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Sounding the Revenue Potential of Land: Fifteen Lost Elements

Mason Gaffney

Text of an address delivered at the annual meeting of the Council of Georgist Organizations, held in Albuquerque, July 2004

© Mason Gaffney


“You see, my dear Watson, but you do not observe.” - Holmes

The revenue potential of land is greater than anyone thinks. This is a progress report on a study that finds, bares, and to some extent measures elements of enhanced revenue potential by using truer and more comprehensive measures of rent and land values. It should go without saying, but often does not, that the purpose of raising more land revenues is not to fatten vexatious bureaucrats. It is to replace vexatious taxes, to provide and maintain and operate needed public infrastructure and services (including a reasonable national defense), to pay off old public debts and avoid new ones, and to fund social dividends (including existing social dividends like Social Security and public schools).

There are at least fifteen elements of land’s taxable capacity that previous researchers have either slighted, or overlooked entirely.

  • Items 1-3 below correct for the downward bias in standard data.
  • Items 4-11 broaden the concepts of land and its rent.
  • Items 12-15 show how exempting production, trade and capital uncaps potential tax rates.

Correcting for downward bias in standard data (Items 1-3)

  1. Standard data sources neglect and understate real estate rents and values. These standard sources include:

    1. Assessed valuations used for property taxation. I will only enumerate, not elaborate much on the many reasons assessed values usually fall short of the market. This in itself is a dizzying experience, and you may want to skip ahead to point “b”. Scanning the bullets below, however, gives a clue as to how landowner pressure has subverted the property tax over the years.

      • Conventional use of fractional assessments in many states
      • Lag of assessments behind the rise of land values, and behind the fall of building values with depreciation and obsolescence. Increasingly, this extra-legal process has been institutionalized, as in Prop. 13, California
      • Use of capitalized income method for assessing business properties (other than apartments). The bias is against intensive uses in zones of transition (ecotones), at every margin between lower and higher uses.
      • Conventional preference given to acreage, regardless of location, regardless of industrial use. (Allis-Chalmers example in center of West Allis, Wisconsin. Omission of acreage from otherwise good studies by the U.S. Census of Governments under Allen Manvel.)
      • Classification of land for taxation, with preferential low assessment for lower uses (rarely are assessments above the market for any use, except apartments and rentals for the poor). In California, some favored use-classes are farming, timber, and golf. Alabama has another set of low-tax classes, favoring land in forests and hunting grounds, catering to the Heston vote in league with absentee corporate owners (and, for no visible theological reason, organized fundamentalists). Lands in classified uses are assessed by capitalizing their visible money income from the official use only, thus exempting from the tax base all values from rustic manorial, recreational, and blood-sport uses, and all speculative values based on higher future uses. In vast rural and sylvan areas these other influences are the main source of market value.
      • Assessments capped by zoning, even when the market does not believe the zoning will endure, or be enforced
      • Regressive assessments, swayed by case law which reflects differential ability to finance lawsuits and appeals.
      • Discounts for large lots or other holdings that should be subdivided
      • Failure to publicize assessed values. In some states the values are not even open to public inspection - Lee Reynis, Director of the Bureau of Business & Economic Research, University of New Mexico, has told this audience of secrecy enforced by law in New Mexico
      • Reluctance to recognize premium for plottage potential
      • Exempt lands, owners, and land uses. Churches, often targeted by critics, are minor offenders. Cemeteries are major: they also include commercial ventures holding vast lands for future sale. Commercial or not, they consume more than their share of water, often at preferential rates. In industrial dependent Milwaukee, cemeteries preempt more space than all industry, which helps account for the city's 20% population decline since 1960. Public lands held by schools and the military tie up much of San Diego. New York City and Washington, D.C., are notorious for their “free lists” of exempt lands. Once an agency acquires land it never again appears in the budget, so bureaucrats squander it.
      • Homestead exemptions, in some states - widely abused.
      • Preferential underassessment of lands with low turnover. Extreme underassessment of lands that do not sell: corporate holdings; proprietary golf clubs; dynastic holdings; inherited lands.
      • Rail and utility adjunct landholdings, i.e. other than their ROW. (These are state-assessed, not on local tax rolls; are assessed as acreage, usually, which means underassessment; anyway, taxes are passed on to ratepayers in the rate-regulation process. Vast holdings by rails, e.g. 10% of Chicago; 5% of Milwaukee; vast SP holding south of Market Street in San Francisco, and statewide. Hydrocarbon holdings by regulated utilities.)
      • Rights of way. Assessors ignore monopoly power inherent in ROW, assess ROW land on its value in the best alternative use
      • Discounts to large owners who have policy of slow sales or leasing. (Such discounts are given to Oregon timber; to Appalachian coal; and many extractive resources. They are given to laggards in ecotones.)
      • Conventional reluctance to base assessments on speculative values, even when condemnation awards are so based
      • Failure to assess land first, using maps (with building value as the “residual”)

    2. Use of IRS data on reported rents

      Many economists rely on data generated by the IRS, taken from tax returns, to tell them the sources of income in the U.S. This is an exercise in crediting bad data. The standard tax procedure of landlords is to deduct alleged “depreciation” from their net operating rents (“cash flow”) to arrive at taxable rents. They accelerate depreciation enough, usually, to report little or no taxable rent. This is what the IRS then aggregates and reports as the sum of all rents. To accept such fiction as fact is inexcusable, but economists do it anyway. Their credulity lends their authority to the IRS, while the IRS “official” status helps legitimize the economists - mutual validation of mutual error, the curse of science.

      When owner A has exhausted his tax “basis” by overdepreciating, he sells to B for a price well above the remaining basis. B then depreciates the same building all over again, then sells to C, who sells to D, and so on, so each building is tax-depreciated several times during its economic life. In any given year, most income properties in the U.S.A. are being tax-depreciated, even though most have already been depreciated once or more.

      In addition, all owners after the original builder are in a position to depreciate some of the land value, as well. This is because the owners control the “allocation of basis” between depreciable building and non-depreciable land. The IRS has no defense against secondary owners who overallocate value to the depreciable building. Congress has never authorized the IRS to develop any in-house capacity to value land. The most the agency does, if it will not accept the word of the tax filer, is to look at allocations used by local assessors. These parties, in turn (with a few notable exceptions), underassess land relative to buildings, by using the erroneous “land-residual” method of dividing land from building value. This is partly to accommodate their local constituents - assessors are locally elected or appointed, and do not report to the IRS. A little math will tell you that to depreciate land just once is to achieve perpetual tax exemption. To depreciate it again and again is a continuing subsidy for holding land.

      When A sells to B there is a large excess of the sales price over the remaining or “undepreciated” basis. This excess is, to be sure, taxable income. However, Congress has defined this kind of income as a “capital gain.” Most rents, therefore, show up as capital gains. These, in turn, are subject to lower tax rates, deferral of tax, forgiveness at time of death, constant pressure to lower rates to zero, and a dozen additional avoidance devices. These are known to every lawyer and accountant and Congressman, but not, apparently, to most economists, who lazily report from “official” data that rents are a low fraction of national income.

      In addition, the IRS reports nothing at all for the imputed income of owner-occupied lands, because this kind of non-cash income is not taxable. Todd Sinai and Joseph Gyourko of the Wharton School report aggregate owner-occupied “house” values in the U.S. in 1999 were $11.1 trillions. The annual rental value of that, figuring at 5%, would be roughly half a trillion dollars a year - quite a chunk to omit from the rental portion of national income. We also know that the prices of lands for both housing and recreation have risen sharply since 1999, perhaps by 50% or so, so that $11.1 trillion may be $16.7 trillion now. That means that the imputed rent income is 50% higher than half a trillion (i.e. ¾ trillion dollars), and also that the net worth of the owners has risen by about $5.6 trillion. Such silent gains are also a form of income from land. To all that, many economists remain blind, dumb, and curiously incurious.

      Sinai and Gyourko