Downtown Tax Fix
December 2014 - Sam Gamble
Have you ever taken a close look at downtown? Have you noticed how many parking lots, empty lots, lots undergoing environmental remediation and underutilized structures there are? Land already tied to city infrastructure (like water, sewer, power and roads) whereas elsewhere in town, new lots, requiring all these services to be constructed are still being built. Obviously location plays a part; not everyone wants to live or work downtown, but with downtown lots roughly twice as valuable as non-downtown lots, basic supply and demand tells us that something else must be at play.
Question: Why do property owners sit on prime land in downtown Yellowknife land which is clearly underutilized for years, or even decades?
Answer: Because the current property tax regime makes it incredibly cheap to hold onto land. In fact, it’s so cheap that it’s an incentive to buy and hold even vacant land.
Property taxes are calculated by multiplying the total of its 2012 assessed value of land & buildings by the tax rate. Different property types are taxed at different rates, ranging from 0.6% for residential to 1.278% for commercial & industrial. A downtown lot owner with a lot worth $1,000,000 is therefore paying $12,780 of taxes each year, half of which are tax deductible against earnings on other properties, making the net cost of owning the lot less than 0.64%. That is less than the rate of inflation for every year in the past two decades except 2009. Sprinkle some gravel and a pinch of plug-ins and, like magic, you have easy money: A decent inflation-hedged investment. The problem being, the City is left with an empty lot and is required to open up and maintain new land at a much higher expense to satisfy ever increasing demand for land.
For the City of Yellowknife
Broadly speaking, there are three main types of taxes: taxing income, taxing consumption (GST, user fees, tobacco tax) & taxing assets (property tax). Taxing assets is probably the least economically sound way to tax. Unlike income and consumption taxes, there is a potential mismatch between asset values and the ability to pay the corresponding taxes. Taxing primary residences is an example of this mismatch. In many locations in Canada property values have outpaced incomes. For many, something like retirement or having a family can put your income out of sync with your property’s increasing value. Suddenly, what seemed like a good thing (your home increasing in value) means your home is now less affordable for you to stay in. You could find yourself “living beyond your means” on a house you own with no mortgage.
Unfortunately, taxing assets is the City of Yellowknife’s largest source of revenue (40%) as well as the most controllable (other sources of income are transfers from governments, land sales & user fees). This is a recipe for a political nightmare (just ask any Kam Lake resident). Given that the City is stuck with taxing assets, how does the City raise revenue in a fair manner that doesn’t incentivize non-development?
Stick and Carrot
In general, governments should tax ‘bad’ things rather than ‘good’ things to encourage things that are better for society. A classic example of this is a “vice” tax that makes smoking such an expensive habit, or on the other hand, the subsidies to recreational activities. In terms of downtown development, the City is clearly aiming for densification and renewal. Empty lots, rundown buildings, empty buildings and low density housing are bad for a cityscape and expensive to keep services maintained, they are Yellowknife’s “vices”. Yellowknife wants to kick that habit and build new, high density buildings and avoid empty lots. As a city it will keep our expenses down and make our city more vibrant.
I propose that the City look at implementing a split tax system with an aim to eventually get to a land tax only form of property tax. Taxing the land instead of the structures on them are the best way to make people value it. To do this, the City would gradually have the mill rates for the land portion of property taxes increase while the building portion decreases. Overall property taxation can remain the same and normally utilized land would see no change in taxation, however under-utilized land would be taxed in a way that would encourage development.
The Current Approach
Of course this isn’t how the city is currently solving this issue, otherwise I wouldn’t be writing this.
Recently, the City has made news approving the purchase of the empty lot on the corner of Franklin & 50th Street for $1.45 million as a strategic acquisition. Strategic land acquisition is tool in the kit of cities around the world and is a potentially good idea; it can promote smart growth and urban renewal. For the City it was a way to deal with this “empty lot” issue but was it really necessary in the case of the Franklin / 50th Street lot?
Based off the current mill rates (12.78 for commercially zoned property), owning the property costs an owner only $14,000 per year, which is about 15% less than what the owners of the Fiddles & Stixs building pays in property taxes (approx. $16,500) for their building on 52nd Street. No wonder the land has remained vacant. For an owner who doesn’t take opportunity costs into account and with no debt servicing costs (safe assumptions given that it’s been vacant for so long and the space is barely even used for parking), there is essentially no penalty for staying with the status quo. Why go through the risks and hassle of building something, when you can just sit on the property and watch the land value increase?
A Split Tax System
How would a split tax system work in this case? You would need to carefully calculate the land rate to apply to the downtown core so that the overall tax taken in by the city doesn’t increase. I don’t want this to be a tax hike in disguise. Using Fiddles & Stixs as an example, if the City determined that $16,500 is the ‘right’ amount of property taxes for that property, I could then apply a different mill rate to the land and building components of their assessment. The Fiddles and Stixs building has a land value of $219,010 and the improvements are valued at $1,291,290. In order to maintain the current property tax bill for Fiddles & Stick and lower the building tax to zero, the land would need to be taxed using a mill rate of 75.
Applying the same split to the Franklin property would increase the property taxes to $82,700 per year, essentially the tax rate that would be paid if a modern 3-4 story building was built there. Maybe the City would still need to purchase the lot to get it developed, but at least the City wouldn’t be fighting what is essentially their own incentive to not develop.
How Could it be Implemented?
Ideally a Land Tax system would be implemented for at least Yellowknife’s downtown core, however instantaneously implementing the new tax regime would be almost guaranteed to be disastrous. Implementing a Split Tax Rate with a gradual and predictable schedule towards a Land Tax system would allow current owners of underdeveloped land plan ahead. If I knew my taxes were going up to $82,700 a car park isn’t going to do the trick, it’s time to develop the land or sell it to someone who will so that you can pay that tax bill. A delayed schedule would need to be implemented for single family homes within the downtown core, we’re targeting the taxation version of squatters here not currently occupied and well used dwellings.
Gaining Steam Internationally
Economists love land value taxes, but they’re not super common because they are beneficial for society while being hardest on traditional landowners who are politically powerful, good luck passing these sorts of reforms in the United Kingdom where aristocrats sit on massive swaths of the county. Luckily though, in Yellowknife we don’t have too many landholding aristocrats so we do have a big advantage there.
Yellowknife wouldn’t be the first jurisdiction in the world to implement such a system. Land Value Tax (only taxing land values) and Split Taxes (different rates for land & buildings) are done all over the world. Portions of Australia (New South Wales, its most populous state) and the US use Land Value Tax. Modern economies like Denmark, Singapore, Taiwan & Hong Kong also use Land Value Taxes. It’s well suited to encourage density, and density is well suited to Yellowknife’s cold and expensive maintenance costs. Those other jurisdictions might have large populations, but Sydney certainly doesn’t have to circulate the water flowing under their city in winter and Taipei doesn’t have to regrade their roads biannually.
Additionally, local jurisdictions in the state of Pennsylvania have the option of a split tax rate and implementation that allows studies of its effects. These have shown that those that have implemented a Split Tax have seen more construction: More buildings for homes and businesses to occupy in the town.
Can We Do it?
While changing the structure of property taxes in Yellowknife will be difficult, we’re all paying for these squatters. Maintaining kilometers of pipes, power and roading around empty and unused lots costs money. The structure we have in place is creating an incentive for landowners to avoid developing downtown Yellowknife at the cost of all the taxpayers who have built or bought well used buildings on their land. These properties area drag on the value of neighbouring properties while benefiting from the value added to the neighbourhood by those that do develop around them, essentially freeloading on nearby development investment.
A Final Example
Here’s one final example: Say you’re a large, publically traded company with hundreds of environmentally contaminated sites throughout Canada. You have a set annual budget which allows you to clean up a few pieces of land and sell them at market price while the others are slowly remediated using less expensive methods. All else being equal, which site would you elect to clean using the quick, more expensive method?
- Site A – which costs your corporation 1.278% of the asset value
- Site B – which costs your corporation 7.5% of the asset value
The answer for a large corporation is much the same as a regular person deciding which credit card to pay off first. Pay the one off with the highest interest rate, cleanup Site B and leave Site A for a later day.
So What is a Mill Rate?
You may have heard mill rates mentioned in discussions related to property taxes. A mill is 1/1000 of a dollar. Property taxes are computed by multiplying the taxable value of the property by the number of mills levied. In this article we’ve made things a little easier to follow by converting the millage rates to percentages. Yellowknife’s current millage rate on commercial is 12.78 and residential is 6.00.
How Taxes Work
A single family home in Frame Lake South has an assessed value of $500,000 ($100,000 land & $400,000 in improvements). The mill rate for residential is 6.00, therefore the annual taxes would be $3,000 ($500,000 / 1,000 x 6.00). If you had a similar property in Kam Lake, say a $400,000 house on $100,000 of land with some RV & boat parking – despite having the same assessed value, the Kam Lake house would be taxed $6,390 because it’s industrial which is taxed higher. Add the fact that Kam Lake residents are on (less desirable) trucked water & sewer and you can see why they might be upset.