Capitalized Property Taxes and the Viability of Rural Enterprise Subject to Urban Pressure

Abstract

There are two views on the impact of property taxation on the rate at which farmland is converted to urban uses. One view maintains that the tax contributes to the breakup of farms because it forces farmers to sell property in order to raise the funds needed to pay property taxes based on the potential of the land for conversion to urban uses-its highest and best use.1 The opposing view maintains that the property tax is neutral because it is merely capitalized into lower land values; what farmers lose in the form of tax payments they have gained in the form of lower interest paid or forgone as a consequence of reduced land values. They would therefore have the wherewithal to pay property taxes. In this latter view property tax concessions to farmland are of no help in prolonging that land use in the face of urban pressure since they have not added to that pressure in the first place.2 This second view is consistent with the opinion of many academic observers that a property tax, which is fully capitali7ed and which is shifted back to the price of land, is neutral towards land use because of the classical argument that a land tax is always neutral.3 Although I do not assert that complete capitalization always takes place-indeed when landowners are genuinely surprised by their tax liabilities this has not occurred-I shall show that in the context of rural-urban land use over time, a property tax which is capitalized and shifted back to the price of land is not neutral to the time at which farmland is converted to urban use. The effect is generally an increase in urban development, but not for the reason given above. Development is hastened because the discount rate effect of the property tax causes landowners to choose urban and rural uses for land which yield relatively quick returns. Therefore, while the property tax leaves undisturbed the relative profitability of farming and urban use, it does bring forward the time of commencement of the most profitable urban use and this shortens farm life. The policy implication is that if the property tax system is to be reformed to extend farm life in the interests of providing urban amenity, reforms should be made to the urban property tax system, not just the rural property tax. The impact of the property tax on the decision to transfer land from rural to urban uses is analyzed in the two following simple models. In the first model