James M. Hohman, Mackinac Center for Public Policy
Michigan legislators are debating bills that would let Detroit substitute some of its property taxes for a land value tax. Detroit Mayor Mike Duggan is the biggest proponent of this legislation, which he sees as a way to address a problem in the city. Detroit has the highest property tax rates in the country. This affects the value of property and the city’s rate of development. Tax something and you get less of it.
The proposals would address this problem by changing the way real property is taxed.
A land value tax is assessed only on the value of the land being taxed. This is a significant difference from a property tax, which is based on the value of both the land and the buildings on that land. From an economic perspective, there are positive dynamics to land value taxes that sometimes make them preferable to property taxes. There are also tradeoffs lawmakers should consider.
Here is a quick overview of the proposed bills:
Land value taxes would eliminate the penalty property owners pay for developing their land. With property taxes, developers who erect new buildings on a vacant lot must pay more in taxes, because improvements increase the assessment of the property. With a land value tax, investment in developing the land does not increase the owner’s taxes.
The proposal aims to be revenue-neutral, that is, to prevent the city from losing out on any potential tax revenue. It achieves this by shifting the relative tax burden from people who own developed and valuable properties to people who own vacant or underdeveloped land.
The proposal keeps the same taxpayer protections that exist in Michigan law.
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How will this help Detroit deal with its declining property values?
While Detroit is not shrinking and shedding properties, it is losing property tax revenue. That’s because the value of property is subject to taxes, not the land mass. Property in Detroit is worth a lot less than it used to be. The taxable value of property was $10 billion in 2008, and this declined to $6.0 billion in 2017, a 47% decrease when adjusted for inflation. It has since increased with inflation.
Part of that decline results from a self-inflicted wound. According to courts, Detroit systematically inflated the assessments of property values in the recent past. The decline in the taxable value of property is more an adjustment to reality than a reflection of trends in property value. City officials are working to fix this problem.
There is a lot of undeveloped land in the city. That means there is a lot of potential to do something with that land. There are already attempts to put to productive use vacant land owned by the city government due to tax foreclosure. Some private owners hold vacant land as a speculative investment.
There are economic reasons why Detroit has a lot of vacant land. There used to be nearly two million people in the city. Now there are 620,000. It is still the poorest large city in America. There may not be a lot of good opportunities to do anything with vacant land in the city until the economic trends change. Market fundamentals do more than city tax policies to determine whether people develop land.
But there may be extra reasons to sit on vacant properties in Detroit. The combination of high property tax rates and low property values make the cost of holding onto vacant land low. If you build on your land, it will spike your property taxes.
This deters development.
Duggan wants to change that. The proposal is not a property tax cut, which would result in less revenue for the city, county and other governments in the area that levy property taxes. The proposals endorsed by the mayor and sitting before the Legislature allow Detroit to replace a portion of its property taxes, dollar-for-dollar, with a land value tax.
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Who benefits?
A key virtue of a land value tax is that it helps alleviate the type of problem Detroit is experiencing: low carrying costs of vacant land and large disincentives to develop it.
It also has other features economists like. Taxes have smaller negative economic effects when people cannot easily avoid them. Raising cigarette taxes encourages smuggling, for instance, an unintended and negative consequence. Land value taxes are tougher to avoid, short of selling the land to someone else who would be subject to the tax. By contrast, property owners can avoid or at least mitigate property taxes by not developing their vacant land. There is not much an individual property owner can do to raise or lower the value of land — it’s based on market forces in which the owner plays only a part.
Economists recommend taxes that collect revenue without greatly affecting the free choices of consumers and producers. The benefit of a land value tax is that it has little impact on the decision of a property owner to develop his land or a homeowner to upgrade her house. There are economic effects to all taxes, of course, since people lose out on the revenue that gets taxed. But that is the case for property taxes as well. The land value tax does not penalize development the way property taxes do.
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So what are the concerns with this proposal?
Because this land value tax is designed to collect as much revenue as current property taxes do, it creates winners and losers. It redistributes the current tax burden of owning property in Detroit from some taxpayers to others. Owners of valuable buildings come out ahead, while people who own vacant but valuable land face higher tax burdens.
Duggan expects the typical Detroit homeowner to have a smaller tax burden under this proposal. Individual property owners will face differing results, however. Whether a property owner comes out ahead or behind on this deal depends on his or her buildings-to-land ratio. The burden of the land value tax is spread across all property owners in the city: A taxpayer with a higher buildings-to-land ratio than the city average will likely have a lower tax burden. The opposite is true for those with a buildings-to-land ratio below the city average.
In other words, people who own big buildings will benefit the most. Those who own vacant and low-value land will have their taxes increased the most. But if those property owners develop their land, they will not see their taxes increase as much as they would under a property tax system. Homeowners who make additions to their homes would also benefit because new construction would not increase their taxes.
That’s part of the point, of course. A land value tax does not penalize property owners for developing their land.
It is difficult to predict the exact impact of a land value tax like this one. Many developers under current law already receive tax exemptions that shield them from bumps in their tax rates when they build.
The proposed land value tax may also cause some people holding land for speculative purposes to forfeit their land to the county rather than pay higher land value taxes. Increasing taxes on vacant land is likely to increase the number of government-owned lots in Detroit. The city already owns a large number of properties.
Converting to a land value tax also changes the trajectory of the city’s future tax revenue. Whether this would increase or decrease revenue is a difficult question. Tax revenue will depend on whether property values increase faster or slower than land values. I suspect property values will increase faster than land values. New construction immediately increases property values, but its effects on land values are more uncertain. While land values may lag changes in property values, however, they reflect similar economic trends over the long term.
But the land tax bills do respect limits on tax increases.
Michigan’s constitution offers landowners protections from sudden increases in property taxes and requires voter approval of new taxes by local governments. These provide relief to homeowners whose home values consistently increase year over year. The proposed land value tax would keep these limits. Specifically, the state’s three constitutional limitations on property taxes will apply to the land value tax.
The proposed bills would follow the Headlee Amendment to the Michigan Constitution and require land value tax rates to be reduced automatically when the value of the tax base increases faster than inflation. Similarly, assessments on land value will not be allowed to increase faster than inflation or 5% per year, whichever is less. That’s according to the Proposal A constitutional amendment protection. Lastly, voters will have the final say in whether this land value tax is approved as a substitute for the property tax, which is another requirement of the Headlee Amendment.
Restricting how much property values can increase leads to some inequities in the property tax system already. Long-term homeowners generally pay much lower property taxes than their freshly moved-in neighbors. A land value tax would create further inequities. Someone who owns a big apartment building on a small piece of land could face the same tax obligation as someone who owns a house on a similar piece of land. It’s similar to the property tax system we have now, but it can lead to larger differences when land value is taxed.
The proposed land value tax system would mean massive changes to the city of Detroit’s property tax system. But it’s important to remember what would not change. For instance, the city would still be counting and assessing the structures on property. The tax only transfers a portion of the property tax to land value taxes. The majority of the tax would still be assessed as a conventional property tax, not a land value tax. And the proposal only gives the city discretion over how much of its property tax it can convert to land value taxes. It leaves the levies authorized by the county, the community college and other taxing entities untouched.
The likely effects of this proposal are difficult to determine. I don’t expect a massive real estate boom if a land value tax is adopted, because Detroit developers face important market fundamentals on rent, real estate demand, construction costs, and financing options. The tax structure matters, though, and the land value tax does not discourage development as property taxes do.
Several governments, economic development agencies and charitable foundations assist developers. Most of these aim to bring more housing to depressed areas where the market does not justify investment. Even if the land value tax does not increase market-rate housing developments, the people who help finance housing construction may find that their resources go further with a land value tax.
The proposed bills would allow Detroit to replace some property taxes with land value taxes. A land value tax’s primary virtue is that it does not hinder development as much as property taxes do. The proposal would raise just as much revenue as property taxes, which would leave some property owners with higher tax bills and some property owners with lower tax bills. It would be subject to all of the state’s existing protections on taxpayers. Voters would have to authorize whatever city officials propose.
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James M. Hohman is the director of fiscal policy at the Mackinac Center for Public Policy.
