Economic Incentives for Affordable And Sustainable Development

How do we create more jobs?  How do we ensure that housing is affordable?  What can we do to reduce traffic congestion and pollution?  These are important questions facing our communities.  And sometimes, the answer to one question seems to reduce our ability to answer the others.  One reason for this is that we sometimes overlook key economic obstacles.

For example, many cities spend a lot of effort determining which business sectors or ventures are “on the rise,” and then provide subsidies to lure these businesses to locate there.  Few if any economic development experts have consistent and reliable success in predicting which business endeavors will succeed in the long term.  And regardless of our confidence in the success of a business sector, we have even less success predicting which individual businesses will succeed in it.  Therefore, rather than trying to predict the market and provide special tax breaks to a few businesses (be they new or existing), cities would be better off removing existing barriers to productive investments.  Then cities can let the market decide which businesses will succeed, confident that their regulatory and tax systems will not impede whichever businesses have an opportunity to grow.

One of the impediments to affordable and sustainable development is the property tax.  When property owners improve their property (providing housing or jobs), property taxes rise.  However, when owners allow existing buildings to deteriorate, property taxes fall.  These economic incentives are upside-down.

Now a typical property tax is only 1% or 2% of value – so this does not seem like much.  However, unlike a sales tax (which is paid only once), the property tax on building values is paid each and every year that an improvement adds value to a property.  A net present value calculation shows that this stream of tax payments can have the economic impact of a sales tax of between 10% and 20% on construction labor and materials.  That’s a significant cost barrier to property construction, improvement and maintenance.

The tax on building values is a cost of production.  (No building, no tax.)  As we know from fundamental economic theory, increasing the cost of production reduces the quantity and quality of what is produced – and this diminished supply results in higher prices for what’s left.  Little wonder that many developers refuse to embark on major projects unless they first obtain some property tax exemption or abatement.

Fortunately, some jurisdictions have made real progress in this direction — leading to job growth, more affordable housing and more sustainable economic development. They accomplish this by reducing the property tax rate applied to building values while increasing the tax rate applied to land values.

But won’t the higher taxes on land values undermine the benefits of lower taxes on buildings?  No.  Unlike buildings, land is not produced.  Therefore, the tax on land value is not a cost of production.  Most importantly, there will be just as much land after a land tax is imposed as there was before.  Thus consumers will not bid up the price of land due to reduced supply.  Because the price of land is based upon expectations of the benefits of land ownership and because a land tax reduces the benefits of land ownership, taxes on land value tend to reduce the price of land.

Thus, reducing the tax on building values makes buildings cheaper to construct, improve and maintain, while increasing the tax on land values makes land more affordable as well.

There’s even an aspect of this reform that helps reduce sprawl.  Property owners do not determine the value of their land.  (This is determined largely by the community, its vitality, and the proximity of particular sites to public goods and services:  “Location, location, location.”)  Also, owners cannot move their sites to other, lower-tax jurisdictions.  Thus, unlike the tax on buildings (which can be avoided by avoiding building investments or by allowing existing buildings to deteriorate), the tax on land values cannot be avoided:

So landowners are compelled to pay the tax on land values.  Where land values are high (near existing urban amenities like job centers, transit stations, etc.), land taxes will be high and this will compel owners to develop those sites (or sell to someone who will do so).  And these high-value infill sites are generally where we want development to occur in order to reduce sprawl.

As mentioned earlier, land values in an urban setting largely represent access to public goods and services.  Thus, to the extent that public infrastructure (roads, water & sewer, police & fire protection, schools, etc.) creates land value, landowners will pay a land tax in proportion to the public benefits that they receive.  This makes a land value tax more like a “user fee,” making it both comprehensible and equitable.   Essentially, jurisdictions that implement this reform use value capture to transform their property tax into a public services user fee — while giving all property owners a “universal abatement” on productive investments.

Jurisdictions that implement this reform can collect the same property tax revenue as they did before — but the incentives are more favorable for building construction, improvement and maintenance.  If properly designed and implemented, this system creates economic incentives for infill development, which makes better use of existing infrastructure, enhances transportation options and avoids premature development of rural areas that are needed for agricultural, recreation and conservation uses.

For more information, see “Using Value Capture to Finance Infrastructure and Encourage Compact Development.”  This article can be found at
https://www.mwcog.org/uploads/committee-documents/k15fVl1f20080424150651.pdf

Additional information can be obtained from http://www.justeconomicsllc.com

Guest post by Zintro user Rick Rybeck


Zintro, Inc

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