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Inefficiencies in Land Markets

Inefficiencies in Land Markets. February 22, 2006. Little House on the Prairie. Benefits = $1400/yr Cost = $600/yr Net benefits = $800/yr. A River Runs Through It. RIVER. Flood Zone. 10% chance of storm that will cause flood. Expected value of net benefits = .9(800) +.1(-600) = 660.

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Inefficiencies in Land Markets

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  1. Inefficiencies in Land Markets February 22, 2006

  2. Little House on the Prairie Benefits = $1400/yr Cost = $600/yr Net benefits = $800/yr

  3. A River Runs Through It RIVER Flood Zone 10% chance of storm that will cause flood

  4. Expected value of net benefits = .9(800) +.1(-600) = 660

  5. Standard reaction to risk: purchase flood insurance Cost of premium: $140/year [based on 10% probability of having to make a $1400 payout in any given year]

  6. Ex. 1 – Land values may be artificially high and send the wrong signal to buyers and sellers Does the land market function properly and result in the efficient uses of land? • Subsidized flood insurance • Bail-outs

  7. Subsidized flood insurance $35/year (instead of $140)

  8. Bail-outs

  9. Ex. 2 – Costs of land ownership may be artificially low and send the wrong signal to buyers, e.g. Subsidizing Sprawl Sprawl – defined as low-density, auto-dependent residential and commercial development Subsidies Provision of utilities Mortgage interest deductions Transportation development

  10. MC with mortgage interest deductions (MPC) P* q* S or MSC $ pe D or MB qe Residential lot size

  11. Growth Management • Direct • Urban growth boundaries • Urban service area boundaries • Zoning • Indirect • Impact fees • Transfer taxes • State investments

  12. Ex. 3 – Externalities in the land market may result in inefficient uses of land • External benefits from using land for agriculture • Ecological benefits • Aesthetic benefits • External costs of developed uses • Water runoff from impervious surfaces • Air pollution from automobile exhaust

  13. P* D=MSB q* S $ pm D=MPB only qm Acres of farmland

  14. S=MSC P* q* $ S=MPC only pm D qm Acres of land developed

  15. Farmland Preservation • Property rights tools – zoning • Taxes – differential assessment • Market • purchase in fee or purchase development rights • create development rights market

  16. Zoning • Exclusive • Concern about windfall/wipeout syndrome • Non-exclusive • Large minimum lot size • Cluster zoning • Conservation design

  17. Conservation Design/Zoning

  18. Taxes • Differential assessment • Preferential assessment: agricultural land is assessed for property tax purposes at a lower rate than is other land • Deferred taxation: agricultural land is taxed at a lower rate but some or all of the taxes are captured at time of development • Restrictive agreements: contractual arrangements that give agricultural land owners lower property taxes in exchange for agreement not to develop

  19. Deferred taxation (penalty) • When land is converted, owner must repay a specified amount of the tax benefits realized (10 years of benefits is common). • Owner of land enters into differential assessment program. • Property taxes assessed at $66.66, rather than $142.88 • When land is developed, owner must repay $76.22 for each year of preferential assessment up to 10 years (maximum penalty is $762.20)

  20. Market • Purchase in fee • Purchase development rights (PDR) • Lease development rights (this is essentially the Michigan model) • Create market for transfer of development rights (TDR)

  21. Purchase of Development Rights • Fair market value is $7144 (can develop) • Agricultural use value is $3333 (cannot develop) • Development value is $7144 - $3333 = $3811 • Public or private entity pays landowner $3811; removes development rights stick from the bundle

  22. Lease of Development Rights • Landowner receives regular (e.g. annual) payment in exchange for keeping land in agricultural use. • Michigan – Circuit breaker program (PA 116) • Farmers sign development rights agreements (leases) and receive income tax credits for the duration of the agreement • Income tax credits depend upon level of property taxes and agricultural income

  23. In Michigan: Farmland owner enters PA 116 agreement. Farm income is $200 rent plus $50 salary per year. Property tax is $66.66. 3.5% of income is $8.75. Income tax credit is $66.66 - $8.75 = $57.91

  24. Transferable Development Rights 8 units/acre 2.5 units/acre Sending Zone – area to protect Receiving Zone – deemed suitable for development .1 units/acre 10 units/acre

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