Retooling Property Taxes
How Re-Engineering the Property Tax Can Be Successful

Walter Rybeck

[Reprinted from GroundSwell, March-April 2010]

The following article is reprinted with permission from the March 2010 issue of Public Management magazine, published by the International City/County Management Association (ICMA), Washington, D.C.

How did some local governments generate adequate revenue during a failing economy, reduce property taxes for most homeowners, entice new private development without subsides, retard sprawl, and keep housing affordable? Certainly a timely question. During this prolonged recession, shrinking funds are forcing localities to cut back on services when they are most needed by people suffering from loss of homes and jobs.

Several dozen cities dug themselves out of a hole by re-engineering their property tax. They reduced taxes on homes and other buildings and raised taxes on land. Pennsylvania's capital city demonstrates the potency of this medicine.

In 1980, Harrisburg, Pennsylvania, was cited by HUD as one of the nation's most distressed cities. It had lost 800 businesses and a third of its population in 20 years. Mayor Stephen Reed initiated the two-rate tax in that era, reducing the tax rate on buildings to one-half the rate on land.

Reed, who continued as mayor until January 2010, credits the reform with playing a major part in reversing the city's downward slide. Most of the 5,200 stores and housing units that were boarded-up when he took office are replaced or back in use. Since then, new construction and rehabilitation of existing structures increased the city's taxable real estate from $212 million to over $1.6 billion. Businesses on the tax rolls rose from 1,908 to more than 9,100 by the start of 2009. Seeing these positive effects, Harrisburg reduced its tax rate on improvements to one-sixth the rate on land.

Tax hikes on idle sites induced owners to put them to use, discouraging sprawl. Reed said, "Unused urban land is what pushes development into open spaces. Many states try to save farmland by buying development rights. That's expensive. Without spending a dime, we achieved the same goal with our two-tier tax."

Upside-Down Property Tax

The conventional property tax combines two distinct taxes, one on land and one on improvements. Taxpayers dislike the tax on buildings-- for good reason. The more they invest, the higher their tax. In contrast, owners who let structures deteriorate are rewarded with lower taxes. Taxing good buildings heavily and poor buildings lightly is like giving blight and slums an engraved invitation to invade a city.

That's only the half of it. The good part of the tax, on land values, generally is too low, especially on vacant sites. Assessors look at the non-existent income streams of bare lots and mistakenly assign low values to them, ignoring their potential. This promotes land speculation, a prime cause of runaway housing prices, sprawl and recessions.

How so? Speculators hold prime sites vacant, waiting for population growth and local government services to make these sites more valuable. Plots kept in cold storage create an artificial shortage of developable sites. This drives urban land prices up, drives growth to the outskirts, and fuels more speculation until a boom, based largely on thin air, goes bust.

Virtues of Taxing Land

Taxing land more and buildings less takes the profit out of speculation, putting land users rather than land holders in the driver's seat. Unlike taxes on most anything else, taxes on site values reduce land prices. Good things flow from this remarkable fact, as these examples show.

Aliquippa, Pennsylvania, not only lost jobs when LTV's steel mill closed 20 years ago, a court order reduced LTV's property tax from $1 million to $200,000. The city reduced tax rates on buildings, making the tax rate on land 16 times higher than on improvements. This enabled Aliquippa to collect $450,000 from LTV's valuable site, and it nudged LTV to promptly find new occupants for its plant. Within a few years, the city treasury had a surplus. City Administrator Thomas Stoner says the two-rate tax "favors residences and puts more weight on industrial properties." This Rust Belt city still struggles economically but its housing costs remain affordable.

Peoria, Illinois, adopted tax reform under an enterprise zone law to revive a seven-mile strip of obsolete factories and blighted warehouses. This area along the Illinois River employed 2,000 people in 1980, down from 50,000 in its heyday. Taxes on new or renovated buildings were reduced 75 percent for five years, 50 percent for the next five. Reductions did not apply to land values. The city offered no subsidies to entice new firms. Building activity mushroomed, land values rose, and so did tax revenues. The dollar value of industrial and commercial building permits quickly rose from 8 percent to 29 percent of the citywide total. Tax incentives favoring instead of discouraging growth worked their magic.

Southfield, Michigan, attracted impressive growth after Mayor James Clarkson and assessor Ted Gwartney in the 1960s corrected the city's under-assessment of land. Land was assessed too low at 10 percent of value and buildings too high at more than 70 percent of value. Assessing both at market value touched off dramatic expansion. Average homeowners won a 22 percent tax reduction. Detroit, literally across the street, failed to follow Southfield's lead and was in decline long before the fall of its auto industry. Note that Southfield did not adopt a land tax. Its turnaround came from simply obeying the law of the conventional property tax and assessing both land and improvements at current value.

Getting Started

Local governments can replicate these successes by taking these steps:

1. Get state legislators to permit taxing land and buildings at different rates, if not already allowed.
2. Keep land assessments at current market value to get maximum mileage from the tax. (Inequitable land assessments in 2000 scuttled the two-rate tax in Pittsburgh, which had been a shining example of urban revitalization via tax reform.)
3. Run a computer simulation of a two-rate tax--lower rates on improvements, higher rates on land--to identify who pays more or less, to determine the optimum shift, and to avoid surprises. Organizations like the Center for the Study of Economics in Philadelphia, which designed many of the Pennsylvania reforms, can provide guidance on this phase.
4. Start with a revenue-neutral reform. If the community generates the same tax receipts citywide as under the traditional system, opponents cannot mischaracterize the tax shift as a tax increase.
5. Set land value rates as high as politically feasible. Everybody loves lower taxes on homes. The initial rate on land, however, should not be set so high that owners of vacant sites, whose taxes will rise, might defeat the measure. Once in operation, rate differentials can gradually be widened. In 2009, for example, Altoona, Pennsylvania, expanded its land tax rate to 27 times higher than its tax on buildings; and DuBois, Pennsylvania, last year reduced its building tax rate to only 0.2 percent, so its land tax rate is 44 times higher, or 8.8 percent.

Pocketbook Obstacles to Enactment

Landholders with little or no improvements on prime sites pay relatively minimal taxes under the conventional property tax. Shifting taxes off improvements and on to land values means their taxes go up. In Allentown, Pennsylvania, for example, the publisher of the local newspaper held acres of central city sites used for surface parking lots, and he managed for years to get the mayor to veto the two-rate tax approved by a majority of council persons, until council eventually won the day. In West Virginia, powerful coal interests, who pay low taxes on their assets, have consistently blocked the legislature's efforts to give cities and counties the option of using a two-rate tax in that state.

Here is a quick summary of the obstacles:

Obstacle 1: Advantages are not well known.

Remedy: Enable taxpayers to answer, "How will this affect me?" Run a computer simulation of the proposed change, showing who benefits and who pays more. Typically, after a large majority see they will pay less, they tend to favor enactment.

Obstacle 2: Political power of opposition. Real estate interests are among top contributors to political campaigns. Surface parking lot owners, slumlords, or others who pay more under the reform may use their political clout to block enactment.

Remedy: Fortunately, most land speculators in America also tend to be entrepreneurs. So it is important to show them how their tax reductions as business people, and as homeowners too, counteract the higher taxes on their unimproved or under-improved land holdings.

Incentives vs. Police Powers

New London, Connecticut, became notorious when the Supreme Court affirmed its right to condemn and replace good homes with commercial development. Widespread outcries arose against such aggressive use of condemnation powers. In July 2009, Governor Jodi Rell signed an act permitting New London to launch a land value tax pilot project that is now being designed. This use of tax reform to stimulate a local economy, as an alternative to manipulation of property rights, will be important to track.

Missing Tool

Harrisburg and the other cities cited used many measures in addition to tax reform to spur renewal, fiscal stability, and economic growth. Their land tax attacked the land speculation that often undermines the effectiveness of those other measures. Shifting taxes off buildings onto land is a vital but missing item in the tool kit of most local governments.

The reform changes urban dynamics. Lower taxes on improvements promote development instead of penalizing it. Higher land taxes return to the local government the site values that result directly from improved public services and facilities. Land taxes also spur in-city growth, opening the way to new enterprises and jobs. They keep housing prices from soaring into the stratosphere--and then tumbling. To save localities and prevent the next crash, the land tax has the earmarks of a reform whose time has come.