Tools for smart growth: Land Value Tax

Improving property on Capitol Hill

Are you excited by talking about taxes? Do you love spending a rare sunny afternoon in Seattle reading about land use? Does the idea of doubling your pleasure by reading about taxes and land use on said sunny day leave you giddy? Today is your lucky day, because I am going to talk about the Land Value Tax (LVT) and whether it can work in Washington. And actually, this isn’t just me but this is about a colloquy between myself and Brock Howell of Futurewise, witnessed, silently, by Dan Bertolet, of City Tank fame.

The three of us got to talking after the visit by folks from the Metro Council about tools to support smart growth. Brock mentioned LVT and I, of course, had to make it clear that “LVT won’t work in Washington because of our tax system.” Brock valiantly made the effort to convince me otherwise but I was not going to give way. Dan jumped on his bike and road away, probably knowing the answer but enjoying the thought of us having an argument clinic outside the Discovery Center.

Later, Brock and I traded a couple of e-mails. I think we cleared a lot of this up. So I think it’s worth sharing, if for no other reason to lessen the “grievous mental confusion” about LVT and how it might work in Washington.

First, LVT is a tax that is applied to land whether or not that land is improved. That is, LVT is applied only to the land and not to any of the buildings or to other improvements made to the land.  The idea is that all other economic factors being equal, a tax only on land and not improvements, would provide an opportunity cost for property owners who don’t improve their land. If I own parcel A and my neighbor who owns parcel B makes improvements, then he pays the same tax I do but generates more profits. My taxes don’t necessarily go up, but I miss out on the potential windfall LVT offers by keeping my property undeveloped.

In theory, LVT is a great incentive to promote certain kinds of development over, say, keeping property as a parking lot or as low rise buildings. I don’t own property and I am not a developer. But the theory does make some intuitive sense. If I had a portfolio of property and if I saw on my regular profit and loss statement that taxes were outpacing my rents, or if, when I made an improvement, increases in my property value because of the improvement ate into my profits, it would affect my decisions.

But my argument is that LVT can’t work in Washington state because of our “budget based” system of property tax. Simply put, we don’t generate additional revenue in Washington from increases in property value because the amount we tax for is fixed. Said another way, as property values increase in Washington property taxes, generally speaking, go down not up.

From my e-mail to Brock:

But here’s what I was trying to get at:

District’s taxing authority/budget $300
Year 1
Properties A B C Total value
Land Value $100,000 $100,000 $100,000 $300,000
Taxes paid $100 $100 $100 $300
Year 2
Properties A B C Total value
Land Value $100,000 $100,000 $100,000 $300,000
Building 0 $50,000 $100,000 $150,000
Total $100,000 $150,000 $200,000 $450,000
Taxes paid on land only $100 $100 $100 $300
Year 2 (with increases in land value)
Properties A B C Total value
Land Value $200,000 $200,000 $200,000 $600,000
Building 0 $50,000 $100,000 $150,000
Total $200,000 $250,000 $300,000 $750,000
Taxes paid on land only $100 $100 $100 $300

The numbers are dumb, but you can see why you don’t end up creating much of an opportunity cost for the owner of property A by taxing only land. even in the third scenario, where the land value increases (which it likely would for all the properties) the tax authority is still spread equally across the land value without buildings. The tax rate drops from $10 per $100,000 of value to $5 per $100,000 of value. But since the authority stays the same it doesn’t really matter what happens to the values, taxes don’t change all that much from making or not making improvements to land. The property owners would share the taxes, uniformly, even if the bare land value increased for the guy who didn’t build anything.

I guess the point I could have stated instead of being such an emphatic jerk (“it won’t work!), is to have said that there really isn’t an adverse tax consequence from improving land value in Washington. In other states with a rate based structure rather than a budget based one (the $300 in taxing authority), it does matter. Here’s what it would look like with a rate based system.

I went on to make the point that in a state with a rate based system, a taxing scheme where value increases result in property owners paying more taxes and generating more revenue, LVT could be an important tool to change opportunity costs.

Tax rate on land value 1.00%
Year 2 with added value
Properties A B C Total value
Land Value $200,000 $200,000 $200,000 $600,000
Building 0 $50,000 $100,000 $150,000
Total $200,000 $250,000 $300,000 $750,000
Taxes paid on land only $200 $200 $200 $600
Taxes paid on land and improvements $200 $250 $300 $750

Here you can see how removing the improvement from the rolls would actually mean something. The owner of property A could be realizing more profits if he made some improvements on his land. Property owners of parcels B and C are saving 50 and 100 respectively. That means that if they do what we want, they don’t get socked with additional taxes. They guy who doesn’t gets hit even though he didn’t do anything.

In Washington, the problem with trying to base any kind of tax benefit on increases in value is that they won’t matter much to property owners. I would suggest (and we should ask some property owners) whether they hold off on building a project because of adverse property tax impacts. My guess is that the answer is “no.” It’s more likely that other costs–materials, permitting, etc–are the costs that are deal breakers.

I think I get how LVT works, but whenever I feel certain about something I usually get a weird combination of emphasis on key points (“it won’t work here!”) and big doubt. What if I’m missing something here? Here’s Brock’s thoughtful response:

The Y1 & Y2 scenarios demonstrate exactly what would happen in any state. The point of the LVT isn’t to raise revenue – LVT’s ambitions are far smaller. It’s ambition is to eliminate the perverse incentive to not build denser (which you demonstrate all too well in your “other states” for Y2-added-value).

Because the point of LVT isn’t to increase revenue, the fact that the Y2-added-value scenario doesn’t raise revenue doesn’t matter all that much.

You are definitely right in pointing out that an LVT would do less (than potentially in other states) to reduce existing tax-based disincentives to build dense. However, I would[n’t] go as far as you did to say that WA’s property tax system has no disincentive to build dense.  You didn’t run the numbers on Washington’s system, so I will:

Year 2 with added  value
Properties

A

B

C

Total value

Land Value

$200,000

$200,000

$200,000

$600,000

Building

0

$50,000

$100,000

$150,000

Total

$200,000

$250,000

$300,000

$750,000

Taxes paid on land only

$80

$80

$80

$240

Taxes paid on land and improvements

$80

$100

$120

$300

As you can see, there is still an opportunity-cost impact between the three properties.  In fact, one could argue that the owner of Property A now has less of an incentive to build dense and may push for a down-zone to their existing density level.  Maybe this is one of the reasons why Seattle continues to have surface parking lots in downtown.

I would also point out that many other states limit the disproportional impact of their tax system, either through exemptions or annual growth caps. So, the tremendous differential  in the “other state” scenario you ran is unlikely to occur.

I think Brock is right to suggest that this isn’t about revenue. But my point about revenue was only to show that revenue is where we start in Washington. The $300 in the example is the operating budget of a city. So Brock’s example is essentially a decrease of property taxation by policy, not by decrease in value. My point still holds, which is that in Washington real estate property taxes aren’t connected in way to increases or decreases in the value of the property.

Because we’re talking Land Value Taxation that matters a bunch. Policy makers don’t have a tool to incentivize behavior based on increases or decreases in the value of property whether it’s buildings or just the land or both. The idea of LVT is that there is some sensitivity on the part of property owners to what happens to the value of their property as it relates to their taxes. That isn’t the case in Washington because a property owners tax bill isn’t affected by increases or decreases in her assessed valuation the way it is in other states.

In Washington the incentive is a strange one. When property values go up in a taxing district property taxes go down. That should be an incentive right there to support more density. But I don’t think it really is, because as I suggested to Brock, I don’t think property owners in Seattle or else where are not developing or improving their property because of property taxes.

That’s why we need to crack open the constitution and fix it to allow for rate based property taxation in places where we’d like to tie property taxes somehow to value. That would make LVT doable and it would also allow for Tax Increment Financing.

And if you’re still reading this, you simply have to weigh in with a comment. Are we getting close to some kind of an answer here? Is fixing the constitution the only way to get to LVT here?

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4 Responses to Tools for smart growth: Land Value Tax

  1. Japhet says:

    I think the real question is “Do we need to get to LVT in order to remove the incentive to land bank and ‘underdevelop’ properties?”

    We already have a provision under state law to abate property tax rates for up to 12 years to encourage new developments. This seems like it would have a very similar effect. If municipalities wish to, they can set it up so that the property owner pays the tax on the value of his unimproved land for the first decade or so. How is that different from an LVT?

  2. LVT is tough in Washington, but there are problems with abatements as they exist: They are temporary, they apply to only new or rehabbed (not existing construction), the permitting process is often difficult, and the tax one pays on unimproved land does not change, leaving the same next-to-nothing holding cost for private land banking. A valuable lot still pays the low holding cost, losing one of the leverages of
    LVT (the stick) while giving away a free carrot that may lead to irrational exuberance and overbuilding.

  3. Mark S Johnson says:

    I agree that this is not a revenue issue. If the amount of tax to be collected is a set amount, as it is under our system, then the tax rate would be set by dividing the tax to be collected by the total tax base. The issue is the definition of the tax base, not what the tax rate should be. How you define the tax base determines who will pay more and who less. Right now the system is intended to make those with the largest assets pay the most. If downtown land was taxed at the same rate per sqaure foot as single family zoned land, there would be an enormous shift in tax budren to the residential properties.

    It might seem like a simple thing, but land value is extremely hard to define. Two properties right next to each other under current tax assessment methods can have very different land values (on a per square foot basis). I know of one site in Northgate where 200 units of solid, 1950’s two story apartments on 9 acres are assessed at $1000 total improvement value, and the land is at $24 million.

    The issue for that property owners is not how much the land is taxed versus how much the buildings are taxed. It is the total tax they pay that matters.

  4. Pingback: Climb every mountain! Ingredients we need for TOD in Washington | Seattle's Land Use Code

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