July 14, 1988

To: Mr. Bernard Grandmaitre Minister of Revenue

Dr. Peter Adams, M.P.P. Peterborough

Dr. Eldon P. Ray, Chairman Mr. Malcolm McCarthy, Director Peterborough Site Value Assessment Committee

From: Francis Peddle, Ph.D. Canadian Research Committee on Taxation

Re: Comment on "A Background Brief on Site Value Assessment," Assessment Policies and Priorities Branch, Ministry of Revenue, Ontario, May, 1987

Introduction

Background

The "Background Brief on Site Value Assessment" prepared by the Ministry of Revenue contains the same errors, misrepresentations, and logical inconsistencies as previous documents on site value assessment (SVA) produced by the Ministry. These matters have been addressed before by the Canadian Research Committee on Taxation as well as by other researchers studying property taxation. Dr. Ray and Mr. McCarthy, in a widely circulated letter of August 9, 1984, critically analyzed a letter from the former Minister of Revenue, Bud Gregory, dated July 25, 1984. The late Professor Hans Blumenfeld also criticized Ministry research and thinking in the letter from Mr. Gregory. Professor Blumenfeld succinctly pointed out that since Peterborough was merely asking for a pilot study, and not implementation of SVA, most of the Gregory letter can be dismissed as irrelevant. More recently, I made a detailed critique of a commentary in the Assessors Review (Winter, 1983) on SVA, which was forwarded to Premier Peterson, and I critically examined, in an open letter to Toronto City Council, June 11, 1987, a Report from the Commissioner of Planning and Development that briefly, but incorrectly, dealt with SVA. Since then the Commissioner of Planning and Development, the City of Toronto Economic Development Committee, and the Assessment Reform Working Group have all recommended that a pilot study of SVA be conducted in Peterborough.

Issues

My view is that the Assessment Policies and Priorities Branch of the Ministry of Revenue has done an incomplete and unscientific survey of the economic literature on SVA. I have enclosed some bibliographical materials on the subject in this package in order to assist the Branch in its research.

The Branch confuses repeatedly the call for a SVA pilot study in Peterborough with implementation of this system of property taxation. Since the SVA Committee in Peterborough has already stated that it will substantially fund the project, the pilot study is hardly a diversion of scarce government resources.

The Brief erroneously declares that SVA has been implemented and impartially studied many times before in Canada. There has never been a comprehensive and proper study of SVA in Canada, despite the fact the Hellyer Task Force on Housing and Urban Development and many other researchers have repeatedly called for such an analysis. Nor has SVA as yet been implemented in the full sense of the concept anywhere in the world. The specious historical and empirical research material cited in the Brief must therefore be carefully qualified and circumscribed.

The Brief shows no knowledge or understanding of the deleterious economic consequences and social injustices of the current system of market value assessment. The Branch appears to be ignoring systematically the well-documented research available on the negative influences of the present property tax regime.

The Branch does not demonstrate in its Brief any understanding of the underlying economic concepts and principles of SVA, nor of taxation and economic activity in general, especially as it relates to land and urban economics. Its research is merely a highly selective historical and empirical account of scattered attempts to implement SVA, and not a rigorous conceptual analysis of the taxation of locational values and economic rent.

Recommendations

The Ministry of Revenue should cease issuing documents and briefs on SVA until it has done a comprehensive and objective survey of the economic literature on the subject and until it demonstrates an adequate knowledge of the tax principles underlying SVA.

The Minster should encourage both public and private sector study of the property tax system in Ontario so that a constructive and well researched alternative to market value assessment on total property value can be developed.

The Minster should approve of the pilot study of SVA in Peterborough because the development of accurate land value maps is crucial in deciding whether or not SVA is a viable and equitable alternative to market value assessment.

Detailed Comments

The Brief, in its Executive Summary, and in the main text, mentions Henry George and the "single tax theory." The primary issue, however, is one of sound tax principles, and not the historical question of how site value assessment (SVA) is derivative from George's tax on economic rent. The Branch shows no indication that it understands how SVA meets the two tests of both the ability-to-pay and cost-benefit approaches to taxation. P.I. Prentice states:

"A tax on unimproved urban location values is the only for which the ability to pay is actually created by the taxing community through the enormous community investment needed to make land in that location richly saleable. The only pertinent question therefore, is how much of this community-created ability-to-pay does the community want to take back in taxes and how much does it want to leave to the location owner. And to the extent that the land tax falls on a value created by the community rather than by the owner it conforms closely to the principle of taxation in proportion to benefits received."(1)

Meaningful discussion of property tax reform cannot take place until the fundamental principles of taxation are clearly and properly enunciated. Equity, objectivity, and simplicity in taxation are all conditioned by the cost-benefit principle as it interrelates with ability-to-pay.

The Branch discusses the introduction of SVA in Western Canada in the early part of this century. Most of the statements concerning this issue are selective and incomplete. SVA was not applied to any significant degree in Western Canada. The statement that "while the introduction of site valuation in Western Canada helped to break up large tracts of absentee owned land, the region also experienced the greatest land speculation in Canadian history," (p.2) is poorly written, since it implies that SVA contributed to, or did little to stem, land speculation during this period, which is a deceptive historical comment. A more accurate description of what happened in Western Canada during this period

1. P.I. Prentice, "Broader Policy Issues in Property Tax Reform," American Journal of Economics and Sociology, Vol.36, No.1, January, 1977, p.67. See also, Mary Rawson, "Property Taxation and Urban Development," Washington, D.C., Urban Land Institute, Research Monograph 4, 1961, p.30, and Land Values Research Group, The Social Effects of Municipal Rating: A Study Conducted in Footscray, 1944-45, pp.21-23. -4- is made by H. Bronson Cowan:

"The six eastern provinces in Canada have always used the capital system. The four western provinces have adopted the site valuation system in part. The rural areas in the three prairie provinces reduced the taxes on improvements a full 100% early in this century. Between 1903 and 1913 western Canada, under the capital system, experienced a boom of disastrous proportions. During that period land values in Regina increased from $10,490,720 in 1909 to $82,490,720 in 1914 - increase $71,718,390, or 684%; in Edmonton from $5,314,405 to $191,283,979 - increase $185,969,575, or 3500%; in Calgary from $2,289,655 to $120,801,588 - increase $118,511,933, or 5180%. During the boom both rural and urban municipalities in a frantic but belated effort to check it began to adopt the site value system. It was too late. All four provinces reeled under the shock of the depression. There was a disastrous crash in both land and improvement values. Its effects lasted until well into the thirties. During this period some municipalities increased their taxes on improvements in part. It has been claimed that these developments prove that the site value system was a failure. The facts are that in its early days it never had a chance to succeed. Most of the urban municipalities have continued to exempt improvements from taxation by percentages that run from small to as high as 70%."(2)

Crucial to any system of site value taxation is not only that improvements be untaxed but that land or locational value be uptaxed from current levels.

Creation of accurate site or locational value maps is the main reason for the pilot study of SVA in Peterborough. Until such maps are created, and a general inventory taken of land values in Ontario, one cannot talk in anything but speculative terms about normal values. And even then a base point of reference is necessary. The current property tax adds to 2. Canadian Tax Foundation, Fifteenth Tax Conference, 1961, p.87. See also, H.T. Owens, "Site Value Taxation," Canadian Tax Journal, Vol.1, No.2, April, 1953, pp.72-73. -5- land price inflation by subsidizing monopolistic practices in the land market. Current land values are therefore well above what they would be under uninhibited free market conditions.

The brief mention of SVA in Australia and New Zealand once again fails to give the complete picture. For example, the Branch does not mention that when municipal voters in Australia are given a choice between SVA and market value assessment, over 90 per cent of municipalities vote in favour of SVA. It might also be pointed out that Pittsburgh was recently cited as the most livable city in the U.S. in World magazine, and this is only with the contribution of a very moderate implementation of SVA.

The statements about proponents of SVA being preoccupied with development are unintelligible. Is providing affordable housing and rental accommodation for low and middle income earners really "one-dimensional" thinking? Is trying to shift the emphasis on short-run liquidity in our current tax system to more permanent and unearned wealth accumulation really one-sided? The Brief fails to take note of the integral components of SVA and how these interact with market economics. Present tax regimes distort the free market and violate property rights.(3)

SVA is far more compatible with zoning and planning requirements than the current system, which puts constant pressure on zoning densities and creates havoc in the area of urban planning.(4) It is the present property tax that creates downtown congestion because of urban scatteration. The statements in the Brief (p.4) about freedom of choice make little sense - it is land monopolization in its various forms, which is encouraged by market value assessment on total property value, that restricts freedom of choice for everyone - individuals, urban planners, and city governments.

Land or site value is not an abstracted or hypothetical value, but market value, this being derivative primarily from locational value. Site value assesses the value of land for tax purposes more on its "capacity-toserve" than actual current use.(5) Capacity-to-serve does not mean "highest and best use" in an arbitrary, "relative," and "unstable" sense (p.4). Capacity-to-serve is in fact the opposite of the "abstract" and "hypothetical" value attributed to "highest and best use" by the Branch. It is the highest currently economical use, and not "the highest use that may become economical in the future."(6) 3. See, for instance, Mason Gaffney, "The Many Faces of Site-Value Taxation," (Canadian Tax Foundation, Twenty-Seventh Tax Conference, 1975), pp.749-763, and D.M. Hagman, "The Single Tax and Land Use Planning: Henry George Updated," UCLA Law Review, 12, 1965. 4. See, Mason Gaffney, "Land Planning and the Property Tax," in R.B. Andrews, ed. Urban Land Use Policy (New York, Free Press, 1972). 5. Gaffney, "The Many Faces of Site-Value Taxation," p.751. 6. Id., p.752. -6- The Branch readily acknowledges market value as an objective and easily understandable form of assessment (p.11). The problem is that there appears to be an inability to see that the current property tax disguises the fundamental fact that it is really two taxes, one on site and the other on improvements. If this distinction is made, then the concept of market value becomes properly focused.

The property tax, as currently structured, plays a role in land use decisions to the extent that it encourages under- and non-utilization of land because of potential unearned increments. SVA, inasmuch as it loosens up the land market, would lead to greater flexibility and efficiency in land use decisions and development. Noted land economist Mason Gaffney, whose extensive writings on SVA are omitted from the Brief, states, with regard to the effect of SVA on land use decisions that, "It would have substantial effects on the incentives to develop and improve land, the time of decisions, and so on. There are a few studies suggesting the policy has little effect but these were studies of cases where there was actually little or no policy to cause any effect."(7) SVA would not impose economic penalties on those who own underdeveloped land. Rather, it would make possible a greater participation of scarce land resources in the urban and suburban real estate market. By utilizing land in accordance with market forces and demand, instead of ignoring this demand in anticipation of ever greater unearned increments, property owners under a SVA system would reap the economic and social benefits of improved housing stock and other community amenities.

The last paragraph on p.6 of the Brief is a good example of what has happened under the current property tax system. Every tax system will have certain anomalies. With market value assessment anomalies are more the rule than the exception. Under SVA the "hardship" exemptions will in most cases apply to less than 1% of total property assessed within a municipality. In addition, SVA would use a "special deferred assessment" where the city would collect deferred taxes in hardship cases when the property is sold or transferred upon relocation or death of the owner. In this way the community created site value is still recouped by municipal governments.

The Branch appears inclined towards referring to, without citing, studies which indicate low-income homeowners would experience tax increases on SVA (p.7). SVA will undoubtedly, over time, redistribute the tax load within the taxable jurisdiction. This is primarily because so many inequities have been built up, which have become rigidified within the current system. Land value maps are needed so these redistributions can be identified and measured. This is another important reason why the pilot study in Peterborough is necessary. Indeed, without information of this sort pertaining to every municipality in the province, nobody is really in a position to state accurately what the redistribution 7. Id., p.749. -7-of the tax burden would be. Discussion of equity should really be muted until such research is completed.

The studies cited on p.8 of the Brief do not recognize the interrelation of the ability-to-pay and cost-benefit concepts within SVA. None of the authors mentioned deal properly with the usually ill-defined concept of equity. C. Lowell Harriss, however, does say that "the equity aspects provide a strong case for shifting tax burdens from improvement to location values."(8) Harriss points out, when discussing the complexity of the concept of equity, that "ability-to-pay" is at best a highly ambiguous term. As popularly used, according to Harriss, it has "limited applicability in judging property taxation" and "even less usefulness for purposes of distinguishing the fairness of taxing land as compared with improvements."(9) In any case, ability-to-pay has only rhetorical significance in the tax regimes of public finance in Canada. A more accurate description of these regimes would be that, de facto, the system is governed by the ability to collect from those who have the least ability to resist taxation.

The material on an assessment appeal system (p.9) is irrelevant. Under an equitable and economically sound system there would be little need to resort to costly quasi-judicial procedures for determining "equitable" assessments. Anyhow, the courts have not been overly consistent in either defining market value or giving proper guidance to tax assessors. Furthermore, no one, to my knowledge, has ever suggested that a SVA system would dispense with a procedure for assessment appeals, as stated in the Executive Summary of the Brief.

The other comments on p.9 about the ability of SVA to control urban sprawl and speculation is refuted by the Brief's own statement (p.3) that in Australia and New Zealand SVA supports "only services of a local and basic nature." One can hardly expect SVA, within the context of the total tax structure, to realize its full potential if it is only marginally implemented. Since marginal implementation of SVA has been the norm historically, one cannot scientifically extrapolate from this data any accurate conclusions about its possible socioeconomic and fiscal impact.

The most objectionable part of the Brief is its frequent mention that SVA has been "widely rejected by impartial studies" (p.11). Only several instances of the inaccuracy of this statement need be cited. For example, the Executive Summary states that SVA has been rejected by the Smith Report, the Blair Commission Report, and the more recent Epp Report. and 8. "Equity of Heavier Reliance on Land Taxation (Location Value) and Less on Improvements," Tax Policy, September-December, 1970, p.11. 9. Id., p.2. See also, H.G. Brown, "Taxation According to 'Ability to Pay,' What It Means and What is Wrong With It," American Journal of Economics and Sociology, Vol.4, No.4. -8- on p.10 it is stated that "site value taxation" has also been rejected in Taxing Matters (1985). These statements are nothing less than disinformation that reveals the bias of the Branch against objective evaluations of tax reform proposals like SVA. There is no mention of site value taxation in the Blair Commission Report. The Blair Commission did report, however, that the assessment of vacant land at 100 per cent of market value "will make the mere holding of land for future value increments much less attractive, and that this would therefore tend to discourage those who might otherwise invest to this end. The result might be a moderating influence in the price of land where the greatest pressure now exists." (p.30).

Taxing Matters, which is a 187 page Report that primarily focuses on the more detailed procedures of assessment management and practice within the context of the present system, makes only the following brief statement about SVA (pp.145-146).

"While a useful presentation was made in favour of this option, it is concluded that relative tax burdens would be reduced for those with higher density buildings, and that the resulting tax burdens would be difficult to justify. It is also concluded that it would encourage the maximum development of all lands, which could serve to counteract the urban planning objectives of municipalities."

It is difficult to see how these two statements constitute an "impartial study" of SVA. The first statement, concerning the redistribution of tax loads, can only be made on the basis of accurate land value maps, which are not available and to which the Peterborough pilot study would contribute. The second statement demonstrates a fundamental misunderstanding about the interaction of SVA and the urban planning environment.(10) The greatest obstacle to modern urban planning is monopsonistic control of the urban land market. In any case, a greater utilization of undeveloped and underdeveloped urban land would in many cases lead to an easing of the pressure to increase land-use densities, which makes more economic and environmental sense.

The Smith Commission Report does not contain an in-depth and impartial study of SVA. This Report makes the same basic economic error as most studies on property taxation - it fails to distinguish between the effects of a tax on land or site and a tax on improvements. It was recommended by the Commission that real property, which is defined as "land and any building or other structure on, over or under the land," "be assessed each year at 100 per cent of actual current value," (Vol.II, p.119). This recommendation laid the basis for the subsequent attempts by the province to assess real property in terms of actual market value in the 1970's. 10. Supra, p.5. -9- H.M. Kitchen's Local Government Finance in Canada devotes one page to site-value taxation in a text of 495 pages. There are only two references to the the extensive literature on SVA in Kitchen's treatment of the subject. This is hardly an impartial and comprehensive study of SVA. Furthermore, Kitchen's quote from Netzer's Economics of the Property Tax, which is also quoted by the Branch, again without accurate citation, namely that "because 'there are no reliable estimates regarding the value of either the benefits of site taxation or the costs of making this change,' it would be quite unwise to consider such a transition," (11) naturally leads to the conclusion that studies of SVA should be conducted immediately in order to determine if going to such a system would be beneficial for communities as well as being cost effective.

Kitchen does appear to support SVA on efficiency grounds. "The current system of real property taxation distorts the use to which resources are put. Because of its relatively heavy impact on buildings and improvements in property, it reduces the quantity and quality of housing that would otherwise exist. In addition, it discriminates against industries that use large physical structures in their production process. A change to site-value taxation would not lead to such distortions, since the impact would be the same regardless of the use of the property."(12) Improved equity and allocation of resources would thus result from SVA implementation.

The Branch also cites Kitchen, who is citing Netzer, that it is difficult to separate the value of land or site from the total value of the property. This statement is contradicted by other authors.(13) Techniques for assessing land have been extensively applied and discussed in such works as Arthur Becker, Land and Building Taxes (Madison, University of Wisconsin Press, 1969), D.M. Holland, ed., The Assessment of Land Value (Madison, University of Wisconsin Press, 1970), J.F.N. Murray, Principles and Practice of Valuation (Sydney, Commonwealth Institute of Valuers 4th ed., 1969), and the publications of the Land Values Research Group in Australia as well as in many other studies. Workability cannot be a reason for rejecting SVA. It would essentially use the same assessment and collection machinery that already exists for property taxation. The significant difference is that a SVA system would be considerably more uniform, simple, and understandable than the present structure.

The final points in the Brief (pp.10-11) on why the call for a pilot study in Peterborough should not be complied with can be briefly addressed in the light of what has already been mentioned in this commentary. First, 11. H.M. Kitchen, Local Government Finance in Canada (Toronto, Canadian Tax Foundation, 1984), p.217. 12. Ibid. 13. For example, see, Gaffney, "The Many Faces of Site-Value Taxation," p.749. -10- it is feasible to separate land from improvement value. Second, site value is not an abstract or hypothetical value since "highest and best" use means capacity of the land to serve, which is the highest currently economical use. Third, SVA is not a complete departure from the present system since the tax base utilized will be the market value of the site or location and the assessment of locational values will use the same assessment and collection machinery as the current system. Land, generally, is underassessed in the present property tax structure, so revisions in assessment will be necessary. Finally, the present updating of Ontario's property assessment is highly erratic in implementation with Toronto being the major problem. After implementation of SVA, assessment could be updated on a regular basis so that market changes are accurately reflected in valuation changes.

The Brief on SVA prepared by the Assessment Policies and Priorities Branch of the Ministry of Revenue fails to explain site value assessment. Nor does it give an accurate and complete presentation of the economic literature available on the subject. The call for a pilot study of SVA in Peterborough is both timely and necessary. Such a study, if properly done, would add considerably to our knowledge about site value assessment and make possible informed and objective judgements about whether or not it is a more equitable, economically efficient, and socially just alternative to the present system of municipal taxation.