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Property Tax Cuts Could Outweigh Incentives Business Group Endorses Simpler Strategy for Economic Development
October, 2008
A report commissioned by the Toronto Office Coalition concludes that a simple reduction in business taxes is the most effective measure a municipality can implement to attract investment and boost economic development. Dr. Enid Slack of the Institute of Municipal Finance and Governance recently conducted an extensive overview of property tax impact studies and analyses of municipal incentive programs to assess the potential outcome of the City of Toronto's newly adopted tax increment equivalent grant program. The following is an excerpt from her findings - Editor.
By Enid Slack
Studies over the last 50 years reveal common themes concerning the impact of property tax incentives on business activity. The following summarizes the findings of the literature review:
( Property tax differentials will have more influence over business location decisions within metropolitan areas than between metropolitan areas. In other words, if a firm is choosing to locate in Toronto or Buffalo, property taxes will not play a significant role. If a firm chooses to locate in the Toronto area, however, the specific location within the GTA will likely be affected by property tax differentials.
( The size of the property tax differential will have an impact on the location decision - the larger the differential, the more likely it will have an impact on the location decision.
( Service levels in a municipality also affect a business location decision. Lower taxes combined with lower service levels are unlikely to attract new firms.
( Property tax incentives will be more successful at stimulating economic activity when only one jurisdiction uses them. If many municipalities in a metropolitan area use tax incentives, they are less likely to be effective in any one jurisdiction.
( Property tax abatements are more effective for some businesses than others. Manufacturing firms will be more influenced by property tax differentials, for example, than other industries. Where there are significant advantages from being in a particular location, property taxes will have less of an impact.
( Property tax abatements are likely to result in higher rates for properties not receiving the abatement.
INEQUITABLE APPORTIONMENT
It has been argued that businesses are leaving Toronto and moving to suburban municipalities in the Greater Toronto Area (GTA) because non-residential property taxes are higher in Toronto than in the suburbs. Whether or not the property tax is the reason for the move in all cases, it is nevertheless clear that business properties are overtaxed in Toronto compared to residential properties and compared to non-residential properties in the rest of the GTA.
Toronto has the highest tax rate on commercial property compared to other municipalities, while the industrial tax rate is at the high end, but not the highest. In all municipalities in the GTA, the commercial and industrial tax rates are considerably higher than the residential tax rates.
There is no economic justification for the over-taxation of non-residential properties. The differential property tax treatment does not necessarily reflect the differential use of services by different property types. For example, non-residential properties often provide their own garbage collection, security and fire protection.
The following studies provide evidence of over-taxation of businesses based on benefits received from local services:
( A review of property taxes and municipal expenditures in eight municipalities in Ontario in 1990 concluded that non-residential property taxes ranged from 28 to 51% of total local property taxes, but accounted for only 31 to 40% of municipal expenditures.
( A U.S. study at a similar time estimated that the business-related share of state/local expenditures in the U.S. is less than the business-related share of state/local tax revenues. The ratio differed from state to state.
( A 2003 study by Hemson Consulting Ltd. and the Canadian Institute of Public and Private Real Estate Companies (CIPPREC) concluded that the office sector in Toronto pays $360 million more in property taxes than it receives in services. Stated another way, the office sector pays 17% of municipal taxes in Toronto but generates only 5% of expenditures financed from property taxes.
( A recent study from the City of Vancouver compares the consumption of services to taxes paid by different property classes and concludes that the non-residential sector pays $2.42 in taxes for each $1 of benefit received, while the residential sector pays $0.56 for each $1 of benefit. The study also concludes that the non-residential share of services consumed is 24% of the total; the residential share is 76%.
POLICY DRIVERS
It has also been argued that property taxes should be heavier on those components of the tax base that are least responsive to a tax increase (lease elastic in supply). Since businesses tend to be more mobile than homeowners (in other words, they are more responsive to tax changes), efficiency arguments lead to the conclusion that non-residential property should be taxed more lightly than residential property.
In reality, however, lower rates are generally applied to residential properties. Differentially higher taxation distorts land use decisions favouring residential use over commercial and industrial use.
The higher taxation of non-residential property also creates problems of accountability because municipalities can easily export the tax to residents of other jurisdictions. For example, a portion of the property tax on automobile manufacture will likely be passed on to the purchasers of new cars. Since most cars are shipped outside the taxing jurisdiction, taxpayers in other jurisdictions bear the burden of the property taxes. These taxes raise revenues from non-residents to pay for the benefits enjoyed by residents. There is no accountability at the local level when municipalities can export property taxes to residents of other jurisdictions.
Notwithstanding the arguments for lower commercial property taxes, a shift onto residential property taxpayers is problematic. The reason is that residential property taxpayers represent the majority of municipal voters and the property tax is very visible.
Unlike income tax, for example, the property tax is not withheld at source. Unlike the sales tax, it is not paid in small amounts with each daily purchase. Instead, the property tax generally has to be paid directly by taxpayers in periodic lump sum payments. This means that taxpayers tend often to be more aware of the property taxes they pay than they are of other taxes.
Moreover, the property taxes finance services that are also very visible, such as roads, garbage collection and parks. Visibility makes taxpayers aware of the costs of local public services. This awareness enhances accountability, but it makes it difficult to increase the tax.
The over-taxation of non-residential property was identified in Toronto many years ago. High business taxes are often cited as the reason why businesses have left Toronto and moved to the suburban municipalities of the GTA. For this reason, the City of Toronto has undertaken a plan to reduce the tax ratio of commercial properties from approximately 4 times the residential rate to 2.5 times the residential rate over the next 15 years, while an accelerated phase-in of up to eight years will apply to smaller businesses.
The tax policy initiative involves a 0.3% annual tax shift, or approximately $6 for the average household, from Toronto's business and multi-residential property classes to the residential property class. It will also permit budgetary tax rate increases on the business and multi-residential property classes of up to one third of any tax rate increase on residential properties.
LOCATION SELECTION FACTORS
Toronto's citywide tax increment incentive program is a tax increment equivalent grant (TIEG) under Section 28 of the Planning Act. Under this grant program, municipalities can designate an area, or the entire municipality, as a community improvement project area. It can then implement a community improvement plan (CIP) with grants and/or loans that can, if the municipality chooses, be calculated on a tax increment basis. In other words, the municipality can offer the developers a grant or loan that is based on the higher property tax that is generated from development - i.e. the tax increment.
Tax equivalent increment financing is used in a number of communities across Ontario. Since this program is fairly new, there do not appear to be any empirical studies that analyze the impact of these incentives on economic activity in each municipality.
The literature on the impact of property taxes on business locations suggests that property tax differentials are more likely to have an impact within a metropolitan region than between metropolitan regions. This finding means that property tax incentives are more likely to have an impact on location decisions within the GTA than between Toronto and other metropolitan areas, and this conclusion only holds to the extent that other municipalities in the GTA do not offer similar tax incentives.
Studies also show that property tax incentives will be more effective at attracting businesses that are sensitive to property tax differentials and are mobile across jurisdictions. In other words, firms that have to be in a particular location are unlikely to be very responsive to property tax differentials.
Because businesses also respond to service differentials among municipalities, the city needs to ensure that tax incentives are not accompanied by a reduction in service levels. Indeed, some authors have argued that improving services and infrastructure will do more to attract business than property tax incentives will, and, at the same time, provide a benefit to existing residents and businesses.
An overall reduction in business property taxes in a jurisdiction has been shown to increase business activity more consistently than the selective use of property tax abatements to specific firms. Lowering non-residential property taxes to all businesses in the municipality is preferable to tax concessions to any specific business.
GAUGING ASSOCIATED COSTS
Toronto is currently working toward lower taxation of all non-residential properties compared to residential properties and this move should have a positive impact on business location in the city. It is unclear whether the tax incentive will do as much to attract new businesses as will the universal reduction in non-residential property tax.
The particular incentive being proposed by the City provides a grant for some or all of the tax increment arising from and investment in non-residential property. These foregone revenues would presumably not have been available to the City in the absence of the incentive, assuming the businesses would not have located there but for the incentive. It is always difficult, however, to determine whether a firm would have located in a specific jurisdiction without the tax incentive.
Finally, if the City has to provide additional services because of the investment of new businesses, then it will have to increase property taxes on other taxpayers. The City needs to weigh the potential benefits against the associated costs of any tax incentive. There are potential benefits in terms of increased economic activity that could create more jobs for existing residents, more tax revenue for the city and greater agglomeration economies for existing firms.
The potential costs are the further public service needs arising from new development. There are also potential environmental costs to the community in terms of increased pollution etc. Only if the benefits of the incentive outweigh the costs to taxpayers will the incentive be worthwhile.
The complete text of Dr. Enid Slack's report can be found at www.torontoofficecoalition.com/pdf/SlackreportreleaseFINAL.pdf.
Chart:
PROPERTY TAX RATES IN GTA MUNICIPALITIES, 2005
Municipality Residential Multi-Res Commercial Industrial
Toronto 0.91 2.56 4.51 4.89
Mississauga 1.05 1.53 2.81 3.17
Brampton 1.24 1.91 2.96 3.37
Oakville 1.09 2.10 2.69 4.00
Markham 1.07 1.07 2.62 2.93
Richmond Hill 1.07 1.07 2.62 2.93
Vaughan 1.07 1.07 2.62 2.93
Oshawa 1.73 3.27 3.72 5.25
Pickering 1.38 2.55 3.22 4.47
Whitby 1.43 2.65 3.29 4.53
Source: BMA Management Consulting Inc., 2005
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