates of our cities. A growing number of economists are convinced, in fact, that a tax on land values is a tax policy fully capable of generating these results. The evidence is provided by the experience of more than a dozen Pennsylvania communities (including the city of Pittsburgh) that have moved in this direction.

Historically, the tax on land value has been linked with the tax on buildings as part of the much-maligned property tax. As a result, the virtues of the land tax have been largely obscured. Consistently heavy taxes on improvements reduce the incentive to build and to maintain. To reverse the economics of the real estate tax, we ideally should gradually reduce the building tax while increasing the land tax until, say, within five or ten years the real estate tax will be levied on land values alone -- with all improvements fully and permanently tax exempt.

An important element in the efficiency of the land tax is accurate assessment of land value. As a consequence of infrequent and archaic assessment practices, present taxes on land throughout most of the United States are relatively nominal and constitute a low annual holding cost for titleholders. Imposition of a higher rate of taxation on land -- even when underassessed -- reduces profit from speculative holdings and causes owners to release more land onto the market for development. Although the absolute quantity of land remains constant, the increased supply of land brought to the market will tend to bring land prices down. Reductions in land prices will then be reflected in a reduced cost of housing for the consumer. Moreover, substitution of the land tax for the present property tax will, for most homeowners, result in lower property taxes and a reduction in housing-related expenses. A property tax that exempts improvements also means that higher assessments and a tax penalty will no longer follow the completion of a new dwelling or rehabilitation of an old one.

THE LAND TAX AND BUSINESS PROPERTIES

When only the underlying land value is taxed, a capital-intensive office building is subject to the same tax as a surface parking lot using an identically-valued site. Owners of properties improved to what the market (and zoning) directs as highest and best use would experience considerable reductions over what they now pay. Owners of vacant sites or significantly underused sites get a tax push to put their land to more appropriate use or to sell the land to someone who will.

LAND BANKING

Land banking, the practice of buying up sites for future use, would become costly under market conditions subject to a land value tax. On the other hand, the need by developers to acquire and hold sites for long periods of time would disappear. Developers have historically inventoried more parcels than they need for immediate or medium-term use in order to avoid losing a large share of their future income stream to land speculators. A high enough land tax makes speculation unprofitable; therefore, the land market will experience less hoarding and developers will find attractive sites at reasonable prices when they are ready to build.

A NEW ECONOMIC EQUATION

Promoters of economic development should note that the land tax leads to a very positive business environment characterized by low land costs and low taxes on production. In effect, an enterprize zone is created for all businesses and not just a privileged few. New and old firms benefit, as do large and small. The land tax exempts all buildings and generates no tax increase as a penalty for modernization or expansion. These incentives to produce goods and services also have a ripple effect in a local economy.

REVITALIZING DETERIORATING NEIGHBORHOODS

Disinvestment has been presented in this analysis as the result, not the cause, of neighborhood decay. The evidence strongly suggests that the tax policies practiced in our cities, with their heavy burden on production and commerce, are serious obstacles in the way of efforts to revive older neighborhoods and provide a decent opportunity for meaningful employment to large numbers of citizens. The real estate tax as it now operates is, in particular, a blighting influence that must be dealt with if renewal is to occur. Moving to a tax based on land values only represents a market-centered rather than a subsidy approach to resolving this problem. The benefits accrue not only to blighted areas, however, but to cities as a whole.