Site Value Taxation, Its Impact
Upon Productivity and Economic Stability

Edward J. Dodson

[A paper submitted for a course on Macroeconomics,
University of Pennsylvania, February, 1981]

Government at all levels has poured literally billions of dollars into the nation's urban centers in an attempt to rebuild blighted areas and regenerate economic prosperity where there has been none for decades. The result in the City of Philadelphia has been a constantly eroding tax base, as employers and tax-paying citizens have moved to suburban or other locations. Those left within the City are, by and large, more dependent upon governmental services, creating a need for increased tax revenues; which serves to repeat the cycle of departure.

Increased energy costs and the desirability of a "Center City" residential and business address have brought a significant number of higher income professionals and service-type industries back into the City. While this demographic shift has brought life back into the urban core, the majority of Philadelphia neighborhoods have not benefited substantially. The City continues to face annual fiscal crises, even though business, wage and real estate taxes are among the highest in the nation.

In an effort to examine the economic principles underlying the problems of the decaying urban center, and the potential for rational solutions, we must first recognize the relationship between the three factors of production -- land, labor and capital.

A community -- such as Philadelphia -- develops over a period of time, and the land upon which its structures are built becomes increasingly more valuable as population increases. The economic principle is straightforward: once a desirable geographic location is completely populated and ownership of each particular parcel of land is sanctioned by government, new arrivals to the area must agree to pay the owners of land (defined to include all resources existing in their natural state) for its use. The return to the owners of land is described as "economic rent", and represents that portion of the wealth produced by labor ("wages") which exceeds what labor could produce on "free" land.

Man is a social animal. Historically, the urban environment has promoted economic growth and contributed to the opportunities for specialization necessary therefor. And, as population density has increased and the demand for housing and industrial sites grew, so did the value of the land. This concentration of development gave Philadelphia a strong economic base well into the twentieth century. The decline of Philadelphia (and many other industrialized cities) as an industrial center has its roots in several crucial historical changes:

(1) The economic depression during the 1930s brought large numbers of rural farmers and other poverty-stricken groups to the urban centers, increasing competition for scarce employment opportunities and driving wages down. This was the beginning of the end of the small, independent farmer; and the acquisition of farmland by large corporate owners for capital intensive farming or eventual sale for non-farming development;

(2) American participation in the Second World War led to a mass migration of population to California and the Southwest in general. Massive federal expenditures for an interstate highway system not only stimulated the movement in population (disrupting natural growth patterns) but also caused an explosion in land values along proposed major highway routes, particularly at interchanges. As a result, even more highly productive farmland has gone out of production and been taken over by wasteful low-density industrial use or urban sprawl; and

(3) Those who left the Eastern cities for "greener pastures" (whether suburban or to the sun belt) were generally replaced by less educated, less skilled families, less able to command wages required to adequately maintain residential properties or support local businesses. Over the three decades following the end of the Second World War, Philadelphia neighborhoods experienced tremendous "destabilization". Attracted by more favorable markets, lower taxes and other amenities associated with other areas of the nation, many industries left Philadelphia and took with them in the neighborhood of 150,000 employment opportunities.

Anyone who uses mass transit, Interstate 95 or the Skuylkill Expressway on a regular basis can easily see that any shortage of jobs in Center City has over the last several years been largely relieved. And yet, the city's work force suffers from heavy unemployment. The explanation is simple. Philadelphia's "Center City" revitalization is based upon the creation of a service-oriented economic base, and most of the educated, professional members of the labor force still live in the suburban communities - traveling to and from the urban center each day, but spending the bulk of wages earned on goods and services outside Philadelphia.

Government programs designed to restructure our society and implement a redistribution of the nation's wealth have provided countless disincentives to produce by rewarding failure. Unemployment compensation welfare programs and other subsidization of the urban poor have trapped these individuals at the subsistence level and contributed to their inability to migrate to areas where opportunities might be available. With few opportunities available for entrance into the mainstream of the economic system and rising disenchantment with a society in which a large segment of the population has no meaningful impact, disintegration of any semblance of social order is an inevitability. No one should be surprised at the high level of crime, neighborhood deterioration or educational maladies. What surprises me is the degree of positiveness which remains.

Thus far I have reiterated the problems. If massive government interference and expenditures is not the solution, then what is? First of all, we can thank the concern over dwindling fossil fuel resources and increased energy costs for focusing the public eye upon the problems of the city. Then we must go back to the initial relationship between population expansion and increased demand f6r land sites upon which to live and work. Then, ask yourself, "which is more valuable, a piece of land on which improvements may be made without payment of tax, or a piece of land on which taxes must be paid based on any improvements?"

The answer, of course, is that the piece of land exempt from taxes on improvements will be the more valuable.

Given the above circumstances, it stands to reason that landowners would be the ultimate beneficiaries of any tax reduction given to labor or the owners of capital, because -- in the long run --any increased returns to labor and capital would attract additional increments of each into productive activity, until the margin of production dropped to a point were the wages earned by labor and interest earned by capital were at their former level. The drop in the margin of production establishes the level of economic rent obtained by the landowner at a point at which all land in use becomes more valuable. Consequently, the price of land would increase as a result of increased demand by labor and capital -- stimulated by the elimination of taxes on improvements.

Since current substantial levels of taxation upon labor and capital have shifted the margin to a significantly higher point on the production curvr than would otherwise be the case, we can project the potential for land values existing at a much higher level than exist today. Additionally, taxation of improvements at such a high level has resulted in a number of serious consequences:

· Productive activity is stifled;
· Employment opportunities are limited by the absence of economic expansion; and

· Developable land sites are misallocated among competing and inappropriate uses.

At the level of national monetary policy, the Federal Reserve System has also been permitted to expand the money supply under the assumption that additional funds will stimulate the economy and solve the problems of contraction (which, as Milton Friedman has stated so often, have been created by actions of the Fed and by government fiscal policy).

EFFECTS OF A TAX REDUCTION

Landowners rather than labor or owners of capital would be the long term beneficiaries. A substantial tax cut would initially stimulate business activity but, as shown above, new increments of labor and capital brought into production would increase the demand for land and cause the margin to shift to a lower point on the production curve. As a result, land values would increase substantially, eventually leading to a curtailment in investment activity and recession as speculation consumed available land sites and withheld the land from the market.

Elimination of this threat to our economy requires a restructuring of the system by which most of our nation's cities -- Philadelphia included -- taxes land and improvements. In conjunction with a planned, graduated elimination -- of the taxes on the productive elements in our economy (labor and capital), the taxes imposed on land values must be gradually increased, eventually absorbing the entire level of taxation upon land values alone. Such a policy would result in more productive employment of both labor and capital, an increased level of wealth, higher government revenues and a reduction in the problems associated with abject poverty.

REFERENCES

1. Jude Wanniski. The Way The World Works, (Simon and Schuster,1979).
2. John Kenneth Galbraith. The Age of Uncertainty, (Boston: Houghton Mifflin Company, l977, Chapter 10), pp. 280-302.
3. Henry George. Progress and Poverty (New York: Robert Schalkenbach Foundation, 1975 edition. Originally published, 1879), pp. 422-472.
4. Henry George. The Science of Political Economy (New York: Robert Schalkenbach Foundation, 1968 edition. Originally published 1897).
5. Karl L. Falk, "How to Save Our Blighted Cities", American Journal of Economics and Sociology (New York, Vol.39, July 1980), p. 260.
6. Mason Gaffney, "Tax Tool for Meeting Urban Fiscal Crisis", American Journal of Economics and Sociology (New York, Vol. 27, July 1968), p. 253-258.
7. George E. Peterson (Editor), Property Tax Reform (John C. Lincoln Institute and The Urban Institute, 1977): "An Agenda For Strengthening The Property Tax" (presented by Mason Gaffney).

Note: The original of this paper includes several graphs with descriptions that could not be reproduced for republication here. Acknowledgement was given in the original paper to Frank D. Walker for assistance in developing the two graphs included.