OVERNMENT FINANCE BRIEF NO . 13

Property Taxation :Economic Aspects

TAX F O U N D A T I O N, I N C .

This pamphlet is 2dapted hors a paper by C.Lowell Harries on Economic Evaluation of RealProperty Taxation : Municipal Income Tares, Pro-credin s. the Academy of Political Science, Colum-bia University. Ed. by Robert H_ Connect. Vol .XXVIII . No. 4. January 1965 7r. Harries is the TaxFoutsdationis Economic Consultant and Professo rof Economics at Columbia L-nh-ersit -The views ex -pressed are Dr. Harris ow t-

.

Tax Foundation is a private, non-profit organiza-tion founded in 19-7 to engage hi nonpartisan re -

f search and public education on focal and manage-ment aspects of government. It serves as a nationalinformation agency for individuals and organiza-tions concerned with government fiscal problems.

Covvnunmt Finance Brief No. 1.3 +August 1988

_

i

Copyright Im - ITAx For%vAm.N, 1%-c-

50 RMWeller Pbra

-hew Yak, ~. Y. 10030

-

I'

Property Taxation:Economic Aspects

By C- Lowell ;4acriss

TIu property tax pL-trs :t role in tool.cs'. o etuntent finance Lame eitm igh to aur-prise Iiialli- tihsrrvers . The tax takessnore• tri p.-i taxl;ta c ps ','!rill eves IxfereIk r •'diili'CF, iI- CiC~fl:t'i eii CtttLYfeiitf flltt;tii.

?N!Irert — sand hringis niorr Into localtzzov-erntnetit treamirico . u"tria- t:1 billionthis fi-ssul ymm about S1 .10 per ripita- orS7,11t1 fora family of five oil the aver-agiup f nn VSi and -S-415 rt .--%pt,-,tively ill1965 dollars in 195£ . The outflow ofexpenditures- how-ever. lists risen morertpicih•. t Such will continue to he thecase- Ina tuasiv localities. property-t:txvielels will not _row so rapidly as Iex:11r_overnntent spending, allowing forgrants-in-aid_ etc-- unless effective prop-erty-t :cx rates keep risin±~. Iiut even i f'.1de•+luate- rite increases were passibl econstitutiomilty. poli: ;callv . ;utd eeonoin-irtlla•. they are not :assured . Nor wouldincre=ases he de--irable cohere rites arealrcadv :s hi-di as in some localities.

Every t=ax has effects oth--r than those

of takiiiz d+-)ILtr. €iam the t-; xpay r andaiug tliltii to :i ~government trcaiurv-

1-he julrerse.' rituirc're nue• ctFeru "in beul In+ire than wimr significance- Iitostvvrnffila- when the t. x rites :ire at thehitz-h levels found in numerous coiiununi-ties to day.

of hxal governments tile piropertyum tun conilxare favorably with aitermt-tive revenue sources — within limits . I tshous tip 1o;tdly- however- when used asintrusively as in a relative fea. (but itn-portant I counininities today. Poor ad-Ministration pla-111cs the tax more geri-c•ralla- than is nect-mtra•. Achievements i niiiinte•rous places have denioustrated tha tadininistration ran lx• improved- And th eatnrrirare• of the t;tx could also Ix- inuchiniproved . This Impe•r % ill not deal wit hoiie• structural problem — the taxation o fpersonal property. Another structura lel!-latent . tice relative reliance on laudand buildings, will get :attention later.

What the Property Tax Is—And Is No tThe property tax falls on IWO111c . exclusively a source of revenue for foca l

"Things" tlo not, in a meaningful sense, government . in four states only realbear tax. The property tax must lie property is taxed . Most states, hou•-thougfit etf as a device to tax people ac- ever, lx-rntit localities to tax tangibl ecording to their ou-inurship. use, and personal property — inachiner% . inven-other tics to praperty . The tax is almost ton•, furniture•, etc. In fact, however. i s

i . n .+s t;ia. :t .a>- .,, tta,.+ .:a t .,s y; ., .i~ „! cx :~ls,-~ .ct (' L .,alit 1{atttaa, !(ar.JG.>n~ ut S:att and lws:.tt l;ua~e'r,rtrt Ftsartt INce Yoti. : Yaa Fautndattat. Lnc.. 1964) .

1

a rule only the m.-AM-:1 prole:*ty of lmsi-nesaes and atitonnilbilcs are taxed- lit a

fvw states there ix still more tlLui liit-or-nliss L ration of isitaia ible persomi lproperty — securities and Ixlnk lxilatices.

11W tax is shat a Ie,.v till isidilidual netwealth. Tfte justification for they tax doesnot refit u_ on :'. l)rtsz2nilYf adrt?d*.Iil'nt ofh;Aen to a Ixrsorl s net ;rortlt_ Tlae ixast•of tl :e IXX is :en a stillLite of the worth o fc.ch particularpicceof property-chiefl yreal estaty . «itbout re- and f )roily debtsa-g aillst it- III ::hnost all "LSes aswun.'esifrild colle.-Vorr are local functions. Manystate coustittstious. local charters- andstate statutes %oreniitrI local affairs pre-scrip- in axinitatn txK rates . Their practi-cal effettiveneys differs widely_ - _

Although property-tax rates when ex-pressed its a percentage are snrall. theycpp rt to capital cattier and are often-high_ Comparison of property-t :u rateswith inconi or stiles-tax rates can bedeceicin-_-_ A 3 per cent property- twcequals 33 per cent of the pre-tac income—and half of that after tax—front a

property which fields s wr vent to theacct:IC'S_ An Increwmvtit 46 l)t•rLviat will il drc-duct• the a motint renuinin- after taxh! such "Ise- ht- about S per cent.11 -property tax differs in essenti :al_[ fro m::It iliconic tax- E ad, should lx judgedzc7,xtrdisl-_- to criteria applicable to it, notto the other-

11-t- tax in inost le.. :alitics is Lir_cly ahunlcst on lui.rsin_. tint substantia lainounts : re collected from Isaisincsst . -\t, hell a rpresst-d in the rune ternils as aretail saic-s txc. the propertv t-: c cctuabr:ill per cent of pure occ-ulunc: cyst ofhatis hiLz in sonic• localities_ Ina r =te:l ec a-tust:sic 4vivic. the pre3perty Lim oil reale-Mate is itc)t one t:-r but two of cntcialh-different natures — :a levy on land an done oat intFl•orenienfs. The condetnna-tort' comments which inake up nicist o fwhat follows apply chiefly to tile secont .aspect . Ciat is. the burden on improye-inents-'Be tax on pure land values. ac-cordin-, to a long and respected —andcorrect — tradition of economic analhaisstands as one of the ]lest possible meansof getting torsi reyenue-

A Powerful Argument Favoring Property Taxatio nProperty taxation deserves support for

a n:isoll soli)etinies slighted by critics 'the tax pays for benefits - ;Oita" to thosewho bear most of the ba .rden. True, weCanpot relate the tax paid by aily partic-ular renter or howcowner to the benefit sof local-government spending which h ereceives. For the group. however, th ecase is clearer. The tax which is collectedloe:dk :aid Spent loo all• goes to bem-fi tthe people of the area. Thus, paynn•nt o fthe• cost of governnu•nt conforms closel yto i ene•fit on an area hasis . in this respectis not the property tax result fairer, more"Mitable, than in the ease of state; and

frderd finances generally? Conclusionsinav differ. "spiflovers- can Ili- cited torc efuire inodifieation of tht- central point .Yet the basic validity_ stands .

hefmty is not the only I0evant crite-- ion . Efficiency in resource allocation isant .th ,-•r. The :allocation of resott-,-es willtend to conform more closely to publi cpreferences when both tax and spendin gare hxal than when one is decided at adiFtance front the other Tltc argunien there :applies with less complete validityto verb- large cities than to smaller con) -niunitics . Yet its basic nierit extendsbroadly indeed over the country.

2

Who Really Bears the Ultimate BurdenOf the Property Tax?

To judge a. tax %viwly. there is need t okno v who re allc lw:irs it . he may be aIverson vet s• different from the one whowrites the cluck. Sometimes when taxesare 5.1ifted—froth building- oxvner totenant—the process wods rather clearly.Often . however. the process is both ob-scure and slow. The sunituary here mus t

somewhat dogmatic_

A challt..e in tax tvill fall on the owne ror user. depending upon calatract andmarket conditions- With the passage oftine. the incidence can clianze- Of thepotion of the tax rate which will h :(vebeen in effect for some year--that is.most e:f the rate—the burden on struc-turev is borne by the user.

The tax on land %-.lines reduces theworth of land . In effect. the ownerat thetime ; of each jump in tax rate will havesuffered a loss of capital .value. Conse-quentl}•. present users of I:and as theypay tax are not in fact truly worse off bythe :amount they pay. If the tax werelever, they would have paid a higherprice or rental rate_

he search for tax equity rests uponthe lest of instincts . Taxation repre-sents governments use of coercion. Andall use of compulsion should be just. Butwhat constitutes fairness in sharing thecosts of government? Would further in -creases in property-tax rates be a fairgray to finance the rising cost of loca lgovernment? "Fairness" has more tha none aspect. My comuactats, once again ,are summary.

1-le property tax *uns coulter to oneconcept of fairness by burdenin-, lou•-inctinle groups chore heavily iI! relationto incJtnc than those with larter in-cotnes. A reeremiee clement exists . Andrt~,re ieih is generally believed to b einequitable . conflictin g, with °vc °tical

_t•(t ;tity." _\felt of goMwill (7111 disagreein the degree of their condemnation o fre-,re~sivity as such . But all wid proh-ahly he distressed to le am how heavvare the property- tax burdens oil personswith Imir and inodest incomes. whereproperty ta.; rates :are :s high as in somecities . In this case. however. the benefitspaid for by the tax Iaive a very large`pro :oW-1111.0111_ bias. Moreover. thegreat hulk of the ree enue conics fro mtaxpayers in the income range in xnichthe burden is not so mach regressive asroughly proportional-

Still another source of criticism o fhigh property taxes lies in "horizontalIlattplllt~ "_ taxpayers within tach incomegroup do n it receive essentially similartax trtahnent . ha every commmnity somefamilies are required to pay more prop-erty tax than do others with about the

same income and in generally the samecircumstances. But communities have i twithin their power to reduce such in -equalities substantiall} .

Properties of the same type (six-stor%apartments, gas stations, or departmen tstores) are treated differently . Assess-nients sometimes vary greatly from onetype of property to another. Assessment

2 . For a more ce•iptete analssis see w . J . %huh ., and c. 1 .oweal harms . American Public Firawe . Slh ed .(Fn~ICx,xW (10k. N . J . Wfo. Cisrptcrc XV111 and XIX. Die .hs:rn.i . n in the presene raper omits referenceli t the eftcas of dcduclihrlity for purposes of income taxation. They motFfy the sukturu somewhat—inamount but not direction .

3

inequalities are pr►ixib'.y- •grc.t',er thantLe corresponding int•sltialitics tolcrite din other t;axes_ Not all t ;tx1my ers haveequal opportunity to -_,et a prole rts--t r;lss smnent rcrfeircif for jxs_v0h1rcorrcc-tion_ Although -oil jmjv ' every- ownerhas the same access to facili!ies for ap-peal . the re:al-tifcdifficttliics y:Irk g-reatly.Aulang the Ion• ineoine groups . those%Vito lice ill Private hotLCini. xvifl Ixtymore property tax per family tkin thosewho lire in public" housing.

The pro=erty tax nuis counter to oneconcept of ft_rncss by burdeltint-, sonstypes of consumption snore than others _1'.ur(lens xury ac-cording to lxittenrc o fconstimption- ror example. familieswhich choose to use above-avert're por -tions of their income for housing Ixn-more of the cost of local goyernni nt_ '

These aspects of horizontal inequalityleave no doubt that the property taxwould licit shone Ilp ;t_s a nuxlel of fairnes sin the distribution of bur(ien anion,families . With the better quality- of :i(1-ministration which is possible. it woul dscore marke(liy ]letter in most plaice sthin it does today.

Inducement to Smaller Structures :Sacrifice of Potential Benefi t

The property tax oil buildings pro-duces rarch• recognized effects whichimpose hidden burdens on the public-u•h ;tt economists call "excess hurdt•n .• •I'll(- tax (leprives the consunu•r of morere ;tl benefit thaii the dollars % % -]licit are •p;kid to the government . The source : of

this hidden loss (ern be explained, bu t- the aillouIits a:ltillot be pleasured.

Illy e_tlensir per eilbic foot of ,oil-struetino of residential units drelincs a sthe size of the house- aIxtrtment . or othertulit increases' lit terms of one of thesss :aior titan• ~,emerelIr drsire.•(1 in hous-ilr,—clthie waitstits--tillli cost drops asroom ±ire mere:t_+e._ One estimate- fo re•xansple. finch- that if the oust per e_•ubi clatest of a more or Irss typical . •,&xxl qu .A_its-_ single family re•.idencr of DXYJuivare feet is lash_ the cost per cubi cfoot for the same type of eoustruetiou•gtv-s tip to 115 if the unit has only TOOsottare• feet and drops to SG if the sizei% I .( XL For another type of c•(utstnle-tion. with DO) stplare feet size ;is 100 .the cubic foot cost is 23 per cent higherfor a 701 foot unit . and 0 per cent lessfor one of 1,4W foot -

The deeline• ill eonstruction expenseper unit of spaev rrffects the fact tha tenhie emitent rises more than propur-tionately to floor. -%-all. and ceilirg ara.Moreover. inuelt the saner plunihing.wirin-. kitchen . he;ttimgr . ;lit(' other fa-editiescaul st•rye larger as w0l as smallerrexmis and buil(lings through a range ofsizes_ The per:] public yve lf :re e: :) lx•st•rved best by the construction of rooms .I :uusrs. and buil(lings of lariter. as op-posed to smaller. size. The property tax.however. by adding to occupant•}• cost screates pressures for h-lilding snuffle rtraits ; in loin- so. the '.ax nutk(s fo rpoorer resource alloc: tion . -

A study of Ei mih• spending show sthat . as out• would expect . the higher th eprice of housing, the wialler the giiam-

J . Retail airs taecs C%Cnl+l rcniah ; c,cn aRCr alhmin,t b,r mdire .t eflcct.. one finde h•nntn} taxed lightlyunder sales taxes . The m :mnc tai treat%w^nct-:atpant . favorAlC. .i . W . A . Motion . llorurnr Toxnmon (Madtwo ; Univ . of Wti ;onitn recs . 1955) tleselopt the point.

tithe of Spacr purchased- Similarly. the,juality- the alliellIties . enjoyed will heless as their coast goes lap. 'line propertytax Iw addin g, to price will reduce th edemand for loth quantity and quality.Each one per-Lent-age point of higherhousing cost h:ads consumers to settl efor about one Iereenta ge Ioint less ofqu=antity. including, amenities-5 _lvera!—in- , over the years . it secins . the dollar

- amounts spent oil housinlg by a f;aalily o f--iven income will Ix about tile saillewhether tax is high or low- To make tapfor ;a hid her price due to tax, however-the cuuount and quality of sp=ace o13-

tained will be curtailed -

Over time, therefore, the property ta x—thron'_ i the effects on demand—g il lIrul to the construction of rooms. ;ap art-inents. and buildings snmewla ;at smallerthan would b built in he absence o ftax . The smaller units ;arc not so ?,rodand yield less utility per unit of input .`b xcess burden- results. The public un-knowingly deprives itself of opportunityto e=xploit fully the potential benefitsf: om -lacy of the cube.- Thus. the publi chearsa hidden burlen by sacrificin- , thebenefits of !--rc Ater economics in enn-struction, per unit of space and qualit .

Ali illustration trill be helpful . Assum ethat a family would spend S2010 a yearon housing . In a market free from hous-in , taxes. it would get that a111411110 o fpure occupancy. But in fact the tax is30 per cent . Thep the total cost for equa lf teilities would be 52,66. However. ou tof 81 spent . around :3 cents goes forhnusing and ?; cents for tax . The familyspends 820M. of which 51 ;5.33 is fo rspace- and S-167 for tax. The ph%. siea damount (allowint, for qe• p ity) of hous-

in nu", he sv-raller bec=ause of t=ax. (Wei!,Iaore the land portion of Ilse tax- 1 It !essence. resources ;arc freed for use inpraltidin!- government services. But perunit of input—the materials ;in,; labormied in producing such space—the knit sc:3stiug 8133:3 per year lr-fore tax willpta'ide less it, cubit contents. les. ofwhat people want . than if =.i. x—d in pro-ducilig housil '= eailits to cost t2.00I al . -nu;aflt-. Tlle• re=al res?aa m" prieeluee lessof what Ix-ople start than would be oil-taita;ablc- 1 1, ; ;it govemulent ual em tri l lthe resources it 'lets will scarcely illaketap for this indirect loss.

The past will not be (lone over . Thvpublic must live in housing whose qual-i'.y has ileen adversely influenced bt -

effeets of the tax in the past on tt•Ixs o fc,nutnaction as described above. Tlaefuture. however. is ours to make. Beingforewarned . society "lit troy more ration-ally to ;avoid ;avoidable errors.

Taxation and Housing Quality:Maintenance versus Deterioration

Most Americans must live most oftheir lives in "not nits- housin!a . Muchwill have been built before their birth .I lousint, will gr duall}• lose its ability t oprovide satisfactory shelter unless labo rand materials are devoted to offsettin gthe effects of tiny• and use. 3'he qualit }of thr residential space actually avail -able will depend !greatly upon the main-tenance of the stock of housing . Unfor-tun=ately. much of it is already poor, no tonly because it was "inferior' whenoriginally built . but also bec=ause it ha sbeen allowest to deteriorate more than11C4'ssart- . Under-maintenance forms oil( -way -by which in owner caul reduce hi s

5 . Did %ever. Jxnnnnrii, nl the rf"PeM T.rs (Wasltmc[un : 'lice 111,r1kincc Intritulion . 1%66 . 63 If .. drawingon stargaw Reid. Unuriaz anj Income. (Chicago ; Unic. of Chicago t'rcss . l96 .) .

net inwc-Stiltent ill a building. His actionsaffect others-

?file maintenance done. or not doneon eal'ia a minority of properties cau lmaterially affect :1 larger neighborhood—for ill or !good . Outl;ays for mainte-nance can be combined with spendin gfor improvement . Over time. the o%vnerst and oec•1upmits) of housing nazis- do

C more than lnereh• preserve earlier qual-it-. Good effects due to be tterinent wil lspill oye r into the ticighborhood- Any

MisollAbl• complete social system fortusking the best of the huge st-ac : ofexisting structures will assign key rolesto the prevention of new deterioratio nand the m-oid :ance of discouragement o fimprovement .

cHigh property taxes on building s

--work against us on both counts. The in-fluence is a matter of degree . of course.and in most communities will be littl eif any worse than one must expect in on ewav or another front any tax. It is inolder cities with high rates. however.that adverse effects can become deplor-ably large. flow? Property taxes influ-ence maintenance in three %% ays . T:axpayments reduce the net return fron tproperty and thus its :attractiveness a sin investment . Owners who rent ou t

some of their properties but do not ge tit s;atisf:actorv- return on investment wil lnaturally her sensitive to taxes as a cost .Any increase in tax will be especiall %onerous if a considerable time is re-quired for full shifting to tenants . Theincentive to make outlays needed fo rmaintenance will hardly benefit. Ali%-force depressing net }field will probabl yinduce Sollie decline• in tit(- supply o fhousing by under-m;ainten :utce ;is it rc-

duixrs avera!,c qu:alit _~ l Ire dollars rasedto Imy tax ;are Hot al-ail:ahle- to financemaintenance- Owner-oeculmuts . for ex-

Inple. (zamtot use the fulad. which '_'oto the lexaI trecsun- to keep the propert yin goexl condition -

The owner may believe that ntainte-natacr expenditures will Iead to hi~,herassessments- The higher the tax rate, o fcourse. the ~,rc:ater are likely to he hisfeua and thus . :ah;o. his incentive t oavoid actions which may raise his assess-ment_ Purcl uliaintetlancruutl:av ssho►ilc fnot affect ;assessed v:aiues except by in -€Iuencin- the rate of deterioration ove rtime. Ali omnie'r seeking to :act in a Ingl-eal cease would not he ueterred by rea lestate tax in maintaining his property i fsuch investment offer"I the hest after-tax return. In fact. however_ misconcep-tions can exert undue influence . With orwithout good rea,on . the owner mayfear that a -repair :and mainten:atuc- jobh avin!, visible results ~ or even one re-ported to the authorities for getting ahit-ligg permit) will result in ;tit ap-preciable :assessment increase .

Iligh property-tax rates on buildinl,sdo seem to deter maintenance even morethan ration ;alit• would justify . And thetypes of maintenance which owners d omake are not those which ;are --wisesteconomically, structurally . or aestheti-calh- :uacl socially . Owners seem to favorfonts which ;ire not likely to trigger anupward reassessment, "inside" a sagainst "exterior."

\f;anv owners of real estate :are notwell versed in property management .Many suppliers of rental housing ow none or a few properties—a two- or four-family building acquired ;is a home acrd

6. Sec James iteilbrun . Kral.. Estate Tuxes and Urban !lousing (New York : Columbia Univ. Ptess. 1W) .

6

as sourer of rental income. t1:e placewhere the fa mil• business is a rried on .inheri ted prop ert'. etc. Their :attitude .beliefs . information . and financial capa-cities will. of course . differ in almosteven' coucrivable way— But we can besure of one thin! : the cumulative effectof their decisions about property main-tenance will have it naaateriaal effect ota

the quality of urban housing . When a srecent surety asked tenement landlords-;about the factors which detenninedtheir outlaws for maintenitnce and im-provement, the replies indicated tha trising tax rates lid hindered unainte-uauce by reducing the income from in -vestments and by adding to the fear ofupward reassessment?

Perverse Character of Burden in Relation to Cost of Governmen t

Tlu• property tax as it applies tostructures i not the portion falling onland) distorts resource allocation per-versel' where there is older property ,especially in urban areas. New, vwell-constructeci . hi!_h-quality buildings aretaxed far more heavily per unit of spacethan slums and -junk . - Can justificationfor such discrimination be found in th ecost differences which the two types o fproperty a nd their occupancy impose onlocal government per unit of space?Most probably, no—just the conu.uy.The badly nun-dome and less heavil ytaxed building is more likely to be as-sociated with the greater costs, if onl yfor fire and police protection .

The social and economic evils associ-ated with slums should not be ignoredin this connection ; but the cause-and-effect relations are complex . Neitherpoverty nor public assistance and simi-lar welfare outlaws are assumed here tobe either a cause or aun effect of low -quality housing in an%- simple relation -ship. A valid conclusion, however, wil lstand : When high- or low .quality build-ings are being compared according t othe sort of calculus recommended byeconomists—matching henefits and costs,

private and public—taxes do not help toharnnonixe for society as it whole-

The users payment for the services oflocal government goes down, relatively .as the building gets worse. even thoughpublic expenses attributable to the prop -.erty are unchanged or mat• even increase .The 'junkier" the building, the less thepayment for government irrespective o fexpense to the government . In short, thetax element of cost of occupancy oper-ates perversely as regards governmen tcosts and benefits. Occupants who pu tthe community to relatively heave• ex-pense pay less in tax . other things beingthe same, than the occupants of highe rquality buildings .

The person who wishes to shift fro mpoorer to better quality housing. or busi-ness propert}', cannot do so without alsopaying more toward the cost of govern-nnents—SI of taxes for each $3 to 84 ofpure occupancy expense . Ordinarily ,however, such a shift to better facilitieswill not add to services received from ,or the expense to, government .

The property tax on structures createan incentive against upgrading of qual-ity in just those parts of older cities

r.-Sec George Sicrnlich, The Tenement Landln .d (hicw Brunswick : Rutgers—nic State University, 1966) .Fos analysis of the theory scc Iteilhrun, ap, cit .

7

where need seems greatest. Such dis-couraging of private effort to raise qual-ity serves no useful public purpose. Thetax on pure land element, in contrast.cam work to hasten putting land to bet -ter use by replacing old improvements

%with better ones. The two :spects of th eprotx rty tax noted above have- in ahighly significant sense. been reverse dfrom the roles which would lx- optimal .Fortunately, reform seems well with ourpower.

Obstacles to Urban Renewa lHeavy taxation of new buildings must

stand :s a tragicall apt example of man-kind creating needless obstacles fo ritself. Cities which urgently need toreplace obsolete, decayed. - degradingbuildings nevertheless put powerful ta ximpediments in the way of progress.Nobody planned to set up a tax systemwith such influence. No one tried delib-erately to base local finance on a taxthat would favor holding on to the de-crepit structures, many of which spreadevil influence through :t larger area ,while penalizing the new. the good, thesource of benefit to a whole neighbor-hood .

An annual tax of 3 to 4 per cent o nfull value is high in relation to whatmost property produces—30 per cent o fgross income, sometimes more. In rela-tion to net income, of course, the burde nlooms larger.

Let us look further. If the constructionof a new building requires demolition o fan old one, the cost which the builde rfaces will include not only the land an dthe new construction ; his expenses wil lalso include the value remaining in th eold building plus demolition costs—a sor tof deadweight burden .

Let us assume that a new buildingwill have a life of sixty years . Its con-struction involves the owner in a com -

naitulent to pay property tax for catch o fsixty years . The nta,gnitude of these fu-ture tax obligations can be expressed interns of tod:n=s dollars. For doing so .each of the sixty tax bills must be dis-counted at some rate of interest to com-pute the present worth . If one assumes5 per cent and a tax rate of 3 per cen ta year on the construction cost, makingroe-h allowance for reductions in assess-ment as the building, ages, then thepresent ratite of the taxes clue over thelife of the building will equal about 30per cent of the construction cost .'

M"hatever the precise figures in a par-ticular case, the property tax bill on apared goes up when a new buildingreplaces an old one . The more that i sspent for quality, etc., the larger is th enew tax liability. And, of course, thehigher the tax rate, the less the desir-abilitr of putting funds into new build-ings . The property tax our structures, i nshort . creates a clear, and at present ratesin some large cities a substantial . biasagainst the replacement of old building sby new ones.

The amount of tax oil land will not af-fect the quantity in existence . The tax oilland (ran influence the availability andthe use made of particular parcels 9 Anymuh-r-assessnu'nt of land will actuall ycurtail incentives :end pressure for urba n

N . M . Mawn Gaftnq . "Properly Taxcs and the Frcyucn.y of Urban Rcnc%al ;' Pracerdings . . . National Ta xTax Association . . . i964 (Harrisburg : National Tax Association, 19651, pp. 12-185 .

8

renewal. Iii practice_ it scents, sonic suchinappropriate under-assessment mayfollow- front implicit or even explici tattempt to truisutit to the land the de -pressed valuationts which are proper lattributable to the deteriorated condi-tion of the strnettire. The motivation forsuch assess bent practices may steincommendable—hut not the results. Theeffect in reducing pressure on the ownerof the land to use it more productivel ywill be to slow- art.t renewal even morethiin clots the property tax when it oper-ates -normall :_` For in this respect thetEfference between the two elements ofreal property taxation—land and build-ings—has great significance.

Property Tax as a Business Tax:Competition for Industry

The property tax is not merely a taxon housing its a frrnt of c-onstiniption .The tax also falls on business, :affectingboth prices and the processes of produc-tion. lit other words, it influences ]lot hthe quantities of productive properth-denianded for use and business decision son when . where. hob- much, and in ghatjorinx to operate and to invest in pro-ductive facilities.

The influences which grow out of ta xconsiderations will rarely be constric-tive in the sense of helping companie sto produce snore efficiently. In general .tax-created additions to business-oper-ating p spense are undesirable ."I lhisi-nesses ;ur overwhelmingly the source o fincome . In taxes, however, they encoun -ter inipedinients--costs for which ther eare usually no identifial,le aids to pro -

duction. Unlike W-Ug'Cs, for example.property taxes do not pad- for service°received by businesses and thus helpingto create inconie. Lawmakers hend topowerful temptations to tax people in-directly throe-li business. rather tha ndirectly on their receipt of intone oruse of it in con suniption .

The significance of property tax forbusiness will depend in part upon therelation between the tax and the govern-mental services. Most serv ices providedby local gov rnnients—education . w-el-fare. sanitation . protection—arc more fo rthe consumer than frr business as such .The expenses of city government are. notof :i type to be . in lark measure. of anydirect benefit to business firn s ."

Managers must take account of prop-erty taxes in making business decision: :.such as where to locate. Most locationde-cisions affected by property tax are notindividually dramatic—perhaps u7ircel-identifiable—but in total they can lavasignificant.

-

Soinc businesses . of course, are finnl•attached to a location, e.g ., those provid-ing local serv ices. They will not leave ifthe tax rate goes tip, but their grrw'th ordecline will be affected . Firms whichdual in tzig A\ competitive markets e an -littt ;afford to incur avoidable costs w jtichdo not. in return, either yield it salableoutput or reduce other costs .

Each rise in property tax unless clearl ymatched by iniprovenients in local serv-ices to business as such tends to rechicethe business use of structures because a nelement of cost has gone tip . The :amount

v. Ibid. . P. 280.10. For more a6mpktc disunion% %cc Committee on Fcdcral Tait Policy. Financing .4nrerietas Future (Kew

York : The Committee . 14 west 51 tit . . IWO ) . ('h . 111 : C . Lowall liarrm,. "Taxing and Untaxing llusiness . . ."Tnx Rctiew . Vol . XXVI . No . 1 . January 1965 . Tax Foundation .

It . llasincsux do not. Of routcc. h.oc the right to %otc. Managas. owners. cmplokccs, and comurttcts will haveno cote in some iocalitics which seek to tax them.

9

of ixoduc:ion in the locality will tend tofall below what would otherwise be thecase. going down- not at once pe.-hipsnot abs.•-ra ably. but gradually. In a %en -emlly expanding econostir . the effect inmost localities,, ould be a slower grova t hrather than any absolute decline-

The cornmutiov with tax rates onbuildings generaih in line with rateseh%-where will probably not experienceappreciabk competitive loss of busingR'hc-n rates are alrcadv much aboveaverage. tIli long-run dangers are quiteanother matter-1 2 Emily exaggerated'Yes . But also easi ly assumed aaray"when in fact they will persist. Alongwith other elements. they will operate,gradually. in amounts not me:, mrablebut ct tainh• unwelcome-

The competition among communitiesfor industry grows. Some competitiontakes the form of property tax favors.occasionally on.' in the open, but oftenconcealed m the foray of assessment fa-

voritism. -No locality can escape suchcompetition- Xaturaily. communitieswould hike to be able to include withintheirboundaries ct-apar :ie s which wouldpay high property taxes while sellingoutside. People elsewhere. in effect.--vouuhi then pay some of the coats oflocal government where the plant is lo-cated- Competition. houvver, limits th epos-sibility of one IorarliWs getting muchrevenue from non-resident consumers.Each of the countless communities-ranting property tax favors, in a sense.'tells"the potential consumer elsewhere_-You can buy prod_zts created by fac-tories. or services rendered . aaithin ourborders without paring (much I towar dthe cost of our local government- What-ever one may think aba.-t the desirabil-ity of such policies, they exist. Commu-nities which do impose high taxes on th ereproducible property of businesses :areIcss able to maintain and build thei reconomic b,se by attracting industry.anv tax on business will have such tend -ea ies-except a tax on pure land values-

Tax Islands and Central City Difficultie sDifferences in full-value tax rates

among loc lities have other nonreve: nueresults. One. though related to businesslocation. must be disting uished. hate smuch above average in one locality wil ldo more than discourage business in-vcstme nt there. The high rate will alsoreinforce opportunities and incentivesfor creating "islands" of relatively lowtrue rates nexadw

:among the numerous localities in thegeneral area. a fen- with tax resourceswhich are much above average in rela-tion to service obligations can get bywith lower tax rates. They can attractinvestments and lvecome low-tax en-claves, perhaps predominantly indus-trial and commercial . The firms operat-ing there thus incur little property ta xper unit of output. They get something

12. The use of the •-catra hi-,h" tax &Vms must affect the results &c ni .eIr . If ditfer :rdi3W high expendituresgo for scrsxes which the ptopre matting the dr ision about business location wart and arc able and witfirn(Zto pay Ax. high taxes wilt riot have the had results dcscrtbed in the teat_ Nut as the test indicates, the benefitsfrom local satndlnr do not pr Lt r.wh to busar--w. as its famdrts . IhBcrtnces to quasar of kwai ednCationwill he srgntficant for empioyers. Yet will mx wage rates be higher wI- -re schooling turns out more productivewtwkers' Ptobaht. to . Will waists lot enough higlvc: to otlses all p rcniial benefits which business may haveespccttd from htghcr progwm wa cs for better schools? The answer does not seem clear m - them. and-cmpincal cvidatcc is not available.

10

of a ccxnpetitice advanu!ze while con-tributing little to help pay the expensesof loyal govvrnnsent anywhere . Thenumber of such localities must be tiny.in relation to the caxxxuv as a whole:but particular cases can be of impor-tance for a metropolitan neon _

Other communities with autonomyover taxes. pinups ba- the use of Zoningpower and building codes. are st le toexclude tapas of property associatedwith high governmental expanse_ Theymay. for exampk% prohibit high-detuita---yang which brings many children .and htavv school costs. per acme Theparts of a maetropolitan area which sue -cc A in such policies can hope to finance-rol atively high-quality local service wit ha propert tax rate wluch is Iess N-rden-soine than the rates nearby Ilu- latterrates, however. tend to go up. or servicesare at a Iow-er level . The ad•.- antages offreedom, and the opportune• for differ-enes in trays of living, must be rec g,Inez*-1 as h;aing kxs welcome resultsbemuse of competition .

As regards buildings but not land .loaner tax rites here and there on thefringzs of an urban area encourage dis -=x i 1 and the deveIopinent -far out- ofactivities. including housing. which ina full economic sense ought not to b eso distant_ Property nearer the centerwill dx ~-ubicrt to high tax rates- andeach rite increase reduces the value o fthe property and the tax base. Muchwill alre:adv have deteriorated but ve thave years of useful life, and of pro -longed de eline. before replacement be-comes economical . As tale tax base --oesdown. such decline in itself adds to theneed for still higher tax rates . Businessproperties . especicallV ellmmercial . be-conic vulnerable: to competition front

outlying m4ithborlwods. aggravated in-forms which awe encouraged b.- . taxdiffer-rnes.

Unk ss the users believe that the bene-fits of loc-a. government go up with taxobligatiexm the repelling forces gathermrni-gth- A destructive process gaussforce. on smirt-what self-reinforcing.but perhaps s<-ueeh• Ix-m- ptible fron tone election to :uaother. The existem.}eof c atclaa~c aches• tax rates on structure sre natively limy. -t.-ax islands.! does

more than hinu neighboring localitiesand accentuate the difculties of olderarmThe,whole region tasty suffer. Such~txation teems arbitrarily to favor hori-:outul over rrrtical growth in mc-tropoli-tan arcs . Ilk---h taxes on land. however.do not have this ape of effLet but ratherthe contran.

The- higher the tax on buildings in th ecity center or sonar part of the whole) .the greater is the indueenxmt for fami-lies and businesses to move to "taxshelters Other residents of the :areawho also %ish to escape the urban cen-ter t for r axons anon? which taxes may -or tn.-ar not, rank high) must then `leap-fro;,~` over the enclaves with their poli-cies of exclusion, going further out_ Th eresulting Iand use imposes higher costson the whole society than if the popuLt -tion were spread more rationally. Theextra disadvantages take the form o fcosts in time and money of travelinggreater distances front home to wort:(and for recreation and perhaps school -ing) ; higher expense of supplying wa-ter. sewer, and utility services f rtherfrom central lo-cations ; and reduction inthe economic and social benefits whic hpopulation concentration brings .

This tendencies In av be of sit-gill force

lI

in the total vcotamny. They ought not tobe iguored. however. \or shexil . weoverlwk the possibility of counteracting

thent by rearranging the tax to shif tburden from structures to land as indi-cated latex

Encoufagementof "Socialization"Iligh property-tax rates stimulate

sonlenitat the expannion of the scope of-,ovcnnlc-tlt:-1 acti'Litt by -ivin'.. linis-leadItlg aipnals of the relative dcsirabil-ity of --ovrnunentaI. as coulpaned withprivate. ownership_ The property ta xiiow clnalunels oine-fifth to mt -third ofwhat the occupants pay for the use ofproperty into treasitrim to finance gov-c-nnniental services- The higher the taxportion. the smaller the anwtmt whichrenecii .s to pay the expense of pure oc-cupancy costs. including return on in-veAlneint . PWIle_h- taxes by affectingthe ixt ;morn oti private investment inIwifdings will reduce supply . Becausethe true for ges occupants to pay n_eorc, i tis-ducrts tk- quantity and quality ofspace used Ilelow what would otherwiseprevail- Such tendencies. however, wil llead non of good will to search forsomething better. Can we not providebuildings whose use will cost less : Yes.One u:ty to do so will be to free theuser front the need to pay the full prop-ertv-tax c le-_ .e nt . But how '! Government-ally sponsored l tax exempt I projectsseem to offer an answer. ( Exemptionfrom sales tax oil materials for new gov -ernmental buildings will tend towardthe swine result_)

The argument will not ordivan . be.`toys finance alai build in woos whichpermit users to escape costs of govezil-ulellt_e More IikeIy. adi-mcates will sa.---ta»ts call he kept down by tax exemp-tioii -- The -saving in costs- howe%--Lsalves the public absolutely nothing inthe sense that schools, streets. or other_facilities can be less expeKnsi%e than theywould need to be if the building weretaxed-

A shift from private to governmenta lownership by exempting some property,however- will tend to bring !tc avier taxrates on other property-. Eketrie andother utility services can give rise tomuch the same argument_ Sponsors Omunicipalization of public ownershipcan hold out :he prospect of providingsomething at less cost than can the tax-paying supplier if—and the -if- is im-portant—the respective contributions tothe cost of government are ignitred. ? Idifference in money costs between thealternatives—governmental and privateownership—induces distortion and mis-allocation . Private ownership yield smore than the services involved directly.It also helps pay for governmental serv-ices.

Pressure for ExemptionsThe growth of exemptions from prop-

erty tax properly- arouses concern . Th ere:Isons for granting exemptions differ .Some groups, we often feel, deservehelp; one way to provide it is to gran ttax exemption_

-

Who, for example will not sympathizewith an old couple living on a r . .odestincome which they have no opportunityto noise and who are called upon to payever higher property- taxes to financeschool expansion' :Although the t.- .: it-

12

self may not, in fact. be a large part ofthe source of distress. it cut be a focusof pressure for relief- Hers- is smaethinggovviminent mn coutrcl . .agriculturalland ore the urban fringes presents an -other type: of case which sometimesseems to call for relief when taxes as

well as values go up but the issuesanti desirable policies art by no mcausso supple as rnag appear.

To Iawntakers—aril the public--grant -ing relief in the form of tax excnnption

As rioted earlier. -the property taxcep be thought of better if one wishes t o:n al 7.e the econoinnc aspects as tirolevies, one :)n land and one out improve -rnerits- High property taxes will swtdefter

appreciably the esnwunt of land in e_-ist-e7ncr. But will the height of the rateinfiuence the use of land? If so, how'The hi~ger the tax rate on LAM, thegreater will be pressure on the owner toput the land to the `highest and bestuse- Society can actually be-tefit fron ta tax other than merely-getting fundsto pay for government -

A point of great significance scenesva li d ImLav" ;s it was even be fe7r- HenryGeorge evrote so eloquently- The extrav-agance of the claims of some advocatesof the Single Tex or site value: taxation-have hurt a good cause, namely theeffort to distinguish between the ceo-noniic effects of tax on land front thos eon improvements . Different results niustfollow from the two.

Every decision involving the construe .tion or use of real properly must heweighed against the tax results . Thegreater the tax. the smaller the numberof investment projects—:and the smaller

can appear easier than an increase- inexpenditure directed toward the par-ticular recd. In fader- lmve cr. exetup-Lion tends to be a crude and inefficientdevice in that the benefits provided tothose in real need are small per dolla rof revenue loss.

Be that as it inav, pressures for relieffronn property tax will grow if tax ratesgo up. The higher rates aggravate theproblem and enlarge the, effect Re worthof the exentp;:on-

the number of dollars put in each—which will field a satisfactory after-taxrs-tunt_ IA--.s housing . in quantity andquality. and less investment in otherhers of buildings arc: to be experted-assuming, as semis reasonable. that al-ternative uses of savings are available-

If the property tax were a minor ele-mcnt of expense . any possible diseau-ageinent of new construction mrouldcause little concern. But the tax alreadyIooins large--:end provides incentives inthe evrong direction in some cities. espe-cially older ones. It reduces the attrac-tiveness of new buildins to add to thetotal supple- and to replace older struc-tures—mithout a corresponding reduc-tion in the need for government spend-ing.

A tax on land reduces the price o fIand . In effect, a new purchaser will pad•

less in price after a hand tax has beenimposed than lac• would have paid be -fore•. But he will then pa}' more eachyear as tax. Government in a meaningfu lseise has changed the conditions o foa'»ership . 9niong other things, tie•ehang:• favors the person with less capi-tal, without burdening or making things

Land Versus Improvements

13

hauler for the person more amply sup-plied pith capital. A lmycr can acquirewith stualler outlay of his owns resourvesplus lxwrrou-ed funds and with lowerannual fitmu in!g chime interest plusamortization' . the niust. however. thempad- more each year to govirnment .Origival financing becomes somewhatIcss of a problem_

Assuming that no reduction in totalrevenue is a realistic possibility- cal lauxtbin- , he done to alleai:ate the an-desireble tendencies' Yes. at le--st intheory- A shift of the proportions ofproperty tax could be be lefic 11 . Sup -pose that the rate on Lind values werethree tilale the rate Oil improvements—or other proportious which would no talter the total revenue for the locality-

-is :a start tuu-ard mforut of a make rt::z_ one whi"41 will eotitilue to play aLame rok ill our stxiety. such shift ofcnephl=lsis St-vilIS Ili!-Iilr attractive. Taesu•cstion here is that to increase thetotal revenue frill : e -two taxes' butto rculigu the proportions_

(hi the avera ge. property ownerswould pay the sallle amount of tax. Bu tfew u-euild he at just the average. Sub-stautialhy Iti;ghar rite on Lind valueswould induce owners of low-use land toconvert to lli!~lle-r--a-; cue uses. %Ivau-while. the lovrer tax rates on buildingswould encourage replatetuent of ol dstructures ha- iw%v ones. as well as netadditions_ The benefits. I subunit, couldbe highly significutt—not revolutionary-not cartlishaking. but not insignificant.

Urbcr Aid, Land Prices, and Taxatio n

A final point. one of great significiincand some urgency- Programs of urba naid which direct funds and resources ofany type into particuLer :areas uill tendto wise Land prices . Under present ar-rau- rem nts . much of the intended bene-fit will almost inevitably be incorporatedinto gains for Iandowners . Thev are notnecessarily . or prilnariIy . the persons fo rw•homa the assistance is designed- Expe-rience should alert us . r eriris expen-sive farni programs have had the effec tpredicted by economic analysis bu tlargely ignored in public discussion swhen policy has liven made : Subsidieshave been capitalized . to considerableextent, in higher land pricks to the bene-fit of owners of land A the tinie . Fainoperators, present and future. must thef tpay more for use of laud and thus get nobenefit from subsidy.

The statue sort of thing must he ex-pected in urh an aid unless new policiescome into effect. Future residents andother users will ,et very inch less ad-vantage than is intended because landprices will rise to absorb the worth o fspecial aid of a localized nature. Carrotsome-thing be done now to avoid suchfrustration of !-ood intentions by theconversion of assistance into higher Lui dpricks. i .e.. • :apital grains for Landowners"The property tax is not the ideal instru-ment for dealing with this challenge .Perhaps . however. it can play :a part ina more comprehensive effort .

-

.\It)st of the analysis of proixrty ta xproblem. has, quite naturally, lien can -ee p irated rtm the• ideal level . The making

-~of national polio- has tended to give• lessattention to the broad aspects of this big

14

tax tkin the general welfare warrants. ways des rable- And today. efforts to fi tCtxnporc4 with other w:tvs of finaming such nfonn into a broader appruadt tolowl government. the property tax does = ~ .-tn progress scent both urgently need -[cave %rc:a merit . But it has avoidable ed :rid pedraps more promising of posi-tiefects. Efforts to n-duce- them art- at- tiv:- results than ever Ix-fore-