Across the United States, county and municipal governments raise revenue through property taxes, based on a percentage of the value of land and all the structures built upon it. Economists, however, have long recognized a problem with that system: The higher the value of the structures, the higher the tax will be, which means that property owners are disincentivized from building on their land. This runs counter to the pursuit of tax efficiency — which essentially means raising revenue without changing behavior that is beneficial for economic growth.

“There’s a long literature in economics that says if you want an efficient tax, you need to tax inelastic factors of production,” says Darden Professor Daniel Murphy. That calls for taxing something that’s not going to change with economic activity — when it comes to property, taxing the land rather than the structures built upon it. “Although economists disagree on many things, the efficiency of a land tax is one of the few things for which there is a general consensus.”

He explores that idea in a new paper, “Implicit Land Taxes and Their Effect on the Real Economy,” co-written with Nathan Seegert of University of Utah.

Theory and Reality

While a land tax may seem superior in theory, there’s a problem: Property taxes are the way things have typically been done. “There’s a lot of hesitation to make any big change like that without broad-based evidence,” Murphy says.

Despite that fact, the city of Detroit made headlines this past fall by announcing it was considering a shift to taxing land differently from property structures — an effort to combat the blight caused by neglectful landlords and to spur economic improvement.

Using a novel technique, Murphy and Seegert’s paper gives a shot in the arm to such efforts by providing empirical evidence that land taxes spur development in the real world. They do that by using a random distribution of land taxes sitting right under economists’ noses, something they call an implicit land tax.

The Implicit Land Tax

Here’s how it works: Every county has an assessor who values a property based on some combination of the land and the property built upon it — and depending on the county, some assessors might weigh one of those categories higher than the other. It’s a percentage of that value that owners pay in property tax.

That’s different, however, from the actual value of the property as set by the market. “The sales price will be some aggregate of people’s preferences,” Murphy explains. “We can get some sense of how much they value a section of land itself versus a big house with a lot of bedrooms.”

By comparing the difference in the assessed value and the market value — and then seeing how that corresponds to the actual amount of land on each property — it’s possible to determine how much each individual county taxes the land versus the structures on it.

“We might see in one county they really tax land relative to the market value, while in another they really tax structures,” says Murphy, “and it’s pretty random.” In the area around Atlanta, for example, the tax rate for land varies dramatically for counties right next to each other — creating the gold standard for a social science experiment: random variation.

When the researchers compared these implicit taxes with other demographic indicators, they found a clear pattern in property taxes. “When it’s more heavily weighted toward land, an area has higher economic growth,” Murphy says. That’s consistent with the theory that land taxes would spur more development than the traditional property taxes that include the structures on those land parcels in the taxation formula.

Growth and Diversity

In addition to higher economic growth, the researchers also found that property taxes with a greater weight placed on the land itself were associated with denser population — and more diversity in race, age and income.

“That diversity is likely a result of concentration of the population,” Murphy says. “The parts of the United States with the most population density also tend to have more mixing, while in the suburbs, things have historically been more segregated.”

With the increased tax efficiency that comes with taxing land, it’s cheaper to build residencies, which means the cost of living goes down, making the area more affordable. And Murphy and Seegert also found more businesses opening in these areas — which also makes sense, since a denser population provides a larger customer base for stores and restaurants.

All of this is good news for municipalities like Detroit that might be considering implementing a land tax — and, in a way, good news for economists to see their theories borne out by actual data.

From Research to Practice

Shifting the entire country to a land tax would not be easy. Someone who owns a big single-family home in the suburbs, for example, could potentially be hurt by such a shift, even while property owners in the densely populated city would win out. Farms would provide another difficulty — there would be cause for debate about whether that land should be taxed at the same rate as commercial or residential properties.

“There would be huge distributional effects from this, and people who live on large lots of land would lose out, so you’d have to figure out how to compensate them or how to transition over time to make it fairer,” Murphy says.

In addition, switching from a national income tax to a national land tax would mean grappling with the fact that income taxes are progressive, meaning those who make more money pay a higher rate, while presumably land taxes would be consistent no matter how rich a person was. “You’d have to think really hard about how a land tax could be made progressive or how to increase progressivity in other areas of the tax and transfer system,” Murphy says.

Despite these challenges, Murphy and Seegert’s paper shows that there could be potentially huge benefits to changing systems of taxation, especially for municipalities looking to increase economic development. “Land taxes have long been considered a good way to raise revenue for localities without hurting other aspects of the economy,” Murphy says, “and we’re providing broad-based evidence that that’s true.”

Daniel Murphy co-authored “Implicit Land Taxes and Their Effect on the Real Economy” with Nathan Seegert of the University of Utah.

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About the Expert

Daniel Murphy

Jung Family Associate Professor of Business Administration

An expert in economics and public policy, Murphy researches the nature of consumer demand and its implications for market outcomes. His work addresses international issues and macroeconomics, including the determinants of cross-country price differences, the causes of fluctuations in the price of crude oil and the consequences of asymmetric economic growth.

Prior to joining Darden’s Global Economies and Markets area in 2013, Murphy was a National Hunger Fellow and research associate at the Urban Institute.

B.S., University of Notre Dame; M.A., Ph.D., University of Michigan