The Effect of Shifting the Property Tax Base from Improvement Value to Land Value: An Empirical Estimate

Abstract

In the literature on property tax reform, one change that is often recommended is either a replacement of the general property tax by a land value tax, or at least a move in this direction by differentially heavier taxation of land than of improvements (a graded property tax).' Chief among the changes expected by supporters of site value taxation are lower housing costs and more efficient use of urban land. It has long been maintained that a land value tax is neutral in its effect on land development decisions, and that a general property tax discourages capital intensity in development. A change to site value taxation should therefore increase the capital intensity of real estate. However, even if the direction of the effect seems clear on theoretical grounds, the actual magnitude of the effect may be small. The purpose of the present study is to estimate the effect on capital intensity of urban land development of a reduction in the tax rate on improvements accompanied by an increase in the tax rate on land value, with total property tax revenues held constant. First, we briefly develop a model of investor decision making, which predicts the impact of land and improvement taxes on capital intensity of urban land development. Then we describe the sample of buildings which serves as the data base to estimate the parameters of the model. Finally, we predict the impact that a reduction in the property tax rate on improvements would have on the optimal capital investment in improvements for the sample of properties.