How Ann Arbor Can Tax the Rich

One thing most Ann Arborites agree on is that we could all be significantly better off if we taxed the rich more heavily in this country. At the local level, however, our City has a very limited toolkit for taxing residents and visitors. But we are not powerless! Rather than complain about all the things we can’t do while idly waiting for the political winds to change in Lansing and DC, we should use the tools we have in the circumstances we find ourselves.

Michigan cities of Ann Arbor’s size have little control over their revenue sources, relying on revenue sharing from the State and various funding programs from the State and Federal governments. The primary tool the State gives cities to raise their own revenue is property taxes. (We could also impose an income tax, which I’ll come back to).

Ann Arbor is a great place to live, and many people want to live here. This includes people who can afford to spend a lot on housing. This has downsides! Because the housing supply is limited, wealthier (current and future) residents bid up the price of homes and force people who can’t afford those prices out of the city entirely. However, if our goal is to tax the rich, we need rich people to tax, and we have them! So who are these people? How can we maximize the taxes they pay while minimizing the burden on everyone else and their negative effect on housing costs?

There are many categories of wealthy people who want to live in Ann Arbor and are willing to pay a premium: wealthy retirees moving from elsewhere in the State for our walkable downtown and world class cultural amenities; prominent and accomplished academics and health care professionals; business owners and executives at firms that thrive with the labor of our heavily educated population; landlords who rake in sky high rents for minimal effort; students from wealthy families; alumni who purchase second homes for occasional visits; and so on. Unless Ann Arbor becomes a significantly worse place to live, these people aren’t going away.

Why not impose an income tax? It would be an ineffective tool for taxing the rich. The State caps the maximum tax rate at 1% for residents and half that for people who work in the City. The tax must be a “flat tax,” so it would tax everyone at an equivalent rate, and cannot progressively target the rich. Also, many of the wealthiest residents in town would dodge this tax. Students from wealthy families and wealthy retirees have significant wealth but do not report high incomes. Business owners and landlords frequently structure their income to avoid income taxes using loopholes that Ann Arbor could not close. A tax on commuters would add insult to the injury of forcing lower-income workers from the city entirely. The income tax option available to us is a poor tool for the job of taxing the rich, which brings us back to property taxes.

Property taxes are, by definition, a tax on wealth. The more valuable the property you own, the higher your tax bill. This is a much more progressive tax than a flat income tax. However, simply raising property tax millage rates also pinches lower-income resident property owners. Fortunately, we have options to increase tax revenues and the effective tax rate on wealthier residents without raising tax rates for current residents: embracing new, dense, market-rate development.

Michigan's property tax system is convoluted and difficult to understand. The Headlee Amendment and Proposition A (1993) create a network of effects that make it difficult for cities to increase revenue during economic upturns and wipe out their revenue streams when the economy slides. The Headlee Amendment requires cities to lower their property tax rates when property values increase, to maintain "revenue neutrality." So if property values increase, tax rates go down. At the same time, Proposition A provides property owners with an effect similar to "rent control" on their taxable property value, so their effective tax rate increases are capped every year. Over time, this accrues into a steep tax discount. This helps long-term residents keep their homes when property values increase quickly, but the same genrous tax break is given to all property owners, including landlords, commercial property owners, and corporate property owners.

The combined effects of these two policies put pressure on cities to make up for lost revenue and add new property tax millages to fill funding gaps, especially as State and Federal revenue sources become increasingly stingy. When a property sells to a new owner, the Prop A discount becomes "uncapped," and the new resident pays the uncapped highest tax rate. So new, wealthy residents who replace current residents are taxed at the highest possible rate. But because of Headlee, rates also go down for everyone proportionally when Prop A caps are removed. This scenario starves the City of new revenue and maintains the pressure to increase millage rates in other ways. But there is an exception to this rule: new property development.

When a parcel is redeveloped, new property is added (e.g., a parking lot is replaced by a building, or a house is replaced by an apartment building). Because this is newly created property, it does not trigger the Headlee Amendment rollback, and it has the highest possible taxable property value. This has the win-win-win effect of charging new wealthy residents of these developments the highest possible tax rates on the highest possible property values, without rolling back overall City revenues, reducing the pressure to increase taxes or cut services. When a new development doesn't meaningfully add homes (e.g., when a single home is replaced with a single, larger one), it still has a displacing effect. But when a new development is significantly denser (e.g., a handful of old homes are replaced by dozens or hundreds of apartments or condos), these new residents are no longer competing with less-wealthy residents for homes elsewhere, and require far less infrastructure (water pipes, power lines, roads, etc) per capita.

Ann Arbor can tax the rich by stacking and packing them into dense, new residential developments. New development ensures that newly wealthy residents pay the highest possible tax rates on the highest property values, without reducing overall City revenues that imperil services or incentivize new property tax millages. Dense new developments concentrate the demand into much smaller areas, reducing competition for homes elsewhere in the City. Dense new development also makes more efficient use of City infrastructure, further reducing the burden of these new residents on the City budget so it can better serve all of us. Stack, pack and tax the rich.

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