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Tax Abatements: The Basics

In the housing sector, tax abatements or exemptions are used by local governments to either provide a financial incentive for the construction or rehabilitation of homes or provide indirect assistance to lower-income households to rehab or maintain their homes. Some communities also offer some form of tax abatement or exemption to developers and buyers of homes in designated revitalization zones and/or rental property owners who participate in housing subsidy programs.

Tax Abatement Structure

The structure of the abatement depends on the associated policy goal. For example, to prompt participation in the Section 8 Housing Choice Voucher program, communities may grant landlords an annual reduction in their real estate tax assessment based on the number of units leased to voucher-holders. Other policies limit annual tax bill increases, freeze the taxable assessed value, reduce tax rates or otherwise reduce taxes owed for a designated time period.

Communities with budgetary constraints should properly structure any tax abatement program to leverage and maximize the desired public benefit in order to minimize the overall fiscal impact. While abatements generally do not reduce tax revenue, they do limit the additional revenue that may be collected during the term of the abatement. Tax abatements can also potentially incentivize new development, countering any loss in tax revenues and meeting the broader revitalization goals of a community.

Key Concepts

The “But For” Test and Tax Abatements

The “but-for” test is used in many localities to ensure that new development or other activity that renders a property eligible for a tax abatement would not have occurred but for the tax break. This standard is intended to ensure that the benefit is applied only where necessary to stimulate needed development and not in cases where investment would have taken place anyway. The determination is typically made by the agency administering the tax abatement at the time it is approved, although specific procedures vary.

Critics of tax abatements and similar programs that result in forgone revenue, such as tax-increment financing, suggest that often the “but-for” test is applied too loosely or not applied at all. In these instances, developers may receive a tax break that deprives the jurisdiction of revenue and results in a project that would have proceeded anyway. To avoid creating problematic tax abatement policies, it is important to consider the trajectory of the community. Communities that have experienced significant amounts of long-term disinvestment are much more likely to benefit from the incentives that tax abatements can provide. Conversely, providing tax abatements to lower-income households in neighborhoods that are quickly becoming high-cost can also be very effective. Both of these scenarios assume that the benefit to the community of a particular development project or program has been determined through an open, equitable and inclusive decision-making process.

Split-rate Taxation

Conventional property tax systems are designed so that structures and land are taxed at the same rate. In contrast, split-rate (or two-rate) systems divide the assessment, applying a higher tax rate to land and a relatively lower rate to structures on the land. The rationale for adopting this form of taxation is to stimulate development and improvements to existing structures and penalize speculative property owners who leave their lots unimproved. Proponents suggest that by incentivizing owners of unimproved or underdeveloped property to improve their property to avoid higher taxation, split-rate taxation may stabilize land values, increase urban infill development and reduce sprawl.

Depending on their home-rule status, communities may need statutory authorization from the state before adopting a split-rate system, and so far only a few jurisdictions in the United States have adopted this type of system. Several of these jurisdictions are located in Pennsylvania. . 

Key Resources

An Introduction to Two-Rate Taxation of Land and Buildings. 2005. By Jeffrey P. Cohen and Cletus C. Coughlin. The Federal Reserve Bank of St. Louis.

The Lincoln Institute of Land Policy has issued a variety of documents related to tax abatement. Most of these reports examine tax abatement as an economic development tool; nevertheless, they may prove useful in understanding alternative applications of tax abatements, including affordable housing, and their consequences.

For example:

An Annotated Bibliography on Property Taxes, Planning, and Development. 2004. By Marshall Feldman. Working Paper. Cambridge, MA: Lincoln Institute of Land Policy.

Effects of Property Tax Abatements on Tax Rates and Capital Costs: The Case of Monroe County, Indiana. 2003. By Kurt C. Zorn, John L. Mikesell and Esteban Dalehite. Working Paper. Cambridge, MA: Lincoln Institute of Land Policy.

Michigan’s Renaissance Zones: Eliminating Taxes to Attract Investment and Jobs in Distressed Communities. 2002. By Gary Sands. Working Paper. Cambridge, MA: Lincoln Institute of Land Policy.

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