Tax Reform That Would be Truly Meaningful

Edward J. Dodson

[A response to a news story, "Lawmakers Eye Property Taxes," by Brad Bumsted, Pittsburgh Tribune-Review, 29 November, 2006. The text below was sent to Mr. Bumsted for comment that same day]

This somewhat long email is prompted by your article on the probable action by the Pennsylvania legislature to do something about property taxes. As the politicians fall over themselves to respond to the widespread public reaction to rising property taxes, they seem to be on a course that will ignore both fundamental economics and even ethics.

My professional life has been spent in the community development field, partly as a researcher and partly as a program manager (20 years with Fannie Mae in Philadelphia and before that with a large regional bank). This work caused me to examine taxation as part of overall public policy as it affects community revitalization efforts and the availability of decent, affordable housing. As one would expect, the property tax is an important component in the equation, as are all the other means by which government raises its revenue.

On numerous occasions over the years - either before city council meetings or at conferences -- I have offered the opinion that two policy changes should be strongly considered under any plan to reform the property tax. The first is allowing homeowners to apply to have their property tax payment capped based on a formula that looks at a combination of household income and liquid assets. The amount of property tax owed would not be affected, only the amount that had to be paid annually. The unpaid amount would accrue as a lien on one's property, to be paid at time of sale or transfer of ownership. So long as property value is the basis for our tax obligation, this approach, I believe, is the fairest way to assure that long-term residents are not forced out of their neighborhoods because of property tax increases.

The second proposal I have advocated is to give all communities, all school districts and all counties the option to adopt a two-rate property tax structure, under which property improvements would be gradually reduced (and, ideally, eliminated) over a stated period of time (e.g., ten years). At the end of this period, land value only would be subject to taxation. There are very good reasons - both economic and ethical - for moving to a land-only property tax base (and around thirty communities and a few school districts in Pennsylvania have done so under a state constitutional provision that permits this approach). When land values are appropriately subjected to taxation, landowners have less ability to hold land idle for speculative gain, creating a more competitive land market and stabilizing land prices.

High land cost is one of the main reasons why many businesses find Pennsylvania locations less inviting than other states. Also, high land cost is also the reason we have such a crisis in affordable housing in so many of our communities. For the last few decades, many people have "cashed out" of their property (i.e., taken the increases in land value) and moved south or to the southwest, where land prices (and, therefore, housing and the cost of living, generally) are lower. These options are disappearing, as land costs have skyrocketed all around the country, but especially in locations attractive to retirees. Moreover, household incomes for retirees in Pennsylvania are often too low to permit the majority of retirees to relocate. So, the elderly stay and those who have the educational and professional credentials continue to depart. Only in the few places that have adopted the two-rate property tax are their signs of economic and demographic stability.

What has not yet come in the debate over the property tax is that there is a calculable amount of revenue that is appropriately available to be raised - specifically, from the taxation of land values. The economics are not that complicated. Every parcel of land has some annual rental value in the market. This value is created by aggregate public and private investment, rather than by what any individual landowner does or does not do on land owned. This annual rental value is capitalized by market forces into a selling price for land, with land speculation driving the price up and up even more. As a simple example, suppose you could lease a land parcel you own for $10,000 a year to someone or some business. If the expected rate of return on investments is 5%, the capitalized value of this land parcel would be 20 times $10,000, or $200,000. The owner today might ask a good deal more than this for the land because of the low effective rate of taxation that is generally levied on land (particularly vacant land). An annual property tax that approaches $10,000 would remove the profit from landowning, but then the landowner would be encouraged to improve the land parcel to its "highest and best use" as determined by market demand, since those improvements would not be subject to taxation (when full land-value taxation is achieved).

Thus, there is some amount of revenue that ought to be raised by the taxation of land values. I do not know what that amount is, but it is probably more than the total amount now being collected by the general property tax. The difference is that revenue would be raised from values created as a direct result of expenditures on public goods and services. Private investment in buildings of all types would no longer be burdened by taxation.

Most economists who have studied land markets and investment decisions agree this means of raising revenue would have a major impact on the revitalization of our urban communities and help to curtail sprawl. So, there are a number of very positive secondary effects of adopting the taxation of land values.

Another serious problem is the infrequency of fair and equitable assessments. Property assessments are all over the map in terms of maintaining assessed values of like properties (with like land values) at the same percentage of current market value. I favor turning this responsibility over to a state agency rather than to the counties or local government agencies, with a mandate to use market data to adjust assessed values on an ongoing basis. For residential properties, market value data is readily available. Moreover, as all of Pennsylvania moved toward a land-only tax base, the cost of keeping land assessments current would be a fraction of the current cost of property assessment. The savings would be significant where income-producing properties are concerned, inasmuch as none of the financial information concerning the property improvement would need to be captured and analyzed.

I have been retired from Fannie Mae since early in 2005. However, for the last few years in my position, one of my responsibilities was to travel to the cities in which the company had a field office to give presentations to groups of "stakeholders" on public policy choices and their implications. I had convinced the people to whom I reported that the above proposals were essential ingredients to our mission to help solve the problem of disinvestment in communities and expand the supply of affordable housing. If what I have written here seems to make sense - and you have questions or objections and concerns - I would be more than happy to respond to any questions you have.

Also, you may wish to interview Alanna Hartzok, Co-Director of the Institute, who has spearheaded an effort to raise these same issues both nationally and internationally, one result of which is a United Nations-funded project to promote the adoption of land-value taxation.