Encouraging value creation by focusing on productivity
In the 18th and 19th centuries, many European countries implemented a tax on windows, or a glass tax, as an alternate means to generating revenue (income tax, at the time, was seen as too intrusive to privacy and an infringement on personal liberty). While perhaps politically more viable, it had unintended costs and consequences. Ultimately, after a couple hundred years, it was repealed with the realization that this was effectively a tax on light and air. This seems fairly obvious in retrospect.
Like the window tax of previous centuries, we may soon realize that our current municipal and county tax policies short-changed us on livability factors just as critical as light and air. Consider, for instance, that a higher Walkscore has been shown to increase property values. This is great for demonstrating the value of living in compact, walkable, mixed-use environments. It is less successful at providing clear tax benefits for neighborhoods to increase value through improving Walkscore or pursuing other investments as doing so actually results in a tax penalty. This is backwards. Will we one day look back at this tax regime and call it the walkability tax?
We need a new model. Rather than assessing value, we must move to a system that assesses productivity. Doing so removes the penalty in creating value and has the potential to drastically change the conversation about how we develop and invest in our neighborhoods, towns and cities.
The current system
While the details vary from jurisdiction to jurisdiction, property taxes are generally calculated based on a periodically adjusted millage rate (typically the aggregate of county, municipality, and school district rates) that gets multiplied by the total assessed value of the property (divided by a thousand). The assessed value is a simple, yet opaque, determination of the value of the land plus the value of all improvements to the land (buildings). The equation looks something like this:
(County + Municipality + School District Millage) x [(Land Value + Value of Improvements)/1000] = Property Tax
This system, which has been in place for some time now, has developed a number of unintended consequences:
- Disincentive for value creation Value is a subjective reflection of scarcity and is the product of both conscious investment and external factors such as proximity to jobs, schools, and services. Since higher values increase the assessment which impacts the tax liability, property owners have little incentive to add physical value (non land-based) other than out of a sense of pride, changing needs, economic opportunity for new revenues, and sufficient wherewithal to absorb increased tax burdens. Further, there is natural apprehension about increasing neighborhood value as the current system only serves to levy a higher tax on such changes to the neighborhood.
- Not in my back yard -ism (NIMBYism) Since new residents, shops, services, and development of any kind drives up scarcity of land and nudges up land value, any new nearby development negatively impacts those that are already in place. This is particularly true if the nature of the new growth is in a format that exacerbates utility or municipal service demands without adequately covering the ongoing operation costs of the new impacts (impact fees are a topic for another day).
- Gentrification This is a complex issue with a number of factors but neighborhoods generally trend toward sterility because the diversity (however so defined by age, ethnicities, incomes, etc) gets squeezed out by an increasing tax bill that cannot be sufficiently be covered by those that are disabled, low-income, fixed income, or businesses operating on thin margins.
- Cost-revenue imbalance As current assessments are based on value of properties and not on the actual cost of providing services (outside of the blanket determination by the millage), there exists a significant redistribution of wealth occurring between those places that are location efficient (in other words, have a high ratio of customers to infrastructure demand) and those that are location inefficient (places with low utilization but high infrastructure demand). New development on the fringes of towns and cities has come in increasingly larger increments with a growing percentage of developable land given over to public infrastructure, lowering the effective productivity of development on the landscape.
- Municipal hardship and bankruptcy With limited ability to adequately increase rates to cover the spread between cost of services and revenue from customers (Prop 13 in California being one of the better known examples), governments at all levels have turned to debt spending to plug the gap. We have seen several cities recently go bankrupt as a result. Many others find themselves cutting essential services such as education, police, fire, and deferring essential maintenance.
We need a different paradigm that corrects for the disincentives of the old regime. We need a system that not only drives value creation but encourages productivity so that the investments we make both as individuals and as cities have rates of return that justify the capital outlays and risk. Further, we need a tax policy that better links service cost to customer.
A new system
Let us assume for simplicity's sake that the millage rates and the means by which they are determined are to stay the same (putting aside for the moment the contentious issue of whether or not school funding should be linked to property value). Instead, we will focus on the means by which we make the assessments. Currently assessed value is determined by a basic function:
Value of land + Value of built improvements = Total assessed value
This is a subjective measure that is routinely contested politically and in courts because of its lack of transparency. It is also rather simplistic in its failure to clearly acknowledge the multiple considerations that determine the cost in providing services to the property and off-setting external impacts that the property exerts on the community. Instead of assessing value, which is inwardly focused and an inaccurate pairing of actual fee to service, we should be assessing productivity, which is a far more quantifiable metric that accounts for inputs (costs) and outputs (investment, economic activity, etc). Therefore the new equation would look more like this:
Land (Lot Area + Frontage - Location Efficiency) + Building (Revenue + Parking - Improvements) = Total assessed productivity
Lot Area Square footage of the lot
Frontage Linear feet of lot frontage along a right-of-way
Location Efficiency (credit) Is a determination of the site's connectivity to and a pro-rata use of services, infrastructure and transportation facilities. This can be adjusted as this improves over time (such as a new residential units, schools, retail, improved Walkscore, community infrastructure, etc); LEED ND has a functioning system in place that may serve as a model.
Revenue Demonstration of economic output in the form of residential units (rents or number of units), sales, jobs, or whatever factors municipalities prefer to benchmark.
Parking Since parking has a direct impact on the number of cars entering the shared street network, congestion, street depreciation, and even (in some places) emission costs may be factored as a result of the number of parking spaces provided.
Improvements (credit) Investments in the building(s) on a piece of property that assure use, safety, welfare, and joy that comes from a looked after built environment.
Lot area and frontage determine the amount of area required to deliver a certain level of productivity to a community and therefore represent an increase to the total assessed productivity. However, location efficiency, as demonstrated by such tools as Walkscore, is seen as a credit against the land-side of the assessment based on the possibility for a decreased service load in meeting many daily service and transportation infrastructure needs within close proximity.
Revenue generation and parking both represent traffic and service loads that must be compensated through assessments. Improvements to the property, on the other hand, ensure that the property is being invested in and cared for. This has measurable benefits to the community with little associated social costs and therefore should be used as a credit against the revenue and parking fees.
Switching from a value assessment to a productivity assessment to determine property tax will mitigate the current system's consequences as outlined above in the following ways:
- Disincentive for value creation Rather than taxing investments that improve the value of the property and the neighborhood, productivity assessments reward investment as a credit to lower the total assessment.
- From Not in my back yard -ism (NIMBYism) to In our backyard (IOBY) With new investment coming into a neighborhood, existing businesses and residents stand to directly benefit through better proximity to services (in other words, a better Walkscore) and higher degree of infrastructure utilization (more paying for the same amount of services). Community stakeholders likely will be more welcoming of new proposals that deliver these benefits. This permits more density and infill while also raising expectations for how new development will perform within a neighborhood.
- Gentrification The productivity assessment model, because it does not check market value, will not discourage a rising market value. Therefore many businesses and residents who own their property in a developing area will still have the same choices to make whether to sell or remain based on what their parcel can fetch in the market. Where the productivity model differs, however, is in not punishing existing residents and businesses. In fact, if development occurs that is beneficial to their location efficiency, their total tax liability could actually decrease. This will increase options for fixed-income households, low-income residents, and low-margin businesses to preserve vital neighborhood diversity.
- Cost-revenue imbalance Productivity assessments look hard at the efficiency of any particular piece of land. Specifically, it is looking at its outputs (density, economic, etc) against the land area it consumes and services it requires. This not only promotes smaller impacts, it minimizes the redistribution of wealth that comes from efficient development effectively subsidizing far flung and low-efficiency development.
- Municipal hardship and bankruptcy Because development will be paired more directly with the cost of servicing it (both suburban and urban), municipalities will not only be able to make much better judgements about which type of development to pursue but, more importantly, the private sector will finally have the price signals necessary to determine this for themselves.
Tax policy plays an outsized role in determining the built form. With the enormous role that the federal government plays in shaping real estate development nationally, localities have to be hyper-creative in structuring appropriate and equitable tax policies. Property taxes are the primary mechanism for doing so. It is critical that we find the right model for encouraging value creation through a renewed focus on productivity.