How to Refute Arguments for Reducing Real Estate Taxes

Herbert Barry, III

[Reprinted from GroundSwell, July-August 2005]

Many politicians and their constituents are demanding reduction of real estate taxes. These proposals fail to distinguish between buildings and land. Buildings in a city should be exempted from taxation to encourage desirable construction and improvements. The tax revenues from real estate should be replaced by higher tax rates on unimproved land. The higher tax on land value has the additional beneficial effect of forcing owners of vacant and underdeveloped lots to develop or sell their properties. Replacement of real estate taxes by higher income or sales taxes would detract from the desirable actions of earning money and commercial exchanges.

Land is a natural resource. Instead of depreciating during time, its value increases due to inflation, which gradually depreciates the currency. Land value is also increased by facilities and prosperity of the community rather than by the owner's action. In a valuable location, such as the center of a large city, the quantity of land is limited. Prevalently insufficient tax on land causes high purchase prices, ownership of most expensive and extensive land by wealthy individuals and corporations, and vacant lots and dilapidated buildings in expensive locations.

A building is constructed and maintained at the owner's expense. Its rental and market values are increased by facilities and prosperity of the community, but these beneficial effects are counteracted by competition from other buildings. In a valuable location, buildings can be taller, larger, and more numerous. Depreciation of buildings is only partly counteracted by expensive maintenance because of preference for newer buildings. It is feasible to exempt buildings from taxation and replace the revenue by a higher tax rate on land. Clairton, Pennsylvania has a negligible tax rate on buildings. More than a dozen other municipalities in Pennsylvania have higher tax rates on land than on buildings.

A frequent argument is that taxation should be based on ability to pay. The owner of a building can obtain the needed income from tenants or by occupying the building as a substitute for renting it. The same argument supports taxation of a portion of income, sales, and capital gains. The owner of vacant land receives from it no income with which to pay the tax.

Taxation inhibits the desirable actions of constructing and improving buildings, earning income, buying and selling, and obtaining capital gains. Contrary to these detrimental effects, taxation of unimproved land has desirable effects. Most owners of expensive or extensive land are wealthy individuals or corporations. Most homeowners benefit by a shift of taxation from buildings to land. They inhabit a well maintained house on a small plot of land in a residential area that is not one of the most valuable locations.

Another argument against higher tax on unimproved land is that some homeowners cannot afford the real estate tax in a location that has become highly valuable. They can attain prosperity by selling the property and moving to a more appropriate location.

A general argument against a high real estate tax rate is that it decreases the sale price and therefore is a hardship for homeowners. If an increase in the land value tax is accompanied by exemption of the house from taxation, the higher sale value of the house compensates for the lower sale value of the land.