Two Property Tax Relief Measures:
Land Value Taxation To Stabilize
And Deferral As Provisional Tax Relief

H. William Batt

[Originally published in the Capital Commons Quarterly CCQ, Issue No 4, Vol 4, December, 2010. Reprinted from GroundSwell January-February 2011]

The property tax structure in New York, as in most other places, has many problems, especially for seniors, but with a bit of attention and tweaking, it could be the perfect tax. I will address what has often been called the "poor widow" problem and the person who fears being expelled from her home by lack of ability to afford her property taxes.

Property tax is really two taxes to an economist, a tax on land values and a tax on improvement values, each with its own dynamic. We should just get rid of the tax on improvements, now something easy to do in light of new computer assessment technology and what we know about the destructive impact of taxing them. Experience shows that doing so is the most effective tool available to revitalize economies.

The tax on land value can be corrected with better assessments, shifting the rates, and allowing for payment at a time when it is not burdensome. But one has to understand what land value is first of all. Then one can understand a land value tax and its virtues.

The value of any parcel site is a function of the flow of what classical economists know as ground rent. Ground rent, or economic rent, is different from rent for payment for using a house or car. More importantly, it reflects the economic vitality of a neighborhood or a region and has nothing to do with what any one titleholder does or doesn't do on his property. If all the market transactions and productivity were to leave a place, there would be no rent to flow and the land values would fall to zero. One can no more alter or eliminate the flow of rent in any area than one can stop the force of gravity. The more productive enterprise a region has, the higher the flow of rent.

People in this country, even many economists, don't understand that rent is a flow; they often think of land value as a stock, like a house or a car or an industrial plant. It is actually more like a river or an emission from a radioactive mineral. Viewed in this way, land sites, just like other natural resources like water, air, the spectrum, and even occasionally time, all have a yield value, even when they are not used. That's because the value is reflective of the broader community's activity.

The total value of rent flow through a location is a constant. It can be broken up into pieces, however, and this offers us a solution: whatever is not paid in a land tax, which is really an expression of rent recapture by the community, is then capitalized in market price. The volume of rent can be captured all at once or over a period of time. The assessment of land is its capitalized rent flow, and this is clearly manifest when a parcel is bought and sold. It is also reflective of capitalized transportation costs.

Because the flow of rent is constant and continuous, the more that is captured in taxes, the less remains to be capitalized in a site's market price. If the tax on land value were totally abolished, all the rent would accrue to parcel sites and escalate their market price accordingly. Relieving households of the burden of their property taxes through caps, circuit-breakers, homestead options, or any other exemption simply results in the increased flow of rent to, and ultimately the market price of property. But the higher the cost of real estate, the less attractive a location becomes to outsiders: areas of California, to take one example, have become prohibitively expensive. When property prices escalate beyond what the flow of rent dictates, speculators move in to generate bubbles of expectancy, resulting in even higher prices than what the community's productive enterprise is able to generate. Ultimately there comes a corrective, even a crash—witness what Japan experienced and what we may be going through now, and that downward slide can be as economically painful as the initial euphoric rise in parcel prices earlier.

So, one way to maintain a viable and stable economy is to tax land according to its market value and even out site values. The higher the payment in taxes, the lower the market prices for land sites. From a strictly economic viewpoint, taxing all the economic rent would lead to a sale price of zero and a rental value commensurate with its continuing flow, and this creation of a perfect market for locations would foster very healthy economies. It could totally supplant taxes on wages and capital that result in so much lost productivity and economic drag (economists call this deadweight loss). The reality is that rent, left to stick in parcel sites, often "gums up the works" in a way that slows down markets and makes economies less efficient. Better to remove it, and taxing it away is the best way to do so. Significantly, one might note, those governments that employ land value taxation have weathered economic cycles most easily of all places.

Ultimately, all tax burdens are shifted to land in any case, as Professor Mason Gaffney of the University of California at Riverside explains:

"After-tax interest rates are determined in world markets and the local supply of capital funds is highly elastic. So, local taxes on capital do not stick to capital. Even national taxes on capital typically fail to stick, because capital is a citizen of the world. Local labor supplies are also pretty elastic, although not so totally. Local taxes on labor, therefore, do not stick to labor, either. Payroll taxes drive people out of localities that impose them, for example. Ditto for sales taxes. Customers move, or shift their purchases, to where taxes are lower, or zero. Sellers shift, too, to the extent they bear the tax. What else is left? Just land, and land cannot emigrate or immigrate from the local jurisdiction. "

Professor Fred Foldvary, author of The Soul of Liberty, Public Goods and Private Communities, Dictionary of Free Market Economics, follows up by asking why not just put the tax on land from the start and improve economic efficiency. Finally, because a tax based solely on rent would supplant taxes on wage labor, and on products of people's hands and minds, it would be on windfall gains only, and be essentially painless.

But that's not likely to happen, at least soon. What we can do, however, is 1) foster economic vitality by phasing out taxes on improvements; 2) shift the burden to land values in a revenue neutral manner; and 3) allow households to pay their property taxes when they have the means to do so — when they cash out. They would do this when they sell their property, paying a portion of the gain to the community along with any interest due. Some 24 states and the District of Columbia do this, and it is the fairest solution of all. How can this all be implemented?

By state law, assessors must separate out the land value of each parcel from its total value. This is standard assessment practice. Economists have known since the time of Adam Smith that taxing just the land value is the ideal way to raise revenue. "Ground-rents," he avowed, "and the ordinary rent of land are . . . the species of revenue which can best bear to have a peculiar tax imposed on them." Some 700 places worldwide do this, with remarkable results. In Johannesburg, there is no tax on buildings at all. So, effectively, does Hong Kong. Twenty cities in Pennsylvania do it, and the power of computers and available data now allow simulation of results so it's no longer a matter of just appreciating the economic theory. It's not my place to reveal anything, but I'm now working with two cities in New York State exploring this option. Gradually phasing out of the building tax rate and raising the land tax rate in a revenue neutral manner could be done in a decade. If the assessments are good, about two-thirds of homeowners pay less. Parcels underused relative to their assessed land value pay more. This gives them an incentive to improve their parcels or sell to someone who will.

The deferral option is fair to both the homeowner and the community and is ideally suited to seniors as they are likely to be on a fixed income. Relieved of any fear that the tax collector will evict a household, the homeowner can live assured that he or she can reside in place so long as desired. This addresses the concern that many households may be very equity rich, even if they are income poor. It also assures that the locality will ultimately, even if not immediately, receive its fair share of property taxes due; no special favoritism is involved. The capital gain when a parcel is ultimately sold provides the income necessary to pay the tax office with appropriate interest.

One should appreciate that the deferral provision is not only fair and accommodating, it also comports with all the textbook principles of sound tax theory. Deferral of payment is neutral, efficient, equitable, administrable, stable, simple, and certain. This is important at a time when we have come to realize how much the property tax fosters sprawl development, leads to under use of strategically valuable site parcels in urban cores, how much it fosters real estate speculation, and how much it dis-equilibrates the whole market in housing.

There are various formulas and permutations of the deferral option that states employ. Sometimes only homeowners beyond a certain age can defer their property taxes. Sometimes there are income caps and thresholds for eligibility, sometimes it is restricted to homes below a certain assessed value, sometimes only a portion of the tax can be deferred or only a certain component—school and not municipal, special assessments and not utilities. Sometimes the provision is statewide; sometimes it is a local option. It is interesting to see that some states impose an interest rate on deferred obligations so high that it prohibits its extensive use—10 percent in Tennessee, 8 percent in Texas. I think the option should be broadly available and interest rates reasonable.

Some observers compare it to a reverse mortgage, but experience shows that there are many more abuses involved there, and it is frequently far more burdensome financially. There may also be concern that municipalities might incur a transitory deficit when many households first avail themselves of the option. Some states have allowed a bridge loan from state sources until revenue, Mausoleum of the Stanford family, parents of Leland and Jane Stanford, founders of Stanford University in California, streams have once again stabilized. A bond backed by the same necessary liens against properties is another answer.

Yet the deferral option, where legal, is not extensively employed. This is because homeowners often don't want to forfeit any of the equity they might have built up in the course of many years of ownership. People often see any home appreciation as their rightful gain. The availability of the deferral option, however, exposes those who are shedding crocodile tears about their property tax burden while salivating over future windfall gains, as opposed to those who may have a genuine hardship. Here is why:

Houses, a Federal Reserve study shows, depreciate at about 1 percent annually, so that net appreciation a home typically has is due to the appreciation of the land value and any inflation. Again, buildings depreciate; only land appreciates. I have already explained that the land value is a function of the flow of economic rent, and has nothing to do with what the titleholder has done; rather it is due to the social enterprise of the community.

The community's recapture of land rent in the form of taxes is, morally speaking, a claim of what it, the public, is properly due. Even if the real estate industry and banks argue that home ownership is an assured way to "build equity," the parcel title provides a passive gain that is morally problematic. "Landlords," John Stuart Mill observed, "grow richer in their sleep without working, risking or economizing. The increase in the value of land, arising as it does from the efforts of an entire community, should belong to the community and not to the individual who might hold title."

Offering homeowners the opportunity to pay taxes on their property with appropriate interest and at a convenient time in their lives is a fair and equitable solution to both the community and to all households at risk. Taxing away the surplus economic rent that runs up the parcel values to prohibitively expensive and speculative levels assures that real estate markets are more stable, more competitive, and attractive on a wider scale.