Inefficiencies in Land Markets February 23, 2005

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

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

Expected value of net benefits = .9(800) +.1(-600) = 660 No storm 90% Storm 10% Benefits $1400 Costs $600 Net Benefits $800 -$600 Expected value of net benefits = .9(800) +.1(-600) = 660

Standard reaction to risk: purchase flood insurance Cost of premium: $140/year [based on 10% probability of having to pay $1400] Benefits $1400 Costs $740 Net Benefits $660

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

Subsidized flood insurance $35/year (instead of $140) Benefits $1400 Costs $635 Net Benefits $765

Bail-outs Benefits $1400 Costs $600 Net Benefits $800

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

$ S or MC MC with mortgage interest deductions D or MB qe q* P* MC with mortgage interest deductions pe D or MB qe Residential lot size

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

Ex. 3 – Externalities in the land market may result in inefficient uses of land $ q* P* D=MPB + MSB S pm D=MPB only qm Acres of farmland

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

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

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

Conservation Design/Zoning

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

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)

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)

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

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

In Michigan: Farmland owner enters PA 116 agreement. Farm income is $200 per year. Property tax is $66.66. 3.5% of income is $7. Income tax credit is $66.66 - $7 = $59.66

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