An Introduction to Two-Rate Taxation of Land and Buildings
Cohen, Jeffrey P., Coughlin, Cletus C., Federal Reserve Bank of St. Louis Review
When taxing real property at the local level in the United States, land and improvements to the land, such as buildings, are generally taxed at the same rate. Two-rate (or split-rate) taxation departs from this practice by taxing land at a higher rate than structures. This paper begins with an elementary discussion of taxation and the economic rationale for two-rate taxation. In theory, moving to a two-rate tax reduces the deadweight losses associated with distortionary taxation and generates additional economic activity. The paper also provides a history of two-rate taxation in the United States and a summary of studies attempting to quantify its economic effects. Discussions of the practical and political challenges of implementing two-rate taxation complete the paper.
"In my opinion, the least bad tax is the property tax on the unimproved value of land, the Henry George argument of many, many years ago."
--Milton Friedman, as quoted in Mankiw (2004), 1976 Nobel Prize laureate in economics.
"The property tax is, economically speaking, a combination of one of the worst taxes--the part that is assessed on real estate improvements ... and one of the best taxes--the tax on land or site value."
--William Vickrey (1999), 1996 Nobel Prize laureate in economics.
Revenues from the taxation of real property play a key, and frequently controversial, role in the funding of elementary and secondary education as well as many other publicly provided services. Our focus is on one suggested improvement of property taxation known as "two-rate" or "splitrate" taxation. When taxing a specific parcel of real property in the United States, the same rate is usually applied to the land as well as to the improvements to the land, such as buildings. The opinions expressed by Nobel Prize winners Milton Friedman and William Vickrey are at the root of proposals to differentiate the taxing of land from the buildings on that land. Such proposals have attracted increasing attention from researchers and policymakers in Connecticut, Massachusetts, Virginia, and Pennsylvania in recent years. (1)
The two-rate proposal is a modification of the extreme case in which the only tax levied is on the value of land. Taxes on the value of buildings, as well as all other taxes, would be zero. Thus, the owners of buildings would no longer pay a property tax; only the owners of land would be taxed. Such a pure land tax approach was advocated by Henry George in a book published in 1879, Progress and Poverty. He argued that land should be taxed at 100 percent of its "rental value." (2) George reasoned that the land value tax would increase efficiency (and the wealth of society) by allowing governments to abolish taxes on improvements to land, as well as eliminate all other forms of taxation. He also cited equity reasons for the "single tax" on land. (3) Namely, increases in land value (exclusive of improvements) in the early 1900s were due primarily to an entire community's private-sector and public-sector economic activities rather than the actions of the specific land owner. Therefore, George argued, land owners should not benefit disproportionately from city growth, and the tax on land would allow for the redistribution of these unearned gains. (4)
A pure land tax, however, is not without some faults. First, it is not easy to measure the value of land net of improvements, and this would make it difficult for government to determine the amount of the land tax. This shortcoming of the pure land tax would also be present with the two-rate tax. Second, if a pure land tax were to capture all current and future rent from the landowners, the market value of the land would become zero. This would be equivalent to the government taking the land from landowners. Thus, people would have no incentive to hold land, leading to abandonment of the land, and likely resulting in governmental decisions about how the land should be used and by whom. …