I visited Washington, D.C. last weekend and walked around the rapidly gentrifying Columbia Heights neighborhood. While admiring the fantastic looking old houses and the shiny new development, I noticed dozens of abandoned houses dotting the streets. These weren’t houses in the process of being gutted and rebuilt. They were simply boarded up and vacant. With the way property values have shot up in that area since the D.C.’s metro put in the Green Line ten years ago, I was shocked that so many houses could still be abandoned. The explanation I came up with comes from a piece of tax policy known as fractional assessment, which means that only a small percent of a house’s actual value is taxed. This policy became enshrined in statute in large part to protect homeowner’s from the effect rising property values would have on their tax bills.
By ensuring that incumbent owners don’t have to pay the full gains in the value of their homes, fractional assessment lowers the opportunity costs of not developing the properties. Owners of these properties, who may not wish to develop the property themselves, can sit and wait for the neighborhood to grow increasingly expensive, without having to pay a massive tax bill every year. This can lead to a supply constraint in “hot” neighborhoods like Columbia Heights, further increasing prices there. Since home prices are heavily based on previous sales in the same neighborhood, letting the last few houses slowly trickle out onto the market, with intense competition for each, can lead to a permanently higher equilibrium price. Fractional assessment harms the city’s tax rolls and leaves unsightly buildings in developing neighborhoods. It ultimately diminishes the affordable housing stock in a city. While this post oversimplifies the tax and regulatory issues affecting economic development, a subject on which I’ll provide future posts, it’s clear that fixing fractional assessment would be a good start to ensuring stable municipal tax bases and affordable housing.