Land taxes: What they are, and why we’re hearing more about them.

Tom Ferrick took the mayoral candidates to task this morning for running on increasing school funding while running away from Michael Nutter’s proposed property tax increase, and reviewed some of the alternative tax-neutral ideas they’ve proposed.

He left out one plan from the Kenney campaign though, which seems less far-fetched than some of the other candidates’ ideas Tom panned, and which could have interesting consequences for the real estate market.

Last year Isaiah Thompson did some great reporting on how the Actual Value Initiative reassessments seemed to be systematically underassessing land, showing how city assessors had assigned vacant lots in some appreciating areas much lower values than they had recently sold for

Jim Kenney is proposing to “revise” these incorrect land assessments, to collect more taxes from abated and vacant properties. Here’s the full platform plank:

It is undeniable that the Real Estate Tax Abatement has been a major driver in the construction and renovation boom that parts of the City have seen in the past 15 years. Reports have found that for every $1 in abatement, the City sees a return of $2 in other tax revenue, mainly through increased wage taxes and realty transfer taxes.

After the institution of the Actual Value Initiative, however, it has become clear that a number of tax abated properties are receiving extravagant benefits. A 2014 study found that of the of the top twenty tax-abated properties, the land or unimproved value only amounted to 10% of the total value, meaning that the building owner(s) were only paying taxes on a tiny percentage of the overall value of these newly constructed properties. These highest properties, valued at over $2.1 billion, are only paying cumulatively $2.9 million annually.

Additionally, Philadelphia has far too much vacant and unimproved land that is being held by speculators who have been sitting on land without building on it for years and years. Recent reports have found Philadelphia home to over 31,000 privately owned vacant lots not being utilized. These landowners have been paying very little in taxes on these properties, and because of this have little incentive to invest and improve the properties. Jim Kenney understands that the City must do more to get speculators to improve this land, or at the very least pay a higher tax for doing nothing with it.

While maintaining the tax abatement to ensure continued development, Jim would work with the Office of Property Assessment to increase the unimproved value on properties across the City, and specifically on vacant land, to more closely reflect the actual value of that land, as opposed to just an arbitrary percentage of the total assessed value. This will increase revenue from abated and vacant properties without increasing taxes on many Philadelphians who faced a substantial increase just a few years ago under AVI. Based on the nearly $6 billion of exempted value for property receiving an abatement, and the value of vacant privately owned land, increasing land value slightly will provide an additional $15 million in recurring revenue which could all be directed to education.

As Isaiah pointed out, under-assessing land is essentially a tax break for speculators–people who strategically hold vacant land off-market in hot areas until rents go even higher. Kenney wants to “get speculators to improve this land, or at the very least pay a higher tax for doing nothing with it.”

The idea is that the higher correct land assessments would raise the cost to landowners of not improving land, nudging them to either build on their lot, sell it to someone who wants to build sooner, or simply pay a higher tax bill.

Land taxes have been experiencing something of a comeback lately. The Economist ran a special report on urban land economics last week, which highlighted the public costs of underutilizing urban land, and extolling the virtues of 19th century Philadelphia-born economist Henry George’s land value tax. That’s the idea that we should tax land values at higher rates than improvements to land, like buildings. 

It’s been catching on with some segments of the technocratic center-left as well. A few weeks ago, former Obama OMB director Peter Orszag wrote a Bloomberg View column titled “To Fight Inequality, Tax Land,” making the case for land taxes as a powerful tool for downward redistribution of wealth. Economics blogger Noah Smith made a similar case for land taxes as a way to redistribute San Francisco’s ballooning real estate values, but Matthew Yglesias said it wouldn’t do much without up-zoning. And the economics blogosphere has also been debating the more academic point of whether a100%,land value tax would be economically distortionary. 

Few people operating in the world of practical politics are suggesting a 100% land value tax though. That would probably be unconstitutional under takings law. But there are some interesting arguments for using land taxes, and variations on the land tax, worth reviewing for their relevance to live policy debates in Philadelphia like inequality, the 10-year improvements tax abatement, wage and business tax reform, transit-oriented development, and stormwater management, to name a few major ones.

Location, Location, Location

A three-story rowhome near Rittenhouse Square costs a lot more than a three-story rowhome in Passyunk Square. The difference is (mostly) land value. Great as Passyunk Square is, Rittenhouse has more going for it location-wise. It’s more centrally located near more jobs and rapid transit choices, it has access to a wider selection of high-end shopping and dining options, and it has direct access to the city’s most popular park.

There are just more advantages that come with living on that area of land than the one further down in South Philly, and people are willing to pay more for the privilege. Increasing the land share of the property tax by an equal amount would generally shift the responsibility to pay for city services onto property owners in the highest value locations with the best access to lots of nice public and private amenities. 

Who likes land taxes?

Land taxes appeal to activists affiliated with a variety of political causes, but inequality has really been driving the recent interest.

As economist Thomas Piketty argued in last year’s surprise hit book Capital in the 21st Century, more and more of the wealth created by our economy has been accruing to capital, rather than wage labor. Instead of economic growth translating into bigger and bigger paychecks for middle class wage-earners, it’s translating into higher and higher portfolio valuations for people who own valuable assets, including central urban land, resulting in yawning wealth inequality. 

Twenty six year old MIT student Matt Rognlie recently made an interesting case though that the increasing capital share Piketty observed can be explained almost entirely by the rise in housing values, and really, land values. The Economist drew out the (debateable) political implications of this hypothesis, that not-in-my-backyard politics in the most desirable neighborhoods, cities, and metros is driving up the cost of housing, and thus the wealth divide between rich and poor. 

They also appeal to economists and people concerned with pro-growth tax reform. If you’ve heard Center City District President Paul Levy’s stump speech for Philly wage and business tax reform, you’ve probably heard him say that we need to lower taxes on things that can move (people, businesses, investments) and start taxing things that can’t move (land, buildings) more heavily. To put that in economics jargon, Milton Friedman and Joseph Stiglitz have both endorsed land taxes because they’re non-distortionary and impose less deadweight loss on production. People can’t make less land in response to the tax.

And the reason you’re reading about this on PlanPhilly is that a Philadelphia budget that raised a larger share of its revenue from land value taxes would clearly have an impact on the physical shape of the city, promoting upward growth rather than outward growth–the name of the game for smart growth activists.

Who stands to lose from land taxes?

For the same reason that many urbanists like land value taxes, surface parking lot owners, vacant lot owners in appreciating areas, and urban car dealerships and shopping centers hate them. Shifting the tax responsibility onto land and away from improvements would cause property tax bills for underbuilt centrally-located land parcels to jump. In theory, surface lot owners would either build on their lots to generate some more revenue to pay the taxes, sell their parcels to someone else who’s ready to build, or just pay the higher tax bill. 

Surface parking lot owners in Center City would certainly see their property tax bills rise, and developers land-banking multiple properties in preparation for a much larger development like a skyscraper might object to increasing the carrying cost of land. 

As we saw with AVI, a revenue-neutral tax policy that shifts the tax burden around is going to create winners and losers, and the losers have more of a reason to engage politically, so the politics of a tax shift get pretty difficult once you begin dealing in specifics, even in a mostly Democratic city where elected officials are nominally committed to some kind of progressive wealth redistribution.

Does Philly have anything like this already?

Two things, actually.

The Water Department’s stormwater pricing kind of works like a land tax, in that properties with more impervious surface area pay more, and properties that are fully built out pay less. Skyscrapers saw their stormwater charges go down under the new pricing scheme, while impervious shopping center parking lots saw big increases. 

The 10-year tax abatement on property improvements is also kind of similar to a land value tax.

If you follow the economic logic of the tax abatement policy, the operating idea is that taxes on property improvements discourage people from making property improvements. Delaying taxes on improvements for 10 years reduces one of the overhead costs of construction, allowing homes to sell at a price point affordable for median wage-earners. Without the abatement, the argument goes, high local construction labor costs combined with the East Coast land premium would make local home prices unaffordable to a great many Philadelphians.

Whether that’s still true in many of the city’s stronger real estate markets is a matter of live debate, but few have disputed its effectiveness in powering a boom in new construction. And the mechanism that’s doing the work is pretty similar to how land taxes are thought to work: reducing the cost of improvements. But the land value tax employs a carrot and a stick by lowering the overhead cost of improvements, while raising the cost of not making improvements.

Are split-rate property taxes legal in Pennsylvania?

Back in the realm of real-world politics, what Jim Kenney is proposing is essentially just another reassessment. He is specifically not talking about changing the millage rates for land and improvements, so that’s clearly within the scope of the city’s legal powers.

There’s been some confusion over the years though as to whether Philadelphia is allowed to actually split our millage rate to establish one tax rate for improvements, and a different higher one for land.

Pennsylvania state law is unusually friendly to municipal land value taxes, giving cities of the third class, school districts that are precisely coterminous with third class cities, and Home Rule municipalities the authority to levy different rates. It has not been clear though whether Philadelphia, as Pennsylvania’s only city of the 1st class, but also a Home Rule county, was afforded the same right.

Rep. Brian Sims’s office obtained a legal opinion from the House Democratic Office of Chief Counsel though that says this would be legal:

In regards to Philadelphia, current statute does not explicitly authorize a split-rate tax.  However, the Act of August 5, 1932 (Special Session 1, P.L. 45, No. 45), also known as the Sterling Act, permits Philadelphia to “levy, assess and collect, or provide for the levying, assessment and collection of, such taxes on persons, transactions, occupations, privileges, subjects and personal property, within the limits of such city of the first class, as it shall determine.” In the opinion of the House Democratic Office of Chief Counsel, the Sterling Act presently permits Philadelphia to levy a split-rate tax. 

In addition, the Act of May 22, 1933 (P.N. 853, No. 155), also known as The General County Assessment Law, does not restrict Philadelphia from levying such a tax.  As such, legislation authorizing a split-rate tax in Philadelphia is likely unnecessary; however, the city solicitor’s interpretation of the Sterling Act could warrant future legislation if the solicitor does not believe the Sterling Act grants Philadelphia the authority to levy a split-rate tax.

Why are so many weirdos excited about this issue?

Your guess is as good as mine, but I’ve been puzzling over this for years and I think maybe the simple elegance of the policy combined with a clear-seeming moral and political story makes it political catnip for a certain type of ideologue. Google “land value tax” and you’ll see that people write about this idea with a quasi-religious fervor that can be off-putting to those not yet converted, kind of like how marijuana decriminalization advocacy sounded before groups like Drug Policy Alliance and Marijuana Policy Project professionalized that space.

Which is too bad, because the basic case for land taxes seems fairly sensible. Altoona, PA recently became the first US city to go to an all-land property tax, and Allentown, Scranton, and a couple dozen other PA cities have split-rate property taxes. Pittsburgh taxed land at five times the rate of improvements for many years and it may be one of the reasons they have so few downtown surface parking craters compared to other Rust Belt cities. 

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