March 18, 2021
Technological change has disrupted many traditional industries. Some of the most notable include print media, telecom, retail, and music. Some cities have firsthand experience with ride-share technologies like Uber and Lyft disrupting the traditional taxi industry. Many more local governments, though, have experience with technology disrupting traditional revenues.
The effect of online retail on sales taxes is perhaps the most obvious example of local government revenue disruption. More recently, short-term rental platforms like Airbnb disrupted local hotel taxes. Technology has also begun to disrupt the biggest local government revenue of them all: property taxes. Property tax is the largest revenue generated by local government in North America. In the U.S., for example, it accounts for approximately 30 percent of all revenues generated by local governments.
Technology challenges traditional property tax systems
Because property tax is rooted in physical land use, it might seem like it would be insulated from technology-led disruption. After all, there is no single big, obvious technological force we can point to as a disruptor, as we can for hotel taxes and Airbnb or sales taxes and online retailing, but many less obvious 21st century technological forces are conspiring to reduce the relevance of property taxes, which have been in use in North America since at least the mid to late 1600s.
"As the economy and labor market evolve, we must actively explore ways to maintain financial sustainability and modernize approaches to revenue generation," says Stephen VanOfwegen, chief financial officer of the Region of Peel, Ontario, which is very dependent on property taxes.
Research out of the Mowat Center, which is affiliated with the University of Toronto, commissioned by Region of Peel, Ontario, identified four key trends that are threatening to make the property tax obsolete for local governments across Canada and the U.S. Because land uses are closely linked to property tax, it could have future implications for land-use professionals like planners.
1. Stagnant real wage growth
The real median wage is essentially unchanged in the U.S. since 1980. But even though inflation has increased, indicating economic growth, median hourly earnings have stagnated. According to the Pew Research Center, after adjusting for inflation, today's average hourly wage has just about the same purchasing power it did in 1978. In terms of value, the average hourly earnings peaked more than 45 years ago: The $4.03-an-hour rate recorded in January 1973 had the same purchasing power that $23.68 would today.
If real wages are staying essentially the same (or going down) but taxes go up at more than the rate of inflation, that means people are less able to afford taxes. If they are less able to afford taxes, they are more likely to resist paying them or worse, not pay them at all. The property tax is an unpopular tax already, so it would bear the brunt of popular resistance to taxation. Of course, stagnant wages also make it more difficult for people to buy new homes, and new homes add to tax rolls. In the U.S., homeownership rates steadily declined from 69 to 63 percent between 2004 and 2016 before leveling out and rising through 2018 (though 2019 was down again). It was 65 percent as of 2020.
Stagnant wage growth is due in no small part to technological change. First, automation has eliminated the need for many lower-skilled jobs. This decreases the demand for lower-skilled workers and, therefore, reduces the wages they can obtain. Automation shows few signs of abating, and many experts expect large numbers of jobs to be automated in the future. For example, a report by the Brookings Institution suggests that about 25 percent of U.S. jobs are at high risk of automation. To cite one concrete example, driverless automotive technology could endanger many jobs in trucking and other driving professions. This is not to say that automation doesn't have benefits, but real median wage growth does not appear to be one of them, up to this point.
A second technological force behind stagnant wage growth is the increased mobility of business activities and the ability to locate work in the lowest-cost area, including offshore. Call centers are an example we all have direct experience with in our personal lives, but bookkeeping, manufacturing, and other tasks have been offshored as well. Again, this depresses demand for lower-skilled labor in high-cost countries like the U.S. and Canada.
2. Shift from goods production to goods movement
Technology has also facilitated an expansion of international trade. Though increased trade has certainly brought many benefits to consumers, it's also had the effect of displacing many traditional manufacturing industries. Goods produced abroad must be transported to consumers, so manufacturing has been supplanted by warehousing.
Of course, not all communities that see a decline in manufacturing can go on to become freight hubs. But even among those that do see warehouses replace factories, warehouses tend to employ fewer people (contributing to wage stagnation). Also, depending on local assessment practices, warehouses may generate less tax revenue than a manufacturing facility of similar size.
As consumers increasingly turn to e-commerce over brick-and-mortor retail, empty stores and shopping centers across the country are being converted into fulfillment centers for online retailers like Amazon and the market for warehouse space is booming. Photo by Hiroko Masuike/The New York Times.
3. Shrinking workplaces
The trend toward deindustrialization and the expansion of the services industry has led to less demand for physical workspace. Peel's research, for example, found that the average square footage per employee for an industrial space (e.g., manufacturing) in the Peel region is approximately 2,000 square feet, whereas the average for office and retail spaces is approximately 400 square feet per employee. Furthermore, office spaces are often less valuable per square foot.
If this didn't place enough pressure on the property tax already, technology is reducing the demand for office space. For instance, digitalization has reduced the need for filing space for paper, while cloud computing reduces the demand for space for the computers the digitized files are stored on.
Of course, people, not files or computers, require most of the space at many offices, and technology has reduced demand there as well. Communications technology makes flexible work arrangements like telecommuting and office hoteling more practical. It has also given rise to the "gig economy," where many of the human resources an organization needs can be secured through short-term contracts. These freelancers may work from home or perhaps a coworking space, reducing the demand for conventional office space in either case. Many are also wondering if the work-from-home trend catalyzed during the COVID-19 pandemic will remain when vaccinations are more widely distributed.
4. Shrinking retail space
Internet retailing doesn't just impact the sales tax. It also means less demand for the spaces that retailers occupy. For example, according to a report by Credit Suisse, between 20 and 25 percent of American malls will have closed between 2017 and 2022. One of the main culprits is the increasing popularity of online shopping. The buildings that these retailers occupied were often not of very high quality and have few other potential uses. Once the building becomes vacant, its value (and the taxes due) plummet.
Technology might even have an impact on commercial activity we might otherwise think of as firmly anchored in physical space, like eating out. The sales of online food ordering and delivery have almost quadrupled since 2016 (those figures do not include online food sales during the pandemic). If people are eating less in restaurants and instead taking food home, restaurants may decide they need less space to seat customers.
Connecting the dots
If industrial and commercial properties are becoming a less important source of tax revenue, then residential properties will become a more important source of tax revenue. That means residents will be forced to pick up the slack. But, as mentioned earlier, median wages have stagnated, which means many residents are unable to shoulder an increased responsibility to fund local government.
So what does this all mean for you and your community?
Property tax is the largest and probably least popular local government revenue source and adapting it to modern realities will not be easy — but it's a reality many cities may soon face, particularly given the fiscal challenges caused by the COVID-19 pandemic.
Indeed, this might be the most opportunistic time in a century for cities to self-examine their "fiscal architectures," including property taxes, says Michael Pagano, dean at the College of Urban Planning and Public Affairs at the University of Illinois at Chicago and author of "The Call for a New Fiscal Architecture."
The solution might involve both updating the property tax itself and finding new revenues that are better aligned with the sources of economic value in today's world. And because property taxes, in particular, are firmly rooted in land uses, planners could have a unique role in shaping this revenue.
According to Pagano, planners can prepare themselves for these changes by working to understand their cities' revenue sources economic growth drivers so that they can ultimately help city leaders, elected officials, and citizens look beyond the challenges to envision a better, fiscally sustainable, and fairer future.
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