Thomas J. Nechyba is professor of economics at Duke University in Durham, North Carolina, where he also serves as director of undergraduate studies for the Department of Economics. In addition, he is a research associate at the National Bureau of Economic Research, and he serves as associate editor for the American Economic Review and the Journal of Public Economic Theory. His research and teaching focus on the field of public economics, in particular primary and secondary education, federalism and the function of local governments, and public policy issues relating to disadvantaged families.

Professor Nechyba has lectured and taught in courses at the Lincoln Institute for several years, and he recently completed a working paper based on Institute-supported research, “Prospects for Land Rent Taxes in State and Local Tax Reform.” This conversation with Joan Youngman, senior fellow and chairman of the Institute’s Department of Valuation and Taxation, explores his interest in land taxation and his research findings.

Joan Youngman: How is a land tax different from a conventional property tax?

Thomas Nechyba: It’s really a question of tax efficiency. Any tax has two effects, which economists call the income and substitution effects. The income effect of a tax is the change in the choices made by the taxpayer because payment of the tax has reduced the taxpayer’s real income. The substitution effect arises because the very existence of the tax changes the relative prices of the taxed goods, and therefore gives an incentive to taxpayers to substitute non-taxed goods for taxed goods. The income effect does not give rise to any efficiency problems; it simply implies that some resources are transferred from taxpayers to the government, and we hope the government will do something useful with the money. But, the change in behavior from the substitution effect causes an economic distortion that does not benefit anyone. That is, when the higher price of a taxed good causes me to substitute to a different non-taxed good purely because of the distorted prices, then I am worse off and the government gets no revenue. This is the source of the loss of economic efficiency from taxation, because people are worse off than they were previously, and by a larger amount than the tax collections themselves. This phenomenon is sometimes called a deadweight loss.

Once I asked my students to react to the following statement on an exam: “People hate taxes because of income effects, but economists hate taxes because of substitution effects.” One student wrote that it was undeniably true because it showed that economists aren’t people! Well, I think at least some economists are also people. However, it is true that people dislike taxes primarily because they don’t like paying money to the government. Economists especially dislike those taxes that cause greater deadweight losses, i.e., taxes that have greater substitution effects.

A land tax is a very unusual tax. It does not carry this deadweight loss because it does not give rise to a substitution effect. No one can make a decision to produce more land or less land, and the fact that land is taxed will not distort economic decisions. If we think of the price of land as the discounted present value of future land rents, a tax that reduces expected future rents will cause the price of land to drop. But the total cost of the land, which is the purchase price plus the tax, remains unchanged. Those who are considering the purchase of land therefore face the same cost before and after the tax: before the tax, they simply pay a single price up front; after the tax, they pay a lower price up front but they know they will also have to pay all the future taxes. There is no substitution effect, only an income effect for those who currently own land, because now they can sell it for less than before. Property taxes that tax both land and buildings, on the other hand, do give rise to substitution effects because they distort the cost of making improvements to the property.

A revenue-neutral shift to land value taxation would reduce other, distortionary taxes. A shift to a more efficient tax can improve economic welfare without a loss in tax collections. This much is well known. What is not well known is the magnitude of this benefit and of the cost to landowners in terms of lower land prices. Conventional wisdom predicts that a shift to an efficient land tax would increase income and output but reduce land prices. This kind of general statement isn’t much help to policy makers. If one is suggesting major changes in a tax system, policy makers need to know whether the benefits and the costs are going to be large or small. My recent Lincoln Institute working paper, “Prospects for Land Rent Taxes in State and Local Tax Reform,” constructs a model of state economies in the U.S. to help us think about the effects of such changes.

JY: How did you become interested in developing an economic model for land taxation?

TN: A few years ago, Dick Netzer, professor of economics and public administration at New York University, suggested that I look at the implications for the U.S. economy of replacing capital taxes with land value taxes. Most economists know of the Henry George Theorem and recognize that land taxation is efficient, but they associate his ideas with nineteenth-century economic thought. We assume that all the changes in the economy since then, and changes in the economic role of land, have left these ideas inapplicable to contemporary tax systems. So I was quite surprised that my model indicated that substituting a land value tax for capital taxes on a national level would not only be efficient, as expected, but would actually raise the value of many types of land. However, property taxes are state and local taxes, and the U.S. constitution places special impediments to a national property tax, so a land tax would not be possible on a national level. Further, since each state economy is different, the results of substituting land value taxes for other taxes will also vary from state to state.

JY: How can a tax on land increase land prices?

TN: In and of itself, a tax on land does not increase land prices; it actually reduces land prices, because it reduces the discounted present value of land rents. My research does not consider a land value tax in isolation, but as part of a revenue-neutral tax reform that replaces other, distortionary taxes with a land value tax. Lower taxes on capital will increase capital usage, and more intensive use of capital will raise land prices. For example, if constructing a building becomes more profitable because the tax on the building is lowered or eliminated, an investor may be willing to pay a higher price for its components, including the land.

JY: How did you go about estimating the magnitude of these effects?

TN: I developed a general equilibrium model of an economy that uses land, man-made capital and labor in production. A general equilibrium model is one that examines how changes in one kind of market affect all other markets. This model is then applied to different states, as well as to one hypothetical “average” state, to see how various tax reforms that substitute land value taxes for taxes on capital or labor would affect prices and production. The division of capital into land and man-made capital is a departure from standard analysis, which generally looks at capital as a single category.

One critical element is the elasticity of substitution among these factors; that is, the ease with which one can be substituted for another. Technically, it is the percentage change in one factor that results from a 1 percent change in the other. This is the key to efficiency gains from reducing the tax on man-made capital and on labor and increasing the tax on land. A lower tax on man-made capital will increase the use of that capital, which in turn will produce greater output and more hiring of labor. The easier it is to substitute man-made capital and labor for land, the greater the benefit from a switch to land value taxation.

JY: Where do the elasticity numbers come from?

TN: I use a range of estimates drawn from the economic literature. For example, most studies of the substitution between capital and land give elasticity estimates between 0.36 and 1.13. My paper uses the relatively conservative estimates of 0.75, 0.5 and 0.25 as high, medium and low values, and looks at the result under each assumption. This number is then adjusted to reflect the amount of land in the state devoted to farming, on the assumption that farmland is less easily substituted for capital in the production process. I also ask similar questions with regard to substitution between land and labor.

The elasticities of the actual supplies of man-made capital and labor are also crucial. If taxes on them are reduced, how much extra capital and labor will be available as a result of the increased after-tax return? Often in studies of this sort we make what is called a “small open economy assumption.” We assume that the economy we are looking at is small in relation to the rest of the world, and that capital and labor flow freely into and out of the jurisdiction. In that case, the elasticity of supply is infinite. The opposite extreme would be an economy with the equivalent of closed borders, where no capital could enter or leave. In that case the elasticity of supply would be zero. In looking at U.S. states, the small open economy assumption is not completely accurate, and zero elasticity is not accurate either. The right number is somewhere in between. Neither capital nor labor is as mobile internationally as within the U.S., and labor in particular is less mobile across state boundaries than within a state or a small region. The small open economy assumption may be appropriate in some circumstances for smaller states, but we have to introduce more complex assumptions in other cases.

JY: How does your model compute taxes on land and labor and man-made capital? This isn’t a standard classification of taxes.

TN: This is complicated, because it involves payroll taxes, federal and state corporate taxes, federal and state income taxes, property taxes, sales taxes, and so on. So the model looks at all these taxes and makes assumptions about who is paying them to estimate an overall tax rate on labor from all sources—federal, state and local. Similarly, the model estimates an overall tax rate on land and on man-made capital. This allows us to move from an illustrative example in which taxes on labor and capital are replaced by land value taxes to considering changes in real-world taxes, which of course are never based solely on labor or capital.

JY: How do you represent the shift in taxes from labor and man-made capital to land?

TN: This is a hypothetical policy experiment in the model. Suppose, for example, you wanted to eliminate all sales taxes in a revenue-neutral way, making up the lost collections through a land value tax. Sales taxes are the average state’s largest revenue source, so this shift would be quite ambitious. The model shows what would happen under various elasticities of substitution and elasticities of supply, as described above. The tables in the paper show what land tax would be necessary to maintain revenue, and the changes in capital investment and land prices that would result.

JY: How do you move from the hypothetical average state to the 50 individual states?

TN: You have to begin by asking what factors might cause states to have different experiences with land value taxation. We consider each state’s taxes, because the benefits of shifting to a more efficient system will vary according to how much current taxes distort economic choices. Some states have no income taxes. Some states tax property heavily, while others tax sales heavily. The other critical component concerns the state’s sources of income—how they are divided among land, labor and man-made capital. The Bureau of Economic Analysis reports income from various sources by state, but does not account separately for income from land. For that information we draw on the Census of Agriculture data on the amount and market value of farmland to estimate an income figure.

JY: What kinds of results did you obtain?

TN: Since taxation of land is always economically efficient, and since taxation of other factors is always economically inefficient, a shift to land taxes always increases capital, income and labor use. For the “typical” state it seems that most of the simulated tax reforms are feasible, particularly those that reduce taxes on capital. A 20 percent cut in the sales tax, for instance, requires a nearly 24 percent increase in the tax on land, while a similar cut in property taxes requires virtually no change (0.2 percent) in the tax on land. Even a complete elimination of the state and local property tax calls for only a 23 percent increase in the tax on land, while an elimination of the sales tax would require a whopping 131 percent increase. Landowners would be deeply and adversely impacted by reforms that cut the sales tax (losing up to two-thirds of their wealth under a complete elimination of the sales tax), while they would barely feel the impact of most reforms focused on the property tax. They would experience at most a 7 percent decline in their wealth under the complete elimination of the property tax, and an actual increase in their wealth for less dramatic property tax reforms.

But these results differ substantially by state. For instance, the percentage change in the tax on land required to maintain constant state and local government revenues as taxes on capital are eliminated ranges from -1.91 percent to over 104 percent. Similarly, the impact on land prices varies greatly, with prices barely declining (or even increasing) in some states while falling by as much as 85 percent in others. While the elimination of all state and local taxes on capital is therefore technically feasible in all states, it is clearly politically more feasible in some states than in others. Overall, of course, replacing distortionary taxes with nondistortionary taxes on land always brings growth in the employment of capital and labor and increases output—but the size of these impacts also varies greatly. Given that the main political hurdle to land taxation is the expected adverse impact on landowners, these results seem to indicate that, as in the case of the “typical” state, such reforms should emphasize the simultaneous reduction in taxes such as the corporate income tax or the property tax.

JY: What do you take as the central lessons of this work?

TN: Several broad lessons emerge from the analysis of a typical state. First, elasticity assumptions are crucial to the exercise of predicting the likely impact of tax reforms. Second, under elasticity assumptions that are both plausible and relatively conservative, this model predicts that some types of tax reforms are more likely to succeed than others. In particular, tax reforms that reduce taxation of capital in favor of land taxation will have more positive general welfare implications while minimizing the losses to landowners. So policy makers might consider reforming corporate income and property taxes rather than sales and personal income taxes. Third, since elasticities tend to be lower in the short run, it is likely that some of the positive gains of tax reforms that reduce distortionary taxes in favor of land taxes will emerge only with time.

The most striking lesson from simulating tax reforms for the 50 different states is how greatly results can vary depending on underlying economic conditions and current tax policies in those states. Thus, far from arriving at “the answer” regarding the impact of land tax reforms, this study suggests that such answers are likely to differ greatly depending on the context in which the reforms are undertaken. Reforms that raise the tax on land are likely to be more effective the larger the size of the reform, the higher the initial distortionary taxes in the state, and the lower the current level of state income. And, reforms are more likely to be politically feasible (in the sense of not causing great declines in land values) when they involve reductions in taxes on capital.

The idea that land value taxation is unrealistic or would drive land prices into negative numbers is based on a static view of the economy, where no one responds to tax changes by substituting one factor for another. Once you accept that behavior will change in response to taxes, that static view no longer applies. Under these fairly conservative assumptions, tax reforms that use land taxes to eliminate entire classes of distortionary taxes are economically feasible in virtually all states. This work shows that, far from being quaint or outmoded, the idea of taxing land value is quite relevant to the contemporary policy debate.

Working Paper Information: Thomas Nechyba. 2001. “Prospects for Land Rent Taxes in State and Local Tax Reform.” 70 pages. The complete paper is posted on the Lincoln Institute website at www.lincolninst.edu and may be downloaded for free.

The potential for sharp and unpredictable assessment increases is an important source of dissatisfaction with the property tax. Rapid price rises that are accurately and promptly reflected in assessed valuations can leave homeowners responsible for cash payments on paper gains that are unexpected, uncontrollable, and possibly short-lived. Two decades ago, this situation paved the way for adoption of California’s Proposition 13, which rejected fair market value as a basis for assessment.

Increasing valuations do not necessarily produce a corresponding rise in property tax bills, since a higher assessment base could raise equivalent revenue with a smaller tax rate. This solution is not feasible, however, when prices increase disproportionately only in particular neighborhoods or for particular types of property.

What other means are available to address price volatility and its impact on property tax rates? A number of states have recently introduced limitations on annual valuation increases. These measures avoid extreme assessment increases but may still allow assessments to match fair market values at some point in the future. They substitute a non-market value basis for assessment and diminish uniformity by distinguishing between those properties that are assessed on the basis of current values and those that are not.

Assessment Limitations in Washington and Texas

In the November 1997 elections, voters in Washington state approved a referendum generally limiting increases in assessed valuation to 15 percent a year on all classes of taxable property. If a property’s market value rises more than 60 percent, one year’s assessment may reflect no more than one-quarter of that increase. A similar measure strongly supported by business representatives was passed by the Republican legislature but vetoed by Gov. Gary Locke (D), who would have limited it to homeowners.

This case raises an important point concerning uniformity and distribution of the tax burden. Phase-in provisions ease the burden on owners of rapidly appreciating property but correspondingly increase the relative share of the tax borne by owners experiencing slower growth, or no growth, in property value. While tax limitations are generally promoted as protection for homeowners, residential benefits may pale in comparison to commercial gains.

Supporters of the Washington referendum urged passage “to soften a tax blow that could be devastating to a homeowner on a fixed income.” Yet major funding for the campaign came from industrial giants, including Microsoft, Intel, Hewlett Packard, Boeing and Weyerhaeuser. Opponents, including King County assessor Scott Noble, argued that the tax benefits “will go disproportionately to the large corporations that are bankrolling the campaign because of their much higher property values.” On the other hand, restricting such provisions to residential property introduces another level of non-uniformity to the tax.

Texas voters chose this split valuation alternative in November, approving a measure that limits increases in assessed values of residential homestead property, but not business property, to 10 percent a year. The president of the Texas Taxpayers and Research Association said this provision will “keep a terribly hot neighborhood from getting sort of a sticker shock.”

Critics saw the irony of this action. One wrote, “If the Texas Legislature had offered voters a chance to cap appraisal increases on their homes a few years ago, lawmakers would have been lauded as heroes. Angry homeowners were storming the offices of appraisal districts in the early and mid-1990s, demanding relief from double-digit increases in the appraised value of their homes and the prospect of significant property tax hikes. . . Nothing happened. Now that appraisal increases have fallen to three percent or so, the Legislature is offering voters a chance to cap the increases by changing the state Constitution. . . .” Ironically, before the price rises of the 1990s, Texas tax protests centered on whether assessments reflected falling property values quickly enough in the regional recession of the 1980s. For example, Harris County, which includes Houston, saw challenges to one-quarter of all its tax valuations in 1984 and 1985.

A Legislative Approach in Montana

Annual increases of 10 or 15 percent do not necessarily prevent assessed valuations from reaching full market levels. However, Montana lawmakers responded this year to dramatic value increases with an even more drastic measure. After studies reported that residential and commercial property values had increased by an average of 43 percent statewide since the last reassessment, the legislature required this change to be phased in at a rate of only two percent annually-taking 50 years to enter the tax rolls completely. Court challenges to this provision could raise an interesting question as to how long a phase-in period is compatible with state constitutional provisions requiring uniformity in assessment.

Assessment Reform in Ontario

Large valuation increases may be due to assessment lags as well as to price rises. One of the most startling examples of outdated tax valuation is found in Toronto-a surprise to U.S. observers who normally expect a high level of administrative efficiency from their northern neighbor. At the September conference of the International Association of Assessing Officers (IAAO) in Toronto, a panel of speakers brought together by the Lincoln Institute explored this situation. The potential for huge valuation increases stems not so much from extraordinary market activity as from extraordinary assessment inactivity. Metropolitan Toronto has not had a full-scale reassessment since1954-and that was based on 1940 market values.

Attorney Jack Walker described the public as generally supportive of current tax reform efforts, which encompass the entire province of Ontario. By contrast, a 1992 reassessment proposal for Metropolitan Toronto alone sparked such protest from residential and small business taxpayers that the proposal was abandoned. As a result, the 1997 measure explicitly addresses the concerns of many taxpayers groups. Professor David Amborski of Ryerson Polytechnic University explained that it would ensure current value assessments and regular updates. In addition, it will eliminate the business occupancy tax, permit different tax rates for different classes of property, provide special treatment for senior citizens and disabled taxpayers, and reduce taxes on agricultural and open space lands.

Thus, Toronto has also chosen to soften the impact of large assessment increases at the expense of uniformity. In this case, where municipal valuations were so out of date, the net effect may be judged an improvement in assessment equity. It will be important to evaluate the experiences of other jurisdictions struggling with the challenge of balancing uniformity and acceptability to see if they can make the same claim.

Joan Youngman is senior fellow and director of the Institute’s Program in the Taxation of Land and Buildings. An attorney specializing in property tax issues, she also writes a column for State Tax Notes, published by Tax Analysts.

Notes

Joseph Turner, “Ref. 47 Debate: Do Tax Savings Justify Change?” Takoma News-Tribune, October 23, 1997, p. A1 (quoting Rep. Brian Thomas (R-Renton))

2 Tom Brown, “Big Guns Back Property-Tax Lid,” Seattle Times, October 24, 1997, p. B3.

3Clay Robison, “Measure Would Cap Hike in Residential Appraisals,” The Houston Chronicle, November 2, 1997, p.2.

4Michele Kay, “Tax Appraisal Cap on Ballot,” Austin American-Statesman, October 20, 1997, p. A1.

Supporters of land taxation view it as an efficient and effective means of financing government, and the concept has wide appeal among public finance scholars. Many economists, including several Nobel Prize winners, actively endorse this method of taxation, which taxes land value separately and instead of buildings and improvements. At least from an academic perspective, then, the case for the efficiency and fairness of a land-based tax system seems irrefutable.

Despite that support, the concept of land taxation has not been widely embraced in the United States. Property tax bases are set by state constitutional or statutory law, so local governments cannot implement a land tax, or its split-rate variant, without authorization from their respective state legislatures. Other than a handful of Pennsylvania cities that have adopted split-rate or two-rate tax systems, no American jurisdictions currently place higher tax burdens on land than on buildings and other improvements. Virginia recently responded to interest in two-rate taxation with legislation allowing two local governments to adopt graded tax programs, but they have not yet done so. While split-rate taxation is discussed periodically as a reform measure, there are no current proposals for its adoption awaiting action before a state legislature (Brunori and Carr 2002).

Statutory or constitutional enactment of a land tax would entail revising property tax laws that have been substantially unchanged for more than a century. In general, state legislators are cautious about implementing dramatic reforms in any public policy area, and comprehensive tax reform has been a particularly elusive goal. Adoption of split-rate or land taxation would be a dramatic change, requiring significant awareness, advocacy and support in the ranks of the legislature and at the local level.

There are few areas of government finance in which scholarly opinion and actual public policy diverge so dramatically. This situation prompted me to undertake two nationwide research surveys. The first survey sought to ascertain the level of knowledge of land taxation on the part of the nation’s state legislators. Without an understanding of the issues presented by the taxation of land, legislators are unlikely to champion, advocate or even vote for such measures. I also surveyed local elected officials, because state legislators will not advocate any reforms without constituent support. Moreover, since the reforms at issue will affect primarily local government finances, any legislative body seeking to reform a tax system will solicit the views and advice of local officials.

The Survey Questions

To gauge general awareness of the concept of land value taxation, the survey began with a broad question, describing it as “taxing the full value of land but exempting buildings, structures and other improvements from tax.” The next question narrowed the scope to determine familiarity with split-rate taxation, the version of land taxation practiced in Pennsylvania and authorized in two Virginia municipalities. Because it entails less dramatic reforms, split-rate taxation is the version of land taxation most likely to be adopted in the U.S. This concept was described as “taxing land at a higher rate than buildings, structures and other improvements.”

Legislative research has long found that state lawmakers are likely to support policies that they believe will foster economic development and oppose policies perceived to deter development (Beamer 1999). Taxing land at a higher rate than improvements has historically been thought to encourage building and investment by eliminating or reducing the tax burdens of improving the land. Thus, the third question asked for the respondents’ opinion on the effect that taxing improvements at a lower rate than land would have on economic development, defined as capital investment and job creation.

The proliferation of suburban sprawl is a growing concern among legislators and local officials across the country. The vast academic literature suggests that policy makers view sprawl unfavorably and that most officials think that policies that promote sprawl are unsound. Some public finance scholars believe that adopting split-rate tax policies will limit the negative effects of sprawl (Brueckner 2001). If this belief is true, split-rate taxation could play an important role in the continuing debate over policies intended to deter suburban sprawl. Question four asked what effect taxing improvements at a lower rate than land would have on sprawl. Sprawl was not defined in the question because the term can refer to a number of developments affecting density, suburban growth, loss of open space and decrease in population. Indeed, scholars have lamented the lack of a single operational definition of sprawl. Still, the perception of sprawl as an undesirable land use pattern and policy outcome warranted inclusion of the question in the survey.

Finally, state and local legislators are influenced by the desires and concerns of their constituents. The more important a particular issue is to constituents, the better informed a legislator will become about that issue. Thus, survey participants were asked if during the past year any citizens or organizations had contacted their offices with respect to the issue of split-rate taxation, and if so, whether the constituent supported or opposed the idea.

State and Local Respondents

The first survey focused on state legislators who served on committees with primary responsibility for tax policy and local government finance during the period January–June 2003. There were 106 such committees in the 50 state legislatures, but I excluded those in Pennsylvania and Virginia. Since those states have either adopted or authorized graded tax systems, I assumed that their legislators would be more familiar with the concept and could bias the results.

For the second survey I chose city and county officials from 15 randomly selected local jurisdictions within the 25 largest metropolitan areas in the U.S. To insure a national perspective, I also included city council members from the largest city in each state. Again I focused on officials with primary responsibility for implementing and administering public finance policy and excluded all jurisdictions in Pennsylvania and Virginia.

The survey questions were sent to 1,284 legislators, of whom 780 responded (see Brunori 2003 for more information on methodology). An identical survey was sent to 3,298 city and county officials, of whom 430 responded. The response rate for the state legislators was far above national standards, and the response rate for the local officials was considerably below national standards, but both were statistically significant.

Before revealing the results of the survey research, I must confess that I entered this project with a bias. Having worked in the state and local tax field my entire professional life, as a lawyer, teacher and journalist, I think about tax policy more than any sane person should and have come to know many state legislators and local public officials. In my experience, these government officials are quite capable of finding revenues to pay the bills, but they generally have little in-depth knowledge of the more philosophical and theoretical underpinnings of tax policy. So I assumed that few of them would understand what I was talking about when I began asking questions about land taxation. After all, I did not think most politicians were using their spare time to read Henry George’s classic book, Progress and Poverty. I was quite surprised at the responses.

The Results

In a country where there are virtually no land tax policies in place, the survey results show that a vast majority of elected political leaders do know about land and split-rate taxation (see Table 1). More surprising, to me at least, most political leaders are aware of the benefits of adopting land tax policies. More than 70 percent of the state legislators and 65 percent of the local government officials responded that they were either very or somewhat familiar with the concept of land value taxation, and 67 percent of state legislators and 65 percent of local officials were very or somewhat familiar with split-rate taxation.

The single most important policy goal (after public safety) that concerns American politicians is economic development. When asked about the relationship between the economy and land taxation, more than 62 percent of state legislators and 76 percent of local government officials replied that adopting a split-rate tax system would promote economic development. About one-quarter of both state and local officials thought that taxing improvements at a lower rate than land would have no effect on economic development. These results are arguably consistent with the conventional view that land taxation would have a benign effect on economic decision making. Only 5 percent of the state legislators and no local officials believed that taxing land at a higher rate would deter economic development.

One of the common misperceptions about land taxation is that it will lead to more sprawl, and many, but not a majority, of the respondents shared that misperception. Forty-one percent of surveyed state legislators and 46 percent of local officials said they believed that adopting a split-rate tax system would lead to more suburban sprawl. About 51 percent of the state legislators and 53 percent of local officials surveyed said that split-rate taxation would have no effect on sprawl or would deter sprawl. The fact that so many respondents believe that split-rate taxation would foster more sprawl, presumably by encouraging development of open space in suburban and rural areas, should be troubling to advocates of land taxation.

Finally, a surprisingly small number of elected political leaders have been contacted by constituents regarding land taxation. Eleven percent of state legislators and 9 percent of local government officials said an individual constituent or organization had contacted them regarding the issue of land-based or split-rate taxation, and all were supporters of the idea.

What Does It All Mean?

What originally sparked my interest in this research project was the disconnect between scholarly opinion about land taxation and political action to promote it. I thought this discrepancy might be the result of ignorance of the concepts of land taxation on the part of state and local political leaders. If state legislators and city council members were unaware of land or graded taxation, then they could not be expected to champion such reforms.

The survey results show, however, that this discrepancy cannot be resolved by looking at level of awareness alone. Most state legislators and local officials involved in public finance and taxation issues are familiar with both land taxation and split-rate taxation, and they know that moving to a split-rate tax system would have a positive effect on economic development. Moreover, a slight majority of those surveyed believe that graded taxes would have no negative effects on sprawl.

Since state and local officials know about land taxation and believe it could lead to positive policy outcomes, why are so few local governments using this method of public finance? It is difficult to answer that question without eliciting views on more technical aspects of land or split-rate taxation. Implementation of land taxation raises complex issues as to the feasibility of adopting major property tax reforms, the effects on other revenue sources, and the administration of a land tax system, particularly with respect to valuation. Solving the mystery as to why more jurisdictions are not exploring the policy of taxing land at a higher rate than improvements may lie in analyzing these important operational factors.

References

Beamer, Glenn. 1999. Creative politics: Taxes and public goods in a federal system. Ann Arbor: University of Michigan Press.

Brueckner, Jan K. 2001. Property taxation and urban sprawl. In Property taxation and local government finance, Wallace E. Oates, editor. Cambridge, MA: Lincoln Institute of Land Policy.

Brunori, David. 2003. Awareness of land taxation: Survey of state legislators. Working paper. Cambridge, MA: Lincoln Institute of Land Policy.

Brunori, David, and Jennifer Carr. 2002. Valuing land and improvements: State law and local government practices. State Tax Notes (September 30):1023–1033.

David Brunori is contributing editor of State Tax Notes for Tax Analysts in Arlington, Virginia, and research professor of public policy at The George Washington University in Washington, DC. This article is based on research he conducted as part of a David C. Lincoln Fellowship in Land Value Taxation, awarded by the Lincoln Institute.

Past trends will not foretell the future, but charting how state and local finances weathered the 2001 recession suggests viable ways to navigate going forward. Lacking the deficit finance ability of the federal government, states and localities must set a spending course based on anticipated taxes and revenues. An unexpected crisis-like the stock bubble burst at the beginning of this century and the subsequent economic slowdown-that throws budgets into fiscal chaos requires such unpopular bailouts as tax increases or cuts in services and welfare. Did that happen?

Participants at a Lincoln Institute-sponsored conference in March 2007 gathered at the Urban Institute in Washington DC, to discuss the recession and share findings on how states and localities determined various actions and policies to address its impacts. This conference, titled “State and Local Finances after the Storm: Is Smooth Sailing Ahead?”, was also hosted by the Urban Institute-Brookings Institution Tax Policy Center, and by the Kellogg School of Management and the Institute for Policy Research, both at Northwestern University.

Cities face major difficulties when attempting to introduce a more efficient property tax system. One such challenge is controlling volatile political issues associated with taxes levied directly on assets, such as the highly visible property tax. The close proximity between the taxing authority and the taxpayer translates into political pressure to reduce taxes and avoid updating property valuations. City officials become an easy target of criticism and may suffer electoral consequences.

Although the property tax is recognized internationally as a preferred instrument to finance urban public services, in most Latin American countries the tax has limited significance as a source of revenue, representing on average 0.32 percent of GDP (De Cesare 2010). Brazilian cities collect an average of about US$46.50 per capita in property taxes per year. However, most cities do not reach the national average. In more than half of the municipalities, revenues do not exceed US$5.00 per capita (Afonso et al. 2010).

The Brazilian Property Tax Model

The property tax (IPTU: Imposto sobre a Propriedade Predial e Territorial Urbana) is a direct tax paid to the local municipality based on the estimated fair market value of real estate property. In Brazil, much of the potential for collecting this tax is lost because local authorities fail to administer the tax correctly and effectively. Discussions of legislative revisions of the IPTU always result in heated debates and intense political response, in many cases causing mayors and other officials to avoid embarking on the process.

An added problem is the strict legal requirement that valuation criteria must be approved by law before the tax base can be updated. The criteria must include the characteristics of the property and its components, as well as the monetary value attached to each component. In other words, it is not enough for Brazilian legislators to set criteria to determine that one property is more valuable than another and therefore must pay a higher tax. The law itself must clarify how a property with certain characteristics will be appraised in monetary terms.

After years of debate, Brazil’s Superior Court ruled in 1996 that a municipal law would be required to update the IPTU tax base whenever the adjustment is higher than the official consumer price index (Statement 160). Before this ruling, cities used to reappraise the property values for tax purposes by executive acts (decrees), independently of the municipal legislature. Since this legal requirement was introduced in 1996, many local governments chose not to send the necessary bills to the municipal legislature for the much-needed updates of property valuation.

In some cases the resulting political disasters served as an alarming inhibitor to any new attempt to revise the tax base. To resolve this dilemma, several cities opted instead to raise the IPTU tax rates to compensate for their reluctance to reappraise properties. Moreover, for each new law approving an assessment update, new types of exemptions or tax reductions tend to be created, often cancelling the efforts to enhance the performance of the IPTU.

As a result of political resistance, the IPTU was often disregarded as a revenue source for municipal finance in Brazil. The largest cities, with more than 500,000 inhabitants, began to concentrate their efforts on the tax on services (ISS: Imposto Sobre Serviços); smaller cities relied more on funds transferred from state and federal government through the municipal revenue-sharing fund (FPM: Fundo de Participação dos Municípios) (table 1).

The federal Applied Economic Research Institute (IPEA 2009) reports the loss of IPTU’s importance as a share of direct municipal revenues at the national level and the rise in revenues from the service tax—an indirect tax that tends to be regressive. The share of the IPTU in direct municipal revenues decreased from 38 percent to 28 percent between 1991 and 2007, causing it to lose its position to the ISS as the principal source of direct municipal revenue (table 2).

An important change that directly affected the IPTU came in December 2009, when the Ministry of Cities published Resolution Act No. 511 establishing National Directives for the Multipurpose Cadastre (CTM: Cadastro Técnico Multifinalitário). This law provided local governments with a valuable standard instrument on which to base their legislative proposals to update the IPTU tax base. The Lincoln Institute of Land Policy had a major role in supporting the development of the technical aspects of this legislation.

The Resolution Act states that property assessment for fiscal purposes is a technical process that must be carried out according to guidelines from the Brazilian Technical Standards Association (ABNT) to reflect fair market value. It also states that an effective IPTU promotes fiscal and social justice by ensuring equitable treatment of taxpayers. Periodic updating of the IPTU tax base is recommended either (1) every four years for cities of 20,000 inhabitants or more (smaller cities may adopt longer cycles); (2) when the assessment ratio is less than 70 percent or greater than 100 percent compared to the market value; or (3) when cumulative property values are not distributed equally, as measured by a dispersion coefficient greater than 30 percent.

What Prompted the Property Tax Reform?

Combined with a strengthened institutional framework, two other factors have put the IPTU back into the current debate about sources of municipal financing in Brazil. The first was the accelerated appreciation of urban land in both large and mid-sized cities. This appreciation was caused principally by economic growth, the housing credit explosion, low taxation, and low risk compared to investment in financial assets from 2003 to 2007 (Carvalho Júnior 2010). The expansion of the real estate sector exposed the discrepancy between the collection potential and the actual flow of funds into the public treasury from the property tax.

A second factor that unleashed the discussion about updating tax assessments to enhance the performance of the IPTU was the global economic crisis that began in 2008 and reached Brazil in 2009. As economic activity declined, reflecting lower consumption and production and a credit contraction, federal transfers to municipalities declined as well. The cities facing this loss of revenue had little alternative but to revive the IPTU, the oldest and most traditional local tax.

In this context, some of the larger Brazilian cities updated their property value maps with revised land value estimates, as well as the construction cost tables used to assess property values, both of which were extremely undervalued. Belo Horizonte, São Paulo, and Salvador are among the cities that acted to strengthen their revenues by updating the tax base for the IPTU. These cities also introduced new policies to guide the implementation of the property tax.

It should be noted that to keep the IPTU tax base unchanged is a risk. One of the major sources of tax injustice, along with the problem of omissions in registering land or development areas, is the use of outdated appraisals when imposing the IPTU (Smolka and De Cesare 2009).

The Case of Belo Horizonte

Belo Horizonte is the capital and largest city of the state of Minas Gerais, located in the southeastern region of Brazil. With a population of 2.4 million, it is the fifth largest Brazilian city and the center of a metropolitan region with a population of approximately 5 million.

The local government has a long history of innovation and good governance. It was a pioneer in introducing the participatory budgeting process in 1993, in adopting GIS applications to improve city management, and in carrying out a widely successful campaign to eradicate hunger, among other noteworthy initiatives. Belo Horizonte collected approximately $332 in property tax per capita per year in 2007, prior to the reform, ranking seventh among Brazil’s large capital cities (Afonso et al. 2010).

The property tax reform started in Belo Horizonte with a revision of the tax base and was guided by the dual desire to eliminate distortions created by its antiquated model and to introduce a new fiscal culture that would support a permanent process of updating property valuation to reflect market variations.

The need for additional revenues and the experience of the 2009 financial crisis also influenced the mayor’s decision. The subsequent reductions in economic activity and federal transfers convinced the local government that it had to establish more sustainable financial conditions to maintain administrative autonomy. Intensifying the use of the IPTU and convincing the lawmakers of this necessity was the first step on the road to update the property tax base.

In devising a strategy for tax reform, the city government realized the change could not be presented simply as a revision of property valuation driven by the need to increase revenues. It also had to involve other aspects, such as measures to mitigate the impact of the tax increase and to provide incentives for taxpayer compliance. Smolka and De Cesare (2009) note that despite the accuracy of valuation estimates, if the reassessment generates large differences in the amount of taxes due, there will be a reaction from taxpayers who are substantially burdened. In this case, plans must be offered that ease such impacts.

The Legislative Process

Once the reform was designed and its virtues and vulnerabilities were identified, the project was submitted first to the municipal legislative council to keep the focus on those empowered to vote and approve the bill. It is a common mistake to seek popular support before or during the voting process, and the executive often loses the battle if it tries to act on two fronts at the same time.

Voting processes in the case of the IPTU are established by municipal law. However, intimate knowledge of the legislative process is necessary, and it is a trump card at the same time. In Belo Horizonte it was important to avoid having either a long, drawn-out process that could leave room for extended questioning or too short a process because an unexpected event could put voting off indefinitely.

Once presented to the lawmakers, all points of the tax reform project were thoroughly clarified. All aspects, positive or negative, were discussed at the council and, of course, favorable aspects were always compared to any noted weaknesses. Legislators must be sheltered from the doubts that are always posed to them and constantly be well-informed and committed to the tax justice criteria embedded in the project. This is the main role of the mayor’s representative, a key member of the core group that implemented the reform. As expected, at the end of November of 2009, the project was approved in its second and final round.

The legislative debate on the bill was both an end in itself and a preparation for the public presentation of the project. During the legislative approval process many expectations were created about the reform, especially by the press. From that point on, the strategy was to promote all of the benefits of the new IPTU system of assessment and collection to quell fears until the actual arrival of the tax bill in January 2010.

The Public Information Campaign

The main instruments used to present the reform to the public were launching a public information campaign and setting up information desks throughout the city to resolve citizen’s queries. The next phase implemented the measures intended to mitigate the impact of the reform and to provide incentives for taxpayer compliance.

In the campaign, the administration emphasized the message that all the revenues from the IPTU are used for works that transform people’s lives. The goal was to make the benefits of IPTU revenues concrete and visible, and that proved to be an efficient way of showing citizens the practical importance of the tax for the development of the city and for the well-being of its citizens. This message was repeated frequently.

In January of 2010, ten taxpayer assistance desks were operating in different parts of the city. Around 200 municipal staff participated directly in assisting taxpayers in more than 20,000 personal consultations. Of these, 26 percent became requests for review of the tax bill. This number was higher than in 2009, but much lower than the pessimistic expectations of those who foresaw a flood of claims (figure 1).

The overall strategy was to determine how well the situation was controlled, which involved implementing a tax structure compatible with the level of claims expected. Building this structure requires extraordinary foresight and attention to soothing the taxpayer and concentrating his attention on what really matters—the correct calculation of the tax and its payment within the timeframe established by law.

However, a good tax structure is not enough. Also important is training staff to provide taxpayer services. Trustworthy, relaxed, quick attention precludes spoiling the quality of the process, the revision of the tax base, and the new tax policies; good taxpayer services also lower the political risks of periodically updating property valuations.

Managing the Process

Among the useful lessons from the Belo Horizonte tax reform process is to avoid updating the tax base only in times of financial crises as an effort to boost revenues. Doing so may undermine the work of instituting accurate valuation practices. Instead, it is advisable to adopt and maintain a permanent updating policy that ensures fairness.

Second, the fairness of the revaluation process should be emphasized in light of the ever-changing market, which imposes price variations that require tax adjustments. Consumption taxes are indiscriminate as to the taxpayer’s economic condition and have a regressive effect, whereas IPTU permits progressive rates and thus helps to improve equity, which in turn improves access to housing, contributes to municipal autonomy, and leads to efficient city planning. Instead of relying primarily on indirect taxes or federal transfers, the municipality that uses the property tax efficiently can reduce social inequalities and better order urban spaces, while also avoiding speculation and helping to preserve the environment (IPEA 2009).

A third important point is to establish clear channels for discussing the reform plan. Preferably, policy steps should be taken by a trusted representative of the mayor who is authorized to negotiate on his behalf through a democratic and collective process. Belo Horizonte established a core group with one person named to coordinate what information will be disclosed and how it will be discussed with the public.

A misunderstanding of the process can create insurmountable resistance and place the complete project in jeopardy. Thus, a key factor is having a well-informed press agent who is capable of dealing with the criticism and inquiries that will surely come, as well as a technical person who knows the reform project well and can offer the explanations required by the different actors involved in the process.

Property Tax Relief Measures

Belo Horizonte succeeded in achieving its goal through arguments for justice and administrative autonomy that culminated in the approval of a complete revision of the property tax system, including the following relief measures.

• Tax rate reductions. These were introduced after updating the tax base to avoid a tax burden beyond the capacity of the taxpayer to pay.
• Adjustment of the progressive tax. The city also introduced graduated tax rate brackets consistent with property values, effectively replacing what had been, in practice, a single tax rate.
• Expansion of the exemption value threshold. This would correct for the fact that, in a dynamic real estate market, many older properties or those belonging to lower-income owners would be priced out of the IPTU exemption band once the revaluation is completed. To avoid this situation, the threshold was raised for property values exempt from the tax.
• Spreading the impact of the reform over two fiscal years. Even for taxpayers who have the capacity to pay, an increase in the IPTU could cause an imbalance in their personal budgets because of other financial commitments. Thus, the city allowed payment of half of the increase in 2010 and the full amount in 2011.
• Deferred payment. Special circumstances, such as unemployment, illness, or prior debt, can affect one’s ability to pay the property tax. The reform established that a taxpayer who demonstrates conditions of duress could request the postponement of a portion of his tax until 2013.
• Creation of discount programs. One of the objectives of the tax reform in Belo Horizonte was to make the IPTU a tax that promotes redistribution of income and contributes to a higher quality of urban life. Thus, the city offers tax discounts in exchange for citizen’s participation in social, health, education, and economic development programs that foster development.
• Discounts for early payment. The annual IPTU in Belo Horizonte can be paid in eleven equal installments, due on the 15th of each month between February and December. Taxpayers who make a minimum of two installments by January 20 receive a 7 percent discount for paying in advance, and historically a large number of taxpayers chose this option. These advance payments guarantee sufficient revenues to meet financial commitments in the beginning of the fiscal year, which runs from January to December.

Evaluating the Results

The final part of the reform is to verify the results. In Belo Horizonte, this evaluation confirmed the success of the entire planning and implementation process, and is a source of information for future improvements. This success can be measured in part by the increase in early payments, which illustrates taxpayer acceptance of the model. Table 3 compares increases in numerous measures from 2009 to 2010, and table 4 compares increases in IPTU revenues for the first six months of both years.

Nevertheless, all of these achievements can be lost over the long term if certain conditions are not met. One such condition is to institutionalize the periodic updating of property values used to calculate the property tax. This is critical since the strategic planning for this reform was motivated precisely by the long period during which the Belo Horizonte land values map had remained unchanged, creating discrepancies from actual market prices and eroding city revenues.

A second condition is to create mechanisms that both guarantee the technical quality of tax assessments and relieve the local government of the political burden of performing the necessary updates. The objective is to make the updating procedure a legal obligation of a technical nature instead of a political decision.

Another option considered was the creation of an assessment committee to perform mass valuations coordinated by municipal authorities. Such a committee would bring together collaborators from entities that operate in the real estate market, such as brokers, builders, private assessors, or financing entities. This measure could help to mollify the political overtones that permeate the property tax system and develop property reassessment programs that rely on participants instead of critics.

Belo Horizonte’s successful experience (albeit with room for improvement) can serve as a reference for other cities that expect to update their property cadastre and their guidelines for mass assessment. Table 5 outlines some of the issues to be considered.

References

Afonso, José, et al. 2010. The urban property tax (IPTU) in Brazil. Unpublished research report. Cambridge, MA: Lincoln Institute of Land Policy.

Carvalho Júnior, Pedro Humberto Bruno de. 2010. Defasagens na cobrança de IPTU. Desafios do Desenvolvimento 61 (January/February): 32.

De Cesare, Claudia M. 2010. Overview of the property tax in Latin America. Working Paper. Cambridge, MA: Lincoln Institute of Land Policy.

IPEA (Instituto de Pesquisa Econômica Aplicada). 2009. https://www.ipea.gov.br/portal/images/stories/PDFs/comunicado/090827_comunicadoipea28.pdf (27August).

Smolka, Martim, and Claudia De Cesare. 2009. Necessária, revisão requer transparência. Folha de São Paulo, October 14.

About the Author

Omar Pinto Domingos has a law degree from the Federal University of Minas Gerais (UFMG) and has a postgraduate degree in administration of municipal taxation from the Center for Specialization in Law, in association with the Gama Filho University. He is a fiscal auditor and property tax manager in the Municipality of Belo Horizonte, and has participated on many tax reform commissions. He is also a frequent lecturer on fiscal and taxation themes in programs sponsored by the Lincoln Institute’s Program on Latin America and the Caribbean. This article is based on his presentation to a seminar in Curitiba cosponsored with Brazil’s Ministry of Cities in May 2010.

Mark Skidmore is professor of economics at Michigan State University, where he holds the Morris Chair in State and Local Government Finance and Policy, with joint appointments in the department of agricultural, food and resource economics and the department of economics. He received his doctorate in economics from the University of Colorado in 1994, and his bachelor’s degree in economics from the University of Washington in 1987. He serves as coeditor of the Journal of Urban Affairs.

Professor Skidmore’s research has focused on public economics and urban/regional economics. Current research interests include state and local government tax policy, intergovernmental relations, the interrelationship between public sector decisions and economic activity, and the economics of natural disasters. His work has been funded by the Fulbright Program, the Lincoln Institute of Land Policy, the National Science Foundation, the Urban Institute, and USAID.

His articles have appeared in journals such as Economic Inquiry, Economics Letters, Journal of Urban Economics, Kyklos, Land Economics, National Tax Journal, Public Choice, Regional Science and Urban Economics, and the Southern Economic Journal. His research also has been cited in prominent news outlets such as the BBC, China Post, The Economist, Europe Intelligence Wire, Forbes, International Herald Tribune, Los Angeles Business Journal, MSNBC, Newsweek, The New Yorker, The New York Times, and PBS News Hour.

Land Lines: This year, you are a Visiting Fellow at the Lincoln Institute. What issues are you working on?

Mark Skidmore: About two years ago, my colleague Gary Sands and I were invited by City of Detroit Councilman Kenneth Cockrel to evaluate Detroit’s ailing property tax environment. Councilman Cockrel wondered what gains might result if Detroit were to shift to a land-based tax. We were given access to detailed data for more than 400,000 property parcels within the city, in order to conduct an evaluation, and we are grateful for the Institute’s support to pursue that project. Our report identified significant erosion of the property tax base and explored options for expanding the base, including a shift to a land-based tax. Our evaluation showed that a land-based tax would serve to broaden the tax base but also would produce substantial shifts in the tax burdens of residential, commercial, and industrial property owners.

In 2013, Detroit’s fiscal challenges came to a head when Governor Rick Snyder appointed an emergency financial manager who subsequently set in motion a filing for bankruptcy. On December 3, 2013, Judge Rhodes ruled that the City of Detroit is eligible for Chapter 9 bankruptcy protection. Despite the near-complete collapse of the real estate market within the city during the Great Recession, the property tax remains an important revenue source, and its administration can help or hinder economic and fiscal recovery. This year, I plan to use the parcel-level data set to examine important issues such as tax delinquency, the over-assessment of property, the value of vacant land, and policies related to transfer of property ownership from the private sector to the public sector due to tax foreclosure, and transfers back to the private sector.

Land Lines: What are some of the underlying factors behind Detroit’s current problems?

Mark Skidmore: About 48 percent of Detroit property owners are delinquent on their tax bills, a fact that reflects the erosion of the social contract between citizens and the city. This extraordinarily high delinquency rate is the result of a confluence of factors. First, the city has failed to enforce tax compliance, particularly for low-valued properties. Second, many citizens perceive the tax to be unfair because of the over-assessment of their property. Finally, anecdotal evidence suggests citizens are not paying taxes because local authorities are failing to provide basic public services such as street lighting, snow plowing, and public safety.

One key cause of the high delinquency rate is the over-assessment of property for tax purposes. The real estate crisis hit Detroit particularly hard. In 2010, the average selling price of a residential parcel with a structure was less than $10,000, yet the average assessed value of such properties for tax purposes was $54,000. According to state guidelines, the ratio of assessed value to sales price should be close to one. In September 2013, city officials announced that over the next three to five years all properties within the city would be reassessed.

Second, Detroit has a history of tearing down dilapidated tax-foreclosed structures. As a result, it is one of the few large cities in the United States with frequent sales of vacant land. The value of vacant land is often difficult to ascertain in highly urbanized areas, but accurate valuations are essential if one wants to impose a land tax or a two-tier tax on land and structures. The large number of sales transactions of vacant land in Detroit provides an opportunity to estimate land value. Interestingly, the average value of an unimproved parcel in 2010 based on sales data was $34,000—much higher than the average price of residential parcels with structures, which, as mentioned, was less than $10,000.

The city government now owns and manages more than 25 percent of the city’s land area, and public ownership continues to grow because tax foreclosures have outpaced the transfer of publicly owned parcels back into private hands. Some of the questions I am investigating are: What are the appropriate policies in a market-oriented society for managing low-valued urban land transactions? Why is the delinquency rate so high, and what can be done to improve property tax compliance in the context of a nearly collapsed urban real estate market? What role does the perception of “unfair” assessments play in tax delinquency?

Land Lines: What is the long-term prognosis for Detroit?

Mark Skidmore: The city’s fiscal challenges are a symptom of deep underlying issues. Whether one considers the redevelopment of a declining urban area or reconstruction in the wake of a major natural disaster, the most important elements in any recovery are human capital and social/cultural attributes. If one accepts the premise that they are essential building blocks for redevelopment, and if these elements are lacking, then a top priority is to consider policies and actions that can develop them. In 2011, the high school graduation rate in Detroit was 62 percent. The percentage of households headed by a single parent was 62 percent. By some measures, the functional literacy rate among adults is just 53 percent. It is difficult to build a dynamic and robust urban economy upon such a weak foundation.

Clearly, policy makers must address the immediate fiscal challenges, but the longer-term prognosis for Detroit will depend on actions aimed at improving the underlying economic base—human and social capital. Without addressing these deep challenges, Detroit will continue to flounder. There is no quick fix. In order for Detroit to have a chance to prosper once again, Michigan needs to make a long-term commitment to improving these underlying conditions.

Land Lines: Is Detroit a harbinger for other U.S. cities?

Mark Skidmore: Yes and no. A number of other local governments face significant fiscal challenges—Chicago, Jacksonville, Los Angeles, Oakland, and Providence, to name a few. Underfunded retiree compensation promises are often cited as a major issue. Yet, many of these cities stand a reasonable chance of re-emerging and potentially prospering in the not-too-distant future because they suffer from acute crises brought on by the recession, but not necessarily from chronic fiscal challenges. However, cities with chronic challenges due to significant deficits in social and human capital can look to Detroit as an indicator of their future. My hope is that state and local policy makers from around the country can learn from the Detroit experience and begin making the necessary long-term investments in their most important asset—people, particularly children— so they can avoid the chronic economic and fiscal challenges seen in Detroit.

Land Lines: How does the Detroit project fit into your larger research agenda?

Mark Skidmore: Much of my research has addressed the interrelationship between public decision making and economic activity. Over the years, I have examined issues such as the effectiveness of tax increment finance, the implications of imposing impact fees to cover the infrastructure costs associated with development, and the effects on development of property taxation, tax abatements, and other subsidies. I have also considered other public finance issues such as state lotteries, sales taxes, and income taxation. I am particularly interested in the spatial-dynamic-competitive relationships between adjacent and overlying taxing jurisdictions.

Land Lines: Much of your research has focused on government policy and finance in the United States. What other work have you done internationally?

Mark Skidmore: In recent years, I have partnered with my MSU colleagues on a USAID-funded grant in Mali. My role has been to consider how Mali’s recently decentralized governmental system can be utilized more effectively in food security and land use management. Climate change is affecting Mali in very tangible ways—as the land in the north has become more arid, there has been significant migration to areas in the south, which has better access to water. This migration is resulting in increased violence due to ineffective land tenure and property rights. Now that democratic rule has been re-established, we are again working with our Malian partners to develop systems that involve local authorities in managing food security, land access, property rights, and land-related conflicts. Interestingly, the issue of what to do with all the publicly owned land in Detroit has informed our work in Mali, and vice versa.

I also have ongoing research in the economics of natural disasters. One of my recently published articles (with coauthor Hideki Toya) used thousands of disaster events from all over the world to show that countries with more decentralized governmental systems have significantly fewer disaster-induced fatalities. Our research provides evidence that decentralized governments provide essential services more effectively than more centralized systems.

A third recently completed project shows that societal trust tends to increase in countries in the years following climatic disasters. The relationship we observe is robust, and we hypothesize that such disasters require and provide opportunities for people to work across social classes to address their challenges, thus building trust and social capital. While natural disasters can have devastating human and economic impacts, a potential spillover benefit of greater disaster exposure may be a more tightly knit society.

Land Lines: How does your research reflect the interests and values of the Lincoln Institute?

Mark Skidmore: The Lincoln Institute is recognized worldwide as a leading organization concerning the use, regulation, and taxation of land—property taxation, tax abatements, economic development policies, decentralized fiscal systems—and all of these are topics of my research. Over the years, the Institute has supported my work on Wisconsin tax increment finance, Michigan local government fiscal stress, and my ongoing evaluation of the Detroit property tax environment. The U.S. system of national and largely autonomous subnational governments provides fertile ground for researchers to study and learn about which policy “experiments” lead to better, or worse, outcomes. I really love doing this work and am thankful to have the Institute as a partner.

Over the past decade of transition from communist to market economies, property taxation has taken on economic, political and legal importance as the countries in Central and Eastern Europe have developed new fiscal policies and new approaches to property rights. Taxes on land and buildings have served not only as revenue instruments but also as adjuncts to decentralization and privatization. In spite of the complex and varied national differences in this region, a number of common issues have emerged in regard to property-based taxes.

A period of transition places a premium on revenue sources that impose a minimum burden on the functioning of nascent market economies. Many of these postcommunist nations seek to strengthen local government, and all must adjust their tax systems to account for emerging markets for land and buildings at a time when state administrative capacity is challenged by the introduction of new income and consumption taxes. There is often strong support for retaining a public interest in land as a fixed, nonrenewable element of the common heritage which, once sold, cannot be reproduced. This sentiment coexists with an equally strong impetus for development of private business and private ownership of property. Each of these concerns raises special questions with regard to the role of land and building taxes in the transition.

Such taxes on land and buildings have already been designated as local revenue sources in many nations of Central and Eastern Europe. As a tax base that cannot relocate in response to taxation, real property permits an independent local revenue source. Times of fiscal stringency at national government levels dramatize the importance of such revenue for local governmental autonomy. Moreover, the goal of eventual international integration through the European Union and other trade arenas encourages development of taxes not subject to international competition.

Two primary difficulties confront efforts to implement land and building taxes in these countries. First, in the absence of developed property markets, the tax base requires a choice among formulary values, price approximations, and non-value means of allocating the tax burden. Second, times of financial hardship present special problems in imposing taxes on assets that do not produce income with which to pay the tax. This dilemma has left many property taxes at nominal levels.

These problems are closely related because the lack of reliable market prices, together with the legacy of officially determined price levels, can encourage legislation that assigns specific, sometimes arbitrary values to various classes of property for tax purposes. Given these difficulties, it is particularly significant that many of these nations have either adopted or are seriously considering some form of value-based taxation of immovable property as a source of local government finance.

The Case of Lithuania

Since declaring its independence from the USSR in 1991, the Republic of Lithuania has made rapid strides in economic reforms, privatization and government reorganization. Its plans for market value-based taxation of land and buildings reflect the country’s transition to a market economy and private ownership of property. Municipalities will receive the revenues from the new tax and will have the power to choose the tax rate, subject to an upper limit set by the national government. The Lithuanian Parliament has recently prepared draft legislation for this tax which assigns responsibility for developing a valuation system to the State Land Cadastre and Register (SLCR).

The SLCR was created in 1997 to consolidate a number of functions: registration of property rights, maintenance of a cadastre of property information, and valuation of real property for public purposes, including taxation. Since then the agency has organized a central data bank for legally registered property rights, land and building information, and Geographic Information System (GIS) maps. The data bank currently holds information on more than four million land parcels and structures, and it is linked to mortgage and other related registers and to branch offices throughout the country.

The proposed market value-based real property tax will replace two existing taxes on real property commonly found in post-Soviet systems: a land tax on privately owned land and a property tax on buildings and other property (not including land) owned by corporate entities, enterprises and organizations. Taxable values are currently set by the SLCR through application of varying “coefficients” that adjust base prices to reflect land use and location. The resulting values do not reflect current market prices. The tax rate of 1.5 percent of the taxable value for land and 1 percent of the taxable value of property yielded represent approximately 7 percent of local budgets and 2.5 percent of the national budget in 2000.

Lithuania’s growing demand for market-based property valuation data requires an increase in professional appraisal skills and experience with assessment administration. To address these needs, an Association of Property Valuers and a system of professional certification were established in the mid-1990s, in collaboration with other international valuation associations. Lithuania has also joined Estonia and Latvia in publishing periodic reviews of real estate markets in the Baltic states. Information regarding market activity is posted on the SLCR’s website www.kada.lt.

Lincoln Course

The Lincoln Institute has taught courses on property taxation in transition countries for nearly a decade, and in February the Institute collaborated with SLCR to develop a curriculum for seven senior public officials from Lithuania. The week-long program was based on the course that the Institute presented, in cooperation with the Organisation for Economic Cooperation and Development (OECD), in the Lithuanian capital of Vilnius in December 1997, for government officials from Estonia, Latvia and Lithuania. Recognizing the importance of this year’s program to Lithuanian public policy, the United Nations Development Programme (UNDP) provided support for the delegation’s travel to Cambridge.

The program offered a policy-oriented analysis of issues relating to market-based tax systems. It included guidance in developing a strategic plan and a legal and administrative framework for a computer-assisted mass appraisal (CAMA) system suitable to Lithuania. Technical subjects were presented in the context of larger economic and political issues in land and property taxation. The course combined lectures, discussions with experienced practitioners, case studies, and field visits to state and local agencies in Massachusetts. Lectures addressing introductory, policy-focused subjects were supplemented by more specialized presentations covering market value appraisal techniques, mass appraisal, CAMA and tax law.

The Lincoln Institute will offer similar courses to public officials from other transition countries, and is continuing to develop other educational programs with Lithuania and its Baltic neighbors.

Jane H. Malme is an attorney and a fellow of the Lincoln Institute in the Program on Taxation of Land and Buildings. She has developed and taught courses on property taxation and has been a legal advisor to public finance officials in Central and Eastern Europe. She is co-editor with Joan Youngman of The Development of Property Taxation in Economies in Transition: Case Studies, a book being published in 2001 by the World Bank.

Public officials from Lithuania and Lincoln Institute faculty members met at Lincoln House in February to learn from each other about market value-based taxation policy and plans for introducing property taxation in Lithuania.

Delegates from Lithuania: Arturas Baksinskas, Vice-Minister of Finance; Dalia Bardauskiene, Advisor to the Prime Minister on Rural and Urban Development and Planning; Algirdas Butkevicius, Member of Parliament on Budget and Finance Committee; Rimantas Ramanauskas, First Deputy Director, SLCR; Albina Aleksiene, Advisor to the General Director on Property Valuation, SLCR; Arvydas Bagdonavicius, Deputy Director, SLCR; Algimantas Mikenas, Deputy Head of Property Valuation and Market Research Department, SLCR.

Lincoln Institute Faculty: Joan Youngman, Senior Fellow and Director, Lincoln Institute Tax Program; Jane Malme, Fellow, Lincoln Institute Tax Program; Dennis Robinson, Vice President, Lincoln Institute; Richard Almy and Robert Gloudemans, partners, Almy, Gloudemans, Jacobs and Denne , LaGrange, Illinois; John Charman, Consultant Valuation Surveyor, London; David Davies, Director of Information Technology, Massachusetts Department of Revenue; Jeffrey Epstein, Consultant, Quincy, Massachusetts; Sally Powers, Former Director of Assessment, City of Cambridge.

Una versión más actualizada de este artículo está disponible como parte del capítulo 3 del libro Perspectivas urbanas: Temas críticos en políticas de suelo de América Latina.

La inversión de fondos públicos en áreas urbanas suele traer como resultado un aumento en el valor de la tierra que solamente beneficia a un grupo pequeño de propietarios privados. En una iniciativa sin precedentes, la ciudad brasileña de Porto Alegre está usando el impuesto a la propiedad como un instrumento para recuperar la plusvalía de los bienes raíces, con lo cual logran frenar la especulación en el mercado inmobiliario y promueven el desarrollo urbano racional.

Contexto económico y social

Porto Alegre es la capital y la ciudad más grande del estado brasileño de Río Grande do Sul, el más meridional del país. Con una población de 1,5 millones de habitantes y aproximadamente 450.000 unidades inmobiliarias en 1994, las autoridades de la ciudad estimaron una escasez de más de 50.000 unidades residenciales. No obstante, los mayores problemas económicos y sociales limitaban la capacidad que tenía la ciudad para proporcionar viviendas a las familias de ingresos bajos y medianos.

Al igual que en muchos países en desarrollo con ciclos económicos inestables, la tierra es uno de los principales medios para acumular riqueza en Brasil. En Porto Alegre, la existencia de grandes predios sin urbanizar cerca del centro de la ciudad propicia la propagación urbana en la periferia. El principal factor causante de esta situación es la especulación con las tierras por parte de propietarios adinerados que poseen grandes extensiones de terreno baldío y esperan un momento favorable para realizar inversiones o vender los terrenos con enormes ganancias.

A medida que las familias de ingresos bajos son empujadas hacia la periferia, su segregación lleva a una exclusión social más acentuada y mayores demandas de servicios. No obstante, la dotación de infraestructura básica, como los servicios de transporte público en rutas largas entre la periferia y los núcleos de comercio, industria o entretenimiento, exige que el gobierno haga inversiones considerables.

Las autoridades de la ciudad de Porto Alegre se habían fijado una meta fundamental de proveer servicios urbanos de calidad para la comunidad de las afueras, entre ellos una infraestructura básica, educación, transporte público, limpieza de calles y seguridad. Sin embargo, un diagnóstico financiero de los ingresos de la ciudad hizo que las autoridades se percataran de la escasez de recursos para tal inversión. En contraste, muchos distritos en áreas más centrales estaban bien dotados de infraestructura, equipos y servicios, y su densidad de población era menor a la prevista en el plan de desarrollo urbano de la ciudad.

Era obvio que la especulación obstaculizaba el desarrollo de la tierra, pero las autoridades gobernantes creían que el ambiente político era favorable para un cambio. Después de un período en el que el gobierno se enfrentó a una inflación crónica en Brasil, se introdujo un programa de estabilización económica en julio de 1994. Antes del plan económico, la inflación anual llegó a alcanzar el asombroso nivel del 7.000 por ciento. A partir de la aplicación del plan, el índice promedio de la inflación mensual osciló entre el 0,7 y el 1,7 por ciento. La medición de la economía en términos del producto interno bruto (PIB) arrojó índices positivos de crecimiento anual a partir de 1993. El gobierno local tenía confianza en que el momento era ideal para recuperar la inversión y las actividades productivas que se habían paralizado durante el anterior período de inflación alta.

En resumen, los siguientes factores fomentaron la iniciativa de Porto Alegre de usar el impuesto a la propiedad como instrumento para simultáneamente recuperar la plusvalía de la tierra, refrenar la especulación en el mercado inmobiliario y promover la justicia social y el crecimiento económico:

• Estimulación de la ocupación y desarrollo de tierras urbanas, puesto que el mercado privado no respondía de forma positiva a la demanda de los residentes de ingresos bajos y medianos.
• Reducción de la escasez de viviendas.
• Asistencia a las familias de bajos recursos, para garantizarles mejores oportunidades de vida y trabajo.
• Recuperación del valor de la tierra generado por la inversión pública, motivando a aquellos individuos que habían sido favorecidos por la inversión pública para que retribuyeran los beneficios a la comunidad.
• Limitación de las inversiones adicionales a gran escala en infraestructura y servicios públicos mediante la utilización racional de los recursos financieros.

Medidas gubernamentales

La constitución de Brasil (1988) define el impuesto a la propiedad como un tributo aplicado a la tierra e inmuebles urbanos y especifica que puede utilizarse como un instrumento de las políticas urbanas a fin de promover un uso racional de la tierra que genere beneficios sociales para toda la comunidad. Esta disposición permitió que Porto Alegre emprendiera las siguientes acciones:

• Definir las zonas urbanas prioritarias para el desarrollo y la ocupación. El proceso implicaba la selección de cinco áreas distintas caracterizadas por su alta calidad en infraestructura urbana, equipos y servicios. Estas áreas acogerían una mayor densidad de población sin necesidad de inversiones públicas adicionales.
• Localizar 120 predios vacantes, cuya área oscilaba entre 3.000 y 360.000 metros cuadrados (m2) en las zonas prioritarias.
• Introducir una legislación local que estipulaba el desarrollo de las propiedades seleccionadas en lapsos de tiempo específicos. La ley establecía que si no se cumplía con dichos lapsos para el desarrollo de los predios, se aplicaría progresivamente el impuesto a la propiedad correspondiente. La tasa del impuesto aumentaría en intervalos de 20 por ciento anualmente hasta alcanzar un tasa máxima del 30 por ciento. Las tasas básicas para tierras vacantes varían entre el 5 y el 6 por ciento del valor de la propiedad en el mercado.
• Otorgar prioridad a los proyectos de construcción en los terrenos seleccionados. Las entidades del Ayuntamiento encargadas de los permisos de planificación facilitarían la construcción y la ocupación.

Efectividad de la iniciativa

La legislación fue promulgada a finales de 1993 y el gobierno comenzó a aplicarla en 1994. La propuesta contó con el apoyo de los miembros del Ayuntamiento, tanto los pertenecientes al partido de gobierno como los de la oposición; esta instancia tiene la responsabilidad de aprobar las decisiones en materia de legislación municipal.

A la fecha de octubre de 1997 la iniciativa no ha dado los resultados esperados. Sólo se han desarrollado cinco de los 120 predios vacantes. Los propietarios de 50 inmuebles están pagando el impuesto a la propiedad con una tasa de aumento progresivo. Tres de las propiedades fueron eliminadas de la lista porque habían sido incluidas incorrectamente desde un principio debido a registros inexactos sobre sus características físicas.

No se ha descrito el estado de desarrollo de las 62 propiedades restantes. Algunas pertenecen a terratenientes acaudalados y políticamente influyentes que apelaron ante el Tribunal Supremo contra la constitucionalidad de las medidas aplicadas por el gobierno de la ciudad. De hecho, dos terratenientes (A y B) que poseen casi el 44 por ciento de los terrenos baldíos están apelando y otros terratenientes aparentemente están a la espera de la decisión judicial para tomar sus propias decisiones. (Véase el cuadro.)

Solamente será posible evaluar la efectividad que ha tenido la iniciativa del impuesto a la propiedad en Porto Alegre después de que se conozcan las decisiones judiciales sobre la materia, pero otros beneficios cruciales derivados de la experiencia ya han garantizado su éxito. La legislación ha dado lugar a un debate intenso en el ámbito nacional y local sobre los derechos políticos y privados, los derechos de propiedad y los intereses públicos. La experiencia también ha servido como ejemplo para que otras autoridades gobernantes tomen conciencia de la responsabilidad que tienen de fomentar el uso racional de las tierras urbanas.

En Brasil, los factores culturales y económicos parecen seguir propiciando la especulación con la tierra, en detrimento de las actividades productivas, y la dificultad para establecer límites entre los intereses públicos y los derechos privados es, sin duda, compleja. No obstante, los esfuerzos iniciales realizados en Porto Alegre representan un paso decisivo hacia el control de la especulación privada y el fomento del desarrollo urbano responsable. Otras iniciativas similares en otros lugares ahora tienen mayores posibilidades de convertirse en alternativas viables para lograr justicia en la distribución de los recursos públicos con ventajas sociales para la comunidad.

Claudia M. De Cesare trabaja para la Municipalidad de Porto Alegre y está postulada para cursar un doctorado en el Centre for the Built and Human Environment, de la Universidad de Salford, Inglaterra.

After spending more than a decade on restructuring central-provincial fiscal relations, the Chinese government is advancing its efforts to reform local public finance. In 2003 the central government issued a directive to ameliorate the real property tax system in China. To fulfill this mandate, tax authorities are reviewing international property taxation experiences, sending officials overseas to study pertinent models and inviting foreign experts to China for consultation. Yet comparable cases from which the government can draw relevant lessons for tailor-making a Chinese property tax system are few. The danger is that when public officials are under pressure to move the reform forward, they may be tempted to adopt concepts that do not match the country’s conditions.

One recent proposal that may develop into such a scenario is to establish an ad valorem property tax system in which leasehold land would be taxed as if it were freehold. This article explains what the Chinese government’s current proposal entails, why it may not be consistent with existing land tenure arrangements and, more tentatively, how the establishment of a land rent system could mediate potential contradictions of taxing land that is not private property.

China’s Property Tax Reform Proposal

The Chinese property tax system currently has as many as nine property taxes, depending on the definitions (see Hong 2003; 2004). The central government has proposed to consolidate three of these taxes into a single levy to simplify the existing tax structure. One of them is the Township and Urban Land Use Tax (LUT), which all land users (except foreign entities, government and nonprofit agencies, and agricultural industries) are required to pay. To collect this tax, local governments divide their jurisdictions into different taxing zones according to population size or land use. Land in different zones is taxed at an array of tax rates preset by the central government, ranging from 0.2 to 10 yuan per square meter (1 yuan = US$0.122). Some Chinese officials have admitted that the tax rates for the LUT have been set too low; hence its collections have little impact on local revenue. The government plans to eradicate this tax.

The other two taxes, the Building (or House) Tax and Urban Real Estate Tax (URET), will also be subject to reform. While the Building Tax is imposed on income-generating properties held by Chinese nationals, the URET is levied on all real estate owned by foreign entities and overseas Chinese. Both are ad valorem taxes whose bases can be the discount original purchasing cost, assessed capital value or gross annual rental value of the property.

When the assessed capital value (or the purchasing cost for the Building Tax) is used as the basis for tax assessment, the tax rate is 1.2 percent for the Building Tax and 1.5 percent for the URET. If an estimated rental value is used instead, the tax rates for the Building Tax and URET will be 12 and 15 percent, respectively. In some locales, like Beijing, if actual rental value is available because individual property owners rent their dwellings to another party at the market rate, the Building Tax rate will be 4 percent of gross rental income of the property. In view of this discrepancy in taxing local- and foreign-owned real estate, the government would replace these two levies with a single property tax as part of the upcoming reform.

The proposed new property tax would be imposed on both land and buildings at a uniform rate. The tax base would encompass all properties, domestic and foreign, located in rural as well as urban areas. As some public officials argue, a standardized property tax could have at least three advantages. First, the new property tax system may ease tax administration. Instead of administering the collection of the LUT, Building Tax and URET separately, local tax bureaus will be able to concentrate their effort on just one tax.

Second, the new property tax would be a value-based tax, which allows the government to capture future land value increments if property reappraisal can be done regularly. Third, one key purpose for creating the new property tax is to convert selected real estate development charges into a unified tax. Many scholars argue that some local governments might have abused the current system of user charges, thereby making payments for public services unduly cumbersome.

Collecting these charges through the new property tax may lower the transaction costs of doing business. As well-intentioned as the proposal may sound, policy designers might have underestimated the importance of one fundamental matter: the integration of the new property tax system with the current land tenure arrangements.

Property Taxation and Public Leaseholds

As specified in the Chinese Constitution, urban land is owned by the state and rural land is owned by collectives. Local governments, empowered by the state, can assign land use rights to users through a set of leasing arrangements. Lease terms are 40 years for commercial land, 50 years for industrial land and 70 years for residential land. If a local government wants to lease an urban land site to a private entity, it must be assigned through a bidding process. The winning bidder must pay the total set of leasing fees (including a “conveyance fee,” expropriation costs if land is acquired from the collective, and various land allocation charges) in a lump sum and immediately to obtain the land use rights.

The payment of the market-determined conveyance fee allows the lessee to transfer or rent the land use rights to another party and to use them as collateral. In the past, land rights were allocated mainly to private entities through negotiation, but this method failed to collect proper fees due to personal connections or corruption and it was suspended by the central government in 2002.

Users of land assigned administratively to public agencies or state-owned enterprises are not required to pay the conveyance fee, but must compensate the state for any allocation costs. The assignment of the land rights has no term limit. According to the law, if a state-owned enterprise wants to transfer its land rights to a private entity for commercial purposes, it must pay the conveyance fee to the state before doing so. For the transfer of rural land into urban uses or to nonmembers of the collective, the state will first expropriate the land from the collective with compensation and then lease the use rights to interested users for the payment of the conveyance fee and other leasing charges.

Owing to a long bureaucratic process and high transaction fees, many users have transferred their land rights to other parties without going through the proper procedure and registration. As such informal exchanges have gained in popularity, the official land leasing record is no longer reliable. Hence, any future attempt to identify the actual landholders, delineate their land rights, and estimate the leasehold value for tax purposes would no doubt be a difficult task.

The design of the new property tax system must take these unique land tenure arrangements into consideration. Aside from the extensive informality involved in land transaction and possession—a topic that is beyond the scope of this article—the most basic question is: How can the government convince lessees to pay property tax on lands that they do not own?

Certainly not all property tax systems are based on the premise that property owners should be taxpayers; occupiers are sometimes liable for tax payment. In some countries, such as Australia, the Netherlands and United Kingdom, taxes paid by occupiers are referred to as rates, a council tax or a user tax to avoid any confusion. Despite the different names, the calculation of these levies is still based on either the capital or rental value of the property, which is the same approach as for the property tax.

More fundamentally, since the supply of land is fixed, the landowner (the state government in the case of China) would bear the ultimate tax burden even if land users paid the property tax directly to the government. This is because the new tax would dampen the demand for land use rights and in turn reduce the fees that local governments could receive from leasing public land.

Because the Chinese government is both the landowner and property tax collector, lessees who leased land in the past and paid the entire leasehold value without anticipating the additional property tax burden would wonder why they should pay more land tax to the government. Thus it is essential to have a rationale for taxing leasehold land, so as to convince lessees to comply with their property tax obligation.

One way to analyze the matter is to treat property rights as a bundle of rights, which includes the right to own, use, develop, transfer, bequest and benefit from land. This bundle also comprises the right to exclude others from enjoying these privileges.

Viewing the Chinese land tenure arrangements through this lens, the government holds the ownership of land and leases other attributes of the bundle of land rights to private entities. So long as the privileges and obligations of holding the leased land rights are fully delineated and recognized, both legally and by the society, there is no reason why leasehold rights cannot be regarded as private property of the lessees for a specific period of time as stipulated in the lease.

In 1988 the Chinese National People’s Congress amended the Constitution to acknowledge the transferability of the right to use land. Further amendments are needed to explicitly recognize leaseholds as private property and empower the state to establish special legislation for the enforcement and protection of leasehold rights. In this way, the implicit contradiction in imposing property tax on leased public land would be clarified and resolved.

One technical issue remains, however: valuation of leasehold rights for tax purposes. Since the new property tax will be value-based, assessors will face the challenges of estimating the leasehold value of land independently, based on market data that normally reflect a combined value of land and all improvements. Most property valuation methods presume that land is freehold, and that developed real estate markets are present. Neither of these assumptions can be applied to China. Although there are practices that separate land and building values for tax purposes, the divisions are generally based on crude assumptions. How can assessors modify the existing (or invent new) valuation techniques to accommodate these special Chinese conditions?

More important, leasehold value is highly sensitive to the lease term and conditions, both of which can vary significantly from one case to another. At this moment, time-tested mass appraisal techniques for assessing large numbers of leasehold sites do not exist. Do these issues imply that property assessment for tax purposes under the Chinese leasehold system requires a case-by-case approach? If so, do local governments have the capability to carry out such detailed property appraisals for the collection of the new property tax? The Chinese government must find ways to deal with these practical matters if it decides to tax leasehold rights as private property.

It is also extremely important to educate would-be taxpayers and public officials about the distinctions between freehold and leasehold systems. Lessees must recognize that they possess only the leased land rights that are not designed to last in perpetuity. If the rights and obligations of both the state and lessees are not clearly delineated, taxing leasehold rights as if they were freehold could complicate the implementation of future land and tax policy. For example, in Canberra, Australia, and Israel, lessees are requested to pay the entire leasehold value up front, and thereafter they pay an annual property tax (or rates in Australia) for leasing public land. Lease terms in both cases are long and renewable—99 years in Canberra and 49 years in Israel with four automatically renewable terms totaling 196 years.

This method of collecting leasehold charges and taxes is tantamount to the payment system for land in countries where land is freehold. Due to this similarity, lessees have developed the perception that land is privately owned (Hong and Bourassa 2003). This view, albeit legally a fiction, has engendered the expectation that any government’s attempt to exercise its rights as the landowner to retake land for public uses or to demand additional payments from lessees for enlarging or extending land use rights would constitute an infringement on private property.

This expectation has added conflict to government efforts to redistribute land and land value between private landholders and the state on behalf of the public. As Neutze (2003) argued, had the Canberra government provided enough public education about its leasehold system, it would have spared the Australian capital from many intractable disputes over land ownership.

The Chinese government has no immediate plan to give fee simple deeds to private landholders. Thus, if local governments continue to collect all leasehold charges up front and then levy the new property tax on both land and buildings, they may be at risk of creating the same mistaken expectations, that is, that land is privately owned. This may put the government and lessees at odds with each other when there is a later need to reallocate land from private to public uses. Designing a real property tax that will not add more complications to the already unsettling land tenure system is a critical task that policy makers should not overlook.

Land tenure reform is a long, controversial process, however, and the Chinese government would be ill-advised to delay the implementation of the new property tax system until land reform is completed. What the government needs is a transition system in which property tax reform can proceed as planned without interfering with its endeavors to restructure land ownership. Establishing a land rent system seems to be an option.

Land Rent System

Under a land rent system, leasehold charges would be paid in the form of an annual land rent, not a one-time leasing fee. Local land bureaus could continue to assign land use rights by public auction, but the bidding would be to determine the amount of annual land rent. Similarly for lands that were assigned to state agencies administratively, users would pay their conveyance fee for transferring land rights to other private parties in annual installments, which would be equivalent to the yearly rental payments. The land rent system has pros and cons (see Hong 2004 for a detailed discussion); four important advantages are discussed here.

First, collecting a land rent is the most straightforward way to characterize the landowner-tenant relationships between the state and lessees. More important, requesting lessees to make their rental payments annually would serve as a constant reminder of their leasehold relationships with the state.

Second, if leasehold charges were paid in annual installments, local officials would no longer be able to generate a large amount of cash instantly to cover short-term fiscal shortfalls. This in turn may lower their incentive to lease land rapidly—a major malady of the current land leasing system.

Third, research using the input-output (I/O) technique and the 1997 I/O Table of China found that collecting land rent could facilitate the transition to the new property tax system (Hong 2004). Had the central government required all land users to pay an annual land rent in 1997, rental income would have added 29.8 billion yuan (US$3.6 billion) to the government treasury, representing a 2.9 percent increase in total tax revenue (see Table 1). This revenue increase would represent a net gain over estimated tax revenue losses under the proposed property tax reform.

The land rent system, however, may generate a cash flow problem for local governments. When leasing fees are deferred and paid by lessees in annual installments, fewer funds would be immediately available for local governments to cover public expenditures. To resolve this problem, local jurisdictions may borrow money from the central government or other financial intermediaries, using perhaps the future land rent collections as collateral. Loans would then be repaid in annual installments by funds gathered from yearly rental payments made by lessees.

Had the government decided to keep the total tax revenue approximately the same, it could have set the new property tax rate at 4 percent, which is the same as the Building Tax rate for personal dwellings rented at market prices, and then discounted the land rent by as much as 47 percent (see Table 1). With a reasonable tax rate and a substantial reduction on rental payment, taxpayers would be less resistant to the reform.

Table 1 also shows several possible combinations of rent level and property tax rate to produce a revenue-neutral shift. If the government were to increase the new property tax rate to deepen the tax reform, it could lower the rent level to avoid antagonizing taxpayers. This approach would provide local governments with an array of options to adopt the new property tax system in stages and at a pace that suits their economies.

Fourth, the proposed land rent system could keep future tenure choices open. If the sociopolitical sentiment of the country favors public leaseholds, local governments could continue to levy the land rent and property tax at the ratio that matches local needs. Subsequent adjustments to the rent-tax ratio could also be made when new circumstances arise.

If central authorities, in response to popular demand, were to grant fee simple deeds to all lessees, it could order local governments to phase out the collection of land rent and raise the new property tax rate accordingly. As shown in Table 1, directing the reform toward either path would not create adverse effects on local government budgets.

This analysis shows that choices available to the Chinese government are not limited to privatizing land ownership and relying solely on real property taxation to recoup land value. Undeniably, the Chinese government may eventually choose to do just that because it is indeed an option, but there are many other possibilities as well. Why, then, should the government make such a decision now, when there may be other viable alternatives that can keep all options open? Recognizing that there are many choices could unleash the creative powers of policy makers and scholars to imagine a unique Chinese system to capture land value.

References

Director General of State Statistics Bureau. 1999. Input-output table of China, 1997. Beijing: China Statistical Press.

Hong, Yu-Hung. 2003. The last straw: reforming local property tax in the People’s Republic of China. Working paper. Cambridge, MA: Lincoln Institute of Land Policy.

_____. 2004. Assessing property tax reform in China. Report for the David C. Lincoln Fellowship Program. Cambridge, MA: Lincoln Institute of Land Policy.

_____ and Steven C. Bourassa. 2003. Why public leasehold? Issues and concepts. In Leasing public land: Policy debates and international experiences, Steven C. Bourassa and Yu-Hung Hong, eds., Cambridge, MA: Lincoln Institute of Land Policy.

Neutze, Max. 2003. Leasing of publicly owned land in Canberra, Australia. In Leasing public land: Policy debates and international experiences, Steven C. Bourassa and Yu-Hung Hong, eds. Cambridge, MA: Lincoln Institute of Land Policy.

Yu-Hung Hong is a fellow of the Lincoln Institute of Land Policy. This article reports on selected preliminary results of his research funded by the David C. Lincoln Fellowship in Land Value Taxation.

Most people are not particularly fond of paying taxes of any sort, but the discontent with one particular type of public levy, the local property tax, is gaining momentum across the country. Disgruntled homeowners are demanding that governors and mayors find alternative methods to raise revenue in order to relieve their own property tax burden.

Decades ago this discontent led to such tax limitation measures as Proposition 13 in California and Proposition 2½ in Massachusetts. More recently, this movement has been driven by sharply rising property tax levies in many cities and suburbs as a result of the extraordinary appreciation in property values over the past few years. The high visibility of the property tax, which in contrast to sales and income taxes is often paid annually in one or two large installments, makes this form of revenue generation an attractive target for taxpayer antipathy.