The Impact of Property Taxation on Housing Markets

Edward J. Dodson


[A paper presented at the annual conference of the Council of Georgist Organizations, held in Philadelphia, Pennsylvania, 4 August, 2005. Reprinted in GroundSwell, May-June 2006]


This paper examines how the gradual implementation of land value taxation (i.e., exempting property improvements from the tax base, while progressively capturing location rental values) is likely to affect the market for housing over time.

An important theoretical assertion suggested by Henry George's writings on the subject, is whether, as communities approach the full collection of location rental values, the selling price of land will fall toward zero. George predicts this outcome will result because location rental values are no longer privatized and, therefore, cannot be capitalized into selling price. He asserts in Progress and Poverty that, "by compelling those who hold land on speculation to sell or let for what they can get, a tax on land values tends to increase the competition between owners, and thus to reduce the price of land."

The cautious supporter of George's analysis can point to his actual wording and his inference of tendency. More generally, George develops the laws of production and distribution of wealth as laws of tendency. He is well aware of the many variables, or externalities, at play in any market.

Even more relevant for the future is the expected change in how people behave in response to the financial incentives resulting from liberating from taxation labor and investment in capital goods while removing the financial rewards of hoarding land for speculation. Once the process begins, the dominoes will begin to fall at an accelerated pace in the right direction:

"For this simple device of placing all taxes on the value of land would be in effect putting up the land at auction to whosoever would pay the highest rent to the state. The demand for land fixes its value, and hence, if taxes were placed so as very nearly to consume that value, the man who wished to hold land without using it would have to pay very nearly what it would be worth to any one who wanted to use it."

Externalities Abound

Today, the externalities affecting land markets are even more numerous than in George's time. In every regional market there are both natural and societally-imposed limits on the quantity of land available for development. Our experience with sprawling development surrounding large cities and even relatively small towns shows that these limits are not fixed in any absolute sense. Land that was once outside the ring of reasonable commuting distance is made accessible by limited access highways or high speed rail systems. At the same time, land is also set aside for these and other public purposes. As we move away from the high density development patterns of our older cities and towns, we press our public officials to keep huge tracts of land open for recreation or (more recently) as wildlife habitat preserves. Zoning and other planning tools can result in either more sprawl (e.g., because of large lot zoning) or in walking communities (e.g., because of provisions for mixed-use development or transit-oriented development).

Height restrictions for buildings also play an important role in the efficient use of land, with the added complexity that even in the central cities higher buildings tend to create more automobile use and land allocated for automobile parking. Parking lots absorb over 10 percent of the land in U.S. cities, but a much higher percentage in our central business districts. As much as 80 to 90 percent of the total is developed as surface parking lots. The amount of land used for automobile parking around the typical suburban shopping center or mall is several times greater than the actual land area developed with stores. A regional mall will include as much as sixty acres of land paved over for automobile parking.

These are important characteristics of every regional market, operating in conjunction with other key factors -- all of which are then influenced by state, national and global economic dynamics. If we were to attempt to construct a regional market model for purposes of forecasting land prices, we would need to know a good deal more information, including:

  • Population movement, most importantly whether in-migration exceeds out-migration, and whether those entering have greater or lesser household incomes than those departing.
  • Population demographics showing to what extent the population is aging and how many households are forecasted to have children attending area schools.
  • Land ownership statistics, to identify who owns the most developable but undeveloped land and whether they reside in the community or are absentee owners.
  • Scheduled or contemplated infrastructure projects that will take land out of the market and increase (or decrease) the value of contiguous land parcels.
  • The effective age and condition of existing housing units, as well as the number vacant due to condition, abandonment or other reasons.
  • The number of new housing units and type constructed annually.

This is only a partial list of the information we need to compile and analyze. And, even with all of this detail put into a computer model, other factors may prove to be more powerful than local or regional dynamics.

Where Are We Today

Last year, the Federal Reserve funded a study on residential land prices across the United States. The findings will not be surprising to most attendees of this conference:

  • since 1970, residential land prices have grown faster but have also been twice as volatile as existing home prices; averaged from 1970 to 2003, the nominal stock of residential land under 1-4 unit structures accounts for 38% of the market value of the housing stock and is equal to 50% of nominal annual GDP;
  • the real stock of residential land under 1-4 unit structures has increased an average of 0.6% per year since 1970; and
  • residential investment leads the price of residential land by three quarters.
  • we also estimate that in 2003:Q3 the nominal value of the entire stock of residential land is the same as annual GDP.

Even without the statistics, we know that land -- and, therefore, housing -- prices have been climbing year after year for more than a decade.

Actually, land prices have been climbing with periodic "adjustments" almost from the day the colonists set foot on land at Jamestown. For the first century and a half, what made the experience of life in colonial North America so remarkable was the widespread access to enough land at little or no cost. Some poverty existed, but the opportunity existed for most families to be largely self-sufficient. Today, there are comparatively few families making their living as farm owners. Yet, for the bottom two-thirds of households in the United States net worth in a home and the land underneath represents most of their personal wealth.

As indicated above, land value is fast approaching 40 percent of the total value of residential property. Despite the fact that the land market bubble seems close to bursting in the most speculation-driven markets, the national median price of housing continues to increase, to over $207,000 in May of 2005.

There are no statistics on the amount of vacant but developable land parcels in residential communities. Estimates run up to 15-30 percent of total land area in many cities and towns. To get a rough idea of the current total residential land value in the United States, we can use the above-quoted median housing price and the 40 percent land value figure, as follows:

Median residential land value = $82,800 ($207,000 x 40%) Total residential land value = $10 trillion (120,834,000 housing units x $82,800)

Remember, this figure is based on median residential land value. Using average housing/land prices would likely produce a much higher figure. Moreover none of the vacant but developable residential land is included.

The Future Under a Land Value Taxation Regime

The economic stress associated with spiraling land prices is clear to many here but not so clear to others. Numerous analysts continue to forecast that housing prices will plateau and, perhaps, fall somewhat in response to rising interest rates. Even those who are forecasting the bursting of "the housing bubble" do not make the connections we make based on the lessons learned from Henry George. With George's methodology to guide him, Fred Harrison forecasts 2010 as the next major burst in the land market cycle. For reasons beyond the scope of this paper, I am inclined to expect the crash to come before then. After this crash, we will have the next decade or so to achieve significant progress toward a land value taxation regime and, thereby, avoid yet one more recession or depression.

Whether and how far land prices will fall in response to higher and higher taxation of location rental values is more difficult to predict. As a community imposes higher costs on land owners for holding land out of use, we can expect that some owners will put their land on the market or initiate development plans sooner than they otherwise might have. The lower costs imposed on property improvements will work in conjunction with the higher carrying cost on land to stimulate development to bring land to its "highest and best use" as determined by local market conditions. The tendency of land prices to come down -- due to the increased competition between land owners for purchasers -- may be offset by increased demand. The key variable will be how quickly investors begin to recognize the opportunity to profitably develop locations in the community and the competition to purchase the most advantageously positioned locations. Another variable is the ability and willingness of owners of land parcels to absorb higher annual taxes without feeling any pressure to act. Wealthy individuals or entities may not bring their land to development even at the point where they are paying the full location rental value in taxes. This could keep the supply of land offered below that sought by investors for development.

Conclusion

As proponents of land value taxation, we need to stress when attempting to convince elected officials and others of the merits of our case that every regional market is affected by distinct qualities. Thus, while its is theoretically possible for the selling price of land to fall and fall to a very low level, this is not likely to occur in the short run. More likely, land prices will stabilize as supply more closely matches demand. This means that government expenditure and private philanthropy will continue to be needed to increase the supply of decent, affordable housing to people whose household incomes continue to fall in real terms.

The extent to which communities have already moved toward land value taxation has been too limited to stimulate the type of expansion in economic activity Georgists predict will occur when the taxation of location rental values replaces most or all other local taxes. What can be said is this: cities such as Harrisburg, Pennsylvania are no longer hindered by the disjointed incrementalism that continues to plague most other communities. Harrisburg now at least has a strong enough revenue base to begin to channel funds into its more distressed neighborhoods, where housing needs are great and housing costs surpass the financial capacity of many residents. Advocates of affordable housing everywhere would do well to press for the adoption of land value taxation to replace taxes on property improvements, wages and commerce. There is no other change in public policy with the potential to stabilize and eventually lower the cost of housing.



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