More on incentives

For local governments where property tax is the primary source of revenue, there is an incentive to have the values of property increased. The greater the value, the greater the tax base and the greater the level of revenue that can be obtained from the same tax rate. I worked with a number of cities over the decade prior to 2008 and found it amusing how "fiscally conservative" they found themselves when their tax base increased by 10%, but they "cut taxes" by increasing the overall tax levy by only 8%.

For a farmer that has had their property value increase, there is an increasing incentive to obtain a higher return from the land. This may mean steps to increase production yields or, as is frequently the case, selling the land for a higher level of development. This is where we get the idea of the farmer's land as their 401(k). The land becomes the last cash crop.

The intersection of these incentives, especially post-housing bubble, is interesting to examine, especially since it is the incorrect assumptions in the system that drive this feedback loop.

When the assessor goes out to determine the value of a property, they naturally look at the value the market has placed on similar properties for comparison. When our neighbor's farm sold to a developer for $35,000 per acre, my parents naturally felt their 80 acres was worth around two-and-a-half million dollars.

There are just two problems with this analysis. First, at $35k per acre, you can't afford to farm the property anymore. If it were going to be sold as agricultural land, it would need to be around $1,500 - $2,000 per acre to get a proper return on investment through farming. So the assessor will value the property assuming it will be developed.

The second, bigger problem is that there is vastly more land than there is development demand. Only so many farmers can sell at $35k per acre. The rest will either never sell or will sell for much, much less.

Think of it using this analogy: Five people each have one apple. At the end of the day, the apples will be rotten and need to be thrown away. (Also, assume all five are allergic to apples or at least are compelled to sell the apple they have instead of consuming it themselves).

Now assume there is only one person that is going to purchase an apple that day. What price would they pay? Essentially nothing, since each seller would be compelled to undercut the other to gain the sale. If they don't sell the apple for something - even a penny - the apple rots and they get nothing. Once one apple is purchased from one vendor, the rest get nothing. There is a strong incentive to sell.

There is a delusion inherent in our property tax system that is going to be painful in correcting, but needs to be if we are going to reduce the bad incentives. That delusion is the assumption that every farmer is going to ultimately sell their land for development. Even if every farmer wanted to cash out, there is not anywhere near the number of buyers for their land. In other words, in a functioning market, the land is worthless in terms of development.

The adjustment in housing that we are partially through is proving this.

But for agricultural production, the land has value. Real value based on its yield. In days past we used to value land based not on size but on yield. Those days may return.

In the meantime, local governments need to readjust farm property values to be more in line with a true market value based on agricultural production. This will be painful because it will mean shifting the tax burden away from farmers. Farmers need to understand this tradeoff and be willing accept a tax system that adds a "development tax" for lands taken out of agricultural production for development purposes.

We can charge every farmer a higher rate of taxation than what agricultural production justifies (which is what we do now) or we can tax them according to how the land is used, a very low rate for agricultural land with a surcharge applied for converting from agriculture. This notion would have been impossible to even consider years ago when every farmer thought they were going to be rich selling their land to a developer, but with reality sinking in and farms and farm communities in desperate need of their own transformation to stay financially viable, many farmers will now see the wisdom in this fair tradeoff.

Our system today creates an incentive for local governments to overvalue agricultural property, which in turn creates an incentive for rural farmsteads to transform into more intensive uses. This is a distortion of the market that ultimately costs the community more than it produces in value. A Strong Towns approach would address this imbalance.

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