I was recently reading AIER founder E.C. Harwood’s “Useful Economics,” which can be accessed online through our website’s Harwood Economics tab , when I came across a particularly interesting passage. In Chapter XIII, “Practical Applications,” Col. Harwood was discussing the role that taxes on site values, meaning taxes on the unimproved value of land, play in limiting the value of monopoly privilege that landholders can extract from economic producers.
This kind of land value tax has been advocated by economists for centuries, most notably by Henry George in his 1879 book, “Progress and Poverty.” Land value taxes do not distort economic behavior by taxing production or labor income, and by the same token they encourage development to reach the most productive use of land. Under a property tax based on the total value of the land and improvements, a developer looking to build an office building on a vacant city lot must take into account his higher tax bill when evaluating the return on construction, and a speculator holding an adjacent lot may want to wait until the area is booming to sell his own. Under a land value tax, these barriers to development are lessened or taken away.
In the chapter, Col. Harwood noted a feature of some local taxes in Pennsylvania:
“In Pittsburgh and Scranton, improvements are partially exempt from taxes and the tax on site values provides an even larger share of the funds for public expenditures. In at least some of the third-class Pennsylvania cities taxes may soon be levied only on site values; and improvements…as well as human processing efforts may be exempted, except for the Federal income tax, which is by no means negligible. These experiments under way in the United States may provide most interesting results in future decades.”
At the time of his writing, the property tax rate in Pittsburgh was twice as high for land as for buildings, and in subsequent years the ratio changed further. Between 1977 and 1982, Scranton raised land tax rates to 9.6 percent from 5.1 percent while leaving tax rates on the value of buildings constant at 2.55 percent. Pittsburgh similarly raised the land tax to about 13 percent, while building rates went only to 3.2 percent. Both cities offered temporary tax rebates on new construction at the same time.
Both cities experienced a construction boom, as documented by Steven B. Cord in the 1983 “Proceedings of the Academy of Political Science.” This boom was not seen in surrounding cities. Cord compares Scranton with nearby Wilkes-Barre and further supports this claim by showing similar comparisons in other, smaller matched pairs of cities in Pennsylvania that did or did not adopt a two-rate system. However, this analysis was necessarily incomplete. Since the two-tiered tax rate was implemented simultaneously with other tax benefits, and there were only a few years of data, construction increases were not proof that the new tax scheme would lead to more productive uses of land. It was possible the government was in fact creating distortions and encouraging construction to move to Scranton from what could have been a higher-value project in Wilkes-Barre, or to rush into a project that might not have been profitable at all without the tax rebates.
A more thorough analysis was offered by Plassman and Tideman in a 2000 paper in the “Journal of Urban Economics.” They used 1972-1994 data from 15 Pennsylvania municipalities with a two-tiered tax structure and over 200 that did not have one. Their findings indicate the two-tier system does lead to more construction in dollar values, which they then showed is due to more structures being built rather than a higher average value of new structures. Although these Pennsylvania taxes are not pure land-value taxes, as they do include some taxes on the value of the buildings, they provide real-world evidence to support the prediction that land-value taxes lead to land reaching its highest-value use. Other recent work provides examples of how such a system can be evaluated and implemented in other places, from Colombia to Cardiff. A practical application, indeed.