Revitalizing An Old City: A Better Way
The voters narrowly defeated the plan of Lakewood officials to take homes from their owners in order to sell them to politically favored developers. The episode attracted attention because of the political, legal, and constitutional issues, but the economic issues are also important.
Replacing $20 million of existing real estate with a development valued at $150 million will not be a gain of $130 million for the tax base of Lakewood unless values in the surrounding areas stay constant. The Heartland Institute of Chicago recently published a study of "tax increment financing" (TIF), the financing technique that Lakewood plans to use to assemble and clear the land and build infrastructure for the redevelopment. In TIF, the city issues bonds to pay for its share of the project and repays the bonds with the increased tax revenue attributed to the increased assessment of the TIF district.
The Heartland Institute study analyzed changes in the TIF district and in the surrounding community, as well. The basic result is that the gains in the TIF district are offset, or more than offset, by the losses in the surrounding areas. If, for example, a movie theater is part of the West End development in Lakewood, it may be profitable. Unless more people go to the movies, however, existing, unsubsidized theaters in the surrounding areas will lose business and perhaps fail. For those of us who watched the new retail development at Tower City suck the life out of Euclid Avenue, such offsetting losses are a very real threat.
The Heartland Institute study found a net decrease in jobs as a result of losses in the surrounding areas. Most disturbing, the number of businesses decreased as activity concentrated in a small number of relatively large firms in the TIF district. The loss of small businesses is especially troubling because they provide the vitality and character that make city living more interesting for some people than the sprawling suburbs with their look-alike malls.
Old, fully developed cities do have real problems. Existing land use, determined decades ago when commuting modes and living styles were different, may be inappropriate today. Moreover, cities that are primarily residential are always struggling for tax revenue. Redevelopment must happen, but how can it occur without heavy-handed governments taking homes and pretending to know what kinds of new land uses will succeed in the market?
There is a better way! It starts from the recognition that the one scarce and unchanging input in a city is the land. Other inputs move-people move in or out quickly, and with just a slight delay they can take their capital with them as buildings deteriorate or are built and renewed in response to market signals. The land is always there, but the value of land changes to reflect the development potential of that land as perceived by the investors and developers who make their living by guessing correctly whether the best use of a parcel of land is an old single-family house, a luxurious condominium, a movie theater, a unique shop, a discount store, or an office building.
If a particular parcel would be worth far more with intensive redevelopment, one has to ask why the homeowner has not heard that message. The most likely reason is that the land value appraisal for tax purposes is not really "highest and best use," but rather reflects continued use as residential property. If the homeowner were taxed for the full value of a parcel that is worth a million dollars in its highest use, he would be more eager to sell at the market price of $1 million.
An even better approach (which requires action at the state level) is to eliminate the tax on buildings and other improvements and levy the entire tax on the value of land. Such a land value tax (LVT) has no negative effects on the economy, but rather puts constant pressure on landowners to develop the property in the ways that produce the greatest value for the community. Best of all, land use would evolve through the decisions of individual landowners, rather than being a game for politicians and a few big players.
William S. Peirce is a Professor Emeritus of Economics, Weatherhead School of Management, Case Western Reserve University and member of The Buckeye Institute's Board of Research Advisors.
