Creating Wealth Through Property Tax Cuts

Commentary, Taxation, Frontier Centre

Race riots convulsed Detroit, Michigan, during the sweltering summer of 1967. The urban middle-class fled the pandemonium. From 1960 to 1994, the population of inner-city Detroit declined by 41% while suburban populations grew by 30%.

Today, Detroit has approximately one million people, half of its peak population. However, the city is recovering and the reason offers lessons for our policy-makers.

Harry, a high-powered economist from Brantford, Ontario, resides in Indian Village, an eclectic community within Detroit proper. He recently described how a bold change in tax policy is reviving Motor City.

When he moved to the Village in 1985, about 80% of the city was categorized as "distressed." Whole neighbourhoods grimly lay abandoned. A tiny tax base remained to carry the cost of city services, and a handful of neighborhoods faced enormous property tax burdens.

High property taxes, in turn, depressed property values through a phenomenon known as the "tax capitalization" effect, which ties a property’s value to the financial cost of owning it. High property taxes mean low property values. Conversely, low property taxes create high property values.

Compare a house that pays $2,500 in yearly property taxes with an equivalent paying $6,000, a difference of $3,500. In order to come up with the extra cash, the owner of the latter property has to set aside other uses for that money. If interest rates stand at 5%, another $70,000 is needed to cover the difference (i.e. $70,000 X 5% = $3,500). The owner of the home with lower taxes is therefore ahead by that amount. His property is worth $70,000 more than the one belonging to the hapless homeowner with higher taxes.

Harry bought a substantial property in 1985 for $88,000, a 6,000-square-foot house with a swimming pool and three-car garage. His annual property tax bill was $6,500, about 7.5% of market value. As in Winnipeg, his property tax subsidized swaths of abandoned properties in other parts of the city.

Indian Village became a beachhead for broader urban revitalization. Artists and gays were the shock troops that bought tax-depressed properties and transformed the neighbourhood into a vibrant residential community.

But the policy hammer for fixing the city reduced the tax capitalization effect. In 1992, Michigan’s Governor increased the sales tax by two per cent and removed public school funding from property taxes. The impact was dramatic. The new tax structure made a sustained recovery possible. It chopped Harry’s property tax bill to $3,000. Today, his home is worth $335,000.

Harry points to the sharp reduction as the key factor pushing up property values in Detroit and statewide.

Not coincidentally, Winnipeg property owners face about the lowest property values in Canada. As a per cent of market value, Winnipeggers pay among the highest property taxes in Canada. The Michigan approach can change this and create a construction and renovation boom for Winnipeg.

Unfortunately, two obstacles stand in the way.

City council has missed the relationship between excessive property taxes and falling property values. They could lower property taxes substantially by introducing competition into services, and shifting to user fees. Instead, in a classic focus on the trees and not the forest approach, they pursue Mickey-Mouse policies like the New Home tax credit program, which cuts property values on its own and does nothing to correct the tax capitalization effect.

Now that NDP Saskatchewan and B.C. have cut taxes, the Filmon government presides over the highest tax regime in Western Canada. Only real public sector reform that improves the efficiency of provincial spending, particularly in schools, and the sale of assets would give it room to absorb the public school portion of property taxes.

Simple, isn’t it?