This image shows a mostly undeveloped parking lot, occupying a full block of prime real estate in the heart of downtown Minneapolis. Why does this lot remain underdeveloped? The owner of the land could increase their income drastically if they developed the land to its fullest potential. Additionally, the city as a whole would gain significantly from a more productive use of the land.
For example, a new apartment building could help increase housing stock in a city in the midst of an affordable housing crisis. More office space would increase the tax base by bringing in new workers to downtown, while new commercial businesses could easily serve thousands of existing residents thanks to the lot’s central location and easy access to transit. Building a new park in this space would add more greenery to the city and give the 50,000 downtown residents a new place to relax. And if the owners thought that parking was the best usage of the plot, a new parking ramp would still be a better use than a flat lot.
So if the landowner and the city both stand to gain from new development, why doesn’t development happen? One of the biggest reasons is that our tax code actually discourages new construction from taking place, in the form of property tax. Just the threat alone of an increased tax burden can make it unprofitable to construct new and useful developments.
Fortunately, there is a better way — the land value tax. Popularized by the American economist and politician Henry George, the land value tax has been advocated for by Benjamin Franklin, Thomas Jefferson and Adam Smith, among others. It has support from across the political aisle. The conservative icon Milton Friedman famously called it the “least bad tax,” while Joesph Stiglitz wrote that a land value tax would “would reduce inequality and … enhance growth.” Mentions of an LVT date back even to ancient India!
What is a Land Value Tax?
To explain how a land value tax works, it’s easiest to compare it to property taxes. When properties are assessed for taxes, the total value of the property is taxed at a flat rate. To get the total value of the property, the value is split up into two amounts: the value of the land itself and the improvements that are built on top of the land.
For example, the IDS Center in downtown Minneapolis has a land value of $25,233,700, and an improvement (building) value of $278,971,300, giving us a total market value of $304,205,000. With a traditional property tax, both the land value and improvements value are taxed at equal rates. A 3.7 percent property tax would mean the IDS must pay about $11 million a year in taxes. However, using a land value tax means only the land value ($25,233,700) is taxed, and the value of the improvements ($278,971,300) is left untaxed.
Why do we want to leave the value of the improvements untaxed? Essentially, choosing not to tax improvements removes an extra cost associated with building improvements, and makes it much easier and more profitable to actually build new developments. Take the vacant lot pictured above. Because there isn’t much built here, the majority of the property value consists solely of the land value, and the property tax ends up being very light, under $500,000. However, what if the parking lot owner wants to redevelop into something better? Here’s a quote from the owner of the lot in question:
“There isn’t any, I believe, surface parking lot owner in the city of Minneapolis that would rather have a surface parking lot as opposed to having the next IDS Center built on his or her piece of real estate … If there is somebody who thought they could make money on an office building, there would be an office building under construction at this moment.”
https://www.minnpost.com/politics-policy/2016/06/why-does-downtown-minneapolis-still-have-lot-surface-parking-lots-its-compli/
If any landowner wants to redevelop their property to increase usage, the city should welcome that idea with open arms. Instead our current tax code actually discourages it from happening. A hypothetical new office building at this space might project to bring in $5 million a year in increased profit, after accounting for construction and maintenance costs. However, if the amount of property tax goes up by $6 million (the amount that the office building across the street currently pays), then the developer would actually lose money on the new building, and it would be better for them not to build it at all.
To alleviate this issue, authorities may occasionally grant tax abatements, but it is more equitable and simple just to grant this tax reprieve in the form of eliminating property tax. With just a land value tax, no new costs would be associated with the office building, so it becomes viable for the lot owners. As a result, the lot owners gain by improving their income, other companies in downtown gain through the benefits of agglomeration, and the city’s economy grows thanks to the increased utilization of land overall. Everybody wins!
Although empty parking lots present the most obvious case of how removing the improvement tax rewards productive land use, this same shift in the cost-benefit analysis happens with development at all levels. In a city using land value taxes, building a residential duplex or triplex might be more viable than a single-family home, a proposal for a six-story apartment building could now become more profitable as an eight-story building, and businesses of all sizes will be free to redevelop extra, unneeded parking space. Even if we look at residential housing at the individual level, a land value tax removes disincentives for people to take better care of their property. With a land value tax, the owners of an unmaintained, run-down home would be encouraged to improve their home, since they would have no tax burden from any of the renovations.
Other Benefits
Other than incentivizing development and good land use, land value taxes have a few other notable benefits:
- LVT is progressive. Because the supply of land is inelastic, it is impossible to pass on an LVT from landlords to renters or consumers, unlike property tax.
- LVT is difficult to evade. Companies and individuals might be able to shift all their income to the Cayman Islands, but they will have to leave their land behind.
- LVT minimizes the downsides of the economic boom/bust cycle, since it discourages land speculation.
How would a land value tax work in Minneapolis?
Here are a few options of the many ways to implement a land value tax in Minneapolis:
Option #1: Replacing Minneapolis Property Tax with Land Value Tax
The financials behind our property tax are messy since there isn’t a single flat rate. It varies from city to city, and even from neighborhood to neighborhood. Hennepin County collects the tax; the county keeps some of the money, and the rest is divided up among the cities. For simplicity’s sake, and to keep these proposals at the city level instead of the county level, I will consider only the share that Minneapolis counts toward its local city budget, about $462 Million in 2020.
In 2019, Hennepin County assessed the value of the land in Minneapolis as about $11 billion, and the improvements on that land as about $44 billion, giving us an effective average property tax rate of 0.85 percent. This ignores the share of property tax spent by Hennepin County. To raise the same amount of money by just taxing the land, this would give us a new LVT rate of 4.2 percent.
This idea could become more politically palatable by reducing the scope of the land value tax. Instead of applying the LVT to every single property in Minneapolis, we could apply it to commercial properties only, or the downtown neighborhoods only, or properties very close to transit nodes, for example.
Option #2: Replacing Minneapolis Property Tax with a Two-Tiered Rate
This option means that both land and improvements would be taxed, but at different rates. Several cities in Pennsylvania, such as Harrisburg and Pittsburgh, have taken this approach.
The ratio between the land and improvements varies from city to city, but a typical ratio would be 6 times, meaning that the tax rate on improvements is six times lower than the tax rate on land. To generate the same $462 billion in revenue using a 6 times split tax rate, this would give us a land tax rate of 2.52 percent, and an improvement tax rate of 0.42 percent (compared to a flat 0.85 percent before).
Option #3: Replacing Minneapolis Sales Tax with Land Value Tax
The land value taxes aren’t comparable only with property taxes. We can use them to replace other sources of revenue as well, such as sales tax. Getting rid of sales tax makes sense for two main reasons: First, sales tax is regressive. People at lower income levels generally have to pay a higher percentage of their income on sales tax than richer people.
Second, sales tax discourages consumption, as taxes on elastic goods decrease demand for those goods. The most famous example of this would be the “sin taxes” on alcohol and tobacco, where the explicit goal of the tax is to lower use of the products. The same effect, though unintentional, happens with sales tax as well. However, we don’t actually want to reduce consumption; it’s in the best interest of the city to have people spending money at our local restaurants and businesses.
In 2020, sales tax is projected to bring in about $94 million into the Minneapolis city budget. With a new LVT of 0.9 percent, we could eliminate the local sales tax. If we wanted to combine this with the first option to replace property tax, we would end up with a new LVT rate of 5.1 percent, allowing us to eliminate completely both sales tax and property tax at the city level.
Option #4: Using Land Value Tax for Value Recapture
In addition to replacing existing taxes, we can implement the land value tax as a way to recapture some of the value generated by various government programs. The value-capture model has been used to fund transit programs to great success in cities like Tokyo, Singapore and Hong Kong (though the method of recapture is different than LVT).
For example, let’s take a simple 1 percent LVT in Minneapolis, which would raise about $110 million. Here are some ways we could spend that money with the explicit goal of increasing land values in Minneapolis.
- We could upgrade the operations of every single local bus route in Minneapolis to a bus rapid transit (BRT) level for $72 million per year.
- We could double the operations budget for the Minneapolis park system for $89 million per year.
- We could implement the entire All Ages and Abilities Bike Network for a one-time cost of about $27 million.
- In 2014, the latest data I could find, Nice Ride cost about $3.3 million per year. We could allocate some of the LVT revenue toward buying more scooters and e-bikes, and building more stations. We could even make Nice Ride free to use for all Minneapolis residents!
Option #5: Land Value Dividend
It would also be possible to use the revenue from a land value tax to fund a universal dividend, payable to all residents of the city of Minneapolis, similar in concept to Alaska’s Oil Dividend. A 1 percent LVT would raise about $110 million, enough to give the 430,000 residents of Minneapolis about $250 per year. This approach would combine the appeal of using LVT to incentivize more efficient use of the land with the social and economic benefits of universal basic income. At a high enough LVT rate, this could entirely fund a universal basic income program above the poverty level (though this approach would probably be more effective at a higher scale).
Because this plan would be revenue-neutral, some people are bound to lose out when comparing the increased tax versus dividend amount, but most residents of Minneapolis would benefit greatly from the program. Renters make up 53 percent of the population, and they would all come out ahead, as they receive the dividend, but wouldn’t face any increase in living costs (since LVT is impossible to pass on to renters).
If we look at single-family homeowners, the breakeven point for the tax is about $25,000, as anybody who owns less than this much land would receive more from the dividend than they would pay in taxes. This number is multiplied for each member of the household, so the number would be $100,000 for a family of four. Considering that the median home value in Minneapolis is about $300,000, and land costs are usually 20 to 30 percent of the home price, a significant proportion of homeowners in general, and probably a majority of families, would come out ahead with the dividend.
Challenges to implementing a Land Value Tax
If Minneapolis actually wanted to start collecting a land value tax, they would face a number of roadblocks. The city would likely need to get permission to collect this type of tax at both the county and the state levels, which could be difficult. It’s also possible that land value taxes are actually illegal to implement under Minnesota state law, as it is in a few other states.
Even if the legal obstacles were overcome, passing a land value tax would face significant political opposition. There’s a reason why LVT is so rare around the world – most landowners would naturally block such a tax under the impression, rightly or wrongly, that they would be negatively affected by it. It doesn’t help that landowners tend to be wealthy and wield significant political power as a small minority.
However, even landowners may benefit from a transition to LVT if they are making efficient use of the land. This population would generally include condo owners, multifamily housing owners (like duplexes or townhomes), and even families living in single-family homes. Landowners who aren’t making efficient use of the land presently, but want to in the future, would also benefit since an LVT would significantly lower the cost of development.
Conclusion
For the past several years, the Twin Cities has been experiencing huge amounts of growth in population. However, it’s vital that this population growth is accompanied by a corresponding increase in new housing. If we don’t keep up with this exploding demand (and we haven’t), then the result will be skyrocketing rent, a loss of affordable housing and residents being pushed out of their own neighborhoods. Just compare Tokyo, a city that has managed to keep housing prices stable for decades, with San Francisco, where a lack of building has caused rent to increase 70 percent since 2010.
In light of this, it’s ridiculous that our current tax policy actually discourages new development and instead incentivizes wasteful land usage. It’s time to start spreading the word about land value taxes with local residents and politicians and demonstrate our commitment toward sustainably improving and growing our city. Implementing a land value tax is the single greatest step we can take to lower housing costs, encourage new housing and incentivize higher-quality development in Minneapolis.
Thanks to Kelvin Liu for his help in collaborating and editing this article.
Hey keep yer darn hands off my favorite building, the last remnant of downtown in the 1880s! https://minnesota.cbslocal.com/2019/05/30/130-years-young-minneapolis-oldest-apartment-building-is-getting-restored/
Other than that, great column!
Just what MN needs, another tax. People who don’t have much in the way of assets are all for raising taxes. On everybody else.
It wouldn’t be “another tax”, we’d be using LVT to replace existing sources of revenue (like property tax). The benefit is that LVT has zero economic deadweight loss, unlike pretty much every other type of tax that we have today.
Moderator note: I deleted a comment. No need for name calling or personal asides. Please consider everyone’s comments as if they are sincere.
Great article, gave me a lot to think about. Thanks
I’m having trouble understanding why LVT can’t be passed to tenants. I’ve googled and gotten two unconvincing rationals:
1. Really smart people have said it.
2. Rent is what the market can bear and is not set by landlord costs.
#2 would seem to apply to any tax, not just LVT. As a landlord, I know that taxes and cost impact the amount of rent I collect. Can someone please explain it or direct me to an explanation? Thanks
Essentially, in a competitive market, landlords set rent at a level that maximizes profit, not based on individual costs. If they price rent too low, they lose out on potential income. If they price it too high, their customers move to a lower priced competitor, and they sell less units overall. So the reason why a landlord wouldn’t raise prices due to a LVT is the same reason a landlord doesn’t raise prices now – it would lower their total profit. This is true because LVT doesn’t change the supply or demand of land, so the price level where profit is maximized remains the same.
On the other hand, a property tax does change supply – a higher property tax means developers build less property. When supply goes down, the price with the highest profitability shifts up, meaning that a landlord can (and will) raise rents to increase profit further.
Here’s an explanation that goes into more detail: https://bluerepublik.wordpress.com/2019/07/31/welfare-economics-of-the-land-value-tax/
Thank you, that is exactly what I needed, I understand and agree with the theory. I don’t think it will work out that way in the wild.
Like the supply curve, the rental housing demand curve is nearly flat; many (perhaps most) renters don’t have the option to exit the rental market (but landlords do)
Switching costs are enormous (and asymmetrical between landlords and tenants.)
Most rental housing is provided by individual investors. We are not homo economicus; many of us are not profit-maximizing so much as hassle-minimizing. I profit maximize in year one, then in subsequent years I only increase rent due to cost increases. I would have no problem passing on costs of any kind. I don’t know for sure, but I think this approach is common. If I couldn’t pass on the increased taxes, I’d just exit the market.
Thank you again for the article and the response.
Thanks for the question! Yeah so in your case, if you are setting rent lower than the optimum, profit-maximizing point, then you might be able to increase rent to meet the LVT. However, it’s important to note that LVT isn’t giving any landlord a new ability to increase rent, they could have increased rent before but chose not to.
Another thing to note is that most landlords who own apartments or multifamily housing (duplexes, fourplexes, etc), would probably see their taxes go down with a LVT vs Property Tax, since these types of housing are typically much better uses of land per acre than the average building. The landlords could pass on these savings to their renters (but probably wouldn’t if they are profit-maximizing).
Finally, a LVT would increase the supply of property overall, since we’d be changing the incentives to promote more and higher-intensity building. This increase in supply would bring prices down for renters who are looking to switch apartments, or move in from a new city.
The crux of the explanation is that the increased taxes would be paid by single family owners and it would have to be dramatic, right? If the tax on all these commercial buildings and apartment buildings which are all essentially owned by corporations and as you pointed out, there are some significant decreases in commercial taxes, the only one left to pay are the individual SFH owners. You’d have a account in a few years to a
dramatic decrease in the value of “average to expensive” SFH’s so their land value would have to go down quickly because the value equation just changed so it would no longer be worth the value they paid/it’s assessed at? What do you estimate the “house/land value” would be at a break even point? $300,000 is the average cost of SFH’s are selling in Minneapolis.
It seems the net effect would be to reduce homesteaded single family detached housing in the city in favor of investor owned rental property in various forms as the premium for owning a house with a private yard in the city vs the suburbs increases even more than it already has. Most homeowners don’t have the wherewithal to build ADUs or even raze their house and rebuild as a duplex, triplex, or condo building, and if that’s the living situation they wanted they would have bought one of those initially. So it will be investors large and small buying houses rather than people that want to homestead.
It’s fine of that’s what the city wants to happen or views a decrease in homesteads as an inevitable side effect for the greater good of increasing housing, but I though I’d point that out.
I mean there could have been plenty of homeowners who didn’t mind living in a duplex, or even preferred a cheaper duplex over a more expensive SFH in the same location. However, because duplexes and above were illegal to build, they weren’t available to move in, so those homeowners bought a SFH instead. The net effect would to make denser development more attractive by removing the penalty that somebody has to pay if they want to build up.
Why can’t investors and homesteaders be the same people?
They could, but that doesn’t mean it’s going to be common. Maybe the mindset of a single family detached homeowner in the city is different than me, and there’s a writer here that’s writing about their experiences getting an ADU build. But I think I speak for a lot of people when even if I could I have no desire to build a duplex or an ADU on my lot, I have no experience in construction, tenant management, or financing, nor do I want to give up the privacy that comes from one dwelling unit on one lot. If a land value tax came to Bloomington and made living on a private lot untenable, I’d sell, to probably a real estate investor who would build a duplex or whatever, then move to another city. My home is a place to live, not an investment opportunity, I make enough money to live on doing my day job.
More curious than anything, is your analysis more of just a theoretical exercise? MPLS has very few empty lots to build on and the cost to bulldozing/rebuild is pretty high.
I’m planning to write a follow-up post that analyzes and maps out which parcels in the city would experience an increase in property tax, and which parcels would see a decrease. In general, if we replaced a 0.85 property tax with a 4.2 LVT, any parcel where land value is worth less than 20% of the total property value would see a their tax amount go down. However, like I mentioned above, there are a few ways to structure this so that SFH owners aren’t negatively affected – you could only apply LVT to parcels downtown or only commercial nodes. You could also create a homestead exception to mitigate this. You could even charge different levels of LVT to commercial vs residential properties. It all depends on the cities priorities, and how they want to encourage development.
The core problem with a land value tax is that it fails to consider the government’s cost of maintaining properties. Although the parking lot looks a lot worse, the city spends almost no money maintaining it. By comparison, a large apartment building requires the city to spend money on water supply, transportation, park land, and so much more. Developments create administrative burdens for cities. Currently this is not a problem because property tax increases pay for this increases government cost but LVT eliminates this mechanism.
Certain costs, like police or schools, scale linearly with population growth. But not all costs do – including most of the ones you mentioned actually. If you replace every single SFH in a neighborhood with a 10-unit apartment, you might need to build 9 new schools to handle the increased population. However, the amount spent on roads, the sewer system, or transit lines, or parks would increase at a far slower rate. https://3kpnuxym9k04c8ilz2quku1czd-wpengine.netdna-ssl.com/wp-content/uploads/2015/12/sprawlurban.jpg
This is a fair criticism though. Costs will rise somewhat with new development, and it’s possible that these costs rise faster than the value of the land does (since every time you build a new school or transit line, land values will increase somewhat). If LVT doesn’t generate enough revenue on its own, it would have to be supplemented with a two-tier system or user fees. However, it’s really hard to say if this will be an issue without actually implementing it in practice. If the worst case is a two-tier system, that’s still better than the model we have today.
Proponents of LVT will say that parking lots are a poor use of land because the city had to pay for water and sewer lines to run in front of a property that doesn’t even need water or sewer. On the other hand, water and sewer lines should be paid for from fees for services, and not from taxes.
Any forward looking approach needs to recognize that the “land value” in the Hennepin County books today is not accurate and a conversion to LVT would require a comprehensive revaluation and allocation. It’s pretty typical across Southwest Minneapolis to see in the system a house with a value of say $500k where the land is $150k and the rest the building improvement – however it’s also common to see smaller/older houses through the region sold down and demolished for $500k or more – so clearly the value of the lot in that case was $500k but the county on paper valued it at $150k.
LVT is really just a social engineering tax, but nobody ever says that. Proponents generally want parking lots to go away so fewer people will drive due to increased parking costs. Notice that the author also said that LVT should be used to pay for transit.
There are a dozen or two dozen large high rises in Minneapolis. If they each pay $5 million less in property taxes then the rest of the properties in Minneapolis have to pay more to cover that $50 million loss of taxes. If homeowners pay less and large property owners pay less then the burden will probably fall on small businesses.
Also, landlords of office space don’t pay property taxes from their profits. Office buildings charge tenants operating costs in addition to rent. Operating costs include things such as cleaning, property taxes, electricity for common areas, elevator costs, snow removal, and so on.
To me, the term “social engineering” is vacuous. All policy is social. Engineering is social. Our society is literally engineered to do things, such as carry water into people’s homes or sewage out of them.
Tax policy should reflect our social values and this seems like a great situation to improve that relationship.
It is only considered an improvement to those that want force people out of cars. Every time LVT is brought up the first thing mentioned is getting rid of parking lots.
I don’t want to live in a big city or an apartment ever again. LVT is really designed to encourage multi-family housing.
Parking lots are fine if they pay equivalent taxes. Parking your car should be expensive, if that’s what land putting your car somewhere when you are not using it is worth. Cities should not subsidize private car storage through the tax code.
Parking lots do pay equivalent taxes. They pay the same tax percentage as other properties.
Great article! Join the MN Chapter of Common Ground USA here: https://commonground-usa.net/?page_id=5317 Then you can help us pass the Land Value Tax Districts bill, first introduced in 2016. More info on the bill here:https://www.minnpost.com/community-voices/2020/02/land-value-tax-a-promising-land-use-tool-proposed-for-our-communities/?hilite=%27nymoen%27