At What Cost?

Cities that feel hamstrung by property tax caps are increasingly using alternative approaches to taxing real estate, with the goal of eking out more revenue and, in some cases, changing behavior. But rather than helping city coffers, experts warn, such moves may be more likely to disrupt economic growth, raise equity concerns, and insert instability into the otherwise fairly predictable property tax revenue stream.

In some instances, cities and states are raising so-called “mansion taxes”—transfer taxes on high-value residential real estate—as a way of cashing in on a booming real estate market. Connecticut, which is losing population, even structured its tax to discourage wealthy people from leaving the state. This fall, Boston approved a higher transfer tax rate on residential and commercial property sales over a certain market value. If approved by the state legislature this session, the shift would allow the city to add a local transfer tax of up to 2 percent on sales of $2 million or more. Chicago is considering a similar move, as are several other smaller cities. In other cases, local governments are taxing vacant properties at a premium as a way to nudge owners to lease, develop, or sell. 

Opponents of these alternative taxes say they will discourage the very investment that has benefited the real estate market. Greg Vasil, CEO and president of the Greater Boston Real Estate Board, has warned that increasing the cost of doing business in the city could ultimately backfire by pushing up the cost of rent. Proponents in Boston pitched the recently adopted tax as an issue of fairness: Boston’s booming real estate market has left some behind and made it more difficult to find reasonably priced housing, they say. A high-end transfer tax could raise more than $150 million in any given year that would go toward affordable housing, more than doubling the city’s current funding stream for affordable housing. 

“We want to make sure that everybody in the city can grow with the developers, can grow with people who are building homes,” the bill’s lead sponsor, City Councilor Lydia Edwards, said at the bill signing last year.

But any time taxes are narrowed to specific populations, whether it be smokers, gamblers, or the rich, it is likely that the revenue from that tax will be volatile. The best tax policies—in terms of fairness and revenue stability—tend to be ones that have a broad base and are both limited in exemptions and progressive in nature, says Ron Rakow, a Lincoln Institute fellow and Boston’s former assessing commissioner. Increasing mansion taxes runs counter to that.

“What happens when the market dips?” he said. “Unlike the property tax . . . transfer tax revenue can be really volatile. It’s not unusual to see it drop by half in any given year.”

Targeted taxes also tend to invite taxpayers to game the system or find loopholes, which also lessens their long-term effect. For example, New York state has long had a higher transfer tax rate on properties sold for $1 million or more. But in 2019, the legislature approved an even higher rate for New York City. Before the new rate went into effect that July, Manhattan saw a closing frenzy. According to a report from Douglas Elliman Real Estate, sales from April through June 2019 were up 12.5 percent compared to the same period in 2018, surging by a full 37 percent in the $2 million to $5 million price range. The following quarter, the city’s inventory increased, and sale prices dropped by 12 percent.

In Connecticut, lawmakers added an unusual provision to not only curb evasion, but also encourage these presumably wealthy sellers to make their next home purchase inside state lines: Those who retain their in-state residency for at least three years after a sale become eligible to claim a tax credit against their mansion tax. Whether the lure works remains to be seen—it goes into effect July 2020—but those in the high-end real estate market have still criticized the tax hike, calling it punitive.

Vacancy taxes have drawn similar criticism. Washington, DC, and Vancouver, Canada, already have such taxes, and San Francisco and Oakland, California, and New York City are all considering following suit. 

DC’s tax was created in 2011, and included a tier for vacant properties, taxed at $5 per $100 of assessed value, as well as a higher “blighted” tier taxed at $10 per $100. The blighted tax rate is more than ten times the city’s ordinary property tax rate. The idea was to force absentee landowners into doing something with properties they were neglecting. 

But Lincoln Senior Fellow Joan Youngman notes that there can be many reasons for commercial vacancies, depending on market conditions and the owner’s situation. In some cases, landlords may be seeking creditworthy tenants and long-term guarantees; in others, changing retail patterns may affect the desirability of the location to traditional tenants. Residential vacancies present a different set of issues. “The first step is to understand the market conditions that lead to a pattern of vacancies, and to tailor the most effective response, which might not be through a tax instrument,” Youngman said.

Hartford, Connecticut, a small city dotted with vacant lots, also considered making it more expensive for property owners to hold unused land. But in 2017, Mayor Luke Bronin killed a proposed vacant property tax due to concerns that it would hurt development even more.

Two years later, Bronin was among a group of officials who pushed the state to pass two pieces of legislation that took a more holistic approach to blight for all Connecticut cities. The first targets absentee landlords and speeds up the process of turning vacant properties over to a receiver. The other bill allows cities to establish a land bank to help revitalize properties.

Of course, in the short term, it’s politically easier for officials to pick out one thing they don’t want to happen, and then use taxes to discourage it. And in some places, it’s easier to tax the rich—or at least try to. But Rakow points out that Boston’s property tax structure already is progressive because homeowners are exempt from paying on the first $200,000 in value. That is a significantly greater discount for the average homeowner, compared with wealthy owners of multimillion-dollar homes.

Many cities already have the tools they need to raise property tax revenue without creating a new layer, Rakow adds. Boston, for example, can go to voters and ask them to approve additional revenue above the city’s cap that would be dedicated to affordable housing, or to buffer the general fund budget against instability.

At a minimum, Youngman and Rakow advise proceeding with caution and acknowledging that any revenue impacts from targeting certain property taxpayers are, at best, unpredictable. As Youngman put it, “it’s important not to assume that a new tax is the best way to deal with a land market problem.”

Liz Farmer is a fiscal policy expert and journalist whose areas of expertise include budgets, fiscal distress, and tax policy. She is currently a research fellow at the Rockefeller Institute’s Future of Labor Research Center.

Photograph: Implementing targeted taxes such as transfer fees on high-end real estate can be alluring to municipalities, but experts warn that these moves can backfire. Credit: www.aag.com via Flickr CC BY 2.0.