Make Tax Abatement General

William S. Peirce

[Reprinted from GroundSwell, March-June 1990]

ED.NOTE: The writer is a professor of economics at Case Western Reserve University and an advisor to The Heartland Institute. His thoughts appeared first as one of a series of articles on public policy issues: a Heartland Perspective. It carried in that instance, however, a caveat ("should not be construed as ncessarily reflecting the views of the Heartland Institute*) which does not apply here. Professor Peirce's arguments are sound, and do, indeed, reflect the views of this publication.

The battle over tax abatement for particular projects focuses public attention on the wrong issues. The important question is not whether a particular hotel, office building, or factory will benefit the community, but whether the public squabbling (and whispering of private deals) is really an efficient and fair way to promote development.

All real estate development creates what some economists call "neighborhood effects." This means that if one person improves his property, the value of the neighboring properties rises as well, because the whole neighborhood becomes more attractive, if this happens on a grand enough scale, a whole district may turn around as development becomes self-sustaining.

The possibility of this revitalization, however, does not necessarily mean that the public should support subsidies to or special treatment for developers or large employers. The same forces that convey benefits to the community from a major hotel or steel mill also apply to the more humble investments of individual property owners or the proprietors of tiny businesses employing a handful of people. It is certainly not obvious that the major projects appealing for abatement do more for the community than the myriad of little ones.

Everyone wants abatements, but only the favored few get them. As more abatements are granted, those who do not obtain them may rightly feel that they will be left holding the bag.

Who are to be the favored few? First, only the big players need apply. In an ideal world, perhaps, urban planners and economists with perfect foresight would analyze competing requests for abatement to see which moved the city most efficiently toward the long-term goals in the city plan.

In our less than perfect world, however, urban planners and even economists may have less wisdom and worse foresight about how the city should develop than do the property owners and developers.

Moreover, it is likely that decisions to grant tax abatements will be influenced by politics, as well as by economics and urban planning. One can imagine a city so corrupt that bribery or favoritism plays a role. In any event, the importance of tax abatement means that developers will spend time and effort in an attempt to obtain this special favor. This is inefficient, unfair, and conducive to corruption.

This is not criticism of the developers or of any of the projects that have applied for abatement. Nor is it a criticism of the city government. The players are just responding to the existing set of rules. For now, city governments may have no choice but to lure particularly important investments with particular tax abatements - and then we can all ponder .whether the little taxpayers got stuck in the process.

Better rules can be written. The defect in the present system is not the tax abatements, but the fact that they have to be granted as special favors. A property owner's investments do confer benefits on the neighborhood, but this alone cannot justify special treatment. After all, a homeowner's new family room, the landlord's refurbishing of a duplex, and the shopkeeper's new storefront all bring benefits, too.

Chicago, Cincinnati, Detroit, Milwaukee, St. Louis - in fact, most urban areas in the Midwest - desperately need investments both large and small if they are to renew their aging residential neighborhoods, spur the growth of their downtowns, and revitalize their manufacturing sectors. All these (and other) improvements deserve tax abatement, not as a matter of special privilege, but as a result of general policy.

Exempting all improvements from taxation is economically feasible and efficient. The result would be to shift the entire burden of the real estate tax to the value of land alone. We need only examine the experience of Pittsburgh and several other cities in Pennsylvania for evidence of the many advantages that can be found in such a reform of the tax system. White none of these cities has shifted the entire property tax burden to land, some tax land at higher rates than improvements, and some exempt new improvements entirely for a limited period of time. Other research has found that lowering overall tax burdens also stimulates economic growth and job creation.

. If tax abatements are good for the community when they are extended to a few favored projects, let us redouble the benefits by exempting all improvements from taxation.