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In June the Lincoln Institute convened a roundtable of experts from around the country to examine how and why property ownership and title problems exacerbate abandonment. The group debated the merits of public policy intervention, identified policies with the greatest potential for success, and outlined anticipated complications and issues in remedying abandonment. This article reports on that discussion.
The prevalence of vacant and abandoned property in U.S. cities has reached crisis proportions despite efforts to foster reuse of these sites. A mix of macroeconomic and demographic trends, such as deindustrialization, population shifts from urban and rural to suburban communities, and the shrinking urban middle class, have precipitated the decline in real estate demand that can lead to property abandonment in certain neighborhoods.
These trends, along with other factors, have resulted in various abandonment “triggers” (Mallach 2004) depending on the property type: inadequate cash flow; multiple liens; liens that exceed market value; fraudulent transactions; predatory lending; and uncertainties regarding environmental, legal, and financial liability. These triggers often prolong abandonment or relegate a property to permanent disuse, particularly in markets characterized by widespread disinvestment. Many of these triggers also “cloud” the property title and interfere with a potential new owner’s efforts to acquire property title or obtain site control in order to make improvements or commence reuse activities.
Comparable data on vacancy and abandonment across cities are difficult to obtain and vary widely due to different definitions and gaps in data sources, particularly in commercial and industrial land uses. Estimates of the amount of abandoned housing stock range from 4 to 6 percent in “declining” cities to 10 percent or more in “seriously distressed” cities (Mallach 2002). The following city statistics from Census 2000 data and city records only suggest the scope of the problem.
The abandonment problem is even more profound and perhaps less susceptible to reversal in some smaller cities of less than 100,000 that have lost at least 25 percent of their population over the last few decades. The situation in Camden, New Jersey, East St. Louis, Missouri, and other cities with large-scale abandonment suggests a severely weakened market with multiple contributing socioeconomic factors. Where the number of abandoned properties indicates a systemic problem, there may be an inherent limitation on the ability to stimulate market activity.
This problem has ramifications for the quality of our public and private lives, because abandonment can lead to other detrimental social and fiscal impacts: depressed property values of surrounding properties (Temple University 2001); increased criminal activity; health and safety concerns due to environmental hazards; and additional disinvestment. All of these outgrowths of abandonment raise costs for the city, including site cleanup and demolition, provision of legal services, police and fire protection, and legal enforcement.
As urban vacancy and abandonment increase and suburban open space becomes less available or attractive for development, market pressures may improve redevelopment prospects, as in Boston, Chicago, and Atlanta. However, for several reasons we cannot just wait for this to happen everywhere.
First, the market does not always operate perfectly, in part because it is subject to existing laws and regulations (e.g., tax foreclosure statutes and clean title requirements) that impose high transaction costs to taking title and therefore affect market redevelopment. Some level of public policy innovation is needed, whether reform of existing laws or new laws and practices. Second, preserving open space is arguably a public benefit, but that also implies the need for public action to steer new development to previously developed properties. Finally, decisions about whether to spend public money, time, and effort are not made in a vacuum, but require an understanding of the problem, the available tools, and the resources and skills to implement them.
The magnitude of the problem suggests there are no easy answers. Multiple, interconnected market factors and differing state legal frameworks mean that the remedies to abandonment vary. In an effort to better define the public strategies for addressing the problem in different settings, this article sets forth the challenges of overcoming property acquisition barriers to abandonment, outlines a range of remedies, and explores potential next steps.
Neighborhood Redevelopment in New Jersey
Several years ago, Housing and Neighborhood Redevelopment Services, Inc. (HANDS), a nonprofit community development corporation (CDC) in Orange, New Jersey, tried to acquire an abandoned multifamily property. The property was burdened by tax liens that the city had sold to third-party purchasers, a strategy that cities use to raise revenue for other needs. The lien holders included out-of-state investment groups and speculators, and the current property owners did not have the financial ability or desire to redeem the liens. No entity was taking responsibility for property upkeep, so it sat idle and accumulated more tax liens, further elevating the stakes involved in clearing the title and heightening the financial, legal, and psychological barriers to acquisition. HANDS had a plan for neighborhood revitalization and a productive use for the property, but it lacked the funds for acquisition and the tools to clear the legal title.
Over the past few years, however, New Jersey reformed state programs to provide up-front subsidies for property acquisition, removal of liens, and other activities necessary for CDCs to establish site control (Meyer 2005). At the same time, a new state law, the Abandoned Properties Rehabilitation Act (2004), accelerated foreclosure action on vacant property by eliminating the waiting period between the time a potential new owner gives notice of its interest in foreclosing and lien acquisition. In cases where the owner will not rehabilitate a property, the new law allows the municipality to undertake rehabilitation or find a CDC to do so.
In this instance, HANDS took advantage of the new state law and financial incentives to acquire the multifamily property and convert it into housing for first-time homebuyers as part of the CDC’s larger neighborhood revitalization strategy. A few other organizations have begun to use these tools to acquire and redevelop single-family and multifamily homes around the state.
Ownership and Title Issues
Where abandonment or prolonged vacancy occurs due to owner inaction, two options exist for reuse. First, the property may be left abandoned indefinitely, or until the market changes. Alternatively, a new owner (e.g., the municipality, a CDC, or a private developer) may intervene, acquire the property, and carry out rehabilitation or reuse. It is this second alternative and the remedies for implementing it that concern us here. New methods for acquiring abandoned property will help to obtain property control from unwilling, unknown, or incapable owners.
However, the debate between these two alternatives raises significant issues that need further exploration. If the primary objective is to put the property back into productive use, one impetus for intervention is to eliminate the legal barriers to transferring the property to a new owner. Clear title is a critical issue. The multiple tax liens that encumber the title, and often cause the property’s abandonment in the first place, can cloud the title and prevent effective title transfer.
These title complications can be further compounded by the use of certain supposed remedies. For example, forcing title transfer involuntarily, from an unwilling owner or in abandonment cases where ownership is in doubt, can result in a cloudy title that may jeopardize obtaining title insurance—a mandatory precursor to procurement of conventional financing—and thereafter present title problems whenever the property changes hands. Clear title is part of the larger challenge for many states that do not have efficient, workable processes for moving title into the hands of responsible owners.
Remedies: Laws, Practices, and Tools
Municipalities seeking to reduce their stocks of vacant and abandoned property may be inspired by strategies and programs used in other localities, but they should carefully assess their own situations first. Differences in state laws may require a variety of approaches, such as reforming existing laws; improving local practices and implementation; and introducing innovative new tools. Some remedies to facilitate acquisition of vacant and abandoned properties for redevelopment seek to
Remedy choice depends on the property’s stage of abandonment, the current land use (e.g., multifamily rental, single-family house, commercial, or industrial), the property’s ownership status, and state statutes and regulations. A property at an early stage of abandonment due to general neglect and code violations, including conditions that adversely affect the health, safety, or well-being of building residents or neighbors, may be turned around with regular inspections and enforcement. These preventive remedies can slow disinvestment and prevent permanent abandonment by forcing a known owner to either renovate the property or transfer it to another entity willing to do so. Effective code enforcement varies widely because it is a function of local practice, but persistent municipal issuance of orders for code violations is critical.
Localities may also enforce state-authorized nuisance abatement laws to address these code violations by requiring an owner to make repairs or improvements, such as trash removal, structural repairs, and building demolition. If an owner refuses, then the municipality can enter the property to undertake these activities and seek to collect the costs from the owner. If that fails, the municipality may place liens on the abandoned property equal to the costs of these actions, enforcing them through foreclosure actions, or in many states by attaching the owner’s assets. The effectiveness of nuisance abatement laws varies across states, depending on the definition of “nuisance,” the prescribed statutory penalties, and how the local authority chooses to carry out nuisance actions (Mallach 2004).
Significant disinvestment generally occurs where property owners fail to undertake property management responsibilities that cause significant disrepair; stop paying back taxes, utilities, or other public services; and/or allow the property to remain vacant for more than a designated period, usually six to twelve months. Some of these complicated cases require innovative, sometimes controversial remedies.
Under Baltimore’s vacant property receivership ordinance, for example, the city or its CDC-designee may petition a court to appoint a receiver for any property with a vacant building violation notice, though it is generally used in the case of severely deteriorated single-family houses. The receiver may collect rents (if the property is still occupied), make repairs, and attach a super-priority lien on the property equal to the expense; or immediately sell the property to a private or nonprofit developer who will conduct the rehabilitation. Advocates argue that the receivership approach is beneficial because it focuses on fixing the property (bringing an action in rem, literally against the “thing”) rather than on punishing the owner (known as an in personam action, or against the person) (Kelly 2004).
In Cuyahoga County (where Cleveland is located), CDCs have used nuisance abatement as a form of receivership. In these cases, the CDC brings such an action in a special housing court to abate a nuisance and have a receiver appointed, and then the CDC collects the incurred improvement costs from the owner or conveys the property to a new owner.
In both Baltimore and Cleveland, the concept is used effectively against speculating investors who buy inexpensive, dilapidated properties and do nothing but pay taxes, hoping that the revitalization work of others in the community will increase their property values. These “free riders” frustrate efforts to identify them as targets in a legal action by creating sham ownership entities or providing the vacant house as the owner’s only mailing address (Kelly 2004).
Nuisance abatement or receivership actions ultimately may not provide secure title for the subject properties, or may cause properties to be more susceptible to unclear title outcomes. Receivership can create an encumbrance on the title that is difficult to extinguish, thus clouding the title and providing an excuse for banks not to lend on the property. The current title system, as adhered to by title companies and financial institutions, works relatively well for tracking and recording straightforward, linear property transactions, but is not set up to handle properties with multiple liens or encumbrances arising from checkerboard-type transactions that are characteristic of vacant and abandoned properties. Nevertheless, these actions constitute an underutilized and powerful tool, when used in the right legal and market circumstances.
Tax foreclosure is the most commonly used property acquisition tool for local government. It involves the taking of title to properties where owners have failed to pay their property taxes or other obligations to a government entity (e.g., a municipality, school district, or county). Third parties, such as CDCs or private developers, can also use tax foreclosure proceedings, as governed by state law, to acquire properties. The tax foreclosure process is based on the principle that a tax lien has priority over private liens, such as mortgages, so when the buyer forecloses on the tax lien, any private liens are extinguished and the property is acquired “free and clear” (Mallach 2004).
The common problems associated with this otherwise powerful tool arise from the lengthy time periods imposed by state statutes on different stages in the foreclosure process (e.g., the time in which the owner has a right to redeem his or her rights to the property); the length of time that taxes must be delinquent before a sale can occur; and whether the state first requires sale of the liens or sale of the property outright. Constitutionality standards also require strict notice requirements to all parties holding a legal interest in the property. Although rewriting state statutes to reduce or eliminate these time requirements may be a politically protracted process, state law reform can occur. For example, the law passed last year in New Jersey substantially reduced the notice periods, and Michigan’s tax foreclosure reform offers faster judicial proceedings to increase the timeliness of property transfer (Mallach 2004).
An increasingly popular tool is the local land bank, a governmental entity that acquires, holds, and manages vacant, abandoned, and tax-delinquent property. The properties are acquired primarily through tax foreclosure, and then the land bank develops or, more likely, holds and manages the properties until a new use or owner is identified. Land banks can provide marketable title to properties previously encumbered with liens and complicated ownership histories. They also provide localities with a way to create an inventory and monitor properties, and assemble properties into larger tracts to improve opportunities for targeted economic development.
Each city’s land bank is organized and operates differently. Some operate within city agencies, while others exist as legally separate corporations (Alexander 2005). The Genesee County, Michigan land bank has pioneered a way to self-finance redevelopment by using the financial returns on the sale of one property to support the costs of holding other properties, an approach that ultimately reduces municipal costs (Kildee 2004).
Exercise of eminent domain powers pursuant to the Fifth Amendment of the U.S. Constitution is another remedy that transfers real property titles to the government for public use. Targeting blighted properties remains an agreed upon use of eminent domain, although state statutes differ on how it is carried out. Cities are certain to be more wary of using this tool in the wake of the controversial U.S. Supreme Court decision, Susette Kelo et al. v. City of New London, Connecticut, et al. (Kelo), which sanctioned New London’s condemnation of nonblighted private property for economic development purposes. The Kelo ruling has caused state legislatures around the country to consider reevaluating the meaning of public use and limiting the circumstances under which government entities can utilize this powerful remedy.
Without overall market improvements, it is unlikely that these remedies alone can give cities, neighbors, courts, or community nonprofit organizations the tools needed to address the vacant and abandoned property problem. However, anecdotal experience and discussions at the Lincoln Institute roundtable indicate that these tools have been used successfully on a case-by-case basis; whether they affect change on a neighborhood- or city-wide basis and over a period of years is still unclear. Success may depend, in part, on market strength and conditions, but also on localities’ vigilance (for instance, with code enforcement), willingness to take risks and use new tools, and institutional capacity.
Local Impacts of Remedy Implementation
Even where one or more of these tools is legal, available, and effective in eventually converting vacant and abandoned property to productive uses, there are three types of hurdles that may prevent valuable projects from being pursued: local administrative and procedural barriers; unintended and potentially negative consequences; and ancillary local strategies that can enhance or decrease their effectiveness.
Local barriers include costs to cities of administering, managing, and implementing these conversion activities; political opposition, inaction or apathy; and lack of local knowledge or capacity. The up-front costs to cities or nonprofit entities of taking ownership to dilapidated properties and making improvements are not trivial. Also, some tools may require investment in training, innovation, and minor risk-taking by local governments. Studies and experience are beginning to reveal that, for similar reasons, localities are not taking advantage of tools already provided for in some state statutes. One researcher found that local governments in Massachusetts were not utilizing existing mechanisms to address tax delinquent properties (Regan 2000). New Jersey is reportedly experiencing a similar phenomenon, where local entities are underutilizing tools available since adoption of new abandoned property laws and funding programs.
The possibility of unintended consequences fostered by intervention in the market should not be an argument for no intervention, but it is a reminder that any remedy needs to fit market conditions and be used with appropriate reuse restrictions or incentives to avoid new problems. One downside to successful neighborhood revitalization is gentrification, which is the displacement of lower-income residents by new, wealthier residents who can afford the higher prices placed on renovated properties. For instance, in Atlanta and Boston neighborhoods with relatively strong metropolitan-wide real estate markets, carrots and sticks must be used selectively to promote the transfer of abandoned property in some areas. One way to minimize the extent of gentrification is to require that any residential reuse maintain an income mix by preserving a percentage of units as long-term affordable housing. Another model is the nonprofit community land trust (CLT), which generally owns the land and provides affordable housing in perpetuity by leasing it to the building owners (Greenstein and Sungu-Eryilmaz 2005).
Local neighborhood revitalization strategies combined with other appropriate remedies can improve the chances of success as cities and CDCs work to address their redevelopment challenges. These strategies may include documenting and inventorying abandoned properties; targeting pivotal properties in neighborhoods selected for redevelopment; increasing home ownership; forging partnerships with business groups, city hall, hospitals, universities, and other nonprofits; and identifying and reforming significant policies and regulations on tax liens.
Communities must also continue to be innovative and to adapt available tools and remedies to address ever-changing local abandonment triggers. One such challenge is the recent phenomenon of lien securitization, which occurs when one entity buys up multiple liens on multiple properties and bundles or securitizes them for resale. This puts the liens into the hands of investors who presumably have no interest in the local economy or the property’s productive reuse, and can prevent title transfer, especially in weak secondary markets.
Next Steps in Meeting the Abandonment Challenge
Property title and acquisition obstacles are not the only barriers to fostering productive reuse of abandoned property, and removing these obstacles may not overcome the abandonment cycle. However, use of the remedies outlined here is an essential first step, and several next steps could significantly enhance their implementation. First, a pressing need exists to clarify the meaning of “clear title,” possibly by updating title insurance company standards to reflect new practices.
Second, case studies of successful and failed tools and mechanisms in weak and strong urban markets could provide valuable lessons. Possible criteria to evaluate a remedy’s success or failure include the frequency and extent of their use; their applicability to all property uses (residential, commercial, industrial); their effectiveness in fully clearing the title; unexpected consequences; and, if possible, the property’s ultimate reuse and its sustainability.
Third, a study of states where statutory reform has occurred, such as Michigan or New Jersey, would offer an analysis of how such reform has impacted property transfer and reuse. Finally, since local entities play a key role in tool implementation, improving local capacity through education about these tools and their importance in revitalizing urban areas would be another crucial next step in ultimately reducing the numbers of vacant and abandoned properties.
Lavea Brachman, a visiting fellow at the Lincoln Institute of Land Policy in 2004–2005, continues to research public policy remedies and the roles of local nonprofits and government entities in fostering brownfield and abandoned property reuse. She also directs the Delta Institute’s Ohio office, a nonprofit working on sustainable development solutions to environmental quality and community and economic development challenges.
References
Alexander, Frank. 2005. Land bank authorities: A guide for the creation and operation of local land banks. New York, NY: Local Initiatives Support Corporation.
Black, Karen. 2003. Reclaiming abandoned Pennsylvania. Philadelphia, PA: Pennsylvania Low Income Housing Coalition Report, March.
Greenstein, Rosalind, and Yesim Sungu-Eryilmaz. 2005. Community land trusts: Leasing land for affordable housing. Land Lines 17(2): 8–10.
Kelly, Jr., James J. 2004. Refreshing the heart of the city: Vacant building receivership as a tool for neighborhood revitalization and community empowerment. 13-WTR J. Affordable Housing & Community Dev. Law 210.
Kildee, Dan. 2004. The Genesee County land bank initiative. Flint, MI: Genesee County Land Bank.
Mallach, Alan. 2002. Abandoned properties, redevelopment and the future of America’s shrinking cities. Working paper. Montclair, NJ: National Housing Institute.
———. 2004. Addressing the problem of urban property abandonment: A guide for policy makers and practitioners. Montclair, NJ: National Housing Institute, April.
Meyer, Wayne T. 2005. High-impact development for long-term sustainable neighborhood change: Acquiring, rehabilitating, and selling problem properties. Orange, NJ: HANDS, Inc.
National Vacant Properties Campaign. 2005. www.vacantproperties.org.
Regan, Charleen. 2000. Back on the roll in Massachusetts: A report on strategies to return tax title properties to productive use. Boston: Citizens’ Housing and Planning Association (CHAPA).
Temple University Center for Public Policy and Eastern Pennsylvania Organizing Project. 2001. Blight-free Philadelphia: A public-private strategy to create and enhance neighborhood value. Philadelphia, PA, October.
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A major argument in support of land-value taxation is that it creates no incentives for altering behavior in order to avoid the tax. By contrast, a conventional property tax, levied on buildings, can deter landowners from erecting otherwise desirable structures on their land. For example, homeowners may decide against finishing a basement or adding a second bath because it would increase tax liability. Thus, a conventional property tax can lead to excessively low capital-land ratios and “excess burden”—a cost to taxpayers over and above the actual monetary payments they make to the tax authorities. This article reports on a recent study of excess burden resulting from an early British antecedent of the modern property tax—the 17th-century window tax.
The Case of the Window Tax
In 1696, King William III of England, in dire need of additional revenues, introduced a dwelling unit tax determined by the number of windows in an abode. The tax was designed as a property tax, as described by this discussion in the House of Commons in 1850: “The window tax, when first laid on, was not intended as a window tax, but as a property tax, as a house was considered a safe criterion of the value of a man’s property, and the windows were only assumed as the index of the value of houses” (HCD 9 April 1850).
In its initial form, the tax consisted of a flat rate of 2 shillings upon each house and an additional charge of 4 shillings on houses with between 10 and 20 windows, or 8 shillings on houses with more than 20 windows. The rate structure was amended over the life of the tax; in some cases, rates were raised dramatically. In response, owners of dwellings attempted to reduce their tax bills by boarding up windows or by constructing houses with very few of them. In some dwellings, entire floors were windowless, leading to very serious and adverse health effects. In one instance, lack of ventilation led to the death of 52 people in the surrounding town, as reported by a local physician who called on a house inhabited by poor families:
“In order to reduce the window tax, every window that even poverty could dispense with was built up, and all sources of ventilation were thus removed. The smell in the house was overpowering and offensive to an unbearable extent. There is no evidence that the fever was imported into this house, but it was propagated from it to other parts of town, and 52 of the inhabitants were killed.” (Guthrie 1867)
The people protested and filed numerous petitions to Parliament. But, despite its pernicious effects, the tax lasted more than 150 years before it was finally repealed in 1851.
The window tax represented a substantial sum for most families. In London, it ranged from about 30 percent of rents on “smaller houses on Baker Street” to as much as 40 to 50 percent on other streets, according to a House of Commons debate in 1850 (HCD 9 April 1850). The tax was particularly burdensome on poor families living in tenements, where assessors taxed the residents collectively. Thus, if a building contained 2 apartments, each with 6 windows, the building was taxed at a rate based on 12 windows. By contrast, on very large houses of the wealthy, the tax typically did not exceed 5 percent of the rental value.
The tax schedule underwent several significant changes before it was finally repealed. In 1784, Prime Minister William Pitt raised tax rates to compensate for lower taxes on tea. Then in 1797, Pitt’s Triple Assessment Act tripled the rates to help pay for the Napoleonic Wars. The day following this new act, citizens blocked up thousands of windows and wrote in chalk on the covered spaces, “Lighten our darkness we beseech thee, O Pitt!” (HCD 24 Feb. 1848).
England and Scotland were both subject to the window tax, but Ireland was exempted because of its impoverished state. One member of Parliament quipped, “In advocating the extension of the window tax to Ireland, the Honorable Gentleman seemed to forget that an English window and an Irish window were very different things. In England, the window was intended to let the light in; but in Ireland the use of a window was to let the smoke out” (HCD 5 May 1819).
The window tax, incidentally, was viewed as an improvement over its antecedent, the hearth tax. In 1662, Charles II (following the Restoration) imposed a tax of 2 shillings on every fire hearth and stove in England and Wales. The tax generated great resentment largely because of the intrusive character of the assessment process. The “chimney-men,” as the assessors and tax collectors were called, had to enter the house in order to count the number of hearths and stoves. The window tax, by contrast, did not require access to the interior of a dwelling; the “window peepers” could count the apertures from the outside and avoid invading the privacy of the home.
The window tax, however, created some administrative problems of its own—most notably the definition of a window for purposes of taxation. The law was vague, and it was often unclear what constituted a window for tax purposes. In 1848, for example, Professor Scholefield of Cambridge paid tax on a hole in the wall of his coal cellar (HCD 24 Feb. 1848). In the same year, Mr. Gregory Gragoe of Westminster paid tax for a trapdoor to his cellar (HCD 24 Feb. 1848). As late as 1850, taxpayers urged the Chancellor of the Exchequer to clarify the definition of a window.
Notches and Their Effects on Behavior
Throughout its history, the window tax consisted of a set of “notches.” A notch in a tax schedule exists if a small change in behavior—such as the addition of a window—leads to a large change in tax liability.
Notches are rare (Slemrod 2010) and not to be confused with kinks, which are far more common even today. A kink in a tax schedule exists if a small change in behavior leads to a large change in the marginal tax rate but just a small change in tax liability. The income tax in the United States, for example, has several kinks. Married couples with taxable income from $17,850 to $72,500 are in the 15 percent marginal tax bracket; couples with taxable income from $72,500 to $146,400 are in the 25 percent marginal tax bracket. If a couple with income of $72,500 were to earn an extra dollar, its marginal tax rate would jump to 25 percent, but its tax liability would increase by just $.25.
Microfilm records of local tax data in the U.K. from 1747 to 1830 allow for a more systematic examination of the impact of the window tax and notches. This article draws on a data set from 1747 to 1757, with information on 493 dwellings from Ludlow, a market town in Shropshire, near the border of Wales. Over this period, the window tax schedule included 3 notches. A homeowner in this period paid:
Homeowners who purchased a 10th window thus paid a 6 pence tax on the 10th window as well as on each of their 9 other windows, which previously had been untaxed. Thus the total tax on the 10th window was 60 pence, which was equal to 5 shillings. If the window tax distorted decisions and thus led to excess burden, then one would expect to find many homes with 9, 14, or 19 windows but very few with 10, 15, or 20. A test of this argument is discussed below.
Through the first half of the 18th century, the administration of the tax had been troublesome, as homeowners frequently camouflaged or boarded up windows until the tax collector was gone, or took advantage of loopholes or ambiguities in the tax code. As a result, tax collections were much lower than expected. In 1747, however, Parliament revised the tax by raising rates and introducing measures to improve its administration. Most notably, it prohibited the practice of blocking up and subsequently reopening windows in order to evade assessment; violators had to pay a penalty of 20 shillings (1 pound) for every window they reopened without notifying the tax surveyor (Glantz 2008).
The 1747 act reduced tax evasion significantly, so the data for the following 10 years should provide reasonable estimates of the actual number of windows. If the window tax distorted behavior, one would expect to find spikes in the number of dwellings at the notches, with 9, 14, or 19 windows. And this is precisely what the data demonstrate. Figure 1 is a histogram showing the number of windows for homes in the sample. The pattern is clear; there are sharp increases in the number of homes with 9, 14, or 20 windows:
Standard statistical tests reject the hypothesis that there are equal numbers of houses with 8, 9, or 10 windows; with 13, 14, or 15 windows; or with 18, 19, or 20 windows. It is manifestly clear that people responded to the window tax by locating at one of the notches so as to minimize their tax liability.
Data on a sample of 170 houses for the period 1761 to 1765 shed light on the response to Parliamentary revisions to the tax in 1761. In addition to rate increases, the 1761 revisions expanded coverage of the tax to include houses with 8 or 9 windows. Under the earlier rate structures, houses with fewer than 10 windows paid no window tax. For this second sample, figure 2 shows a large spike at 7 windows: 28.2 percent of the houses have 7 windows, but only 5.2 percent have 6 windows, and just 2.9 percent have 8 windows. Once again, it’s easy to reject the hypothesis that there were an equal number of houses with 6, 7, or 8 windows.
In summary, the evidence from our two samples makes it quite clear that there was a widespread tendency to alter behavior in order to reduce tax payments. People chose the number of windows not to satisfy their own preferences, but to avoid paying higher levels of taxes. The window tax, in short, generated a real “excess burden.”
How Large Was the Excess Burden from the Window Tax?
As discussed, the window tax was substantial and induced widespread tax-avoiding behavior. Based on some standard techniques of economic analysis, our simulation model generates an estimate of what people would have been willing to pay for their preferred number of windows. The model captures each consumer’s demand for windows with and without the tax, the taxes paid, and the loss of welfare from adjusting the number of windows in response to the tax.
In the sample from 1747 to 1757, the estimated welfare losses were very large for households at one of the notches. For them, the welfare loss (i.e., excess burden) is 62 percent of the taxes they paid. That is to say, for every dollar collected under our simulated version of the window tax, the tax imposed an additional burden or cost of 62 cents on these households. The excess burden, not surprisingly, is particularly large for households that chose 9 windows. One criterion economists use to evaluate a tax is excess burden relative to taxes paid. By this standard, a good tax is one that collects significant revenue buts leads to very small changes in decisions. Consumers who purchased 9 windows are thus the worst possible case. Those consumers paid no tax; so, for them, the entire burden of the tax is excess burden.
For our entire sample of 1,000 simulated households, the excess burden as a fraction of taxes paid is about 14 percent. Thus for each tax dollar raised by the window tax, our simulation suggests an additional cost of 14 cents to taxpayers as a result of their distorted choices.
Some Concluding Remarks
The window tax represents a very clear, transparent case of excess burden—a tax that placed heavy costs on taxpayers in addition to their tax liabilities resulting from tax-avoiding adjustments in behavior. But, as mentioned early on, modern property taxes also create an excess burden, although the consequences are less dramatic than in the case of the window tax.
In designing a tax system, it is important to consider this issue. The ideal, in principle, is a neutral tax that raises the desired revenues but doesn’t distort taxpayer behavior so as to create additional burdens. Such a tax is a pure land-value tax levied on the site value of the land—that is, its value with no improvements. Thus, the assessed value of the land (and hence the tax liability of the owner) is completely independent of any decisions made by the owner of the land parcel. Unlike the window tax, which provides a compelling example of the additional costs that arise when property tax liabilities depend on the behavior of the property owner, a land-value tax creates no incentives for tax-avoiding behavior.
About the Authors
Wallace E. Oates is Distinguished University Professor of Economics, Emeritus, University of Maryland, and University Fellow at Resources for the Future.
Robert M. Schwab is a professor of economics at the University of Maryland.
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Weitzman, Martin L. “Prices and Quantities.” Review of Economic Studies 41: 477–491.
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Liz Wood wanted to buy a house. It was 2006, she had been renting for A decade, and her monthly payments were getting high. She was 43 and steadily employed, earning $34,000 annually plus benefits as a family educator. She didn’t want anything fancy, just a place where she could “gather love and bring stability.” She would stay within her means.
Nonetheless, the math was tricky. Wood lives in Duvall, Washington, a town of roughly 7,500 in the foothills of the Cascade Mountains. Steeped in lush forest, Duvall is about 30 miles from Seattle and a mere eight miles from the City of Redmond, the headquarters for Microsoft. The median income in Duvall is nearly twice that of the state of Washington, and homes in this area are expensive. In 2010, the median value of owner-occupied homes in Duvall was $373,500, compared to $262,100 for the state, according to the U.S. Census Bureau.
With few options, Wood eventually decided on a used factory-built home (also known as manufactured housing) for $55,000 in Duvall Riverside Village, a four-acre community of 25 manufactured homes in the middle of downtown Duvall. “It’s amazing here,” she says. “I live on riverfront property, so when I walk out my door I see water, pine trees, and a walking trail that goes from my house to the next town. I wake up in the morning hearing birds. I know all my neighbors; I’m connected to my community. I’m a block from the police station. I feel safe.”
But it was still difficult. Wood owned her house, but not the land on which it sits. Instead, she rented the plot for $450 a month, plus water and utilities, as did the other residents of Duvall Riverside Village. As a result, Wood and her neighbors remained largely at the mercy of the property owner, their landlord, and forfeited much of the autonomy and security associated with more traditional home ownership models.
Their landlord prohibited garages, leaving residents limited storage options. He charged them $25 a month per additional car or adult beyond those registered at the time of move-in. He charged $5 a month for every pet and required dogs to be leashed at all times. There was a $5 monthly fee for every extra half-cord of firewood, which Wood needed to fuel her stove. Though he employed a groundskeeper, he didn’t install outdoor lights, nor did he maintain the community roads, which were pocked and cracked.
In 2012, Wood and her neighbors received a written notice that the owner was selling the land. Unlike many owners, who prefer to sell their properties to a developer, this landlord was open to selling to residents. He had agreed to host a meeting between the tenants, a real estate broker, and the Northwest Cooperative Development Center, a nonprofit that supports cooperatives. The parties discussed the possibility of establishing a nonprofit, resident-owned cooperative to purchase the property. In doing so, they would conserve the land for manufactured housing, continue living there as a community, and collectively manage it to guarantee a safe, affordable, high-quality experience.
The residents voted to go for it. The landlord had two demands. He wanted fair market value, and he wanted to complete the sale by the end of the year. It was already August. They had five months.
In addition to the collaboration with Northwest Cooperative Development Center, the residents also began working with ROC USA, a New Hampshire–based nonprofit organization that offers residents of manufactured housing communities a mix of technical assistance and affordable financing to purchase their rented land when it becomes available for sale. Since its establishment in 2008, ROC USA has successfully facilitated 80 of these transactions nationally and secured more than $175 million in financing for them.
ROC USA works with a network of eight regional affiliates, including the Northwest Cooperative Development Center. In Duvall, the nonprofits worked together with the residents to assess the economics of a possible deal and to confirm that the community was a good fit for resident ownership. Next, the organizations helped the residents to hire a third-party lawyer and establish their cooperative, which would operate as a democracy with residents elected into leadership positions by fellow residents. ROC USA assisted the residents to hire an independent engineer and conduct due diligence of the property; secure financing through ROC USA’s lending subsidiary, ROC USA Capital, to purchase the property and undertake critical repairs; and organize the real estate transfer.
On December 27 of that year, the newly formed cooperative bought the Duvall Riverside Village with $1.3 million in purchase financing from ROC USA Capital, granting Wood and her fellow home owners control over their living arrangements, and permanently preserving 25 affordable homes in a town where such housing stock is scarce.
The residents continue to pay $450 a month to rent the land, but now they vote to determine community rules, and use the rent to make improvements and to pay the community’s mortgage, taxes, and expenses.
“Now, you can have a garage if you want,” explains Wood, who is president of the Duvall residents’ cooperative and a ROC USA board member. “And we spent $35,000 to fix the roads. We don’t have to live in fear anymore, so people are willing to invest in their homes. We have annual meetings to vote in projects. We can lower the monthly rent if we are over-budgeting for things we don’t need. The bottom line is that we are in control of our own destiny.”
Upon completing the sale, ROC USA and the Northwest Cooperative Development Center have continued providing the residents with technical support to ensure smooth operations.
“If they had just lent us the money and said, ‘these are the guidelines, here’s what you need to do, have at it,’ we would have failed,” explains Wood. “But they are an ongoing resource. They help us with tough situations, or when we don’t know how to do something legally. The goal is for us to become independent and to be able to run our community like a business. Pay your bills, and your house can stay where it is. Period. Forever.”
Benefits
Across the United States, more than 18 million Americans live in factory-built homes, which represent 5 percent of the nation’s housing stock in metro areas, and 15 percent in rural communities. They range significantly in quality. Roughly 25 percent of today’s manufactured housing stock is the stereotyped, rickety trailers of the 1960s and early 1970s, produced before the federal government introduced quality controls in 1976. The remaining 75 percent complies with the federal standards, and includes charming, energy-efficient homes, indistinguishable to the untrained eye from their site-built counterparts. Though manufactured homes have long been cast aside as a housing choice of last resort, today’s models are robust, efficient, and inviting, with the potential to help alleviate the nation’s shortage of safe, affordable housing.
Modern manufactured homes cost approximately half as much as their site-built counterparts and can be built five times faster, making them a genuinely viable option for low-income consumers. The production process is less wasteful, and models that comply with the federal government’s Energy Star standards offer home owners meaningful energy savings. And they are durable. Whereas manufactured homes built prior to the 1976 regulations were made to be portable, like recreational vehicles, modern models are built with stronger materials and designed to be permanent. Today’s manufactured homes can sit on any foundation that would otherwise accommodate a site-built structure, creating the flexibility to use the housing in a wide range of geographies and environments.
“The manufactured housing stock is a critical component of the nation’s affordable housing,” says George McCarthy, president and CEO of the Lincoln Institute of Land Policy. “It easily outnumbers our subsidized stock two or three times in almost every market.”
Manufactured homes are cheaper to produce than site-built houses because of the manufacturing process. As Andrea Levere, president of the Corporation for Enterprise Development, writes in the Huffington Post, the “term ‘manufactured housing’ itself has less to do with quality and more to do with the production process, which is a derivative of Ford’s assembly lines. This model allows manufactured homes to be built in a more controlled work environment, translating into predictable costs, increased efficiencies, and reduced waste” (Levere 2013).
In 2013, a new, energy-efficient manufactured home cost $64,000, compared to $324,500 for a new, site-built one, according to the U.S. Census, though the price for the latter includes the land. Even after stripping out the land costs, manufactured homes are still significantly less expensive, averaging $44 per square foot, versus $94 per square foot for site-built homes. And they are unsubsidized, which is a boon given the extremely short supply of subsidized housing compared to demand. Currently, only one in four income-qualified families receives a housing subsidy according to the Bipartisan Policy Commission, leaving the remaining 75 percent in need of an affordable, unsubsidized alternative. By helping to fill that gap, manufactured housing can relieve some of the demand for subsidized housing that state and federal governments are struggling to supply in the face of shrinking budgets. “The majority of families who live in manufactured housing would qualify for subsidized housing, but instead they choose this less expensive and unsubsidized option,” says McCarthy.
The stock is also very versatile, argues McCarthy, who cites its role in housing people during the immediate aftermath of Hurricane Sandy. “Recovery workers got 17 manufactured homes on the ground in New Jersey within weeks of the hurricane—permanent homes for displaced renters, not the problematic ‘Katrina trailers.’ And they did it before most organizations even had a housing plan. This speaks to the efficiency and nimbleness of building manufactured housing. The production times are about 80 percent shorter than for site-built homes, making them the best housing option for disaster response.”
Nevertheless, manufactured housing often gets a bad rap, due largely to the widespread misperception that today’s models are the same as the earliest generations of mobile homes built prior to the introduction of quality control standards by the U.S. Department of Housing and Urban Development in 1976. Today, there are roughly 2 million of these pre-1976 homes; many are barely hanging together and house the nation’s most vulnerable populations, including the elderly and disabled. Though the pre-1976 stock is virtually unrelated to its present-day counterpart, these older, dilapidated dwellings dominate the general public perception of manufactured homes in the United States.
The housing stock’s reputation is further diminished by the vulnerabilities facing home owners who do not own the land on which they live. Roughly 3 million people live in one of the nation’s 50,000 manufactured housing communities, while another 3 million rent on private property. There are manufactured housing communities in every state in the country. Like Duvall Riverside Village, many of them are on prime real estate, and the landowners routinely receive purchase offers from developers.
Advocates working to improve the manufactured home ownership experience, and to promote the stock’s viability as affordable housing, are focusing on three critical areas of innovation: conserving mobile-home parks; replacing pre-1976 units with modern, energy-efficient homes; and increasing access to affordable financing for potential buyers, which is virtually unavailable in the current market and is imperative to building equity and preserving a home’s resale value.
Conserving Manufactured Housing Communities
The conversion of Duvall Riverside Village from a privately owned mobile home community to a resident-owned cooperative is not common. For every community available for purchase that is successfully preserved as affordable housing, there are many more that end up sold for redevelopment, displacing residents who may lack good alternatives.
“It’s not as simple as just moving the home,” says Ishbel Dickens, president of the National Manufactured Home Owners Association. “First, there’s the question of whether the home can even be moved. It may be too old or unstable to survive a move. And even if it can be moved, it’s expensive to do so, and very hard to find a space in another community. In most instances, when a park closes, the residents are probably going to lose the home and all their equity in it. In all likelihood, they will never own a home again. They’ll likely end up on a wait list for subsidized housing, or may even end up homeless.”
To some degree, it’s an accident of history that so many of today’s mobile home parks occupy plots of coveted real estate, says Paul Bradley, president of ROC USA. As he explains it, in the late 1950s and 1960s, Americans began to embrace transportable trailers and campers, in part because of a cultural shift toward outdoor recreation, and in part because post–World War II factories began producing them to utilize excess manufacturing capacity, making them widely available and affordable. As the units grew in popularity, they transitioned from temporary structures to permanent ones, and people began adding makeshift carports and sunrooms. At the time, urban planners accepted the evolution toward permanency. As they saw it, most of the trailers were on land that no one else was using in outer-circle developments. Why not let these campers stay for awhile, until the cities expanded to meet them, at which point the land would be redeveloped?
“These original communities were built with a plan to close them,” says Bradley. “Back then, no one contemplated the full implications of creating a housing stock for which home owners lacked control of the underlying land. No one anticipated that these communities would be full of low- and moderate-income home owners who spent their own money to buy these homes and had few alternatives. And that’s what we are still grappling with today. That lack of control of the land means that home owners live with a deep sense of insecurity and the feeling that it’s irrational to make investments in their properties because they won’t get it back. What’s the implication for home owners who cannot rationally argue for investing in their home? What does that mean for the housing stock? For neighborhoods?”
Short-sighted land use policies are not the only challenge to preserving manufactured housing communities. An equally onerous obstacle is the lack of legal protections afforded to residents. In 34 states and the District of Columbia, the landowner can sell the property without giving residents the opportunity to purchase it. In fact, in most states, the landowner doesn’t have to notify residents that the community is for sale; the landowner can wait until the property has been sold to inform residents of the transaction, suddenly leaving them in a tenuous position. Even the 16 states that require the owner of a manufactured housing community to provide residents advance notice of a sale do not necessarily afford tenants the necessary protections. “In most of the states with advance notice, there are so many limitations on the notice requirements that it is rarely of any use to residents,” says Carolyn Carter, director of advocacy at the National Consumer Law Center.
To better protect residents, advocates support legislative reforms to state laws and tax incentives for landowners who sell to residents. The most effective of these strategies are state laws requiring a landowner to give residents both advance notice of the sale—ideally 60 days—and the opportunity to purchase the property, argues Carter. According to her, there are six states with laws that “work on the ground and provide effective opportunities for residents to purchase their communities,” including New Hampshire, Massachusetts, Rhode Island, Florida, Vermont, and Delaware. She says Oregon passed promising legislation in January 2015.
“In those states with effective notice and opportunity to purchase laws, resident ownership takes off,” Carter explains. Roughly 46 percent of the 80 communities that ROC USA supports are in either New Hampshire or Massachusetts—two small states with some of the nation’s strongest resident protections. There are an additional 89 resident-owned cooperatives in New Hampshire that predate ROC USA’s launch.
To understand the value of strong consumer laws for residents, consider the story of Ryder Woods, a 174-unit mobile home park in Milford, Connecticut, 11 miles south of New Haven, just off a major thoroughfare. Connecticut is one of 19 states that either offer tax incentives or provide residents “some” protections when a community is sold, but also contain “significant gaps,” according to Carter.
In 1998, Ryder Woods’ landowner sold the property to developers. He informed the residents via eviction notices, in violation of state laws requiring him both to give them advance notice of the pending sale and to provide them the right of first refusal to purchase the land. Ryder Woods had an active home owners association, and very quickly they organized protests and petitions and lobbied the state legislature to reverse the sale. Eventually, the local news picked up their story, at which point a Milford-based attorney volunteered her services to help them. As she dug into the case, she realized that the law was on the side of the residents and that the community needed more legal support than she alone could offer. She enlisted help from a friend and fellow attorney—a partner at a prominent, Hartford-based firm—who agreed to take the case pro bono and assigned it a team of attorneys. The case ended up going to trial, eventually making its way to the state’s highest court. Uninterested in the unfolding legal headache, the original buyer resold the property to a second developer.
Four years after the original sale, the courts ruled in favor of the residents. In an unprecedented deal, and as required as part of the settlement, the second developer purchased a new piece of land a mile from the original parcel and completely rebuilt the community there. The developer purchased 174 new mobile homes and sold them to the residents at significantly reduced prices with more favorable mortgage terms than any available in the conventional financing market. He built a community center and a pond, complete with swans. And, as required by their agreement, he provided the residents the opportunity to form a cooperative and buy the land, which they did in 2009 with $5.4 million in purchase financing from ROC USA Capital. They closed on their purchase in the offices of the Hartford firm, which had continued to volunteer its services to the residents through the sale’s completion. Today, there is a Walmart on the land that housed the original Ryder Woods community.
“Sometimes, when we look back, we think it was crazy. We chartered a bus, went to Hartford, spoke to the legislature, and just fought it. We stuck together and won against two big-time, billion-dollar developers,” explains Lynn Nugent, 68, a part-time merchandise associate at Sears, and one of the residents who helped organize the campaign, along with her husband, a retired locksmith. “Now I always say, ‘Somebody else used to own us, and now we own ourselves.’”
Improving Access to Quality, Affordable Manufactured Homes
Unlike the residents of Ryder Woods, many owners of manufactured homes struggle to secure a quality unit with affordable financing. Here again, legislation is a primary culprit. Under federal law, manufactured homes are considered personal property, like a car or a boat, opposed to the real property designation assigned to traditional homes. Consequently, buyers cannot access mortgage loans. Instead, financing is available in the form of personal “chattel” loans. More expensive than mortgage loans, they average an additional 50 to 500 basis points and provide fewer consumer protections. More than 70 percent of purchase loans for manufactured homes are these higher-cost loans, which are considered a proxy for subprime products.
“This second-tier status is one of the biggest limitations to increasing the stock of permanently affordable manufactured homes,” says McCarthy. “It makes financing the homes more challenging and expensive than it should be, and it diminishes the homes’ wealth-building potential because it reduces effective demand for existing units.”
While the dream fix would be to change federal titling laws, such revisions are not forthcoming. Instead, Next Step, a Kentucky-based nonprofit organization, has established “Manufactured Housing Done Right (MHDR).” This innovative strategy works to make high-quality, affordable manufactured homes—and financing—available to low- and moderate-income consumers through a combination of energy-efficient homes, home buyer education, and affordable financing. Here’s how it works.
First, Next Step gives low-income buyers access to high-quality manufactured homes. The organization created a portfolio of models that are both robust and affordable. Each Next Step home meets or exceeds Energy Star standards, reducing utility costs for the home owner and shrinking the environmental footprint. According to Next Step, testing has shown these homes to be 30 percent more efficient than a baseline code home and 10 to 15 percent more efficient than a baseline Energy Star home. On average, this results in $1,800 in energy savings each year for every pre-1976 mobile home replacement and $360 each year for every new home placement.
Additionally, Next Step homes are “value engineered to ensure affordability while upholding quality standards.” They are installed on permanent foundations, providing for greater structural support against wind and reducing settling issues. The homes contain high-quality flooring and insulation, which helps to increase durability and reduce energy costs. And because water is the number one problem for foundations, Next Step homes contain additional safeguards to protect against moisture.
Improving Access to Sustainable Financing
Next Step also makes sure the home buyers can secure sustainable, affordable financing. “One of the problems facing the industry is that the capital markets don’t participate in a big way,” explains Stacey Epperson, CEO of Next Step. “The secondary market is not there in any meaningful way, so there are very few lenders in this marketplace and very few options for buyers. Our solution is to prepare our borrowers for home ownership, and then bring them good loans.”
Next Step works with a mix of nonprofit and for-profit lenders, vetted by the organization, to provide safe, reasonably priced financing. In return, Next Step reduces the lenders’ risk. The homes are designed to meet the lenders’ requirements, and the home buyers receive comprehensive financial education so that they are equipped to succeed as home buyers. Consequently, Next Step home buyers not only secure a better initial mortgage, but also have the capacity to build equity and obtain a good resale price for the home should they decide to sell it one day.
Importantly, each Next Step home is placed on a permanent foundation in order to qualify the home owner for certain government-backed mortgage programs, which are less expensive than a chattel product. Next Step estimates it has saved its 173 home buyers approximately $16.1 million in interest payments.
“Right now, close to 75 percent of all financing for manufactured housing is going out as chattel. But 70 percent of new manufactured homes are going out on private land where, in many cases, the home could be put on a permanent foundation, and the owner could get a mortgage with a lower interest rate and a longer term,” says Epperson.
The MHDR model is innovative in part because it is scalable. Next Step trains and relies on a membership network of nonprofit organizations to implement the model in their respective communities. Next Step sells the homes to members at competitive prices, and then member organizations oversee the process of identifying and educating buyers, assisting them to secure the loan, and managing the installation.
“The way the industry works, there has never really been a way for a nonprofit to buy a manufactured home at wholesale prices. That’s what we’ve engineered, and that’s what makes these homes a lot more affordable than if the nonprofit or home owner tried to buy them on their own,” explains Kevin Clayton, president and CEO of Clayton Homes, one of the nation’s largest producers of manufactured housing, and one of Next Step’s long-time supporters.
“The Next Step program works because it sets people up for success,” says Clayton. “Next Step takes them through home ownership counseling, and supports home owners if they have a hardship down the road. They get to buy the house for a lot less than they otherwise could have, build equity in the home, and have a low monthly loan payment and energy costs.”
Cyndee Curtis, a Next Step home owner, agrees. Curtis was 27, single, and pregnant when she purchased a used, 1971 Fleetwood mobile home for $5,000 in 2001. She put it on the lot she owned just outside the town of Great Falls, Montana.
“I didn’t have money, I didn’t have a degree, and I didn’t have choices,” says Curtis. “The old steel septic tank was a ticking time bomb, with rust holes. The carpet was worn through, the linoleum underneath had burn spots on it, and the ceiling leaked where an addition had been added. Every year, I would buy construction books, go to Home Depot, and ask how to fix that leak. And every year I ended up there by myself, trying to fix it. There was mold on the doorway from that leak, and I had a newborn in there.”
In 2005, Curtis went back to school for two years, obtained her nursing degree, and began working as a licensed practical nurse, earning $28,500 a year. “I figured now I am earning a livable wage and can explore my options,” says the single mother of two. “I wanted something that my kids could grow up in and be proud of, and to make the most of owning the lot I lived on.”
But her credit was poor, and eventually she ended up at NeighborWorks Montana, a nonprofit Next Step Network member that told her about the Next Step program. Over the next two and a half years, Curtis worked with the staff of NeighborWorks Montana to repair her credit. With their assistance, she secured a mortgage and purchased a Next Step home for $102,000, which included not only the house but also the removal, disposal, and replacement of her old septic system. Because the Next Step home is on a permanent foundation that meets certain qualifications—and because of Curtis’s improved credit history, income, and geography—she qualified for a mortgage from the U.S. Department of Agriculture’s Rural Development program, which was significantly less expensive than the more common chattel products. Additionally, whereas Curtis’s previous mobile home was titled like a car, her Next Step home is deeded like a site-built house. Consequently, a future buyer will also be eligible to apply for a traditional mortgage.
Curtis says her Next Step home has provided her significant energy savings. “I have 400 square feet more now than I had previously. I went from having one bathroom to two. And still both my gas and power bills have been cut by about two-thirds.”
She continues. “My house is a thousand percent better than what I lived in before. If a person goes inside my house, they can’t tell it’s a manufactured home. It has nice doorways, nice walls that are textured. It looks like any new home you would want to live in.”
“Sometimes people think they have to suffer with poor housing conditions. I know how it is, and I want them to know that if you put in some hard work, you can make a difference for yourself and your family.”
Loren Berlin is a writer and communications consultant based in Greater Chicago.
References
Levere, Andrea. 2013. “Hurricane Sandy and the Merits of Manufactured Housing.” Huffington Post. January 8. http://www.huffingtonpost.com/andrea-levere/hurricane-sandy-manufactured-housing_b_2426797.html
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The proliferation of informal and illegal forms of access to urban land and housing has been one of the main consequences of the processes of social exclusion and spatial segregation that have characterized intensive urban growth in developing countries. Given the absence of adequate housing policies and the failure of the land market to offer sufficient, suitable and accessible housing options, millions of urban poor have to create their own shelter, either by invading private or public land or by buying land illegally and constructing their own housing. This phenomenon has attracted the attention of many researchers, policy makers and others worried about the grave socioeconomic, environmental and political implications for the urban poor and society at large.
Peruvian economist Hernando de Soto is one of the most influential contemporary ideologues addressing this complex issue. His ideas and proposals regarding large-scale regularization programs, most recently presented in his book, The Mystery of Capital, have received extensive media coverage and have raised the level of public debate. His influence can be measured by the fact that an increasing number of countries and cities, in Latin America and elsewhere, have introduced regularization policies based on his ideas, and these programs have already had a significant impact on international and institutional approaches to property reform and good governance. In many countries, politicians who were never particularly interested in urban development concerns have now become vigorous defenders of de Soto’s ideas. Why?
A Review of Urban Settlement Trends
Before addressing de Soto’s work directly, a brief summary of the current situation is in order. In Latin America, the urbanization process has been especially significant: 380 million people, some 75 percent of the total population, lived in urban areas in 2000, making it the most urbanized region in the world. While the globalization of urban land markets has intensified in Latin America, the region has also seen poverty escalate. It is estimated that between 40 and 80 percent of the population lives illegally because they can neither afford nor gain legal access to land near employment centers. As a result, illegal tenure arrangements have become the main form of urban land development.
The violent evictions and forced removals of the 1970s have been gradually replaced by a relative tolerance of illegal occupations, culminating in some cases with the official recognition of such settlements. Responding to growing social mobilization, public administrators and policy makers in several countries have struggled to formulate regularization programs aimed at both upgrading informal areas and recognizing the land and housing rights of the dwellers, thus legalizing their status.
Most land tenure regularization programs have been structured around two intertwined objectives: to recognize security of tenure and to promote the sociospatial integration of informal communities within the broader urban structure and society. The definition of what constitutes security of tenure has varied in both theory and practice. The UN Global Campaign for Securing Tenure for the Urban Poor, for example, seeks to protect dwellers against eviction and achieve other basic objectives, such as contributing to sustainable livelihoods; improving access to basic services; securing urban citizenship; producing certainty and incentives for investment; mobilizing disparate communities; and empowering women.
Generally speaking, regularization programs in Latin America have been more successful in upgrading settlements through public investments in urban infrastructure and service provision than in legalization programs. The definition of the nature of the rights to be attributed to dwellers has varied greatly, ranging from titles (such as freehold and leasehold) to contracts (such as social rent and other rental mechanisms) and precarious administrative permits (such as temporary licenses and certificates of occupancy). Experiences based on the transfer of individual freehold titles have been largely unsuccessful, given the many existing legal, technical and financial obstacles.
de Soto’s Contributions to the Debate
Although he has claimed that he initiated the debate, de Soto instead has made an undeniably important contribution to a long-standing discussion of the need to confront the phenomenon of urban informality and illegality through public policies aimed at legalizing informal settlements and other extralegal economic activities. Since the 1970s, this debate increasingly has involved planners and policy makers, but de Soto has repackaged the discussion and, to some extent, contributed to widening its scope and reach.
What makes de Soto’s ideas so appealing is that, perhaps better than anyone else, he has been able to emphasize the economic dimension and implications of urban illegality. Most of the academic research, social mobilization and policy-making on the matter of informal settlements and land regularization have been supported by a combination of humanitarian, ethical, religious, sociopolitical and environmental arguments. de Soto’s approach, on the other hand, has stressed the significant impact that comprehensive regularization programs could have on the overall urban economy by linking the growing informal extralegal economy into the formal economy. Moreover, he has argued that such public policies can be instrumental in reducing social poverty.
In his view, small informal businesses and precarious shanty homes are essentially economic assets, “dead capital,” that should be revived by the official legal system and turned into liquid capital so people could gain access to formal credit, invest in their homes and businesses, and thus reinvigorate the economy as a whole. He has estimated the amount of dead capital in the developing world at about US$9.3 trillion, a staggering figure that has drawn the attention of many influential politicians, land developers, government officials and financial organizations (Bourbeau 2001). His argument has been summarized as follows:
“Most of the poor already possess the assets they need to make a success of capitalism…But they hold these resources in defective forms…They lack the process to represent their property and create capital…They have houses, but not titles…. It is the representation of assets in legal property documents that gives them the power to create surplus value” (Mammen 2001).
In his first book, The Other Path, de Soto advocated the formalization of informal settlements. In his new book, The Mystery of Capital, he has taken this argument one step further, advocating that property ownership is the reason “why capitalism triumphs in the West and fails everywhere else,” which is also the subtitle of the book. de Soto offers a three-part argument:
The recognition of property ownership in de Soto’s proposal is important because it would entail access to credit and finance. He argues that European countries and the U.S. improved their property systems, allowing economic actors to discover and realize the potential of their assets and thus to be in a position to produce the kind of noninflationary money necessary to finance and generate production. Following that logic, national and international organizations have proposed, and even imposed, the full legalization of businesses and the unqualified recognition of individual freehold titles for urban dwellers in some informal settlements as the “radical” way to transform decaying urban economies.
Critiques of de Soto’s Assumptions
Appealing as his ideas are, there are many flaws in de Soto’s arguments. Now that the dust raised by the initial media attention to his book has started to settle down, the debate has become increasingly critical. Such an appraisal is especially important because the regularization programs inspired by his ideas have had a significant impact on the daily lives of millions of people.
To begin with, there has been increasing criticism of de Soto’s methodological approach that led to the highly unlikely estimated figure of existing dead capital. Some analysts have pointed out that his grasp of the role and social construction of individual property ownership in European and U.S. economic history is not entirely correct (Payne 2001). Others have criticized de Soto for oversimplifying, if not totally misunderstanding, the complex dynamics of both informal and formal urban land markets (Bourbeau 2001). I have stressed the specific, perhaps unique, role of land ownership in developing countries, especially in Latin America, where historically the combination of weak capital markets, highly inflationary economies and deficient social security systems has turned land value appreciation into a fundamental capitalization mechanism, thus generating a culture of speculation that has long supported a heritage of patrimonialism and political clientilism. This process has, in its turn, deeply affected the conditions of access to urban land and housing and the spatial distribution of public equipment and services, as well as generating urban illegality.
Another related critical argument is that de Soto has failed to recognize that the poor, despite their poverty, have already amassed assets through access to credit, albeit not from formal institutions. In fact, de Soto has failed to provide evidence that banks and other official financial and credit institutions would be prepared to give systematic credit to the poor, even though there is historical evidence to the contrary. For example, in de Soto’s country of Peru very few people have been able to access official credit following a massive regularization program (Riofrio 1998; Calderon 2001). Moreover, existing research in Colombia and other Latin American countries has indicated that the poor would not even be interested or willing to obtain official credit, given the socioeconomic and fiscal implications of this process (Gilbert 2001). Recent studies also have questioned the urban and socioeconomic sustainability of settlements in Mexico, Peru, El Salvador and elsewhere that have been legalized by programs inspired by de Soto’s ideas (Duhau 2001; Kagawa 2001; Zeledon 2001). Such programs have focused exclusively, and artificially, on the formal legalization of informal settlements and have not included adequate upgrading and other socioeconomic programs, thus failing to promote any sociospatial integration.
From my perspective as a legal scholar, I see three main flaws in de Soto’s argument. First, while discussing the importance of legalizing informal settlements, he has failed to question the very nature of the legal system that has generated urban illegality in the first place. I believe that the discussion of laws and legal institutions has to be supported by a critical understanding of the nature of the law-making process, the conditions for law enforcement, and the dynamics of the process of social construction of urban illegality. In particular, I have argued that the legal treatment of property rights should be taken out of the narrow, individualistic context of civil law so the matter can be interpreted from the socially oriented criteria of redefined public urban law (Fernandes 2001).
In this context, far from being radical, de Soto’s argument is a very conservative one. His work has failed to qualify the discussion on property rights, and he seems to assume that there is a universal, a-historical, “natural” legal definition of such rights. However, in Latin American countries and elsewhere in the developing world, the state has treated differently the different forms of property rights (financial, industrial, intellectual, etc.) and the social relations around them, allowing for varying degrees of state intervention in the domain of economic property relations. It is only for a very specific form of property rights, land and real estate, that the state has failed to affirm the notion of the social function of property versus the dominant individualistic approach given to such rights by anachronistic civil legislation (Fernandes 1999). The historical and political factors that have allowed classical legal liberalism to survive in Latin America have to be addressed before any comprehensive legal reform, such as that proposed by de Soto, can be implemented. The intimate though dialectically contradictory relationship between legality and illegality cannot be ignored (Fernandes and Varley 1998). Such a critical approach to law would certainly serve to dismiss de Soto’s claim that formal, unqualified individual ownership can be used against crime and terrorism.
A second flaw is that research in many developing countries has indicated that, given a combination of certain social, political and institutional conditions, residents in informal settlements can share an effective perception of security of tenure, have access to informal (and sometimes formal) credit and public services, and invest in housing improvement, even without having legal titles (Payne et al. forthcoming).
Third, and more important, existing research has shown that while the recognition of individual freehold titles can promote individual security of legal tenure it does not necessarily entail sociospatial integration. Unless titling is undertaken within the context of a broader set of public policies that address urban, politico-institutional and socioeconomic conditions, legalization programs may actually aggravate the processes of exclusion and segregation. As a result, the original beneficiaries of the programs might not be able to remain on the legalized land, although that should be the ultimate objective of regularization programs, especially on public land.
Moreover, regularization programs have had little impact on social poverty, in part because the traditional banking and financial mechanisms have not embraced them, as de Soto has claimed. The root of the problem runs deeper because regularization programs have a remedial nature. They can only have a more direct impact on urban poverty if they are part of a broader set of preventive public policies aimed at promoting overall urban reform and supported by socioeconomic policies aimed at generating job opportunities and income. There is a fundamental role for the market economy in this process, but it also requires systematic intergovernmental relations, public-private partnerships, and above all renewed social mobilization. Furthermore, de Soto has failed to consider the essential gender and environmental implications of land legalization.
To prevent the production of these perverse effects, we must identify and understand the factors that have contributed to the phenomenon of urban illegality. These include not only the combination of land markets and political systems but also the elitist and exclusionary legal systems still prevailing in Latin America. To legalize the illegal requires the introduction of innovative legal-political strategies to promote the articulation of individual land tenure with the recognition of social housing rights compatible with keeping dwellers in their existing settlements. Housing rights cannot be reduced to individual property rights.
New tenure policies need to integrate four main factors: legal instruments that create effective rights; socially oriented urban planning laws; political-institutional agencies and mechanisms for democratic urban management; and inclusionary macro-socioeconomic policies. The search for innovative legal-political solutions also includes the incorporation of a long-neglected gender dimension and a clear attempt to minimize the impacts such policies have on the land market. The benefits of public investment should be captured by the urban poor, not by traditional and new private land developers, as has happened frequently in settlements regularized according to de Soto’s proposals.
In conclusion, I would argue that regularization programs should be group specific, taking into account the local historical, cultural and political contexts as well as the existing forms of tenure arrangements, both legal and customary and formal and informal. Public administrators and lawmakers should refuse the pressure to homogenize land and property laws. Individual property ownership will always be an attractive option that should be considered, but there are many other legal-political alternatives.
Hernando de Soto is absolutely right when he questions the legitimacy of exclusionary legal systems. However, while he has uncritically assumed that legitimacy would result from the widespread recognition of individual ownership, other research has proved that this is not necessarily the case. He is generally right when he says that lawyers lack an understanding of the economic process. However, many observers believe that his own understanding of the economic process may be deeply flawed, and that he could also learn a thing or two about the legal process.
Edesio Fernandes is an attorney, urban planner and lecturer in the Development Planning Unit of University College London. He is also coordinator of IRGLUS-International Research Group on Law and Urban Space. This article is based in part on his ongoing research and a lecture he presented at the Lincoln Institute in October 2001.
References
Bourbeau, Heather. 2001. Property wrongs: How weak ideas gain strong appeal in the world of development economics. Foreign Policy (November/December):78-79.
Calderon Cockburn, Julio A. 2001. Comparative analysis of the benefited and non-benefited population by the national formalization plan, in Has the well-being of the population improved?: A balance of the main social policies and programs. Lima: National Institute of Statistics and Information (INEI): 65-92.
Duhau, Emilio. 2001. Impacts of regularization programs: Notes on the Mexican experience. Paper presented at the Lincoln Institute workshop on Informal Land Markets: Land Tenure Regularization and Urban Upgrading Programs (October).
de Soto, Hernando. 1986. The Other Path. London: I.B. Tauris & Co Ltd.
_____. 2001. The Mystery of Capital. London: Bantam Press.
Fernandes, Edesio. 1999. Redefining property rights in the age of liberalization and privatization. Land Lines (November) 11(6):4-5.
_____. 2001. Law and the production of urban illegality. Land Lines (May) 13 (3):1-4.
Fernandes, Edesio and Ann Varley, eds. 1998. Illegal Cities: Law and Urban Change in Developing Countries. London: Zed.
Gilbert, Alan. 2001. On the mystery of capital and the myths of Hernando de Soto: What difference does legal title make? Paper presented at the N-AERUS Workshop in Leuven, Belgium (June).
Kagawa, Ayako. 2001. Policy effects and tenure security perceptions of Peruvian urban land tenure regularization policy in the 1990s. Paper presented at the N-AERUS Workshop in Leuven, Belgium (June).
Mammen, David. 2001. Roundtable discussion for the International Division of the American Planning Association. Interplan (June):2-9.
Payne, Geoffrey. 2001. The mystery of capital: Why capitalism triumphs in the west and fails everywhere else. Habitat Debate (September) 7 (3):23.
Payne, Geoffrey, et al. Forthcoming 2002. Land, Rights and Innovations: Secure Land for the Urban Poor. London: International Technology Development Group (ITDG).
Riofrio, Gustavo. 1998. Why have families mortgaged so little? Paper presented at the Lincoln Institute workshop on Comparative Policy Perspectives on Urban Land Market Reform in Latin America, Southern Africa and Eastern Europe (July).
Zeledon, Aida. 2001. De facto and legal regularization programs in El Salvador. Paper presented at the Lincoln Institute workshop on Informal Land Markets: Land Tenure Regularization and Urban Upgrading Programs (October).
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Most jurisdictions require residential assessments to be proportional to market value, but in practice assessment ratios—assessed value divided by sale price—are often lower for high-priced than low-priced properties. This tendency for assessment ratios to fall as sales prices rise is termed regressivity, because it means that property taxes are a higher percentage of property value for lower-priced properties. Regressive assessments have been identified in many jurisdictions and times (such as Cornia and Slade 2005; McMillen and Weber 2008; and Plummer 2010).
Assessment regressivity is an important issue because it has the potential to undermine support for a property tax system. Consider a simple system in which taxes are 1 percent of a home’s assessed value, with no exemptions or deductions. For example, a $100,000 home should have a $1,000 tax bill, and a $1 million home a $10,000 tax bill. However, it is not uncommon to find that a $1 million home is actually assessed at $800,000 or $900,000, resulting in effective tax rates of 0.8 or 0.9 percent rather than the statutory 1 percent.
Having lower-than-prescribed assessment rates for some high-priced properties may result in greater variability in assessments within price groups. One owner of a high-priced home may accept a $1 million assessment as an accurate measure of market value, while another owner may appeal and win a lower assessment. Different tax bills for identical properties can cause taxpayer resistance and resentment.
The Assessment Process in Illinois
I have analyzed data from two counties in the Chicago metropolitan area that provide quite different perspectives on assessment regressivity. In suburban DuPage County, assessment ratios decline uniformly with sales prices and there is no marked difference in the degree of variability in assessments across the range of sales prices. In the City of Chicago, which is part of Cook County, the degree of variability in assessment ratios is greater than the degree of regressivity. Notably, assessment ratios in Chicago are highly variable at low and very high sales prices, while not varying greatly with mid-range sales prices.
Illinois has a simple flat-rate property tax, but the homestead exemption produces a degree of progressivity. This exemption is generally a flat amount that does not vary by price, although Cook County has an “alternative general homestead exemption” that can make the exemption higher in areas with rapid price appreciation. The basic homestead exemption is designed to produce much lower effective tax rates for low-priced properties—where the exemption is often high relative to market value.
Assessment practices in DuPage County are similar to those in all but one of the 102 counties in Illinois, where properties are assessed on a four-year cycle at 33 percent of market value. In DuPage County, properties were most recently assessed in 2007 and new assessments will be established in 2011. Cook County alone has a classified system with varying statutory assessment rates. Prior to 2009, the statutory rates were 16 percent for residential properties, 38 percent for commercial, and 36 percent for industrial, although actual assessment rates were much lower. In 2009, the statutory rates were “recalibrated” to 10 percent for residential and 25 percent for commercial and industrial properties. Cook County assesses its properties on a rotating, three-year cycle. The City of Chicago was last reassessed in 2009, and all city properties will be reassessed again in 2012. Properties in the north suburban part of Cook County were reassessed in 2010, and south suburban properties will be reassessed in 2011.
Traditional Measures of Regressivity
The importance of assessment regressivity has led the International Association of Assessment Officers (IAAO 2007) to recommend that an analysis of regressivity be included as part of any study of assessment accuracy. One common procedure recommended by the IAAO to evaluate assessment regressivity is a descriptive statistic, the price-related differential (PRD), which is the ratio of the simple mean assessment ratio to a comparable statistic that places more weight on higher-priced properties. Typically this ratio is greater than one, which implies that higher-priced properties have lower average assessment ratios than lower-priced homes.
Table 1 presents traditional IAAO measures of residential assessment performance for the most recent reassessment year for which I have data—2006 in Chicago and 1999 in DuPage County. The data on sales prices and assessed values come from the Illinois Department of Revenue, which is responsible for monitoring assessment performance for all counties in the state. I focus on Chicago rather than all of Cook County to keep the sample size more manageable, to focus on a single assessment year, and to avoid combining the county’s three assessment districts.
Chicago’s average assessment rate (mean) of 9.4 percent differs significantly from the statutory value of 16 percent. In DuPage County, the average assessment rate of 29.8 percent is much closer to the statutory 33 percent rate, and it would likely be even closer if the timing of the sales prices and assessment origination dates were closer. The value-weighted mean is calculated by weighting each observation by its sale price. The finding that the value-weighted mean is less than the arithmetic mean implies that higher-priced properties tend to have lower than average assessment ratios in both counties.
The price-related differential (PRD), which is the ratio of the value-weighted mean to the arithmetic mean, formalizes this measure. IAAO standards call for the PRD to be no higher than 1.03; by this standard, DuPage County’s degree of regressivity is acceptable while Chicago’s is not. The coefficient of dispersion (COD) is the traditional measure of assessment variability. By IAAO standards for residential properties, the COD should not exceed 15. Again, Chicago’s COD indicates excessive variability while DuPage County’s degree of variability is within IAAO’s acceptable range.
Statistical Analysis of Regressivity
A second IAAO-recommended procedure to measure regressivity is a statistical regression of a sample of assessment ratios on sales prices, which typically produces a negative coefficient for the price variable, i.e., a downward sloping line. This type of analysis provides estimates of the conditional expectation of the assessment ratio for any given sale price. Although several approaches exist in the literature, the basic idea is to estimate a function that produces a simple relationship between sales prices and assessment ratios. If the function implies that assessment ratios decline with sales prices, the assessment pattern is said to be regressive.
Figure 1 shows the estimated functions when assessment ratios are regressed on sales prices using data from Chicago and DuPage County. The straight lines are simple linear regressions. The curved lines are a nonlinear estimation procedure—a locally weighted regression technique that estimates a series of models at various target values, placing more weight on values closer to the target points. For example, to estimate a regression with a target point of $100,000, one might use only observations with sales prices between $75,000 and $125,000, with more weight placed on sales prices closer to $100,000.
The linear and locally weighted regression estimates are much more discrepant for Chicago’s data set than for DuPage County’s. While both approaches indicate that assessment ratios fall with sales prices, the nonlinear procedure indicates that expected assessment ratios are extremely high in Chicago at very low sales prices—but still below the statutory rate of 16 percent.
The regression lines imply precise relationships, but they do not address differences in the degree of variability at different sales prices. It may be that both unusually high and unusually low prices are simply hard to assess accurately. If so, assessment ratios could have high variances at both low and high sales prices while being tightly centered on statutory rates near the mean sale price. Neither the traditional PRD statistic nor standard regression procedures are well-suited for analyzing a situation where the accuracy of the assessment process varies with sales prices.
Quantile Regressions Using Simulated Data
Another statistical procedure, quantile regression, provides much more information on the relationship between assessment ratios and sales prices by showing how the full distribution of ratios varies by price. The easiest way to understand quantile regression is to imagine two data sets, A and B, where both have 10,000 observations. Each observation represents a sale price and assessment ratio pair, but sales prices are constrained to integers between 1 and 10 (figure 2).
In constructing data set A, a sale price is assigned, and then an assessment ratio is drawn from a normal distribution with a mean (and median) of 0.33 (the statutory rate in DuPage County). Data set A then matches the assumptions of a classical regression model, where the variance of the assessment ratios is constant across all values of sales prices. In constructing data set B, however, the variance of the assigned assessment ratio is higher for lower sale price levels, but the mean is constant and equals 0.33 at each price.
In both data sets the mean is equivalent to the estimated linear regressions in this case, indicating no relationship between sale price and assessment ratio. If these regressions were estimated using real data, they would be interpreted as indicating that assessment ratios are proportional to sales prices, i.e., assessments are neither regressive nor progressive. Despite this finding, figure 2 clearly shows that in data set B assessments converge on the statutory 33 percent rate at high sales prices, whereas homes with low sales prices run the risk of having extremely high assessment rates.
Quantile regression estimates reveal the differences between data sets A and B in the degree of assessment ratio variability, and this approach can be estimated at any target value of the assessment ratio distribution. For example, since the 10 percent and 90 percent quantile lines are converging as sales prices increase, the quantile regression reveals what standard regression procedures do not—low sales prices have highly variable assessments and high sales prices have more precise assessments.
Quantile Regressions for the City of Chicago and DuPage County
In practice, linear regression, locally weighted regression, and a linear version of quantile regression all proved too restrictive to represent accurately the relationship between assessment ratios and sales prices in Chicago and DuPage County, especially for extremely low and extremely high sales prices. Instead, a nonlinear version of quantile regression provides the most accurate representation of the underlying relationship.
Figure 3 shows the results of nonlinear versions of the quantile regressions, which can be estimated at a series of target points, with more weight given to observations that are near the targets. From bottom to top, the graphs show the estimated 10, 25, 50, 75, and 90 percent quantile regression lines.
Chicago’s results suggest that assessment ratios are relatively high at all quantiles for quite low prices, but the high variability is evident in the large spread between the 10 and 90 percent quantile lines. However, as the sale price increases from about $250,000 to nearly $800,000, the regression lines are close to horizontal. The variability is also low in this range. The quantile lines begin to have a downward slope again for prices above $800,000, with a moderate increase in the variance. Thus, the Chicago results suggest that the standard analysis of regressivity is misleading in that most of the regressivity is concentrated at low sales prices where the variance is also quite high.
In contrast, DuPage County has relatively high assessment ratios and lower variances in the $100,000–$200,000 range of prices where most sales took place in 1999. Assessment ratios decline with sale price for all prices beyond about $100,000, while the variance is increasing. The pattern of results for DuPage County is closer to what is implicitly assumed in a standard regression analysis of assessment regressivity.
Assessment Ratios Distributions at Alternative Sales Prices
An alternative to quantile regression is to examine the actual distribution of assessment ratios at a variety of different target values for sales prices to see how assessment ratios vary at given sales prices. Since most of the interesting patterns occur at low sales prices, figure 4 shows estimated conditional density functions for sales prices ranging from $50,000 to $200,000. The density function for Chicago has a huge variance at a sale price of $50,000. As the price increases to $100,000, $150,000, and finally $200,000, the density function moves to the left, meaning that lower assessment ratios become more common—an indication of regressivity. The distribution is also much more tightly clustered around the mean value of 9–10 percent, which indicates that the variance is reduced substantially.
In the contrasting case of DuPage County, the conditional density functions simply shift to the left as the target sale price increases with no pronounced change in variance. This parallel leftward shift of the conditional density function shows what would be predicted by a classic regression analysis of a regressive assessment system.
Implications for Property Taxes
Assessment regressivity has important implications for individual tax bills, as exemplified in a simplified analysis of residential taxes in Cook County. Though not a literal representation of the county’s tax system, the analysis is a close approximation. The starting point for table 2 is the estimated market value, which we assume to be accurate. Although the statutory assessment rate in Cook County was 16 percent prior to 2009, I use an assessment rate of 10 percent because it is closer to the actual rate and it matches the recent recalibration. Thus, the proposed assessed valuation for the property is $10,000.
However, Illinois also requires that assessments across the state must average 33 percent of market value. If assessments average less than 33 percent—as is mathematically a near certainty under Cook County’s classification system—the Department of Revenue calculates an equalization factor by which all assessments are multiplied. Using a representative value of 2.7 for the multiplier in table 2, the $10,000 assessment turns into an adjusted equalized assessment value of $27,000. Finally, the standard homestead exemption of $5,500 (again, a representative value) is subtracted to produce the base for the homeowner’s property tax bill. Thus, the sample tax rate of 10 percent and the adjusted equalized assessed value of $21,500 produce a tax bill of $2,150.
Table 3 compares house values and property tax rates under the assumption that assessments are regressive and are more variable for $100,000 houses than for $500,000 houses. Due to the homestead exemption, the property tax is somewhat progressive even when assessments are proportional to market value. Thus, a $100,000 house that is accurately assessed at 10 percent of market value ($10,000) ends up with a tax bill of $2,150 or an effective tax rate of 2.15 percent, while a $500,000 house that is assessed correctly at $50,000 has a tax bill of $12,950, or 2.59 percent of market value.
But, suppose that assessment rates for $100,000 homes actually range from 9 to 14 percent, while the range for $500,000 homes is only 8 to 12 percent. In this case, the progressivity of the homestead exemption can be reversed completely. Owners of low-priced homes who are “unfortunate” in receiving high assessments end up with effective tax rates of 3.23 percent, which is much higher than the average 10 percent value for owners of $500,000 homes, and is even higher than the 3.13 percent tax rate paid by owners of high-priced homes assessed at 12 percent.
Moreover, actual tax payments vary significantly for otherwise identical homes—from $1,800 to $3,230 for $100,000 houses and from $10,250 to $15,650 for $500,000 homes. In other words, a homeowner may receive a tax bill that is nearly 80 percent higher than the neighboring house even if both have a market value of $100,000.
Conclusion
Because assessment accuracy is the key to an equitable property tax, statistical measures of regressivity are essential tools for evaluating property valuation systems. Standard measures of regressivity can present an incomplete or even misleading picture of the range of assessment ratios in a jurisdiction. Newer analytic tools such as quantile regression can improve our understanding of the distribution of tax burdens and in this way help improve assessment equity.
Note: The statistical tools used in this article are included in a contributed extension package for the statistical program R. The package (aratio) is designed to be accessible to people who have limited knowledge of the R program but are familiar with other statistical software packages. Both R and aratio can be downloaded at no charge from www.r-project.org.
About the Author
Daniel P. McMillen is a professor at the Institute of Government and Public Affairs and in the Department of Economics at the University of Illinois. He is also a visiting fellow of the Lincoln Institute’s Department of Valuation and Taxation in 2010–2011.
References
Cleveland, William S., and Susan J. Devlin. 1988. Locally weighted regression: An approach to regression analysis by local fitting. Journal of the American Statistical Association 83(403, September): 596–610.
Cornia, Gary C., and Barrett A. Slade. 2005. Property taxation of multifamily housing: An empirical analysis of vertical and horizontal equity. Journal of Real Estate Research 27(1, (January/March): 17–46.
International Association of Assessing Officers (IAAO). 2007. Standard on ratio studies. Kansas City, MO: IAAO.
McMillen, Daniel P., and Rachel Weber. 2008. Thin markets and property tax inequities: A multinomial logit approach. National Tax Journal 61(4, December): 653–671.
Plummer, Elizabeth. 2010. The effect of land value ratio on property tax protests and the effects of protests on assessment uniformity. Working Paper. Cambridge, MA: Lincoln Institute of Land Policy.
Even as the economy begins to recover from the greatest recession since the 1930s, the worst may be yet to come for state and local governments because their fiscal situations typically lag the general economy by two to three years. State budget deficits for FY2010 totaled more than 25 percent of general fund budgets—the largest budget gaps on record.
Making matters worse is the impending “stimulus cliff,” which arises because most of the roughly $135 billion in federal stimulus aid to state governments and school districts was used to help close state budget gaps in FY2010, leaving a small fraction of the aid for FY2011 (Lav, Johnson, and McNichol 2010). Even before the current recession, states faced substantial structural deficits. The U.S. Government Accountability Office (2007, 1) predicted state and local governments would face “large and growing fiscal challenges” within a few years time, and continuing through 2050.
These grim forecasts for state and local budgets have led some analysts and policy makers to call for reducing the size of state government, consolidating local governments, restructuring tax systems, and even changing state constitutions. According to Rob Gurwitt (2010, 18) of Governing magazine, the “fundamental assumptions about how state government operates need rewiring.”
Given the likelihood of a long-term state and local government fiscal crisis, property tax relief is an important state government function that is now more critical than ever. This article argues that most efforts to provide property tax relief, such as assessment limits and homestead exemptions, are inefficient and create substantial unintended consequences. Circuit breaker programs—a property tax relief mechanism first developed in the 1960s—deserve renewed attention in an era of streamlined state government because they target aid to those who need it most.
Alternative Approaches to Property Tax Relief
The property tax accounts for the largest share of own-source revenues for local governments, and is particularly suitable for funding local services for at least two reasons. First, it is a stable revenue source: property tax revenues do not fall dramatically during recessions as income tax and sales tax collections generally do. Second, property taxes are imposed on an immobile tax base: while people may have the option to buy the same goods in a nearby town with lower sales taxes, or move across state lines for lower incomes taxes, they cannot move their land across city lines to seek lower property taxes.
The property tax is not without problems, however. Chief among them are the disparities in property values across communities, an inexact relationship to taxpayers’ ability to pay, and the long-standing unpopularity of the tax. Its revenue importance means that improvement rather than elimination is the best way to address these problems.
Property tax relief can be provided in many ways, some of which are more effective and equitable than others. Wealth disparities among communities make locally funded property tax relief programs inherently problematic. Funding property tax relief at the state level is a better option, since communities with large concentrations of needy taxpayers are unlikely to have the resources to fund local-option tax relief programs. State funding also eliminates inequities in property tax relief among communities.
Assessment caps are used as a property tax relief measure in 20 states, and other states regularly examine proposals to employ such measures. A recent comprehensive study on assessment limits found, however, that “30 years of experience suggests that these limits are among the least effective, least equitable, and least efficient strategies available for providing property tax relief” (Haveman and Sexton 2008, 37). Assessment caps provide the greatest tax reductions to homeowners whose property values have increased the most. Even though such gains in housing wealth are not a liquid asset, tax relief should not be structured to provide the greatest benefit to those with the greatest increase in wealth.
Assessment limits also create horizontal inequities in cases where two homeowners with identical incomes and homes in the same community face dramatically different property tax bills solely because one owner has lived in the home longer. Fixed-dollar homestead exemptions are better, but still do a poor job of targeting homeowners with the highest property tax burdens, because they provide the same dollar value of property tax relief to all homeowners facing a particular tax rate, regardless of their income.
Residential property tax relief programs across the United States are seldom targeted by income—the best measure of a household’s ability to pay taxes. Of the 216 residential property tax relief programs in effect in 2006, only 81 took income into account when setting benefits by using an income ceiling, and only 37 programs set tax relief benefits that varied by income (Significant Features of the Property Tax 2010). Given the fiscal crisis, states should consider replacing untargeted property tax relief with circuit breaker programs that can provide relief to more households in need, without spending more money.
The Case for the Property Tax Circuit Breaker
When applied to property tax relief, the term circuit breaker is used to describe programs that provide benefits directly to taxpayers, with benefits increasing as claimants’ incomes decline. As an electrical circuit breaker stops the flow of electrical current to protect a circuit from overload, a property tax circuit breaker is a policy mechanism designed to stop property taxes from exceeding a claimant’s ability to pay, protecting the taxpayer from property tax overload.
A clear definition is critical since most states with true circuit breaker programs do not use that term to describe them. For example, Maine calls its circuit breaker program the Maine Property Tax and Rent Refund Program. Meanwhile, some states use the term to refer to property tax relief programs in which relief does not vary with income. In Indiana, a program is called a circuit breaker even though the program ties relief to property value, not to income.
Over the last 40 years, two-thirds of the states and the District of Columbia have adopted state-funded circuit breaker programs (see figure 1). Each of these programs satisfies the circuit breaker definition described above. However, the design of these programs, and consequently their effectiveness, varies considerably. Properly designed circuit breakers can target property tax relief more precisely and with less expense than broad-based mechanisms such as homestead exemptions and assessment caps.
Recommendations for a Circuit Breaker Program
We offer seven recommendations designed to obtain maximum benefit when creating or reforming a circuit breaker program. The New York case study presents the efforts of one state trying to reform its circuit breaker program (box 1).
Box 1: New York’s Effort to Provide Targeted Property Tax Relief
Policy makers in New York state are considering adopting a new, expanded circuit breaker program to provide more targeted property tax relief because the existing circuit breaker program does not provide adequate assistance. It currently excludes households with incomes above $18,000, and provides an average annual benefit of only $109 per claimant (Bowman et al. 2009).
The state’s primary means of providing direct property tax relief to households is the School Tax Relief program (STAR), which has three components. Basic STAR is available to all taxpayers on their primary residence, and exempts the first $30,000 in property value from school district taxes, with adjustments for municipalities where assessed values diverge from market values and for downstate counties with high real estate prices. Enhanced STAR exempts a higher value, and is available only to homeowners over age 65 with limited incomes. Middle Class STAR provided a rebate check that depended on households’ income and their other STAR benefits, but was repealed in 2009 for 2009–2010 and subsequent fiscal years.
STAR is an expensive program—the three property tax components cost about $3.9 billion in 2008–2009. However, because benefits are spread so widely, many homeowners still face excessive property tax burdens. According to the 2006 American Community Survey, even after accounting for reductions under the Basic and Enhanced STAR programs, 20.1 percent of New York homeowners paid more than 10 percent of their income in property taxes, while 52.6 percent paid less than 5 percent. By providing such generous relief to the second group, the state is not able to provide enough for the first. Also, by providing larger exemptions for counties with high house prices, STAR largely subsidizes households in property-wealthy communities, which makes the state’s property tax system more regressive (Duncombe and Yinger 2001).
To provide more targeted relief, several proposals have been introduced to establish a new circuit breaker program. During the 2005–2006 legislative session, Assemblywoman Sandy Galef and Senator Betty Little sponsored a plan with many desirable features: a multiple-threshold formula to make the distribution of tax relief more progressive; an income ceiling high enough to include all middle-income households; and a copayment requirement to discourage excessive spending by local governments. The cost would have been limited by making homeowners choose either circuit breaker benefits or Middle Class STAR.
The Omnibus Consortium put forward a proposal similar to the Galef–Little plan, but with two improvements. First, it includes renters. Second, it uses a graduated structure for the income brackets, so that a small income increase that moves a claimant from one bracket to the next does not result in a much larger decrease in circuit breaker benefits.
The consortium’s proposal was introduced in spring 2009 by Senator Liz Krueger and Assemblyman Steve Englebright; it is cosponsored by Galef, Little, and many other legislators. Once fully implemented this plan is estimated to cost $2.3 billion annually, which is 65 percent less than the cost of the 2008–2009 STAR property tax programs, even though the new plan would provide much more generous relief to households facing the largest property tax burdens.
Plans to pay for the circuit breaker have been clouded by the state’s repeal of the Middle Class STAR rebates in response to the 2009–2010 budget deficit. Governor David Paterson has also proposed a circuit breaker plan, which would tie circuit breaker benefits to a spending cap for state government. Annual spending growth would be restricted to inflation growth. When revenues exceed this limit, the surplus would be returned to homeowners via a circuit breaker. While this plan may seem attractive, it would accentuate budget cycles and result in unpredictable year-to-year fluctuations in tax relief for homeowners.
Given the state’s fiscal crisis, creating a new circuit breaker program now seems more difficult than when the Galef–Little bill was being actively debated in the 2006–2008 period. Still, it is a positive sign that many legislators and the governor are all advancing targeted and cost-effective circuit breaker proposals, and have repealed the expensive and untargeted Middle Class STAR program.
Provide property tax relief to owners and renters of all ages. Currently, more than two-thirds of state circuit breakers do not cover nonelderly households, and a quarter of programs do not cover renters. Restricting eligibility to seniors is based on the false assumption that age is a good proxy for property tax burden. In fact, while the elderly have higher property tax burdens on average, Census data show elderly and nonelderly homeowners both devote about 35 percent of their incomes to all home ownership costs combined (Bowman et al. 2009, 11).
Furthermore, circuit breakers eliminate the need to use age as a rough proxy for property tax burdens since they target relief based on each household’s income and property tax liability. States should also provide circuit breaker benefits for renters, because they pay property taxes indirectly as part of their rent and they generally have lower incomes than homeowners. States that cover renters typically estimate renter property tax payments by specifying a percentage of rent equivalent to property taxes, most commonly 20 percent.
Avoid low income ceilings and restrictions on maximum benefits.
Many circuit breakers fail to provide meaningful tax relief because they have low income ceilings that exclude middle-income households, or low limits on maximum benefits that result in inadequate relief. For example, Oklahoma’s circuit breaker program restricts eligibility to claimants with incomes below $12,000 and caps relief at $200. In 2008, almost three-quarters of state circuit breaker programs had income ceilings below the national median household income of $50,223. In the current fiscal crisis, states should take care to set appropriate limits to restrain the cost of circuit breaker programs without rendering these programs ineffective.
Use a multiple-threshold circuit breaker formula.
States use three basic types of circuit breaker formulas: threshold, sliding-scale, and quasi circuit breakers. Threshold circuit breakers are the only type that bases tax relief directly on property tax burdens—that is, the percentage of income spent on property taxes. Using multiple thresholds will result in a more progressive distribution of benefits.
Threshold formulas provide a benefit for the portion of a claimant’s property tax bill that exceeds set percentages of income. For example, the Massachusetts circuit breaker, which is limited to taxpayers over age 65, uses a 10 percent single-threshold formula. The taxpayer is responsible for the entire tax bill up to 10 percent of household income, while the circuit breaker benefit offsets the tax bill above this threshold, up to a maximum benefit of $960.
Multiple-threshold formulas set multiple threshold percentages that increase from the lowest income bracket to the highest, with these thresholds usually applied incrementally like a graduated income tax. Maryland uses four threshold percentages: the circuit breaker benefit offsets any property tax liability above 0 percent of income for the first $8,000 of income, above 4 percent for the next $4,000 of income, above 6.5 percent for the next $4,000 of income, and above 9 percent for income of $16,001–$60,000.
Sliding-scale formulas reduce property taxes by a set percentage for each income bracket, with lower relief percentages for higher income brackets. All claimants in a given income bracket receive the same percentage of relief regardless of their property tax bill.
Quasi circuit breakers use multiple income brackets to target benefits to low-income households; benefits are determined without reference to a claimant’s property tax bill, except that they cannot exceed the actual property tax paid. A few states use hybrid circuit breakers that employ elements of all three types of formulas.
Ensure reliable state funding.
Even generous circuit breakers can become ineffective without reliable state funding. Circuit breaker benefits should be treated as an entitlement, rather than relying on budget appropriations that can result in pro-rated benefits (as in Iowa), unpredictable annual changes in formulas (as in New Jersey), or elimination of benefits in some years (as in California). Unpredictable fluctuations in circuit breaker benefits are difficult for taxpayers to manage and can have potentially dire consequences on household budgets.
Given the disparities in property wealth across municipalities, it is important for circuit breakers to be funded by the state, rather than at the option of local governments. Because of differences in program design and participation levels, the costs to state governments of existing circuit breaker programs vary considerably, ranging from .004 percent to 6.3 percent of property tax collections among 14 states where program cost data are readily available (Bowman et al. 2009, 20).
Use copayment requirements with threshold circuit breakers.
States that use threshold formulas should relieve only a portion of property taxes exceeding the threshold. The remaining difference between the taxes exceeding the threshold and the circuit breaker benefit may be considered a copayment. Copayment requirements are important for avoiding inefficient increases in local spending. If a circuit breaker shields taxpayers from 100 percent of any property tax increase, they have no incentive to scrutinize increased local spending since they will benefit from better public services without any increase to their tax bill.
Deliver circuit breaker benefits in a timely and visible way.
States use three methods of distributing circuit breaker benefits: rebate checks, income tax credits, and property tax credits or exemptions. A property tax credit reduces the tax bill based on a property’s full assessed value, while an exemption reduces a property’s assessed value.
Providing benefits through a property tax credit or exemption has two key advantages over rebate checks or income tax credits. First, taxpayers receive an immediate reduction in their property tax bills instead of facing a delay between the date they pay their property taxes and the date their circuit breaker application can be processed. Second, taxpayers observe the benefit as property tax relief instead of mistaking an income tax credit for income tax relief. Since renters do not pay property taxes directly, their circuit breaker benefits can be dispersed through a rebate check.
Use a public outreach campaign.
Low participation is a common problem among existing circuit breaker programs. Taxpayers will not apply for benefits if they are not aware of the program, or if they do not believe they qualify for benefits. To increase awareness and participation, states may promote programs through print advertising, broadcast media, and/or speaking tours. The Internet is a particularly useful and low-cost tool for circulating up-to-date program details including deadlines, contact information, printable claim forms, or online applications. Some states are able to enlist the help of nonprofit organizations in promoting participation if the group views the circuit breaker program as supporting its mission. For example, the Gerontology Institute at the University of Massachusetts promotes that state’s program as part of its efforts on behalf of the elderly.
Conclusion
The current fiscal crisis may usher in a new era for state governments under intense pressure to redesign programs to “do more with less.” Property tax relief is a core function of state governments, and it can be made more fair and cost-effective by using a circuit breaker program. This policy tool is designed to stop the property tax from exceeding a taxpayer’s ability to pay by targeting tax relief to those who need it most.
A majority of the states currently employ circuit breakers, but most programs fall short of ideal leaving ample room for improvement. New York’s poorly targeted property tax relief system, for example, could be replaced with an expanded circuit breaker that provides more help to taxpayers overburdened by the property tax, but costs less than the current program. Circuit breaker programs can also help strengthen the property tax itself as a mainstay of local government finance.
About the Authors
Daphne A. Kenyon is principal of D.A. Kenyon & Associates, a public policy consulting firm in New Hampshire, and a visiting fellow at the Lincoln Institute of Land Policy.
Adam H. Langley is a research analyst at the Lincoln Institute of Land Policy and a graduate student in economics at Boston University.
Bethany P. Paquin is a research assistant for D. A. Kenyon & Associates and the Lincoln Institute.
The authors thank Frank Mauro of the Fiscal Policy Institute in New York State and Joan Youngman of the Lincoln Institute of Land Policy for helpful information and comments on previous drafts.
References
Bowman, John H., Daphne A. Kenyon, Adam Langley, and Bethany P. Paquin. 2009. Property tax circuit breakers: Fair and cost-effective relief for taxpayers. Cambridge, MA: Lincoln Institute of Land Policy.
Duncombe, William and John Yinger. 2001. Alternative paths to property tax relief. In Property taxation and local government finance, Wallace E. Oates, ed., 243–294. Cambridge, MA: Lincoln Institute of Land Policy.
Gurwitt, Rob. 2010. Broke and broken. Governing 23 (4): 18-23.
Haveman, Mark and Terri A. Sexton. 2008. Property tax assessment limits: Lessons from thirty years of experience. Cambridge, MA: Lincoln Institute of Land Policy.
Lav, Iris J., Nicholas Johnson, and Elizabeth McNichol. 2010. Additional federal fiscal relief needed to help states address recession’s impact. Washington, DC: Center on Budget and Policy Priorities, January 28. www.cbpp.org
Omnibus Consortium. 2010. Summary of Omnibus Bill Circuit Breaker. http://omnibustaxsolution.org/overview.html
Significant Features of the Property Tax. 2010. Residential property tax relief programs. www.lincolninst.edu/subcenters/significant-features-property-tax/Report_ResidentialRelief.aspx
U.S. Government Accountability Office. 2007. State and local governments: Persistent fiscal challenges will likely emerge within the next decade. July 18. GAO-07-1080SP.
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A critical aspect of the property tax, but one that is rarely addressed in public debate, is its “economic incidence,” or who actually bears the burden of the tax, as opposed to its statutory incidence, or who literally pays the tax. For example, a landlord might pay a property tax bill, but if some of the tax is offset with a rent increase, then the tenant bears that part of the tax burden. Not surprisingly, estimates of the economic incidence of taxes depend on the relative responsiveness of supply and demand to tax-induced price changes—factors that explain the extent to which consumers and businesses can change their behavior to avoid the tax.
The economic incidence of a tax is also affected by the phenomenon of “capitalization”—changes in asset prices that reflect the discounted present values of the economic effects of future tax and/or public expenditure changes. For example, an increase in property taxes, holding expenditures constant, might be capitalized into land or house values. The prices of these assets might fall by the present value of the projected increase in future taxes, whereas increases in expenditures, holding property taxes constant, might have offsetting effects.
These capitalization effects should include the effects of other tax-induced price changes, such as changes in future housing or land rents. In principle, the economic incidence of all of these capitalization effects is on the owners of land and housing at the time of the imposition of the tax, when the effects are “capitalized” as one-time changes in the prices of these assets. These price changes also significantly affect the ultimate economic burden of the tax on subsequent purchasers.
Benefit Tax versus Capital Tax Views
The complexity of measuring all of these effects implies that determining the economic incidence of taxes is one of the most difficult problems in public finance, and the property tax is no exception. Indeed, the debate over the incidence of the residential property tax has raged for at least the last thirty years, and is still far from resolved. Professional opinion on the incidence of the tax is generally divided between the “benefit tax” view and the “new” or “capital tax” view (Zodrow 2001).
Under the benefit tax view, the property tax is considered a user charge for public services received. It thus serves the function of a local head tax or benefit tax as envisioned by Tiebout (1956) in his celebrated analysis of how interjurisdictional competition coupled with consumer mobility can lead to the efficient provision of local public services. The implications for taxpayers are threefold. First, as a benefit tax the property tax is simply a payment for public services received, analogous to purchases of goods and services for private markets. Second, because the property tax functions as a market price, its use implies that local public services are provided efficiently. Third, the property tax, like all benefit taxes, results in no redistribution of income across households and thus has no impact on the distribution of income.
By comparison, under the capital tax view derived by Mieszkowski (1972) and elaborated by Zodrow and Mieszkowski (1986b), the property tax is a tax on the use of capital and thus inefficiently distorts resource allocation by driving capital investment out of high tax jurisdictions and into low tax jurisdictions. The capital tax view divides the incidence of the property tax into two components. The national average tax burden is in effect a “profits tax” borne by all capital owners, including homeowners, businesses, and investors. The local or “excise tax” components of property tax rates that fall above or below the national average are borne locally through changes in land rents, wages, or housing prices.
The incidence effects of local taxes that are higher and lower than the national average tend to cancel one another in the aggregate. Therefore, the profits tax effect is the main factor determining the incidence and distributional effects of the property tax. From the perspective of any single taxing jurisdiction, however, the burden of local expenditures financed by the property tax tends to be borne primarily by local residents.
The capital tax view has different implications for taxpayers in all three of the areas noted above for the benefit tax view. First, the tax has some significant benefit aspects in that local tax increases tend to be borne by local residents. Second, the tax inefficiently distorts housing consumption decisions; moreover, use of the local property tax can also lead to inefficient underprovision of local public services if government officials, concerned about tax-induced loss of investment, then reduce the level of public services (Zodrow and Mieszkowski 1986a). Third, because the primary effect of nationwide use of the property tax is a reduction in after-tax returns to capital owners, it is a highly progressive tax. Nevertheless, from the perspective of a single taxing jurisdiction, the local tax is not borne by capital owners as a whole but rather by local residents and is a roughly proportional tax. (See Table 1 for a summary of these two views.)
Capitalization and the Incidence of the Property Tax
My recent research sponsored by the Lincoln Institute has focused on a single but critical aspect of this long-standing debate. Dating back to the seminal work of Oates (1969), empirical evidence of the interjurisdictional capitalization of the discounted values of local property taxes and public services into house prices has been interpreted as offering support for the idea that property taxes can be viewed as payments for local public services received, consistent with the benefit tax view.
This notion was extended to the case of intrajurisdictional capitalization in the pathbreaking work of Hamilton (1976). In this model, which is characterized by perfectly mobile households with heterogeneous demands for housing and fixed housing supplies, intrajurisdictional fiscal capitalization converts the local property tax into a pure benefit tax, even though all houses are not identical. Specifically, high-value homes sell at a discount that reflects the capitalized present value of their “fiscal differential”—the present value of the excess of future taxes paid relative to public services received.
Similarly, low-value homes should sell at a premium that reflects the capitalized present value of the extent to which future taxes paid are less than the value of public services received. As a result, all households “pay for what they get” in public services, and the property tax is an efficient benefit tax. Capitalization thus implies that it is futile to follow the conventional strategy of buying a low-value home in a high-value community in order to receive local services at relatively low cost.
In supporting the idea that the combination of strict zoning regulations and fiscal capitalization converts the property tax into a benefit tax, Fischel (2001) interprets the extensive literature on the capitalization of property taxes and public services as demonstrating that fiscal “capitalization is everywhere.” He concludes that empirical support of fiscal capitalization provides compelling evidence that the benefit tax view accurately describes the effects of the property tax. Fischel makes this argument in the context of a model in which local governments are analogous to municipal corporations that maximize the house values of “homeowner-voter shareholders” who strive to protect their housing investments.
The central result of my research is that even if empirical evidence of the phenomenon of fiscal capitalization implies that it is indeed “everywhere,” such evidence does not establish the validity of the benefit tax view. Rather, my model shows that if one adopts all of the admittedly stringent assumptions of the benefit tax view, complete intrajurisdictional land value fiscal capitalization is also entirely consistent with, and indeed predicted by, the capital tax view of the property tax.
When combined with earlier results that demonstrate that interjurisdictional capitalization is also consistent with the capital tax view, my research results imply that the widely observed phenomenon of property tax capitalization provides little if any grounds for distinguishing between the capital tax and benefit tax views. That is, capitalization does not tell us whether the property tax should be viewed primarily as a progressive tax on all capital that inefficiently distorts decisions regarding housing consumption (the capital tax view), or an efficient user charge that has no effects on the distribution of income (the benefit tax view).
A Reconstruction of the Benefit Tax View
My research begins by reconstructing the Tiebout-Hamilton benefit tax view within the context of a partial equilibrium version of the standard differential tax incidence model, which focuses on the effects of use of the property tax in a single taxing jurisdiction. This approach is necessary because the derivations of the benefit tax and capital tax views of the property tax are based on somewhat different theoretical approaches.
Hamilton’s benefit tax view model characterizes the properties of an economy in equilibrium, with local public services financed by residential property taxes rather than the head taxes assumed by Tiebout. In contrast, the derivations of the capital tax view, such as those in Mieszkowski (1972) and Zodrow and Mieszkowski (1986b), are based on the differential tax incidence analysis pioneered by Harberger (1962). Under this approach, the effects of the property tax are analyzed by first constructing an initial equilibrium with either no taxes or only nondistortionary lump-sum taxes, and then introducing property taxes and analyzing their effects.
To facilitate a comparison of the two views, my analysis begins by deriving all of the benefit tax view results obtained in Hamilton’s model of intrajurisdictional fiscal capitalization within the context of a differential tax incidence model, one that is typical of the capital tax view but nevertheless makes the essential—and admittedly rather stringent—assumptions characteristic of derivations of the benefit tax view. In particular, households are perfectly mobile across competing local jurisdictions with an exogenous source of income, and there are a sufficient number of jurisdictions to satisfy all tastes for local public services.
Following Hamilton, the model has two different types of households, one of which demands relatively larger houses. Initially, the local economy is assumed to be in a Tiebout equilibrium, with local public services as well as housing and the composite good provided at efficient levels, and with local public services being financed by uniform head taxes per household. The fixed supply of land within a jurisdiction is used either for large houses for “high demanders” or small houses for “low demanders.”
Property taxes on all land and capital within the jurisdiction are then introduced into the model, with the revenues used to reduce the level of head taxation while holding the level of public services per capita fixed. Zoning is also introduced, by assuming that the amounts of land used for large and small houses are fixed. This is a weak version of the approach followed by Hamilton, who assumes fully developed communities and thus precludes any change in land or capital allocated to the two types of housing. Indeed, some form of land use zoning is required for any capitalization to occur since, in the absence of zoning, all land within the jurisdiction would in the long run sell for the same price and there would be no capitalization (Ross and Yinger 1999). In this derivation of the benefit view, housing capital is also assumed to be fixed, as in Hamilton’s analysis.
The effects of introducing property taxes on both housing capital and land in this initial equilibrium are identical to those predicted by Hamilton. First, for large homes, which experience a disproportionately larger increase in property taxes, the resulting negative fiscal differential is fully capitalized into lower housing prices. Similarly, small houses sell at a premium that exactly reflects the negative fiscal differential between total property taxes paid and the associated benefits of the tax change as measured by the reduction in head taxes.
Second, the net change in land values due to capitalization in a heterogeneous jurisdiction is zero; that is, the aggregate amount of the discount in land prices for larger homes equals the aggregate amount of the premium in land prices for smaller homes. Third, the price of each type of housing rises by just enough to offset the cost of the public services that must be financed with property taxes.
To sum up, all of the benefit tax view results obtained by Hamilton are obtained within the context of a partial equilibrium differential tax incidence model of a single taxing jurisdiction that is comprised of households that are homogeneous with respect to demands for public services, but heterogeneous with respect to demands for housing. Once again, capitalization implies that the property tax is a benefit tax. Accordingly, the combination of property tax payments and capitalization effects implies that (1) taxpayers pay for all their local public services; (2) both housing and local public services are consumed at efficient levels; and (3) the property tax results in no redistribution of income.
Capitalization Under the Capital Tax View
Converting this model to accommodate a version of the capital tax view is straightforward. Recall, however, that this approach considers the effects of the property tax from the perspective of a single taxing jurisdiction, which is modeled as a small open economy that faces a perfectly elastic supply of capital. Since the net rate of return to capital is fixed by assumption, the effect of nationwide use of the property tax on the return to capital cannot be analyzed. Nevertheless, within the single taxing jurisdiction framework the effects of the property tax on the allocation of housing capital, as well as the effects of this tax-induced reallocation on all other variables, including the changes in land prices that are the focus of the analysis, can still be derived.
The key distinction between the benefit tax and capital tax views of the property tax is that under the latter approach the stocks of housing capital are not assumed to be fixed (although the zoning assumption of fixed land supplies for the two types of housing is maintained). That is, under the capital tax view, which clearly reflects a relatively long-run view of incidence, households can reduce their housing consumption in response to an increase in the property tax.
Given these assumptions, the implications of the capital tax version of the model are as follows. First, capital flows out of the production of large houses where property taxes are high relative to benefits received, and into the production of smaller homes where the property tax bill is low relative to benefits received. This reallocation of housing capital is an important factor in determining incidence—who ultimately pays the property tax. The analysis shows that land rents unambiguously increase for land used for small houses and decrease for land used for large houses, and it is these changes in land rents that are capitalized into land prices. The key result is that these land value capitalization effects under the capital tax view are precisely the same as those calculated previously under the benefit tax view. Thus, the existence of capitalization does not help resolve the critical issue of whether the benefit view or the capital tax view more accurately describes the incidence and economic effects of the property tax.
The other results derived in Hamilton’s model obtain in this capital tax model as well. The net effect of property tax capitalization on aggregate land value within the taxing jurisdiction is zero. Similarly, the effects of the property tax on housing prices—which rise by an amount just sufficient to offset the value of public services received—are also identical under the two models, implying that housing prices for smaller homes increase proportionately more than prices for larger homes.
Despite this distortion of the allocation of housing capital under the capital tax view, the local effects of use of the property tax still have some very important features that are characteristic of a benefit tax. For example, residents pay for net local public services received (those not financed with head taxes) in the form of higher housing prices. Simultaneously, fiscal differentials are capitalized into land values, so that the net effect of the property tax burden and land value capitalization is that future purchasers of both types of houses effectively pay for what they get in public services.
Thus, the essential difference between the two views of the property tax is that, under the capital tax view, land value capitalization occurs due to capital reallocations across housing types, implying inefficiency in the housing market. Under the benefit tax view, capitalization occurs with respect to fixed housing capital stocks, and there is no distortion of the allocation of housing capital. For example, if a local government finances an increase in public expenditures with additional property taxes, the resulting capitalization effects are the same under both views (and cause the same gains and losses at the time of implementation). However, the capital tax view implies that in the long run housing demands will decline, while housing consumption remains unchanged under the benefit tax view.
My model also shows that under the capital tax view per capita housing consumption declines unambiguously for both types of households, which is the standard result that the property tax causes an inefficient reduction in housing consumption. In addition, the number of households that purchase small houses unambiguously increases, while the net effect on the number of households that purchase large houses is theoretically ambiguous, and the total population in the jurisdiction increases.
Conclusion
This analysis shows that, within the context of a partial equilibrium analytical framework characterized by assumptions typical of the benefit view of the property tax, intrajurisdictional capitalization into land values of fiscal differentials is entirely consistent with, and indeed predicted by, the capital tax view of the property tax. Earlier results demonstrate that interjurisdictional capitalization is also consistent with the capital tax view (Kotlikoff and Summers 1987). Together, these results suggest, counter to the claims of benefit tax proponents, that empirical evidence supporting full capitalization of property taxes in land values—either within or across jurisdictions—provides little if any evidence that allows researchers to distinguish between the capital tax and benefit tax views.
Instead, the key issue is whether the zoning restrictions or other mechanisms stressed by proponents of the benefit tax view are sufficiently binding to preclude the long-run adjustments in housing capital predicted by the capital tax view. This issue promises to be a fertile topic for future research, which may help clarify the answer to the long-standing and critical question of who pays the residential property tax.
George R. Zodrow is professor of economics and Rice Scholar in the Tax and Expenditure Policy Program of the Baker Institute for Public Policy at Rice University in Houston, Texas.
References
Fischel, William A. 2001. Municipal corporations, homeowners and the benefit view of the property tax. In Property taxation and local government finance, Wallace E. Oates, ed., 33–77. Cambridge MA: Lincoln Institute of Land Policy.
Hamilton, Bruce W. 1976. Capitalization of intrajurisdictional differences in local tax prices. American Economic Review, 66 (5): 743–753.
Harberger, Arnold C. 1962. The incidence of the corporate income tax. Journal of Political Economy, 70 (3): 215–240.
Kotlikoff, Laurence J., and Lawrence H. Summers. 1987. Tax incidence. In Handbook of Public Economics, Volume I, Alan J. Auerbach and Martin S. Feldstein, eds., 1043–1092. Amsterdam: North Holland.
Mieszkowski, Peter. 1972. The property tax: An excise tax or a profits tax? Journal of Public Economics 1 (1): 73–96.
Oates, Wallace E. 1969. The effects of property taxes and local public spending on property values: An empirical study of tax capitalization and the Tiebout hypothesis. Journal of Political Economy, 77 (6): 957–961.
Ross, Stephen, and John Yinger. 1999. Sorting and voting: A review of the literature on urban public finance. In Handbook of Regional and Urban Economics, Volume 3, Paul Cheshire and Edwin S. Mills, eds., 2001–2060. Amsterdam: North Holland.
Tiebout, Charles M. 1956. A pure theory of local expenditures. Journal of Political Economy, 64 (5): 416–424.
Zodrow, George R. 2001. Reflections on the new view and the benefit view of the property tax. In Property taxation and local government finance, Wallace E. Oates, ed., 79–111. Cambridge MA: Lincoln Institute of Land Policy.
Zodrow, George R. and Peter Mieszkowski. 1986a. Pigou, Tiebout, property taxation and the under-provision of local public goods. Journal of Urban Economics, 19 (3): 356–370.
———. 1986b. The new view of the property tax: A reformulation. Regional Science and Urban Economics, 16 (3): 309–327
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High land costs are an obstacle to developing and securing affordable housing for lower-income families. One way to address this issue is to purchase a house without the land, and a community land trust is one mechanism that allows this arrangement. This article reports on a roundtable attended by researchers, policy analysts, technical assistance providers, funders, and community land trust staff members to discuss the community land trust model and related research needs.
The community land trust model is an extremely attractive mechanism for maintaining and expanding the stock of affordable housing. Currently there are approximately 160 community land trusts operating in every region of the country. These community land trusts are nonprofit, community-based organizations whose mission is to provide affordable housing in perpetuity by owning land and leasing it to those who live in houses built on that land. In the classic community land trust model, membership is comprised of those who live in the leased housing (leaseholders); those who live in the targeted area (community members); and local representatives from government, funding agencies and the nonprofit sector (public interest) (Burlington Associates 2003).
A lease within a community land trust also includes a resale formula intended to balance the interests of present homeowners with the long-term goals of the community land trust—balancing the interest of homeowners and the interest of the community land trust to provide affordable housing for future homeowners.
This article addresses some of the questions surrounding the community land trust model;
This article also examine the Sawmill Community Land Trust, located near downtown Albuquerque, New Mexico. In partnership with the City of Albuquerque, Sawmill Community Land Trust’s has created a permanent stock of affordable housing in the neighborhood with housing units as well as a plaza, park, community center, commercial space and open space connected with trails. The plan calls for expanding the Sawmill Community Land Trust model to other neighborhoods to ensure a permanent stock of affordable housing and a mixed-income community for the long term.
For many households experiencing lagging wages or underemployment, the purchase and financing of a house is increasingly difficult. High land costs are another obstacle to developing and securing affordable housing for lower-income families in some markets. One way to address this second issue is to purchase a house without the land, and a community land trust (CLT) is one mechanism that allows this arrangement. This article reports on a roundtable attended by approximately 25 researchers, policy analysts, technical assistance providers, funders and CLT staff members to discuss the CLT model and related research needs. The December 2004 program was sponsored by the Lincoln Institute in partnership with the Institute for Community Economics (ICE), based in Springfield, Massachusetts.
What are community land trusts and How Do They Function?
The community land trust model has evolved in the United States over the last 40 years (ICE 1991). Currently there are approximately 160 CLTs operating in every region of the country and in 38 out of the 50 states and the District of Columbia. These CLTs are nonprofit, community-based organizations whose mission is to provide affordable housing in perpetuity by owning land and leasing it to those who live in houses built on that land. Complementing their status as nonprofit corporations, as defined in the U.S. tax code, and their formal rights and responsibilities codified in the ground lease, CLTs are governed by a board of directors with membership from the community. In the classic CLT model, membership is comprised of adults who live in the leased housing (leaseholders); adults who live in the targeted area (community members); and local representatives from government, funding agencies and the nonprofit sector (public interest) (Burlington Associates 2003).
The community land trust and the homeowner agree to a long-term ground lease agreement (typically 99 years) that spells out the rights and responsibilities of both parties. Among the homeowner’s rights are the rights to privacy, the exclusive use of the property, and the right to bequeath the property and the lease. The CLT has the right to purchase the house when and if the owner wants to sell.
The community land trust’s abiding interest, as the landowner, as the party with the option to purchase the improvement, and as a community-based organization, is to maintain a stake in the relationship long after the original house purchase and lease signing. For example, if buildings become deteriorated, the CLT can force repairs; if the homeowners are at risk for default the CLT can and does act to forestall the default.
The ground lease also includes a resale formula intended to balance the interests of present homeowners with the long-term goals of the community land trust. The intent of affordability in perpetuity is in conflict with the desire of most owner-occupants in the U.S. to reap real estate gains. Thus, the resale formula is designed to balance the interest of individual homeowners to benefit from the use of their home as a real estate investment and the interest of the CLT to provide affordable housing for future homeowners.
Research Agenda
The community land trust model is an extremely attractive mechanism for maintaining and expanding the stock of affordable housing. While the stories one hears from and about CLTs are encouraging and inspiring, little research exists regarding their effectiveness. Furthermore, despite their many attractive attributes, CLTs are neither well known nor extensively used in the U.S. During roundtable discussions, the participants exchanged perspectives and identified six clusters of questions that would constitute a short-term CLT research agenda to help inform future action.
Do community land trusts provide long-term affordable housing?
The separation of ownership of land and buildings is the mechanism by which long-term affordability is achieved. Much of the value in structures comes from their functionality, the materials used and the level of maintenance. These are the contributions of the builder and owner. Much of the value in land comes from its location with respect to natural elements, urban services such as transportation and public schools, and disamenities such as solid waste dumps or prisons. Many of the factors that contribute to land value increases are due to the economic expansion that occurs in metropolitan areas. In strong markets the pace of value increases in land exceeds that of structures. Thus, if the land is excluded from the price of housing, affordability ought to be assured over time. Research is needed to evaluate the effectiveness of the CLT tool in providing long-term housing affordability and to evaluate CLTs as compared to other affordable housing programs.
Do community land trusts contribute to individual asset building?
community land trust housing provides residents with shelter, security of tenure, access to credit and access to urban services, among other benefits. However, individual real estate profits are limited by the design of the resale formula, which varies among CLTs. Outcomes also will vary with real estate cycles in particular cities and regions. A second question, then, has to do with the degree to which the limitation on real estate profits limits individual asset building. It is possible, for example, that the security of tenure and the predictability in housing costs provided by the CLT allow individuals to pursue other, non-real estate strategies for asset accumulation.
How effective are public and nonprofit sector funds when used to produce community land trust housing?
In most cases, community land trust housing requires subsidies for the purchase of land and/or house construction. Grants typically come from government sources or private foundations. One of the premises of the CLT model is that these subsidies are recycled later to reclaim the value of the subsidies and to benefit future homebuyers. Public subsidies are no longer needed when a CLT house is sold under the resale formula. However, it is not known how efficient subsidies are when used to develop CLT housing and how the subsidy capture mechanisms work.
Do community land trusts provide access to urban services and/or regional opportunities for leaseholders?
Quality of housing in the U.S. is closely related to residential location. However, location influences more than simply house quality; it also affects the existence and quality of job opportunities and urban services such as access to transportation, health care, libraries and public schools, all of which have direct and indirect effects on quality of life and life chances.
Researchers looking at regional policy solutions are particularly interested in whether and how community land trusts influence this access to urban services. Economists use the term “spatial mismatch” to refer to the imbalance between the location of many employment opportunities in the suburbs and the location of unemployed jobseekers in the city centers. Many participants at the roundtable were interested in exploring the degree to which CLTs facilitate bridging this mismatch because of their specific location within a region, their connections to other organizations in the neighborhood and region, or employment and training programs offered to support CLT residents.
Do community land trusts contribute to community building?
Community land trusts are unique among U.S. community-based organizations in that their concerns are geographically focused and include economic relationships, the governance structure of the organization, and the provision of direct services. In some communities CLTs are connected to other organizations serving the same community or the same constituency. Much of the literature on neighborhood development and revitalization focuses on the importance of “social capital” to people and their community. Do CLTs contribute to this connective tissue of neighborhoods? How and why? Some CLTs operate across a number of communities and thus have a more regional focus. This difference among CLTs will lead us to consider questions of scale and community definition.
Why have some community land trusts excelled and others failed?
There is great variation in community land trusts across the country. The largest, Burlington Community Land Trust in Vermont, has 370 single-family homes and condominiums and 270 rental apartment leases; other CLTs may have just a handful of units available for lease. Some CLTs have been able to grow significantly while others have not, and some have ceased peration altogether. There are many possible reasons for this variation in success, including staff resources and skills; differences in mission; financing arrangements; ability to receive donations of land; and the strength or weakness of the local land and housing market.
Future Activities Regarding community land trusts
The Lincoln Institute is interested in community land trusts because they provide a window that encourages a deeper understanding of the significant role that land plays in social and economic development and the mechanisms by which it occurs. The roundtable participants hope that investigation into this research agenda would accomplish a number of objectives.
First, new research would spread knowledge of community land trusts to practitioners in fields ranging from urban development to housing policy, neighborhood planning, community organizing, regional sustainability and equity. Second, among policy analysts this research will improve our understanding of the strengths and weaknesses of the CLT model and the contexts in which it is most useful and successful. For CLT members, leaseholders, staff and board members, the findings will provide an understanding of their locally based work within a national context. For funders and lenders the investigations will provide an empirical base from which to make future funding decisions.
This work will be conducted by the Lincoln Institute, the Institute for Community Economics, representatives of organizations who attended the roundtable and others who become engaged in these issues. For example, the National Housing Institute already has begun a study of shared equity home ownership. We expect that documenting, investigating and analyzing the history of CLTs and individual experiences will provide a better understanding of the role of land in housing affordability.
Sawmill Community Land Trust
Sawmill Community Land Trust (SCLT) is located near downtown Albuquerque, New Mexico, adjacent to Historic Old Town, which has become a leading tourist attraction. Gentrification has increased the housing prices in the Sawmill neighborhood, and vacant industrial land has increased from $1.05 per square foot in 1996 to its current high of $4.10 per square foot. A home that sold for $26,500 in 1981 cost $125,000 in 2000 and $175,000 in 2004. From 2000 to 2004, real increases in a single-family home (land and housing) in the neighborhood increased by 31 percent.
Founded in 1996, SCLT evolved from existing community organizations that had been working for years to protect the character of the ethnically diverse Sawmill community and address environmental and pollution problems caused by a particleboard factory on the site. SCLT’s main focus has been to create a permanent stock of affordable housing in the neighborhood.
In partnership with the City of Albuquerque, which acquired the 27-acre former industrial site, SCLT developed plans for 196 housing units of various types (live-work lofts, single-family detached houses, townhouses, duplexes, senior apartments and condos) as well as a plaza, park, community center, commercial space and open space connected with trails. All of the 26 homes built in the first phase of development have been sold, and construction of a second housing phase will begin soon. SCLT has led a cooperative effort to develop a metropolitan redevelopment plan for the surrounding 510-acre Sawmill/Wells Park area. The plan calls for expanding the SCLT model to other neighborhoods to ensure a permanent stock of affordable housing and a mixed-income community for the long term.
Rosalind Greenstein is senior fellow and co-chair of the Lincoln Institute’s Department of Planning and Development. Yesim Sungu-Eryilmaz is a research assistant in the Lincoln Institute’s Department of Planning and Development.
References
Burlington Associates in Community Development, LLC. 2003. Key features of the “classic” community land trust. Burlington, VT: Burlington Associates.
Institute for Community Economics (ICE) 1991. The community land trust legal manual. Springfield, MA: ICE.
Resources
Burlington Community Land Trust
Fannie Mae Corporation (search for the link to CLTs)
Institute for Community Economics (ICE)
Policy Link. See Equitable Development Toolkit and link to CLT case studies.
Public policy changes often have unintended consequences—side effects, feedback effects, benefits to individuals not in the target group, unexpected costs, perverse incentives, new opportunities to game the system, and the like. Early experiences with assessment limitation measures reveal an unanticipated result: some property owners seemingly targeted to benefit from lower assessments may be harmed instead.
