• AIAIIX: NEWS DECEMBER 1995 / JANUARY 1996

RESPONSE TO MEMBER FORUM

TaxReform Motivates Sustainable Development

To counteract sprawl,the property tax can be reformed

by reducing the tax rate applied tobuilding values, while increasing the

tax rate applied to land values.

RICK RYBECK

Rick Rubeck is a staff attorney for the Honorable HildaHowland M. Mason, who serves all the Council of the Districtof Columbia as Councilmemher at Large. * .

Carl Elefante wrote that, regardless of whether ornot "sustainability" is a fad, its underlyingconcepts and issues are important. Furthermore,

architects are responsible for buildings that are energyefficient and promote community, or that promote autodependence, sprawl, and environmental degradation. Yet,architects must satisfy their clients who may not sharetheir concerns. Fortunately, property tax reform can provideclients with an economic motivation to promote moresustainable development that is compact and transit-friendly.

As Elefante indicated, sprawl inhibits the use of transit,necessitates auto travel, pollutes the air and createspolitical and economic dependence on petrochemicalsuppliers. Energy and time are wasted in traffic jams,reducing productivity. Health is endangered from pollu-tion and automobile acci-dents. Per capita infrastruc-ture costs are high becauseroads, sewers, etc. must beextended through sparselyoccupied areas. Undevel-oped areas are too smalland too scattered to sup-port meaningful agricul-tural or conservation uses.The antidote to sprawl is compact, mixed-use developmentthat places homes in close proximity to jobs, schools,recreation and shopping. This promotes walking andcycling. It also enhances the efficiency of transit.

The economic incentives promoting sprawl can bepartially explained by the second of two ways in whichland owners earn money. First, a land owner can makemoney by developing a site, and renting or selling it tosomeone who will use that development. Second, a landowner can wait for population increases, wage increases,or public infrastructure improvements to impart value to a

* For more information, contact Rick Rybeck at(202) 439-4176 or r.rybeok@justeconomicsllc.comwww.justeconomicsllc.com

site, which the land owner can appropriate through ahigher rent or sales price.

All too often; land near public infrastructure at "PointA" (like a subway station or major road intersection)remains vacant or grossly underutilized because a landowner is waiting for a price in excess of what most spaceusers will pay. This drives developers to seek cheaper sites,farther away from public infrastructure at "Point B." Oncethis cheaper land is developed and inhabited, the occu-pants of this area create political pressure to extend theinfrastructure from" A" to "8." Once this occurs, landprices at "B" rise, choking off development there (eventhough additional capacity exists) and driving developersand users farther away to "Point c."

Property tax reform can help create economic incentivesto develop land adjacent to public infrastructure andamenities while reducing development pressures at sitesfarther away. This reform recognizes that the property taxis really two different taxes, each with very differenteconomic consequences.

One part of the property tax is a tax on the value ofbuildings. Because buildings must be produced and main-

tained in order to havevalue, a tax on buildingvalues is a cost of produc-tion. All taxes on produc-tion result in lower pro-duction and higher prices.It does not make sense toinflate the cost of housingwhen so many cannotafford decent shelter.

The other part of the property tax is a tax on the valueof land. Land is not produced. Because a tax on landcannot be avoided by producing less land, or by movingland from one jurisdiction to another, a tax on land valuesis not a cost of production, but a cost of ownership. Bymaking land ownership more costly (less desirable), a taxon land values results in lower land prices.

To counteract sprawl, the property tax call be reformed byreducing the tax rate applied to building values while increas-ing the tax rate applied to land values.

The higher land tax cannot be avoided or passed on tospace users. Thus land owners are motivated to generateincome from which to pay the tax. The greatest economicimperative to develop land will exist where land values arehighest, adjacent to existing infrastructure and amenities.

continued on next page

The greatest economic imperativeto develop land

will exist where land values are highest,adjacent to existing infrastructure and

amenities.

DECEMBER 1995 I JANUARY 1996

At the same time, a reduction in the tax rate applied tobuilding values makes that development more profitable.Away from infrastructure, where land values are low,taxes will be low and there will be less economic motiva-tion for development.

Thus, property tax reform can encourage developmentadjacent toexisting infrastructure. Because the demand fordeveloped space is limited at any given time, the greaterutilization of land adjacent to existing infrastructure willhelp reduce the demand for development in outlyingareas. Reduced demand todevelop outlying areascombined with a lack ofnearby infrastructure willkeep land values and taxeslow, minimizing economicimperatives for develop-ment.

An econometric study,published in the NationalTax lourna], indicates that this tax reform would shrink anurbanized area.' In reality, an urban area would notshrink, but new development would tend to occur withinthe existing urbanized area, rather than outside it. Theeconometric model assumed that land owners maximizepresent income by renting to the uses that bid the most fortheir land. In the real world, vacant and underutilized landexist within an urban area. Thus, the prospect exists thatproperty tax reform could have an even more robustimpact than the model indicated.

Pittsburgh is the largest city in the United States thattaxes building values less heavily than land values. Untilthe late 1970s, Pittsburgh taxed buildings at half the rate onland values. At that time, Pittsburgh increased the tax onland, leaving the building tax the same. Today, Pittsburghtaxes buildings at one-sixth the tax rate on land values.

In spite of the severe depression in steel and relatedindustries that was occurring during this time, residentialand office development within Pittsburgh grew substan-tially. Contrary to national trends, the pace of developmentwithin the city limits exceeded development in the sub-urbs." In 1978, five Pennsylvania cities employed this"split-rate" property tax. Today, fifteen cities do. Thesecities experienced more development after increasing thetax rate on land values than did neighboring cities ofcomparable size and economic character.

Both theoretical models and practical experience lead tothe conclusion that property tax reform can provideeconomic incentives to help reverse urban sprawl. Com-pact development, by utilizing existing infrastructure,conserves natural and financial resources. Compactdevelopment patterns also facilitate the use of walking,cycling and transit. Of course, zoning and other land usecontrols must be coordinated to insure appropriate

AlA IIX NEWS •

development and the establishment of public open spacewithin the urban area.

Political feasibility is shown in a revenue-neutral studycomparing the traditional property tax to a split-rateproperty tax. This study showed a reduction in the taxburden on most residential and neighborhood businessproperties. Vacant lots and surface parking lots experi-enced tax increases.'

Land derives its value from the desirability of itssurroundings (location). Increasing taxes on land discour-

ages speculation andreturns to the publiceconomic values that arelargely created by publicexpenditures in the firstplace.' A building, on theother hand, derives itsvalue from the owner'swork in constructing andmaintaining it. Reducing

taxes on buildings reduces the cost of providing commer-cial and residential space.

Together, these tax changes promote the clustering ofdevelopment adjacent to existing infrastructure, reducingdevelopment pressure on outlying areas and discouragingurban sprawl. They motivate land owners to employarchitects to design more sustainable buildings andpatterns of development. A split-rate tax can help harmo-nize economic incentives with public policy objectives foraffordable housing, economic development and environ-mental protection. •

NOTES

1. Joseph DiMasi, "The Effects of Site Value Taxation in an UrbanArea: A General Equilibrium Computational Approach," National TaxJournal, vol. 40 (December, 1987),pp 577-590.Using data from Boston,the distance from the central business district to the outer urban ringof the model contracted by more than half a mile when the currentproperty tax was replaced by a property tax that taxed land values atthree times the rate on building values.

2. Wallace Oates & Robert M. Schwab, The Impact of Urban LandTaxation: The Pittsburgh Experience, Working Paper No. 95-02,University of Maryland, January, 1995.(see Appendix, table 5).

3. Pro-Housing Property Tax Coalition, "Real Property Tax Rates forTax Year 1992,"June 21,1991.

4. "Value Capture," as described here is listed as an innovativefinancing technique in the Intermodal Surface Transportation Actwhich requires jurisdictions to identify operating and maintenancefunding sources for federally assisted transportation projects. Seesections 134(g)(2)(B)and 134(h)(2)(B).