Topic:
PROPERTY TAX;
Location:
TAXES - PROPERTY;

OLR Research Report


May 2, 2003

 

2003-R-0419

COMPARISON OF THE SINGLE AND SPLIT RATE PROPERTY TAX SYSTEMS

By: John Rappa, Principal Analyst

You asked us to prepare an illustration showing the difference between the single and split rate property tax systems and how the latter discourages property owners from maintaining land in an undeveloped or underdeveloped state.

As the terms suggest, the difference between the two systems is whether land and buildings on it are taxed separately at different rates. In Connecticut and most of the other states, land and buildings are assessed and taxed as one unit at the same mill rate (i.e., single rate). But Pennsylvania allows 16 cities to tax land at a higher rate than buildings and other property improvements (i.e., split rate tax, also known as the land or site value tax).

Taxing land at a higher rate than improvements creates a powerful disincentive against keeping land in an undeveloped or underdeveloped state, proponents of the split rate tax claim. As illustrations 1 and 2 show, owners can offset the burden imposed by the higher land tax by developing the property to its highest and best use. Zoning, construction costs, and other factors determine the extent to which an owner can do this. But, his tax burden falls as he improves the land. The tax burden is ratio between the taxes paid and the property's fair market value.

The illustrations show what happens to a vacant lot after the owner improves it under the two tax systems. Both set the mill rate for the single rate system at 65.00 mills, which was Bridgeport's mill rate for 2001. They set the mill rates for split rate system at 49.00 and 16.00 mills for land and improvements, respectively (i.e., 49.00 + 16.00=65.00). These rates are intended to generate the same amount of revenue as the single rate example (approximately, $168 million).

Illustration 1 presents a scenario in which the improvements made to a vacant commercially zoned lot equal half the lot's fair market value. Under the single 65.00 mill rate, the tax bill jumps from $45,000 to $68,000 while the tax burden remains the same (4.5%). This penalizes the owner for improving the property, proponents of the split rate system claim. Under that system, the owner's tax increase is much smaller ($34,000 to $39,000) and the tax burden falls to 2.1%.

Illustration 2 shows what happens when the value of the improvements made to a commercially zoned lot exceed the value of the land. In this scenario, the owner makes greater use of the property: he builds a $350,000 structure on a lot that was valued at $250,000. Under the single rate system, his tax bill jumps from $11,000 to $27,000 while his tax burden remains the same (4.5%). Under the split rate, the tax increase is smaller (from $8,500 to $12,500) and the tax burden falls to 2.1%.

These outcomes cause many proponents of the split rate tax to theorize that it can simultaneously reverse urban blight and suburban sprawl. “All too often, land near public infrastructure (like a subway station or major road intersection) remains vacant or grossly underutilized because a landowner is waiting for a price in excess of what space users will pay today” (Hartzok, “Pennsylvania Farmers and the Split Rate Tax,” in Land Value Taxation: The Equitable and Efficient Source of Public Finance, 1999). (Connecticut law allows towns to address this problem by phasing in the increase in the property's assessed value after it is improved.) Proponents of the split rate system claim that it encourages owners to develop underutilized properties as a way to reduce the tax burden.

Waiting for buyers encourages developers to seek sites that are further away from public infrastructure. Consequently, “once the cheaper land is developed and inhabited, the occupants of this area create political pressure to extend the infrastructure to it. When this process occurs, land prices rise, choking off development there, (even though additional capacity exists) and again drives developers and users even farther into the hinterland” (Hartzok).

Illustration 1: How the Split Rate Tax System Theoretically Discourages Property Owners from Maintaining Land in an Undeveloped or Underdeveloped State When the Value of Land Exceeds Value of Improvements

Shifting the Tax Burden

The split rate property tax system penalizes property owners who fail to develop vacant or underdeveloped land. It does this by affecting the tax burden any property tax system puts on property. The tax burden is that share of a property's fair market value that equals the amount of property taxes the owner has to pay on the property.

Total Property Taxes Paid

_______________________

Property's Fair Market Value

The tax burden increases and decreases based on the property's fair market value and tax rate. For example, it goes down when taxes go down and the fair market value increases or stays the same.

Under the conventional, single rate tax system, the property burden falls evenly on the land and the buildings on it. That's because land and anything on it is assessed as one unit and taxed at one rate.

The split rate tax system treats land and any buildings on it as separate units and taxes them at different rates. In doing so, it shifts the tax burden onto the land by taxing it at a much higher rate. If the owner wants to reduce that burden, he must develop the land to its highest and best use. He will pay more taxes, but that will be offset by the increase in the property's market value.

Single Rate


Fair Market Value

$1,000,000

Assessed Value

$700,000

Mill Rate

.065

Tax Bill

$45,500

Tax Burden

4.5%

Vacant Lot Zoned for Commercial Uses

Split Rate Tax


Property

Fair

Market Value

Assessed Value

Mill

Rate

Tax

Bill

Land

$1,000,000

$700,000

.049

$34,300

Bldg

$0

$0

.016

$0

Total

$1,000,000

$700,000

NA

$34,300

Tax Burden

NA

NA

NA

3.4%

Same Lot


Fair Market Value

$1,500,000

Assessed Value

$1,050,000

Mill Rate

.065

Tax Bill

$68,250

Tax Burden

4.5%

The owner built a new store, worth half the value of the land. Consequently, his taxes went up and his tax burden remained the same. For this reason, critics of the single rate tax claim that it discourages owners from improving their property.


Property

Fair

Market Value

Assessed Value

Mill

Rate

Tax

Bill

Land

$1,000,000

$700,000

.0488

$34,300

Bldg

$500,000

$350,000

.0163

$5,600

Tot.

$1,500,000

$1,050,000

NA

$39,900

Tax Burden

NA

NA

NA

2.7

The owner built the same new store, but the consequences are different under the split rate tax system.

Instead of dividing the tax burden evenly between the land and building, the system shifts it onto the land by taxing it at a higher rate than the building. As the illustration shows, the owner reduced his tax burden by developing the property. In doing so, he increased its value by an amount that exceeds the amount of taxes he must now pay on the improved property.

Illustration 2: How the Split Rate Tax System Theoretically Discourages Property Owners from Maintaining Land in an Undeveloped or Underdeveloped State When the Value of Improvements Exceeds Value of Land

Shifting the Tax Burden

The split rate property tax system penalizes property owners who fail to develop vacant or underdeveloped land. It does this by affecting the tax burden any property tax system puts on property. The tax burden is that share of a property's fair market value that equals the amount of property taxes the owner has to pay on the property.

Total Property Taxes Paid

_______________________

Property's Fair Market Value

The tax burden increases and decreases based on the property's fair market value and tax rate. For example, it goes down when taxes go down and the fair market value increases or stays the same.

Under the conventional, single rate tax system, the property burden falls evenly on the land and the buildings on it. That's because land and anything is assessed as one unit and taxed at one rate.

The split rate tax system treats land and any buildings on it as separate units and taxes them at different rates. In doing so, it shifts the tax burden onto the land by taxing it at a much higher rate. If the owner wants to reduce that burden, he must develop the land to its highest and best use. He will pay more taxes, but that will be offset by the increase in the property's market value.


Single Rate

Fair Market Value

$250,000

Assessed Value

$175,000

Mill Rate

.065

Tax Bill

$11,375

Tax Burden

4.5%

Vacant Lot Zoned For

Commercial Uses

Split Rate Tax


Property

Fair

Market Value

Assessed Value

Mill

Rate

Tax

Bill

Land

$250,000

$175,000

.049

$8,575

Bldg

$0

$0

.016

$0

Total

$250,000

$175,000

NA

$8,575

Tax Burden

NA

NA

NA

3.4%

Same Lot


Fair Market Value

$600,000

Assessed Value

$420,000

Mill Rate

.065

Tax Bill

$27,300

Tax Burden

4.5%

The owner built a $350,000 office building on the lot, and, as expected, his tax bill went up. The higher taxes still constituted 4.5% of the property new fair market value.


Property

Fair

Market Value

Assessed Value

Mill

Rate

Tax

Bill

Land

$250,000

$175,000

.049

$8,575

Bldg

$350,000

$245,000

.016

$3,920

Tot.

$600,000

$420,000

NA

$12,495

Tax Burden

NA

NA

NA

2.1%

The owner's tax bill still goes up under the split rate tax system, but the increase is smaller due to the lower mill rate applied to the building. Instead of dividing the tax burden evenly between the land and building, the land value tax system shifts it onto the land by taxing it at a higher rate than the building. As the illustration shows, the owner can reduced the tax burden by constructing the office building, which increases the entire property's value.

JR:ro/ts