Paying for Lower Taxes: The Effect of a Place-Based Tax Reduction Program in Detroit

To combat poverty, state and local policymakers have increasingly turned to “place-based” policies that offer financial support, such as subsidies or tax abatements based on location. This assistance is meant to spur redevelopment and economic growth in a particular area. The increasing popularity of place-based policies has been driven by the geographic concentration of poverty. These geographic issues are arguably better addressed through programs that target people in areas where poverty is concentrated as opposed policies that support specific groups (e.g. veterans, senior citizens, unemployed individuals) who may be widely geographically dispersed. One type of place-based policy involves the creation of an “Enterprise Zone” in which residents or business owners are given a financial incentive to stay in, or relocate to, a particular area. This encourages economic development as well as increased revenue through higher property values. Enterprise Zones existed in 43 states in 2005, although there is significant variation in policy and the impact can be difficult to measure.

In an article published in the November edition of the Journal of Regional Science and Economics, Timothy Hodge and Timothy Komarerk examine the effects of one such program: the Neighborhood Enterprise Zone Homestead Program (NEZH) in Detroit, Michigan. Starting in 2006, a total of 52 zones were created in Detroit. Homeowners living in, or relocating to, those zones could apply for the program, receive a NEZH certificate, and complete at least $500 of “qualifying improvements” to their property. They were then entitled to a property tax reduction. Homeowners pay property taxes based on the “millage” rate, a property tax mechanism set by municipalities. A tax rate of 1 mill equates to homeowners paying $1 in property taxes for every $1,000 of assessed property value. The NEZH tax reduction entitled homeowners to a property tax reduction of 11.5 mills out of the total 66.1 mills rate for 12 years, followed by a 3-year period of phasing back into full tax payments. Thus, instead of paying $66.10 per $1,000 in assessed property value, they would only pay $54.60. Policymakers anticipated the NEZH would reduce a participating homeowner’s property taxes  by approximately 17 percent.

Due to the reduction in property taxes, homeowners who receive the tax abatement are the assumed beneficiaries of NEZH. However, understanding if, and to what extent, these homeowners actually benefit from the program is challenging. The NEZH program is intended to encourage property improvements and economic development. As the authors point out, this development, along with lower property taxes, would likely encourage people to buy homes within NEZH zones. With increased competition for these properties, the value of the homes could increase, increasing property taxes. Additionally, homeowners who are living within NEZH zones but who are not participating in the program may also have higher property tax payments. To understand the impacts of the NEZH program on property taxes, the authors determine the extent to which the program participant’s property tax reductions are capitalized into the value of their homes—that is, to what degree are the benefits of lower tax payments outweighed by increasing property values resulting in higher taxes?

The authors compare annual housing prices in NEZH zones and non-NEZH zones starting in 2006. They select comparison neighborhoods that have similar trends in sale prices before the program started as NEZH zones, controlling for seasonal market trends and large events such as the Great Recession. Within NEZH zones, the authors find that homeowners pay six to ten percent more for their homes than buyers in comparable non-NEZH neighborhoods. This percent increase corresponds with property tax payments that exceed the value of the tax reductions for program participants, meaning they are overpaying for the program benefits. Importantly, on average, only 16.1 percent of homeowners within NEZH zones participate in the program and receive tax benefits. However, these higher property values and taxes affect all of the homeowners in the zone regardless of program participation. The effect is even larger for homeowners within NEZH zones who do participate in the program. The authors calculate that these homeowners pay on average 39 percent more for their homes than buyers of similar homes in non-NEZH zones.

Why are residents willing to overpay to live in an NEZH zone? The authors offer several possible explanations. For one, buyers may seek out NEZH neighborhoods after learning about the program, increasing competition and home prices. Additionally, as individuals move into these neighborhoods, non-NEZH areas may have higher vacancy rates, reduced property values, and fewer amenities. This could make them less desirable compared to NEZH areas where even non-participating homeowners can expect to benefit from living in a desirable neighborhood where program participants are making home improvements.   

In a best-case scenario where all Detroit residents pay their property taxes, the authors calculate that the city receives an annual increase in $6.7 million in tax revenue through increased property taxes. This suggests that these polices can be effective tools to increase city revenue while also encouraging local development. However, this research also highlights the complexity of assessing who benefits and who is harmed by this policy, as the local development includes higher property taxes for some residents and potential negative consequences for non-NEZH neighborhoods. Further research is needed to better understand these implications in order to develop strategies that increase the overall efficacy of place-based policies.

Article source: Hodge, Timothy and Timothy Komarek. “Capitalizing on Neighborhood Enterprise Zones: Are Detroit Residents Paying For the NEZ Homestead Exemption?” Regional Science and Urban Economics 61 (2016): 18-25.

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