Can a Site Value Tax be an answer?

Introduction

Interested elected officials in Paterson, NJ and in the State of New Jersey asked the Center for the Study of Economics to perform several studies in increasing degrees of coverage of the impact of a site value property tax (known popularly as SVT). It is the hope that this will culminate in a study of the entire tax roll of Passaic County.

The Center would like to thank the state of New Jersey Division of Taxation for providing the assessment data and providing answers to our questions.

For now, we will look at the effect on a SVT on the various classes of property in the city of Paterson. Due to the known concern of residential property taxes, in the study we directed particular emphasis on residential impact. In addition, we examined commercial and industrial properties.

The general questions asked about the SVT in Paterson are these:

1. Would a site tax make low-income housing more affordable?
2. Would a site tax provide a market incentive for owners of substandard housing to improve their properties?
3. Would a site tax benefit those who have built and stayed in Paterson?
4. Would a site tax make the property tax more progressive?
5. Would a site tax direct new housing to vacant Paterson land?
6. Would a site tax promote gentrification?

The Idea

What is SVT? SVT is a responsive, flexible form of the traditional real property tax. Under a site tax regime, the taxing jurisdiction reduces or eliminates the tax on all improvements. To ensure that the taxing jurisdiction receives the same amount of revenue, it increases the tax rate on land.

Why should a community do this? The property tax is, in fact, two separate and distinct taxes. The property tax falls on land and on improvements (buildings) to land.

The present property tax makes a city worse than it has to be.

If someone improves the city by building a new structure or improving an older one, his or her taxes go up.

If someone lets a building go to rack and ruin, they can go to the assessor and get an assessment reduction and the taxes go down.

If someone owns vacant land, they are barely taxed and have no incentive to build. The real incentive in the present system is to hold the land idle, hoping that the city (or their neighbors) improves the area and the vacant land will increase in value. The low holding cost encourages land speculation.

The present property tax penalizes those who improve the city and rewards those who hold it back. That’s exactly backwards.

It is an economic axiom that buildings – a product of labor and capital – can flee high rates of taxation in much the same way that taxes on sales, wages, personal property and inventories have fled some our more highly taxed jurisdictions. It is also an axiom that the taxation of land has no such downside. Land is immobile; the supply cannot be taxed out of existence. As Will Rogers said, “They ain’t making any more of it.”

In addition, unlike labor and capital, the value of land is directly related to government investment in infrastructure. Many claim – with some justification - that it is inappropriate to tax that which people produce on their own time and their own dime. Yet, it is just as easy (and ethical) to permit government to recoup in taxes what it has created: land value.

Therefore, the philosophy behind site taxation is clear:

1. A tax on land will not distort economic decision-making.
2. A tax on land frees the market to exploit the locational advantages of the community.
3. A tax on land best encourages highest and best use of land.

To confirm this notion, here are some quotes from prominent American Nobel Prize winners in economics. Please note that their political philosophies run the gamut from right to left:

Milton Friedman: "I share your view that taxes would be best placed on the land, and not on improvements."

Paul Samuelson: "Pure land rent is in the nature of a ‘surplus’, which can be taxed heavily without distorting production incentives or efficiency." A site value tax can be called "the useful tax on measured land surplus."

Franco Modigilani: It is important that the rent of land be retained as a source of government revenue. Some persons who could make excellent use of land would be unable to raise money for the purchase price. Collecting rent annually provides access to land for persons with limited access to credit."

Robert Solow: "Users of land should not be allowed to acquire rights of indefinite duration for single payments. For efficiency, for adequate revenue and for justice, every user of land should be required to make an annual payment to the local government equal to the current rental value of the land that he or she prevents others from using."

William Vickrey, 1996 Nobel Prize Winner, also endorses site value taxation: "It guarantees that no one dispossesses fellow citizens by obtaining a disproportionate share of what nature provides for humanity."

James Tobin: "I think in principle it's a good idea to tax unimproved land, and particularly capital gains (windfalls) on it. Theory says we should try to tax items with zero or low elasticity, and those include sites."

James Buchanan: "The landowner who withdraws land from productive use to a purely private use should be required to pay higher, not lower, taxes."

The History

Although most forms of taxation in history have been site taxes, it has become the dominant paradigm that taxes on labor and capital are preferable. In the past few decades however, the increased mobility of Americans, coupled with tax and lending policies that encourage sprawl and abandonment of cities have led to the slow dissolution of tax base to the suburbs.

Although some schemes such as TIF, abatements, and exemptions have shown some promise, in the long term the benefits are generally illusory, they benefit the few and the privileged and they affect just small sections of a community.

Site value taxation has been used on consistent basis – as a conscious idea – since 1913, when Scranton and Pittsburgh, Pa. enacted a limited form of site tax. Since then, 18 more jurisdictions in Pennsylvania have enacted the tax shift, most in the past 15 years (see Appendix1).

Since 1990, interest has grown in the site tax idea as old ideas have been shown wanting, and the results of site taxation have become known. In particular, the decline of Western Pennsylvania steel towns has led to a search for ways to maintain tax base and offset the disappearance of closing steel mills. The Pennsylvania Economy League, for example, recommended implementation of site taxation for the City of Clairton as part of its state-mandated recovery plan (see Appendix 2).

The most recent and convincing studies demonstrating the success of site taxation in attracting private capital to a traditional city structure have been Oates and Schwab’s study of Pittsburgh (1995) and Tideman and Plassman’s study of Pennsylvania (1997) (see Appendix 3 and 4).

The Center itself monitors the progress of the site tax in various communities by studying building permit issuance, using data collected by Penn State Data Center in Middletown, Pa. and by its own field operations to the appropriate local agencies (see Appendix 5).

Almost all of the jurisdictions have enacted SVT through the local legislative body, usually in the form of an annual property tax ordinance (See appendix 4). In the case of Allentown, Pa., the site tax became law by popular vote in 1997 as part of an overall reform of the local tax structure (see Appendix 6).

Two jurisdictions (Hazleton, 1993 and Uniontown, 1991, Pa.) have rescinded their SVT; both towns enacted a too-drastic site tax against the advice of the Center.

Overall, the judgment of local officials who have tried SVT is positive. In particular, when the SVT is used in conjunction with other incentive programs and marketed aggressively, the results seem to very positive (see Appendix 7 and 8).

Background/Situation

The Center agreed to perform an analysis of the assessed property tax roll for the City of Paterson. The Center consciously tries to have as little knowledge as possible about local conditions, relying instead on the numbers to provide a picture of what can be done.

Certainly, Paterson’s property tax is markedly higher than surrounding jurisdictions:

A tax rate so much higher than surrounding jurisdictions leads to outflow of population and productive business as well as under use of expensive infrastructure.

Without systemic tax reform, Paterson will have to rely on expensive tax abatements to spur development. As experience has shown, however, that while tax incentive programs are successful at attracting projects they do little for the overall economic health of the rest of the city.

The Center did get a general sense that lower-income prospective homeowners are having a hard time finding decent, moderately priced homes. Fears of gentrification crowding out those who don’t have the means to hang on in their neighborhoods became part of the pre-study dialogue as well.

Methodology of Data Collection/Analysis

The state of New Jersey provided (on CD-ROM) the tax roll of taxable property for Passaic County. Using the key code 1608, the Center extracted all properties from the city of Paterson. The raw data was entered into a standard spreadsheet program. The data was split into use codes for analysis by land use (residential, commercial, industrial, vacant). The city tax rate of 11.923 is the study benchmark, although the overall tax bite for a resident of the City of Paterson is 20.868 [1] . Why 11.923?

To make a practical application of site tax possible, the most local application is necessary. Considering the “foreignness” of the site tax idea, the Center thinks it best that although the numbers from a mix of city/county/school taxes will be the most dramatic in measuring impact, drama is not the best way to soberly consider the merits of any particular program.

After determining the tax bill for each property, the next order of business is figuring out what the site tax rates should be for the purposes of the study. To do this, first a building to land ratio (B:L Ratio) has to be established. The B:L Ratio is the ratio of assessed building value to assessed land value. For example, the B:L Ratio of a parcel with $100,000 building/improvement value to $25,000 site value is 4:1.

In Paterson, the citywide B:L is 4.64783:1. This ratio is the determining factor in what the site tax rates will be, as well as a concrete indicator of what parcels will benefit from a SVT and which parcels that will pay more. Any parcels with a B:L lower than 4.64783 will see increased liability. Any parcel above that ratio will see a decrease.

B:L Ratio as a Determinant of Tax Rates

The Center has established a formula that will let a jurisdiction determine simply and clearly what the tax rates on land and buildings would need to be to ensure revenue-neutrality. This formula is used by many of the site tax cities and towns in Pennsylvania. For the purposes of this study, Paterson will use the rates of 34.08943 on land values and 7.15380 for building values to provide the same revenue as 11.923. How is this determined?

With assessed values of $103,632,945 for land values and $481,688,823 for buildings/improvements, the rate of $11.923 applied to both sets of value provides revenue of $19,730,179:

IIf Paterson were to reduce the building tax rate by 40%, then the building tax rate would be 7.15380 ($11.923 X 80% = 7.15380). To determine the site tax rate, simple algebraic expression is used: LTRp = (PTRc - BTRp) X (BA/LA) + PTRc LTRp means Site tax Rate Proposed. PTRc means Property Tax Rate Current. BTRp means Building Tax Rate Proposed. Therefore: $.34.08943 = ($11.923 - $.7.15380) X (4.46783) + 11.923

Test the proposed tax rates: With a $15 difference, revenue-neutrality is achieved.

B:L Ratio as a Determinant of Savers and Payers

As an illustration of B:L, two parcels are presented: one a vacant plot, another a residential condo unit.

This vacant lot has a value of 10,500, hence the B:L is 0.00000 (0/16,500). It will pay.

The residential condo unit has 86,600 in building value and no land value; therefore the B:L Ratio is infinity (86,000/0). It will save

The residential condo unit has 86,600 in building value and no land value; therefore the B:L Ratio is infinity (86,000/0). It will save.

The Application in Paterson

There are 23,339 taxable parcels of real property in Paterson. Currently, the city gets 17.71% of its tax revenue from land values; therefore, 82.29% of tax revenue comes from buildings. For a city in competition with cheaper land in outlying suburbs and rural areas, this is detrimental to current attempts to attract private development, especially the kind of development that does not qualify for the usual tax credit/abatement programs. In addition, the lion’s share of revenue coming from buildings discourages, in the market sense, denser less expensive housing. Less dense “McMansion” development is encouraged by the cheaper acquisition and holding of valuable land.

There are many choices the city could make for implementation of a site tax regime. A slight shifting every other year would permit those land owners who would otherwise view the site tax as negative as a positive way to eyeball their holding costs of land versus the benefits of suddenly cheaper development. As the accompanying table shows, the annual “take” from buildings could be reduced substantially, with no revenue loss. The economic advantage to construct and rehabilitate buildings in Paterson becomes more apparent with each reduction in building tax.

For the scenario, a tax rate of $.8597 on land and $.4160 on structures will be used. As stated, the revenue take is the same. Instead of 17.7% of revenue from land, this option provides for just over 50% of revenue from land.

Impact of SVT on Revenue Flows and Sources for City of Paterson, NJ

Analysis by Code and Class

Residential

Residential property is assessed at $362,617,013. That’s 61.95% of the city total. There are 17,594 parcels coded residential in Paterson. As a class, residentials see a decline of 9.18% when a 40% building tax cut is put in place (see Table 1). The largest cuts are enjoyed, naturally, by condo/co-op units, as the bulk of the ownership is in structure, not land.

When one looks at the progression from single family to multi-family, one sees that the amount of tax decrease grows. This illustrates how SVT rewards denser development. To further develop this thought, we must skip to the apartment class (see Table 1) and note that apartments – the launching pads of working people into the economy – save 14.18%. A SVT regime could lead to cheaper rents and/or more humanized living conditions for apartment dwellers (less emphasis on a building tax will not discourage landlords from keeping up their properties).

If SVT were enacted in the city of Paterson, the tax liability of 13,702 (78%) residential parcels would decrease or see no change. That’s one of the best results ever measured by CSE for a community. 3,892 parcels would see increased liability (22%). The average savings with a 40% decrease from the building tax will result in an average savings to these parcels (that save) of $379 annually (no tax on buildings will see $948 annual savings). Since the vast majority of these essential community members see no negative impact, SVT would be politically feasible in Paterson.

On the other hand, what of those who might pay more? It’s instructive to note that the average liability of Code 111 savers will be $488; for pay mores, it’s $497; the change is small.

Vacant Land: an Untapped Source

Vacant land is assessed at $105,783,300. That’s 12% of total site value for the city. That’s a fairly high rate of vacancy.

To better see the impact on affordable housing, an examination of vacant residential land is in order (see Code Table 2). The median value of a vacant parcel zoned for single-family use is $9,500 (the average value is $14,474). For this $9,500 parcel to be developed according to community averages, it will need a “built” median of $47,800 in building and improvements.

Under today’s tax system in Paterson, $47,800 means around $250 a year in added taxation for city taxes. With county and school taxes added in ($1.35 per $100 valuation), a new homeowner – struggling for often the first time with taxes – would need to find nearly $650 annually. That’s often beyond the reach of the poor struggling to achieve homeownership.

The situation becomes more difficult with a 6% sales tax on such items as food, drugs and leased items (such as rent-to-own). SVT would lighten the already heavy tax burden on working families in the area.

Would a SVT take away development opportunities for more modest housing in order to satisfy the top dollars that gentrification and holiday homes command? Not likely; the parcel sizes are much smaller for the vacant land lots zoned for residential. The median size is but .22 acres, far smaller than the median of current occupiers (.29) and dwarfed by the demands of absentee owned homes (.43). SVT would seem to be an ideal tool to get this land used for affordable housing.

Commercial and Industrial

Without a healthy array of commercial and especially industrial properties to make a complete economic picture, any community of size and infrastructure will have trouble keeping housing affordable simply through the tax system’s disconnect with market forces. The loss of commercial and industrial tax base leads to over reliance on residential property taxes, which lower-income homeowners can ill afford.

Commercial real estate is assessed at $1,425,587,900. That’s 38% of the city total. When SVT is being considered, it’s essential to consider the impact on commercial properties, no matter what the reason for implementing SVT.

Commercial interests have the time, incentive and resources to object to any change in the tax structure. It’s a difficult leap of logic for those commercial interests who do pay more to see the long-term economic advantage of SVT: with more homeowners and owner-occupiers coming ‘on-line’, the tax base stays solid with added business for all.

There are 63 different code uses for commercial parcels (see code Table 3). As a class, commercial see an overall increase in taxes, though the increase is slight (1.36% with the 20% building tax cut, 6.79% with no tax on buildings).

Previous city studies of SVT for commercial properties have confirmed what occurs in Paterson: the properties that employ the most people – in construction and post-construction are the biggest savers.

Hotels would see a 16.27% drop in tax. Overall, the Central Business District type properties would see a drop (Banks: 13.82%, office buildings: .06%, downtown row type: 1.33%, regional shopping centers: 7.33%).

Increases come from automobile intensive and cash-intensive businesses: gas stations, convenience stores, parking lots, car washes, etc.

Vacant Commercial Land

There are just over 500 vacant commercial properties in Paterson. Valued at approximately $31 million, these parcels are an important untapped resource to help keep overall taxes down by expanding the tax base. Interestingly, the average value of these vacant parcels is about $60,000 (see code table 3 for more information on vacant commercial). This amount is just about half of the developed commercial average ($121,520).

Why? Most likely, some of these parcels are being used as parking. Most appear to be owned by private individuals for speculative purposes. If these parcels were developed to the average B:L ratio of commercial parcels (2.99432:1) there would be an additional $92 million is taxable parcels.

It behooves Paterson to use a revenue-neutral tool to develop these parcels; SVT is designed to do this.

Industrial properties are few in number (63 developed, 4 vacant) and rather insignificant in value ($71.8 million developed, $69,900 listed as industrial vacant).

The only suggestion that could be made (independent of any knowledge about what is on tap for land use master plans) is to take a look at the Vacant Codes 120-129. These are various agricultural uses, some of which may be converted to industrial park use. It is not known by the Center if any of these parcels are actually used for agricultural purposes.

Revenue Projections

SVT will be revenue neutral to Paterson. There will be class shifts in tax liability, however.

The residential parcels will see a drop in liability of 4.15%. With no tax on buildings, that tax drop will be 20.75%. Again, apartments see the biggest drop in housing tax liability at

To be politically possible, SVT must be introduced gradually, as mentioned before. To ensure a smooth transition, it’s imperative to illustrate the dollar amounts for each parcel, in a way that averages or medians cannot do. Placing the shifts in staggered increments is an effective method.

The range of how much a parcel will save or pay is indicated in the chart:

Clearly, the initial shifts will not be a burden.

For commercial properties the shifts are somewhat larger; no surprise considering that properties that generate income have a much higher value. Yet, the added liability to commercial will be – as a class – only 1.36%. Parcels that personify the traditional downtown will save the most.

Again, the real story is the commercial vacant. A site value tax will – as experienced in other SVT cities – provide both the carrot and the stick to spur appropriate commercial development in Paterson.

The following chart illustrates the ranges of shifts with commercial properties. The ranges tend to higher dollar amounts than residential, but the shifts are spread in a flatter series of ranges.

Conclusions/Recommendations

In line with other cities of its size that have enacted SVT, this study has demonstrated that SVT may be implemented in Paterson with little disruption to city and taxpayer. By de-emphasizing the tax on buildings, Paterson can have an opportunity to encourage denser, lower priced housing with little penalty to developer or homebuyer.

As in the cases of Harrisburg and Allentown, PA (with whom the Center has actively worked), the vast majority of extant homes will see a tax savings. The traditional downtown will not be adversely impacted.

Therefore, Paterson, should first determine from the state attorney general whether a site value tax is constitutional in North Carolina [2] . Next, (as it looks like an open question leaning to “yes”), city enabling laws must be passed by the legislature (the support of the North Carolina League of Municipalities will be important as the Center has learned in other states).

Once the enabling laws pass, the city of Paterson must enact an annual property tax ordinance with the two rates on land and buildings (see appendix 9 for a sample ordinance from Pennsylvania).

The shift from emphasis on buildings for revenue to a reliance on land should be done in progressive stages. For example, the City of Harrisburg lowers it’s building tax rate by about 10% every two years. The city of Allentown does so (by charter requirement) by about 12% every year. There is no particular stop point. If the city thinks SVT beneficial they may proceed to no taxes on land (thus emulating the property tax in New Zealand and Australia).

For Paterson, The Center recommends that the building tax rate be dropped by 20% from $11.923 to $.4160 and the site tax raised $.8597 (refer to page 5 for rationale).

Further study should be made of other jurisdictions in Passaic County.  Implementation should take place after a “probationary” period in Paterson has demonstrated the benefit.

A countywide examination and proposal is appropriate only after the economic picture has started to make Paterson City the place to build, re-build and invest. Economically, a scattered application of this powerful tool might distort economic choices and bring development where it is not desired and could spur development that does not have the idea of affordable housing at heart.

The best recommendation for SVT in Paterson is to provide affordable housing for those who have been left out of the New Economy’s boom. By filling in the many small available vacant lots with denser housing, Paterson can take giant strides for a just and fair city for all.

Final Comments

It costs nothing to implement this idea. Only a software change is necessary. The idea offers the idea of urban rejuvenation without added taxation or government programs. No state or federal aid is necessary.

Everybody get as “tax break.” It is common for a state or municipality to offer tax breaks to encourage development in a particular location. The problem is that the taxes not paid by the favored few must be paid by everyone else. SVT includes an incentive to everyone – whether his or her taxes go down or up – to improve the community.

A site tax is a very stable tax. It is more stable than a tax on improvements. Cities need a stable tax base. It allows them to plan more easily when they have a consistent tax base.

Taxing land more than buildings discourages speculation. People who speculate in land do not contribute to the community. They hold land off the market, out of use, waiting for the value to rise. They take no action nor make any investment to make the value rise. They simply wait for the community to grow, which makes land more valuable. Land held out of use denies opportunity to those who might use that land to improve themselves and thus the community.

Taxing land more than buildings discourages sprawl. When land is taxed lightly there is little incentive to use it. Land in the city has all the infrastructure and utilities, but if held off the market, people have to “hopscotch” over this land, out into the countryside to find available land. This leads to loss of green countryside and farming.

The site tax is progressive. The poor own little or no land and use very little. They will pay the smallest share of site tax. The middle class owns the land under their homes. They will pay modest site taxes. Corporate, absentee or wealthy individuals own the most valuable land. They will pay most of a site tax.

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