Conventional wisdom and basic economic principles would suggest that an area subject to higher commercial and industrial property taxes than its nearby neighbors will suffer reduced economic development in comparison to those neighbors. On the other hand, any effort to reduce such unequal or “classified” property tax rates will produce a revenue shortfall. Raising taxes on homeowners to equalize rates and recover this lost revenue will encounter enormous and obvious political resistance.

This is the situation currently facing Cook County and the city of Chicago, and was the subject of a conference led by Therese McGuire of the Institute of Government and Public Affairs (IGPA) at the University of Illinois at Chicago. Held last September and cosponsored by the Lincoln Institute, the IGPA, and the Civic Federation of Chicago, the program brought together more than a hundred business and civic leaders, academics and practitioners to consider alternative methods of addressing the problems presented by the Cook County classification system.

In Illinois, the use of a property tax classification system by Cook County has been blamed for the economic decline of Chicago and the inner suburbs. The classification system is also seen as a barrier to reforming school funding and the state’s tax system. Are these charges valid? Does the classification system put Cook County at an economic disadvantage compared to its rapidly growing adjacent “collar counties”? If classification has so many shortcomings, why was it instituted in the first place? If we are only now recognizing those shortcomings, what steps can be taken that are both economically and politically feasible to overcome the problems?

Overview of Tax Classification

Illinois has long operated under the twin principles of uniformity and universality for both real and personal property, and both principles were incorporated into the Illinois Constitution of 1870. However, de facto or administrative classification of real property developed in Cook County as a response to the difficulty in taxing personal property in the same manner as real property. By the 1920s, the Cook County assessor publicly acknowledged assessing residential property at 25 percent of real value and business property at 60 percent.

A 1966 Illinois Department of Revenue report noted that Cook County was using 15 different classification groups. Despite the fact that classification was clearly in violation of the 1870 Constitution, the Illinois Supreme Court had refused to confront the issue. By the late 1960s, however, the court was prepared to overturn the existing system, and the 1970 constitutional convention faced the potential threat of court intervention.

The convention was the product of numerous reform efforts in Illinois during the previous decade. The state had failed to find a compromise redistricting plan after the 1960 census, causing the entire Illinois House to be elected as at-large members in 1964. That election brought many reformers to office, and a House-created commission charged with recommending constitutional reforms subsequently called for the 1970 convention.

Several delegates on the convention’s revenue committee were passionately in favor of uniformity, and they had considerable support from experts who opposed classification as a matter of economic policy. On the other hand, the Chicago delegation was adamant in demanding that the new constitution legalize classification. It was generally believed that without legalization, the new constitution would not have the support of Chicago Mayor Richard J. Daley and his delegation, in which case it would fail to pass.

As a result, the 1970 Illinois Constitution allowed counties with a population greater than 200,000 to classify property for taxation. The extension of classification to these large counties was also allowed for the collar counties because many taxing districts crossed those county boundaries. Cook County’s system was thus guaranteed, but the Constitution gave the General Assembly the power to apply limitations because of concerns there would be a crazy quilt of classifications should the collar counties adopt that system. Nevertheless, no collar county has done so.

Today, Cook County’s classification system is considered by many to be an impediment to Illinois’ attempts to deal with a variety of social and economic issues. Politically, classification is believed to be partly to blame for the failure to reform education funding in Illinois. In 1997, then Governor James Edgar led an unsuccessful attempt to convince the General Assembly to gradually shift the burden of education funding from property taxes to income taxes. One of the strongest arguments against the effort was that it would be a windfall for businesses and corporations, whose property taxes would be shifted to individual taxpayers. That shift would have even been greater in Cook County, which has more than 47 percent of the state’s entire assessed value and where businesses pay property taxes at a rate double that of homeowners.

Impacts on Economic Development

In terms of economic development, some observers believe that classification puts Cook County at a disadvantage in the eyes of business people who might consider locating in Illinois or expanding their operations in the state. While there are obviously other factors involved, the concern is that classification would cause these companies to look more favorably at locations in the collar counties or other states.

Recent research has shown that high property taxes do have a negative effect on the market value of property and do deter businesses from locating in the affected areas. Studies of property tax differences in the Boston, Phoenix and Chicago areas have shown that, because higher property taxes mean higher rents and lower market values, real estate development shifts from the high-tax area to the low-tax area over time. Other studies have shown that manufacturers seeking to relocate are very sensitive to local property tax rates. New construction and retail trade are also affected negatively, although the service sector is not as influenced by high property taxes.

Is this the case in Cook County? A recent study by Richard Dye, Therese McGuire and David Merriman, all affiliated with the IGPA, found that the effective tax rate of Cook County (5.52 percent for commercial and 5.78 percent for industrial property) is higher than in the collar counties, which have an average rate of 2.54 percent on all property. Furthermore, they found that four measures of economic activity-growth in the value of commercial property, the value of industrial property, the number of establishments and the employment rate-were measurably lower in Cook County than in the collar counties. But is that the end of the story?

No, according to the study’s authors. A multifaceted national trend is dispersing population, employment and business activity away from metropolitan centers to outlying counties. To determine if it is this national trend or specific property tax differences that is causing slower economic growth in Cook County, the study examined the characteristics of 260 municipalities in the Chicago metropolitan area. The researchers used two samples of municipalities-one metro-wide and the other limited to those near the Cook County border, where the effects of higher tax rates should be most potent.

The researchers presented their results, at the conference finding, “weak evidence at best that taxes matter.” Once other influences on business activity were factored out, the researchers determined that, for the entire six-county region, employment was the only economic activity that seemed to be adversely affected by property taxes, although in the border region the market value of industrial property was also affected. “The bottom line is that the evidence is mixed and inconclusive,” said McGuire. “There is no smoking gun.”

Another participant in the conference challenged this interpretation of the results. Michael Wasylenko of Syracuse University, who had been asked to review the study in advance and discuss it at the conference, said he was convinced that the researchers did find significant effects because the employment measure is a better measure of economic activity than the others. “I think the weight of the evidence suggests that these results are consistent with previous findings that property tax differentials will have a substantial effect on employment growth within a metropolitan area.”

If the employment factor, then, is the one to be given the most weight and Cook County’s property tax classification system is economically disadvantageous, in addition to being a political roadblock to reform, what is to be done? “It comes down to whether the economic gains that might be realized if you went to a non-classified tax are worth the political battles. Are the economic development advantages enough to want to do this,” said Wasylenko.

The economic and political stakes in this decision are high, since Cook County currently levies more than 50 percent of all property taxes in the state. The county cannot rapidly shift a large part of the tax burden among classes of property, but neither can it ignore concerns that the tax burden on businesses located there place it at an economic disadvantage with regard to its nearby neighbors. Any solution must be approached as a component of the overall tax system, be grounded in verifiable data, and have significant support from the public, the media and business interests. The September conference sought to contribute to that process of informed public debate on a crucial fiscal topic.

In early December, the Cook County assessor proposed reducing the assessment ratio (the ratio of assessed value to market value) for certain types of business property: from 36 to 33 percent for industrial properties such as factories and distribution facilities; from 33 to 26 percent for large investor-owned residential property; and from 33 to 16 percent for multiuse storefront businesses with apartments on upper floors. The assessor’s hope is that more favorable treatment of business will lead to even more rapid growth of the tax base over time. While these recommendations came out of several different tax studies, any changes in assessment rates must by approved by the Cook County Board before they can be implemented.

Scott Koeneman is communications manager at the Institute of Government and Public Affairs (IGPA) of the University of Illinois in Urbana, Illinois.

References

Dye, R., T. McGuire and D. Merriam. 1999. “The Impact of Property Taxes and the Property Tax Classification on Business Activity in the Chicago Metropolitan Area.” Lincoln Institute of Land Policy Working Paper.

Giertz, J.F., and T. McGuire, “Cook County, Ill., Assessor Proposese Changes in Assessment Levels,” State Tax Today. Dec. 7, 1999.

Man, J. 1995. “The Incidence of Differential Commercial Property Taxes: Empirical Evidence,” National Tax Journal, 48: 479-496.

McDonald, J. 1993. “Incidence of the Property Tax on Commercial Real Estate: The Case of Downtown Chicago,” National Tax Journal, 46: 109-120.

Wheaton, W. 1984. “The Incidence of Inter-jurisdictional Differences in Commercial Property Taxes,” National Tax Journal, 37: 515-527.

Source: Illinois Department of Revenue

The interactions between land and property markets and the broader economy of cities and nations are central to the Lincoln Institute’s concerns. Two key objectives of our work in this area are (1) to raise awareness about the stakes of good land policy for creating well-functioning land and property markets and for improving the performance of financial markets, labor markets, the fiscal affairs of local and national governments, and ultimately the economic health of both cities and countries; and (2) to indicate the need for high quality data and an appropriate analytical framework to aid in understanding the importance of good land policy, monitoring the effects of land policies throughout the economy and facilitating policy reforms. In November 1997, the Lincoln Institute held a conference on the theme of “Land Prices, Information Systems, and the Market for Land Information” to explore these issues.

Land Values and Land Policy

How important are the stakes of good land policy? Hee-Nam Jung of the Korean Research Institute for Human Settlements reported on the importance of land markets in the economies of five countries (see Table 1). The value of land in mature economies such as Canada, France and the United States ranged from about one-third to three-quarters of GNP during the mid-1980s, and represented from 8 to 21 percent of estimated national wealth. In the more rapidly growing economies of Japan and Korea, land values were from three to six times as high as GNP in the 1980s, and represented half or more of estimated national wealth. In the mature economies these figures illustrate the importance of land as a source of wealth, but in rapidly growing economies land has an even more significant role in determining economic welfare and a host of incentives for the performance of the economy.

In Japan, for example, booming land and property values during the 1980s served as collateral to fund credit expansion throughout the economy and, indeed, throughout the world. Land prices in Japan’s six largest cities increased dramatically from 1980 to 1991, at a compound rate of about 12 percent annually (see Figure 1). By 1990, the estimated price of land being developed for residential purposes in Tokyo was estimated to be about $3,000 per square meter, compared to figures of roughly $110 in Toronto and Paris and $70 in Washington, D.C.

Between 1991 and 1996, however, Japanese land prices fell by nearly half, taking down the Japanese economy and a host of financial institutions in its wake. The cumulative losses of the Japanese banking system associated with the collapse of the property market and associated businesses are estimated around $1 trillion, making the U.S. Savings and Loan “crisis” seem comparatively insignificant. Analysis of Japanese land policy suggests some of the causes of the boom and bust cycle in land prices: policies that have severely restricted conversion of agricultural land to urban uses; an especially complex land development system that requires exceptionally long times for approvals; and a fiscal system that places little emphasis on the taxation of land and property values.

Land prices in Korea also rose at a tremendous rate during the 1980s-over 16 percent annually from 1981 to 1991. Remarkably, in most years nominal capital gains on Korean land were greater than Korea’s GNP. Jung explained that these gains had profound implications for the distribution of wealth and income in Korea, and for economic incentives. Not surprisingly, the recent collapse of Korean property markets has had tidal effects throughout the economy. As in the case of Japan, the Korean land policy framework has been seen as highly questionable. Government intervention in land and property markets over the years has been responsible for severely distorted markets that represent a major structural imbalance in the Korean economy.

Using Land Market Data for Policy Analysis

Other speakers at the conference presented information on the importance of land market performance for a variety of stakeholders throughout the economy: consumers and taxpayers; land developers and builders of residential and non-residential properties; banks and financial institutions; and both local and central governments. In the case of Cracow, Poland, Alain Bertaud from the World Bank indicated that policies embodied in master plans and zoning regulations were highly inconsistent with the nominal objectives of the regulations, and would lead to inefficient and costly spatial patterns within the city. His paper illustrated the value of having good data on land prices, regulations and the spatial distribution of the population in order to evaluate the effects of policies involving land use, infrastructure and property taxation.

Paul Cheshire from Oberlin College and Stephen Sheppard from the London School of Economics illustrated how data on land and housing prices, land and housing characteristics, and regulations can be used to evaluate the effects of government policies such as the preservation of urban open space. Jean-Paul Blandinieres of the French Ministry of Equipment, Transportation and Housing discussed an ambitious program of the French government to establish “Urban Observatories” to collect and analyze information on land and property markets and the effects of government policies.

Data Collection on Land and Property Markets

Recognition of the costs of land policy failures or, conversely, of the benefits associated with implementing good policies, has given rise to a number of systematic efforts to collect and analyze high quality data on land and property markets within various institutional settings. Pablo Trivelli discussed land and property information systems in Latin America that serve the needs of public and private stakeholders. Perhaps the most impressive of these is an effort in Brazil called EMBRAESP, which monitors key indicators of urban property market performance along with urban legislation, land regulations and major public works projects that might have an impact on the behavior of property markets. Data and analyses from EMBRAESP are of interest to many institutions throughout Brazil. The distribution of the information is self-sustaining through contracts with major newspaper chains, sales of periodic bulletins, disks containing standard data, and special reports responding to individual demands. Much of this information can also be accessed through the Internet.

Another major data collection and analysis effort was reported by David Dowall from the University of California-Berkeley. He developed the “Land Market Assessment,” a tool for analysis of land and housing markets that has been applied in over 30 developing countries and transitional economies. At comparatively modest cost, data are collected through aerial photos and satellite images, surveys of land brokers, and secondary sources on population, infrastructure and regulatory frameworks. Dowall’s analysis of the experience with these assessments documents a number of generic policy findings, especially concerning the costs of inappropriate land policies. His work also suggests that even more cost-effective versions of the tool can be developed that will illustrate the workings of land markets and beneficial policy reforms.

Romeo Sherko, David Stanfield and Malcolm Childress from the Land Tenure Center at the University of Wisconsin-Madison, addressed the issue of designing a strategy for the creation and dissemination of land information in transitional economies, where information has historically been tightly held, thus frustrating both the evolution of property markets and opportunities for policy analysis. Their conclusions regarding the role of the public and private sectors, the scope of data collection, and pricing and dissemination strategies help to explain why land market information is often not provided or is poorly provided by either the government or the private sector. On the other hand, their analysis suggests that the benefits of good land market information are considerable. Some of these benefits were illustrated by David Dale-Johnson from the University of Southern California and Jan Brzeski from Jagellonian University, Cracow, who discussed efforts to document rapidly evolving market prices of property in Cracow and to inform property tax reform efforts.

Samu Kurri, Seppo Laakso, and Heikki Loikkanen of the Finnish Government Institute of Economic Research discussed the land price information system in Finland, suggesting that it is only now beginning to catch up with the needs of many different potential users of the data. These users include those concerned with implementation of a new property tax and macro-economic and financial sector policymakers concerned with the interaction of the Finnish property market and national economic performance. Karl (Chip) Case of Wellesley College presented findings from a preliminary analysis of 100 years of land prices in Boston, which was designed, among other things, to highlight some of the methodological difficulties of measuring land prices in a way that facilitates policy analysis and reform.

Stephen K. Mayo is a senior fellow of the Lincoln Institute.