Responding to Incentives

A monkey sits on a chair in front of a panel with two buttons. If the monkey presses button number one, they get one treat. Pressing button number two yields two treats. After participating in this experiment for some time and seeing consistent results, which button is the monkey likely to press?

I appear before dozens of city councils and town boards each year, often to talk about economic development, growth and land use planning. There is a belief system that is near universal that is revealed in these conversations. It goes something like this:

• Our budget is tight, cutting services is difficult and so we need more revenue.
• The best way to get more revenue is by adding commercial development.
• We need more commercial development.
• Mr. Planner, zone more property for commercial development.

Today we're not going to challenge that dead idea - although there are some fundamental flaws in the logic - but instead focus on the incentives that bring about this delusion.

The state where I live, Minnesota, is like most states in that it taxes commercial property at a higher rate than it taxes residential. It is not really clear to me why this is. Is it because businesses cost more to provide service to? Is it because business people are rich and we want rich people to pay more? Is it because we want to encourage homes, so we tax them less? None of these ideas are really logical, especially in an era of high unemployment, but I don't have any others that are.

Whatever the reason, Minnesota taxes the average business at a rate double that of the typical residence. A business owner living and working in the same city will pay twice as much tax on their $500,000 office building than they will pay on their $500,000 home. 

So if you're a monkey, you are going to press button number two, right?

Whatever the reason, this creates a powerful incentive for cities to attract commercial property. In nearly every community we have ever helped plan, a core debate is often over how big to make the commercial area. The range of discussion is typically between "huge" and "enormous" - certainly always far greater than what can be sustained by the local population. The logic for this is simple: The more commercial property we have, the stronger our tax base and the more revenue the local government will have for things we like.

This notion is so pervasive and so powerful that we see cities giving tax subsidies as well as huge discounts on infrastructure (sometimes no cost) to land a business. Any business. In fact, in recent years it is actually rare that a commercial building of any significance will be erected without some type of public subsidy. There may be some outcry opposing this from the "anti-growth fringe", but the serious business people and the money counters at city hall just know that this is good finance. Invest now for the payback later.

Monkey, just keep pressing that button. The rewards keep on coming.

One of the more startling presentations from the Congress for the New Urbanism was from the Friday afternoon session on Rethinking Suburban Development. A speaker from an organization called Redfields to Greenfields talked about a plan to convert hundreds of billions of dollars worth of commercial property to parks. They are working with the Federal Reserve, the Treasury Department and FDIC to create a $200 billion Land Bank Fund that would buy commercial buildings, bulldoze them and then build parks on the sites.

Let me reiterate a few key words: Buy. Billions. Bulldoze. Build parks.

There is a certain percentage of people reading this right now that have the dead idea regarding the windfall of commercial development embedded in their personal operating system. Those people are having a tough time reading this. For them I provide some statistics from Redfields to Greenfields to ease the transition to reality.

• Since January of 2008, the value of commercial real estate has fallen by 45%. That is $3 trillion in lost property value. This is not because of a temporary slowdown or a recession but because we have too much supply and not enough demand.

• Case in point: between 1990 and 2005, consumer spending per capita rose by 14% (adjusted for inflation). During that same period of time, the amount of retail space doubled. 

• Forgetting the effects of ecommerce, we have six times the retail space per capita than any European country (the nearest comparable).

What happens if you keep pressing the button, Monkey?

Our policies have provided powerful incentives for cities everywhere to induce more and more commercial development, to the point where we have grown ourselves into collapse. We've built so much of it that we can't possibly use it all. An excess supply means large price declines, which - in terms of real estate - means default. If commercial development were a golden goose, we've killed it, destroying the capacity of our neighborhood banks in the process (they are holding trillions in underwater Commercial Real Estate loans).

It is this supply/demand curve that Redfields to Greenfields is trying to correct. Instead of subsidizing banks through monetary policy (a story you would not believe if I explained it), they are proposing a much cheaper option: Spending $200 billion to partner with the private sector to tear commercial buildings down and reduce supply.

Drive around your cities and look at all of the vacant commercial property. If you look closely, the volume will likely startle you. Now, monitor your paper this coming election season. I guarantee you will find local politicians proposing a) more land zoned commercial, and/or b) calls to support business and induce new commercial development. It is as if the idea of local windfalls through commercial zoning were written in the Book of Genesis.

On the third day, God created the land. He then zoned transportation corridors for commercial development so His people would have perpetual prosperity.

It is not just greedy investment banks, but governments big and small, that played a significant role in creating the current financial crisis. The powerful incentives of the tax system - the promise of large returns from commercial development - have induced more commercial properties than we can possibly make use of. For America to be prosperous, and if we are to build Strong Towns, cities need a broader set of financial tools that encourage thoughtful, efficient use of the landscape - a higher return on the public's investments - rather than either short-term gain or the hope of a lucky windfall.

Let's not simply be monkeys anymore.

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