Thoughts on the Property Tax

C. Lowell Harriss

[Reprinted from Fragments, April-June, 1981]

What is a property tax? It is a tax on land and its buildings, plus machinery, equipment, and inventories of business. In the United States, it yields close to $70 billion a year. It is a tax designed to permit the residents of a community to finance services for themselves. It has its "merits" and its "demerits."

One of the demerits is that the tax, falling on man-made products, invariably discourages production. Another point, rarely noted, is that the tax, as a cost of occupancy and construction, tends to induce smaller-size rooms. It results in the loss of potential benefits from the "law of the cube." Human well-being can generally be served better by the construction of rooms, houses, and buildings of larger, as opposed to smaller, size.

Still another flaw in the tax is that well-constructed, high-quality buildings are now taxed more heavily per unit of space .than are slums and "junk." In many areas, new machines are taxed more heavily than old. Is it not stupid to decree that if a family or a company supplies more and better capital facilities, it must also pay more toward the costs of government?

The tax on buildings discourages maintenance and modernization. Cities which need to replace obsolete, decayed, destroyed buildings, nevertheless put tax impediments in the way of progress. Is this not both irrational and self-defeating?

One of the merits of the property tax, on the other hand, is that it also falls on land values, thus compelling, rather than discouraging, the use of land. Therefore, a change in the structure of property taxation which would cause only land, rather than improvements, to be taxed, would spur production in two ways. Land, which is often held idle for speculation, would have to be employed or given up. At the same time, the removal of taxation on improvements would create the incentive to produce all materials needed to satisfy the demands of the community.

Raising taxes on the value of land would temporarily work against the owners of land, but, in the long run, would benefit everybody. Many landowners have unrealized capital gain accrued since the land was purchased; and some land, especially that which is largely vacant or under-utilized, is relatively under-assessed. Five years of transition would permit gradual adjustment; and all people, including landowners would gain by the change. The community would capture in taxes some of the value which it has created, and spend it on schools, streets, and other facilities.

If the full tax on land value were collected, the tax would be almost burdensomeless (except that the owners of land and their heirs would lose their "unearned increment"). The necessity of paying tax on the full market value of land would intensify the pressure to get the best income possible, and thus cause the owners to make more effective use of land. The "speculators" would practically disappear.

Today, keeping urban and suburban land idle, or nearly so, while waiting for prices to go up, may cost the owners rather little. Their ability to deduct property tax in computing taxable income reduces the net cost to them (but not to society) of holding land largely idle while waiting for the price to rise. If land value taxation were adopted, the landowners would be unable to continue their current practices.

Predictions of some tendencies seem rather safe. The new tax would weaken the power of some landowners to "force" people in a growing community to settle farther out than otherwise. The effective supply of land would rise, especially where market prices are high. New possibilities of, and incentives for, compactness would appear in urban areas. More intensive use of the higher-priced, central areas of cities, of "close in" rather than "farther out" sections, would result. The filling in of the idle spots would be accompanied by more vertical development, which would, in turn, result in the saving of transportation costs. Horizontal expansion would be somewhat less attractive compared with the more intensive (vertical) use of land.

As a concluding thought, the following words, penned a century ago by a famous economist, seem to be pertinent in guiding our thinking on taxes today:

"The present method of taxation . . . operates upon energy, and industry, and skill, and thrift, like a fine upon these qualities. If I have worked harder and built myself a good house while you have been contented to live in a hovel, the tax-gatherer now comes annually to make me pay a penalty for my energy and Industry, by taxing me more than you. If I have saved while you wasted, I am mulct, while you are exempt. . . We punish with a tax the man who covers barren fields with ripening grain; we fine him who puts up machinery, and him who drains a swamp."

The economist who wrote those words was Henry George.