Fiscal Reform versus Fiscal Decay
Two-Rate Property Tax for Philadelphia
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At a February 12 hearing on tax reform for the troubled city of Philadelphia, Dr. Nicolaus Tideman gave the following testimony. With his permission, we present his remarks here. |
by Nicolaus Tideman
Professor of Economics, Virginia Polytechnic Institute and State University
Testimony before the Philadelphia City Council, February 12, 2002
From an economic perspective, the property tax is a combination of two very different taxes. It is a tax on land combined with a tax on improvements. The tax on land is one of the most benign taxes in terms of economic efficiency, while the tax on improvements is one of the most harmful.
The tax on improvements operates like an increase in the interest rate that banks charge to businesses. It increases the rate of return that an investment must yield to be profitable, and thereby squeezes out some investments. In the same way that the economy slows down when the Fed increases interest rates and accelerates when the Fed lowers interest rates, the economy of a city slows down when it increases the tax on improvements, and it accelerates when the tax is lowered.
But the effect on a city of an increase in the tax on improvements is even more severe than the effect of an increase in interest rates on the national economy, because of the concentration of the effect on a single locality. When the tax rate on improvements rises in a single jurisdiction, people and capital move to other places. When interest rates rise, people would need to go abroad to escape the impact.
A tax on land is benign because land can't move to another jurisdiction. In fact, a tax on land may be not merely benign, but actually beneficial. This is because a tax on land reduces the profit from land speculation, thereby reducing the amount of land speculation, leading to a greater effective supply of land and lower land prices. Thus higher taxes on land motivate people who would otherwise leave the land they hold undeveloped or underdeveloped to either develop it themselves or sell it to someone who is prepared to do so.
Several years ago I had a doctoral student, Florenz Plassmann, working under my supervision on a study of the impact of two-rate property taxes in Pennsylvania. (He is now an Assistant Professor at SUNY Binghamton.) Plassmann and I looked at building permits in the 15 Pennsylvania cities that had used two-rate taxes for more than one year, and at about 200 similar Pennsylvania municipalities that had maintained equal rates of taxation on land and improvements. We examined separately the number of permits and the value per permit for whole structures and for additions or alterations, for residential and for commercial or industrial structures.
We found that two-rate taxation made a difference in all categories except whole commercial or industrial structures. The way we explained the absence of an effect on whole commercial or industrial structures is that most cities, whether they have two-rate taxes or not, use the LERTA program to grant tax abatements to those who build whole commercial and industrial structures. Such tax abatements are economically equivalent to two-rate taxation, except that they apply to only a fraction of the potential sources of development for a city.
When we combined the effects of two-rate taxes on all categories of property, we found that for each one-percentage point difference in the effective tax rates on land and improvements, construction each year was greater by an average of 15%. Our 90%-confidence interval on this estimate was 8% to 23%. This is the kind of impact that Philadelphia can expect if it shifts some of its property tax from improvements to land.
Mr. Saidel is proposing a number of other tax reforms for Philadelphia. While I don't have numerical predictions to make about their consequences, I can say that economic theory supports the expectation that they too will bring major benefits to the Philadelphia economy.
For more on this subject, see these:
Land Value Tax Considered by Philadelphia
Top Article on Property Tax Reform
Commentary from the Philadelphia Daily News
Reform for Philadelphia: Background and Summary (courtesy of Common Ground-U.S.A.)
Controller Saidel's Report
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