Friday, February 7, 2014

Splitting Hairs; Re-Exploring a Henry George Style LVT

A quick plug before I get into the post.  Last night I saw Chuck Marohn speak at the Garland Theater in downtown Garland (the trains had no problem with the weather).  He runs the Strong Towns organization and is good at pointing out the deficiencies and disinvestment built-in to how we finance infrastructure.  Tonight, he'll be at Jefferson Tower in Oak Cliff from 6-8.  Go see him.  He's worth your time.


You would have to be a looooong time reader of this blog to remember the last time I harped on land value taxes.  I'm talking 2009-10, when this blog was younger and more active.  In sum, an LVT is a pigovian tax that taxes unimproved land within a city boundaries.  On one hand, it punishes land owners for under-utilization, speculation, and rent seeking.  On the other, it creates an incentive to do something with that land that is contributive to the necessary multiplier effect of agglomeration economies, cities without gaps in the fabric.

One of the reasons I was writing about it back then was in reaction to the downtown 360 plan.  This was around the same time we began hatching this plan you may have heard about.  Brandon and I discussed that the downtown plan was adding all cost, but doing little to drive demand high enough to the point where investment wouldn't require significant subsidy or the kind of charity that builds nearly half million dollar hotel rooms.  There is only one person that can and will do that.  To bring downtown back, we need hundreds if not thousands of investors and that only happens if the climate is favorable and market-oriented.

What we got was essentially, 1) do some streetscaping, 2) build some parks, 3) create some catalyst projects (which require public participation, subsidy).  If you catch it, all of those things require upfront public contribution.  They're all cost with little proven return, or a sub-linear ROI in that the return, while still above zero is less than one.  You can build parks all day long, but if you're not changing the real estate dynamics that don't favor investment in the area, what are we really doing?  That's why downtown is on course to be little more than parks and parking.  It's masterplanning that worked pre-2008.  But it's antiquated now.

We need super-linear ROI, which means changing the rules of the game.  It means taking out a highway, re-tooling the tax code to incentive improvement, and FOR GOD'S SAKE ELIMINATING PARKING MINIMUMS.   To me, that's real masterplanning.  Healing the market.


I bring it up again because economics writers have begun bringing it up, again.  Most recently by Ed Glaeser here and a few weeks back by Matt Yglesias who wrote that it works best in a place like Houston that we could call under-developed rather than say, San Francisco or DC -- which gets to the point of his book that zoning and height restrictions drive up rents in those places.  He's absolutely right in making the distinction.

I've been trying to figure out for years whether such a thing is kosher within the Texas state constitution.  Some states specifically forbid it.  About 5-6 years ago, I had the mayor of a West Texas town very interested in exploring the idea, even if it could just be some sort of overlay just in the downtown.  Unfortunately, a personal scandal shortly after derailed what could've been the first step into the world of LVT's in Texas.  Except it wouldn't have been an LVT.

One potential loophole isn't a pure LVT, but rather a Split Tax.  This is what we were discussing and what was done in my hometown of Harrisburg, PA.  Harrisburg is a tiny city in terms of land area (and population), punished by high tax rates to compensate for the large amount of tax exempt properties/jobs in the city as the state seat.  It pushes residents and businesses outside of the small core city into the suburbs and left the downtown all but dead (except for all of those state workers).  They instilled a split tax and vacancies dropped from 4000 to 400.

In Texas, we already assess land and improvement separately.  Then we lump them together and tax the two at the same rate.  A Split Tax would set a separate rate for that land assessment and another rate for the improvement assessment.  Typically, that means lowering the improvement tax rate and increasing the land tax rate.  In Harrisburg, the land tax was 6x that of the improvement tax.  I prefer the split tax, because land use improvements still require infrastructure so you can't let them off the hook entirely, but it encourages more land use for less infrastructure.  Efficient tax base to infrastructure balance.  Much like a 14" pipe doesn't cost much more than a 12" pipe but it holds significantly more.  Think about land development that way.

If you have an improved piece of property, it lowers your taxes.  That's why it works politically.  It also creates an incentive towards highest and best use.  It doesn't lower revenue from property taxes if you tweak it right.  Eventually, it encourages more investment and property tax revenue goes even higher due to the increased investment and improvements.

What does our current tax code incentivize?  Like any market, ROI.  However, in this case that means getting the absolute most revenue but while having the absolute minimum level of improvement.  What does that look like in the real world?  A parking lot.  

Our conception of "highest and best use" is tall buildings.  However, under the current paradigm, highest and best use for the property owner is actually a parking lot.  It's just not preferred highest and best use for everyone else, the public sector, the neighbors, the taxpayers at large, and people who just want a better downtown to be proud of.

For downtown to come back, we need everybody pulling in the same direction.  Right now, the rules of the game have us pulling in opposite directions.

Now, a not so hypothetical hypothetical.

Let's say there is a property in downtown that is about 2.5 acres.  You can fit 300 surface parking spots on that piece of property, which you can probably build for $150,000.  According to the way this parking lot is assessed, there is no improvement value.  Land is assessed at $50/foot.  Your land value is about $5.5 million.  Your improved value is 0.  So you're total assessment is $5.5 million.

Despite not having "an improvement," you still have enough of an improvement to generate revenue.  You have paving...which you charge $5 per day for those 300 parking spaces.  You're generating $300,000 a year in revenue.  Taxes take half of that.  Operations costs aren't terribly high for a parking lot, so you're still making profit.  Not a lot, but enough to sit on the land until the fairy princess sprinkles magical pixy dust of reckless investment, subsidy, or charity on your head.  So, you wait.  And development doesn't happen.

Instead of that 2.7% tax rate for city, county, schools, and hospital, we drop improvement taxes to 1.5% and raise land taxes to 12%.  In that instance, the parking lot owner is now taxed $600,000 on the land alone.  They're losing more than 2x revenue every year with O&M costs added in.  There is no improvement to be taxed, but also no improvement to generate more revenue and offset the higher taxes.

Now, for an improved property like the 5 story arts district lofts, their tax burden is $840k/yr.  Their property is worth $27M and land $3.5M.  In such a split tax, their taxes would drop 11,000.  Not much, but that shows us the base line.  What's the minimum amount of development appropriate for downtown land?  4-5 stories.  The new tax code creates an incentive to development that as a minimum.  Anything more is gravy.

Let's look at a tower.  If the improvement is $150M and the land is worth $6M, a tower's tax burden is currently about $4.3.  Under a split tax, their tax burden would be cut to $3M/year.

You want development?  You want to get rid of the blighted eye sores of vacant land and parking lots?  Re-write the rules of the game.