By now, the story is well known. The housing market booms, property taxes rise, and taxpayers demand relief.

In the story’s original version in the late 1970s, inflation in California’s home prices skyrocketed from 5 percent per year to 5 percent per month, setting off a tax revolt that culminated in Proposition 13, a strict set of property tax limits that inspired copycat laws across the United States.

Now, after years of rising home prices fueled by new jobs and migration, Texas faces similar pressure. From 2013 to 2017, property tax collections increased by about a third in major cities like Houston, San Antonio, Dallas, and Austin, and by much more in some neighborhoods.

“Texas is experiencing what California experienced in the 1970s,” said Debbie Cartwright, an attorney for the Texas Taxpayers and Research Association. “People who have owned their properties for a while are feeling the pinch.”

The situation in Texas is just the latest sign of the great property tax conundrum. Favored by many economists for being stable, efficient, and transparent, the property tax is also unpopular because it is so visible, and because it’s not tied directly to people’s ability to pay. Even now that the housing market is cooling, property tax bills are unlikely to decline much in the near future because assessors take a while to catch up to market values.

Texas policy makers are considering a host of measures designed to reduce property taxes, chief among them a proposal to limit the annual growth in local property taxes—the “levy”—to 2.5 percent. Anything greater would require voter approval.

Mayors of 24 of the largest Texas cities have called the proposal unworkable, citing the need to provide basic public services, absorb higher health insurance rates and other costs beyond their control, and invest in public health, safety, transportation, and economic development.

Texas, which already restricts property tax levy growth to 8 percent per year, is not the only state considering new or tighter levy limits. Policy makers have introduced similar proposals in New York, Iowa, and Nebraska, although Texas faces the additional challenge of being one of only seven states without an income tax.

The levy limit, used in about 35 states, is actually an improvement over the Proposition 13 model, which reduces property taxes in a fundamentally different way, by artificially keeping assessed values of long-owned properties far below market value. The result is that owners of identical homes can have vastly different property tax bills. As detailed in a Lincoln Institute report, assessment limits have had many bad side effects, including major inequities and perverse incentives that distort the real estate market.

Levy limits, by contrast, preserve market-rate assessments, but they share some of the other negative consequences of assessment limits—a reduction in local governments’ autonomy, and sometimes a greater reliance on state aid, which can be more volatile. In the end, no property tax limit can defy the basic math of government budgets, and the need for revenue to fund education, infrastructure, public safety, and other priorities.

“Public services cost money,” said Adam Langley, associate director of tax policy and data initiatives for the Lincoln Institute. “If taxpayers want lower property taxes, then governments either need to cut services or fund them through some type of tax—a tax limit does not eliminate this basic trade-off.”

Langley is studying other tools that preserve local governments’ taxing authority but still provide property tax relief to those who need it most. These include “circuit breakers,” which offer relief to lower income and elderly residents if their property tax bills reach a certain percentage of their income—in the same way a circuit breaker protects a home from excess electrical current—and deferrals, which defer collection of property taxes until a property is sold or the owner dies. A more widely used tool, the homestead exemption, spares a certain amount of home value from taxation.

Another option is for states to provide more aid to local governments or to take responsibility for more services. In Texas, lawmakers are exploring options to increase the state’s contribution to public schools, which has declined under a complex funding formula from 46 percent of all education funding in 2011 to 36 percent in 2018 (read more in the Lincoln Institute’s policy brief on school funding). And where possible, local governments should lower their property tax rates to compensate for higher property values.

“The property tax is a critical source of revenue for local governments,” Langley said. “When real estate prices rise, policy makers need to protect residents and businesses from unreasonable burdens while maintaining the integrity of the tax system overall. Research shows that with enough autonomy and the right tools, governments can do just that.”

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As U.S. cities struggle to provide adequate infrastructure and affordable housing, many are underutilizing one of their greatest assets: the land on which they sit. Cities generate large increases in the value of land when they change zoning regulations to enable new development or invest in public works projects, but private landowners typically capture the value as windfall profits.

The auction of development rights offers an innovative, market-based tool that can help cities to recover land value for public benefit. In a new Lincoln Institute working paper, Julie Kim of the NewCities Foundation and Stanford University’s Global Projects Center explores the use of this tool internationally and the potential for its implementation in the United States, especially for transit-oriented development.

“Big problems call for big solutions, and big solutions require big and innovative thinking,” Kim writes.

Kim focuses on Brazil’s largest city, São Paulo, which has issued tradeable development rights called Certificates of Additional Construction Potential (CEPACs, pronounced “see-packs”) for more than a decade. Issued in conjunction with major rezoning and redevelopment projects, these certificates have generated nearly $3 billion in two neighborhoods alone. The city has used the revenue to build a bridge, extend a metro line and a major avenue, and create affordable housing in the same districts where the redevelopment took place.

How CEPACs work

Beginning in the 1990s, São Paulo designated a number of neighborhoods as special redevelopment zones. The city changed the zoning and land use regulations to allow for more dense development and planned for infrastructure projects that would help attract private investment. In a few of the neighborhoods, the city created tradeable CEPACs, which each permit the owner to create a specified amount of development, typically about 10 square feet, up to an allowed maximum.

The city has sold CEPACs at dozens of public auctions, and developers have gladly purchased the certificates, recognizing that the rezoning and the infrastructure funded by the CEPACs made their projects more valuable. For São Paulo, the CEPACs are a tool that allows the city to specify the amount of new development it wants and generate revenue while allowing the real estate market to determine the potential value of plots in the redeveloped area.

The advantages for U.S. cities

For U.S. cities, the auction of development rights could be an effective complement to traditional public-private partnerships (or P3s), in which the private sector builds new infrastructure in exchange for the right to future revenues—highway tolls, for example—or more direct forms of repayment by the city. P3s can be an efficient way for cities to deliver and finance infrastructure, but taxpayers or infrastructure users must ultimately repay the cost. CEPACs, by contrast, can generate revenues for repayment.

The São Paulo model also has advantages over tax increment financing, or TIF, in which cities earmark property tax revenues for economic development to encourage private investment, which in turn helps to grow the tax base. Studies have found that TIF often does not accomplish the intended economic development goal, but, more importantly, TIF does not create a new source of revenue beyond the property tax. CEPACs, by contrast, generate new revenues immediately while also expanding the property tax base for the future.

CEPACs may be most similar to exactions, the monetary payments or public amenities that U.S. cities sometimes collect in exchange for approving development projects. However, unlike CEPACs, these exactions often require lengthy, unpredictable negotiations, which vary depending on the developer’s political relationships.

Finally, CEPACs bring a new player—the private investor—into the infrastructure market, which can help spread out the risks and rewards of projects more widely.

The U.S. experience so far

There is ample precedent in the United States for tapping the value of development rights. Many cities allow for the transfer of development rights as a tool to protect historic landmarks or create parks and open space. Policies vary, but in general owners of properties that are restricted from being developed can sell unused development rights to others who want to build nearby. The buyer of the development rights sometimes pays a portion of the proceeds to fund transit or other public improvements.

Like São Paulo, New York City has integrated the sale of development rights into land use planning for specific neighborhoods. For example, the city recently rezoned the area surrounding Grand Central Terminal and relaxed its rules to allow for the sale of development rights throughout an 80-block area. The city will collect a 20-percent fee for each sale to help fund renovations of subway stations, new plazas, pedestrian- and bicycle-friendly street upgrades, and other public improvements.

The auction of development rights could become increasingly attractive as U.S. cities seek to densify to address environmental challenges, traffic problems, and the lack of affordable housing.

“The up-zoning incentives that underlie CEPACs may be just the catalyst needed to trigger robust transit-oriented development projects in major U.S. cities that have yet to be materialized,” writes Kim.

Photograph Credit: Virtual VV (Getty Images)

In the nineteenth and twentieth centuries, middle neighborhoods sprang up to house middle-income families drawn to U.S. cities by the dramatic rise of industry. Today, middle neighborhoods in “magnet” cities like Seattle, Washington, or Washington, DC, have seen impressive revival or gentrification, but, in legacy cities like Baltimore, Maryland, or Cleveland, Ohio, they often face decline. Often overlooked, middle neighborhoods matter—both to the people who live in them and to their cities and regions—and solutions demand engagement not only from the neighborhood itself but also from the city, region, and state. Nothing less than the fate of millions of people and dozens of cities lies in the balance.