The Impact of Land Capitalization
Incentive Effects and Potential Use of Enterprise Zones
by James R. Landers
Department of Public Administration and Policy Analysis
Southern Illinois University Edwardsville
This paper analyzes the potential impact of land capitalization on the incentive effects of enterprise zones, and their potential for being pursued by rent seeking landowners through the local public policy process. Enterprise zones have become one of the primary economic development tools and development-oriented interventions employed by state and local governments. Enterprise zone programs typically emphasize the provision of tax abatements to businesses locating or expanding within the economically depressed areas encompassed by the zones. The tax abatements are aimed at creating production cost and profit differentials between enterprise zone business operations and non-zone business operations. These differentials represent the incentive for businesses to locate or expand within the zones. The model presented in this paper suggests that enterprise zone tax abatements will succeed in increasing the utilization of targeted production inputs by zone businesses. The model also suggests that enterprise zones and enterprise zone tax abatements may lead to increases in land values that undo the cost/profit differentials generated by the tax abatements and diminish the incentive effects of the zones. Moreover, the capitalization effect may provide the impetus for rather perverse behavior. Landowners and public officials may seek to implement enterprise zones inappropriately, merely to contrive rents in the interest of landowners rather than to facilitate economic development in the interest of the community.
Enterprise zones represent one of the primary economic development tools employed by state and local governments as a means of targeting economic development incentives, especially tax abatements, to businesses operating in economically depressed areas. Enterprise zones are geographic areas that are designated by law for special policy treatment due to the economic conditions that exist within the zones. Presently, at least 40 states have laws authorizing the establishment of enterprise zones or some equivalent (1). In many instances, enterprise zones are designated and established pursuant to economic distress criteria specified in authorizing statutes or administrative regulations. An overview of enterprise zone designation criteria by Erickson and Friedman (1991) indicates that the distress criteria typically involve measures of area unemployment, poverty, and blight.
Enterprise zone programs tend to focus on the creation of production cost differentials that favor business operations situated in the enterprise zones over business operations situated outside of the enterprise zones. Although many financial and regulatory tools are available to create the desired cost differentials, enterprise zone programs in the United States have gravitated toward the provision of tax abatements as the primary means of cost reduction for businesses that operate in the zones. In particular, the tax abatements utilized in enterprise zones are typically aimed at subsidizing the purchase of capital and labor and providing an infusion of additional financial resources to businesses operating within the enterprise zones (2).
Given the reduction in tax cost, a business operating in an enterprise zone is expected to generate a larger profit margin than it would otherwise be expected to generate by operating outside of the enterprise zone. Moreover, the enterprise zone tax abatements are expected to increase the level of capital investment and employment undertaken by zone businesses. Overall, the relative advantage in terms of cost and profit that a business may experience by operating in an enterprise zone is expected to increase the level of business development within these economically distressed zones, and improve the economic opportunities available to the people residing in and around the zones. Consistent with Peterson (1981) and with Jud and Parkinson (1990), this represents a "public interest" explanation for the establishment and operation of enterprise zone programs (3). Local development policies like enterprise zones arise due to the community spirit of local political leaders -- the desire on the part of local political leaders to create employment opportunities for community residents and to maintain the community's fiscal capacity. Nevertheless, the effectiveness of enterprise zones in creating employment opportunities and spurring investment has varied. The following section contains a review of literature assessing the effectiveness of enterprise zone programs.
II. The efficacy of enterprise zones
A rather notable body of literature has developed over the years aimed at evaluating the investment and employment effects of enterprise zone programs operated in the United States (see, for instance, Wilder & Rubin, 1988; Erickson, et al., 1989; Rubin & Wilder, 1989; Erickson & Friedman, 1990; Rubin, 1990; Elling & Sheldon, 1991; Papke, 1991, 1993, 1994; Dowall, 1996). The literature has sought to estimate the change in local levels of capital investment and employment due to the existence of enterprise zones, and due to the tax abatements and other incentives employed by enterprise zone programs. In general, the empirical literature indicates that there is an association between enterprise zone programs and growth in business investment and employment levels. However, the empirical literature also reveals substantial intrastate and interstate variability in enterprise zone investment and employment effects.
Dowall (1996) found substantial variation in employment and investment change among enterprise zones in California. While all but one of California's enterprise zones experienced job growth from 1986 to 1990, the percentage change in zone employment varied from -2.1 percent to 81.6 percent, with an average change of 12.6 percent during that period. All but three of the enterprise zones experienced an increase in business establishments from 1986 to 1990. The average percentage change in business establishments was +3.7 percent, with a range of -7.7 percent to +57.7 percent.
Likewise, Elling and Sheldon (1991) and Erickson and Friedman (1990) found substantial interstate variability in enterprise zone investment and employment effects. Elling and Sheldon found substantial differences in job creation and job retention in 47 enterprise zones located in Illinois, Indiana, Kentucky, and Ohio. Performance in the enterprise zones observed ranged from one to 694 jobs created and zero to 3,362 jobs retained. Mean annual jobs created in enterprise zones for each of the four states ranged from 102 to 243, and mean annual jobs retained in enterprise zones for each of the four states ranged from 84 to 600. Elling and Sheldon also found substantial variability in business investment among enterprise zones in Illinois, Indiana, Kentucky, and Ohio. The number of firms investing in an enterprise zone in these states ranged from one to 69, and the value of investment within zones ranged from $700,000 to $218 million.
Erickson and Friedman (1990) examined 357 enterprise zones in 186 communities across 17 states. On average, 144.9 jobs were created annually within the enterprise zones and 216.2 jobs were retained annually within the zones. However, the standard deviations for the job creation and job retention measures (174.4 and 437.1 respectively) indicate substantial variation in job creation and retention levels across enterprise zones. Erickson and Friedman also found substantial variation in zone investment effects. On average, 5.6 new establishments and 6.3 expansions of existing establishments occurred per year in the observed enterprise zones. The standard deviations, however, were 8.0 for new establishments and 12.2 for expansions, respectively. Moreover, total investment within the observed enterprise zones averaged $10.9 million per year, with a standard deviation $47.3 million.
Due to the variability in performance of enterprise zones, several of these analyses examine the political and economic factors that explain this variation. With the exception of Papke (1993), however, this literature has overlooked the potential impact that capitalization of enterprise zone tax abatements (and other incentives) into zone land values may have on the efficacy of the zones. A capitalization effect would encompass the shifting of tax abatement dollars from recipient business establishments to landowners through rent or sales prices on enterprise zone property. Shifting of tax abatement dollars through enterprise zone programs could have substantial implications both for the efficacy of the programs and as a basis for local landowners to become rent seekers. Given its relevance in the context of enterprise zones, the next section contains a brief overview and discussion of the literature on property tax and public service capitalization.
III. Property tax and public service capitalization
Capitalization is a concept employed in the study of financial markets to describe the economic process by which the future flow of costs and benefits accrued by the owner of an asset are reflected in the market value of that asset. The capitalization concept has been implemented extensively to study variations in urban land values and the location choices of urban land users. For instance, the literature surrounding the estimation of so-called bid-rent models of urban land valuation (see, for instance, Alonso, 1964; Muth, 1969; Henderson, 1985) explored the influence of accessibility to the urban commercial center on land values and, as a result, the location choices of urban land users. Fundamentally, the bid-rent models assert that urban land values, in particular housing values, decline as distance from the urban center increases. Consequently, variation in distance from the urban center or commuting time is capitalized into urban housing values.
In a sense, the property tax and public service capitalization studies initiated by Oates (1969, 1973) extended or expanded upon the bid-rent approach and tested the notion that urban land users select community locations based upon the property tax and public service levels established within each community. The capitalization literature stems directly from the model of local public goods provision and competition among communities presented by Tiebout (1956). Tiebout posits that urban land users migrate to and from different communities based upon the public service packages offered, and tax prices established, within those communities. Oates reasoned that the capitalization effect could be employed to measure the degree to which land users recognize and value the fiscal benefits and costs of a particular community relative to other communities in an urban area. According to Oates, under conditions of property tax and public service competition among urban communities vying to attract land users, capitalization of the tax and service differences will arise due to the varying levels of demand for land within each competing urban community.
Much of the capitalization literature emphasizes the demand-side analysis of urban land markets (see, for instance, Oates 1969, 1973; Brueckner 1979). Oates, Brueckner, and others posit that demand for higher public service levels or lower property tax levels by mobile urban land users serves to bid up land values in communities with preferred service and tax levels. Consequently, this literature predicts that under long run equilibrium conditions, fiscal differences among communities in an urban area will be capitalized into real estate values (4). The empirical research on property tax and public service capitalization in urban housing markets has shown rather consistently that capitalization does occur. However, the capitalization rates estimated in these studies have varied substantially and most have fallen below 100 percent (Bloom, et al., 1983; Yinger, et al., 1988). Bloom et al. (1983) and Yinger, et al. (1988) applied more appropriate discount rates and time horizons to the results of existent empirical capitalization studies. The results of these analyses suggest that interjurisdictional property tax variations are capitalized into house values at rates of anywhere between 30-40 percent and 100 percent.
Several reasons have been posited for empirical estimates suggesting that most often fiscal differentials are undercapitalized into property values (estimated capitalization rates of less than 100 percent). Chief among these reasons is the claim that capitalization is really a short run phenomenon. That is, in the short run, demand for preferred property tax/public service packages will outstrip the supply of communities providing those preferred packages. As a result, the empirical studies have observed transitory increases in real estate prices due to "an imperfect matching of individual preferences and public goods consumption opportunities [that won't hold in the long run] (Pauly, 1976, 239)." As a result, several policy analysts (Edel and Sclar 1974; Hamilton, 1976, Pauly, 1976, Epple, Zelenitz, & Visscher, 1978) have chosen to highlight the supply-side of urban land markets in analyzing capitalization of property tax and public service levels. They have argued specifically that long run equilibrium would not be characterized by capitalization of fiscal differentials. Rather, under a perfectly elastic supply of communities citizen preferences for public services would be exactly matched with public service consumption opportunities. In the long run, landowners and developers will respond to the demands of urban land users by increasing the supply of developed property in communities having the preferred property tax and public service levels. Consequently, capitalization of fiscal differences among communities will disappear.
IV. A model of development incentive shifting
The model that follows details the impact that the capitalization process may have on (1) the cost/profit differential generated by tax abatements granted businesses operating within enterprise zones and (2) business use of tax abated production inputs. The price effects arising from competition for an inelastic supply of business sites within an enterprise zone and corresponding tax abatements are analyzed with a conventional profit maximization model (5). Consider a firm that produces output Q using land A and a composite commodity v as production inputs. The input A represents acres of land within a community utilized by the firm in production. The amount of A made available or zoned for business use by the community is restricted to an amount equal to . For ease of analysis, is assumed to encompass one geographical area or zone of the community. The unit price of A is equal to one. Conversely, the input v is variable with a price equal to pv. The firm's production technology, Q = f(v), is decreasing in v. Moreover, the firm does not set prices, but takes its output price and input prices as set by the market.
The firm's profit maximization problem is expressed in Equations 1 and 2.
As expressed in Equation 2, profit maximization requires the firm to utilize v = v* so that its marginal revenue product, MRPv, is equal to its marginal cost, pv. The profit maximizing relationship is portrayed graphically in Figure 1.
|Figure 1. Economic rent to land in the absence of an enterprise zone.
The firm's profit maximizing outlay on the variable input is equal to pvv* represented by the checked rectangle. At v* the total revenue to the firm is equal to the checked and shaded rectangles. Under competition for the restricted supply of business sites the producer's surplus (denoted by the shaded rectangle) becomes economic rent to land equal to pQf(v*) - pvv*.
Now, consider the same firm, but assume that is an enterprise zone. Consequently, the firm has the opportunity to secure an economic development incentive by establishing its business operations within the enterprise zone. In this instance, the development incentive is a tax abatement. The tax abatement is provided in the form of a unit subsidy to v. The firm is eligible for the subsidy only if it establishes business operations within the enterprise zone. The subsidy is equal to where is a proportion ranging from zero to one. Consequently, the subsidy could be utilized to lower the unit cost of variable inputs like capital and labor employed within the enterprise zone. The proportion is established by the community and cannot be varied by the firm. The firm may vary only by varying its location among jurisdictions and enterprise zones. Consequently, the dollar value of the subsidy to the firm is and is increasing in v. Given the addition of the enterprise zone subsidy, the firm's profit maximization problem is now expressed in Equations 3 and 4.
As before, profit maximization requires the firm to add units of v in production until profits cease to be positive. As expressed in Equation 4, however, the tax abatement reduces the marginal cost of the variable input by . Therefore, the firm utilizes v = v** such that MRPv is equal to . The profit maximizing relationship given the enterprise zone subsidy is expressed graphically in Figure 2.
Figure 2. Economic rent to land in the presence of an enterprise zone.
The firm's profit maximizing outlay on the variable input while operating in the enterprise zone is equal to represented by the checked rectangle. At v** the total revenue to the firm is equal to the checked and shaded rectangles. As before, the producer's surplus (denoted by the shaded rectangle) would, under competition for the restricted supply of business sites within the enterprise zone, become rent to land. Therefore, the enterprise zone tax abatement increases the rent to land in the area by an amount equal to .
V. The policy and public choice implications of enterprise zone tax abatement shifting
The preceding analysis has implications for the intended incentive effects of enterprise zone programs. Moreover, the analysis suggests a potential motivation other than the community or public interest for landowners and public officials to endorse and pursue the establishment of enterprise zones.
The potential impact of capitalization on the incentive effects of enterprise zones
The model implies that development incentives like tax abatements that subsidize the purchase of variable production inputs increase the amount of the inputs employed by recipient businesses. If the tax abatement is granted only to businesses operating in enterprise zones, it will increase the amount of the targeted inputs employed in production within the zones. This is represented by the change in the profit-maximizing amount of v (from v* to v**) employed by the enterprise zone business. Consequently, the enterprise zone serves to increase the productive use of variable inputs like capital or labor above the level that would otherwise have arisen. This result is consistent with the general findings of the literature evaluating the effectiveness of enterprise zone programs (reviewed above in section II), where enterprise zones are found to have a positive impact on employment and capital investment, however variable the impact may be. What's more, the model reveals that besides the potential for resource transfers from recipient businesses to local landowners, the enterprise zone also leads to an increase in resource transfers from recipient businesses to the local workforce or to local suppliers of other variable inputs.
The model also suggests that businesses in pursuit of sites in the enterprise zone, and the accompanying tax abatements, will bid up zone land values. By and large, this result is consistent with the property tax and public service capitalization literature (reviewed above in section III). Fiscal differentials, in this case created via tax abatements granted to businesses operating within enterprise zones, are reflected in the value of business sites within the zones. However, capitalization of enterprise zone tax abatements would presumably vary depending upon the elasticity of supply of enterprise zone business sites, and depending upon the elasticity of demand for business sites.
If the supply of enterprise zone business sites is inelastic, land rents will be bid up by an amount equal to the producer's surplus (denoted by the shaded rectangle in Figure 2), provided the demand for business sites within the community containing the enterprise zone is relatively elastic. This proposition has important implications for the implementation of enterprise zone policy. In economically depressed communities the supply of business sites is probably rather elastic (even in the short run because of an over-abundance of idle resources) and the demand for business sites is probably rather inelastic. As a result, little or no capitalization of tax abatements will probably arise in enterprise zones in economically depressed communities. On the one hand this result is good since it suggests that businesses receiving tax abatements within these zones will retain those resources. Thus, the decrease in cost and increase in profit for businesses operating in such zones will be maintained. On the other hand, this result also may suggest that the inducements provided by enterprise zones only minimally increase development of land in those depressed communities relative to the land available for development.
Conversely, in more prosperous communities that nevertheless have enterprise zones, the supply of business sites may well be inelastic in the short run and the demand for sites elastic. Under such circumstances, the results of the model would hold. That is, the value of enterprise zone land would be subject to an upward adjustment offsetting (potentially in full) the decrease in the net price of the variable input due to the tax abatement. This implies that given a tight market and sizeable demand for business sites, tax abatement dollars secured by enterprise zone businesses may not be retained entirely by those entities. Rather, the tax abatement dollars may be transferred to owners of enterprise zone land. The monetary amount of the transfer would approach the monetary amount of the producer's surplus (denoted by the shaded rectangle in Figure 2) as the supply of enterprise zone sites is restricted and the elasticity of demand increases.
The discussion above also highlights an important facet in the competition among communities. In a competitive metropolitan setting, more prosperous communities may be able to readily bid potential investment away from the enterprise zones in depressed communities. Given the divergence in the elasticity of demand for business sites in the two types of communities, more prosperous communities may be able to bid investment away from depressed communities by making only marginal fiscal improvements through tax abatements, other incentives, or service enhancements. This suggests that enterprise zones should be limited only to depressed communities. Even with such a limitation, this suggests that competition for development from more prosperous communities will reduce the effectiveness of depressed community zones. Fiscal improvements made at a minimum of cost by more prosperous communities potentially will require depressed communities to offer increasingly costly tax abatements and other incentives with the hope of remaining competitive.
Ultimately, and most importantly, capitalization potentially may drive profits of zone businesses to zero, the same profit margin the businesses would earn outside the enterprise zone. Capitalization of the unit subsidy into enterprise zone land prices serves to diminish the presumed incentive effects of the enterprise zone. That is, the incentive of reduced production cost and increased profit margin that the enterprise zone is intended to offer to businesses is diminished, if not eliminated, by the capitalization effect. As a consequence, the more prosperous the community in which an enterprise zone is situated, the lesser the incentive effect the zone will create as any potential increase in profit margin via the tax abatements is extracted by local landowners. Under these circumstances, enterprise zones appear to be of little use as a tool for providing any competitive advantage in terms of cost or profit to the business receiving zone tax abatements. Alternatively, substantial capitalization should be absent in enterprise zones located in extremely depressed communities. Therefore, the incentive effect of the enterprise zones would be preserved as the tax abatement resources are retained by recipient businesses.
Does the empirical literature confirm the results of the model?
Three studies of the capitalization effects of enterprise zones suggest that resource shifting from enterprise zone businesses to landowners does occur (Erickson & Syms, 1985; Landers, 1999; Engberg & Greenbaum, 1999). In addition, one of the studies (Engberg & Greenbaum, 1999) suggests that the capitalization effects of enterprise zones are influenced by supply conditions.
Empirically, Erickson and Syms (1985) examined capitalization of tax abatements within British enterprise zones. Time trends of rental rates for industrial properties before and after enterprise zone establishment implied that the zones created a dual property market. Within this dual property market industrial properties just outside the periphery of the enterprise zones experienced a sharp decline in real rental rates. In addition, Erickson and Syms found that tax abatements led to a significant increase in rental rates within the enterprise zones. The empirical estimates suggested that almost two-thirds of the value of the tax abatements provided to land and fixed capital in the enterprise zones were capitalized into the rental rates charged by landlords for property within the zones.
Employing sales price and other realty information for 1,732 commercial and industrial parcels sold between 1984 and 1993, Landers (1999) estimated the relationship between parcel sales price and parcel location within an enterprise zone controlling for a variety of structural and spatial pricing variables. Parcels located within and outside of eight enterprise zones in the Cleveland (Ohio) metropolitan area were utilized to estimate the capitalization effects. The regression estimates suggested an inconsistent pattern of enterprise zone price effects. On average, enterprise zone parcels were sold for a price that was 0.195% higher than non-zone parcels. However, this result was not statistically significant at a standard level of significance. Six of the eight enterprise zones exhibited positive price effects. However, only two of these enterprise zones exhibited statistically significant price effects. On average, parcels in those two enterprise zones sold for a price approximately 0.6% higher than other zone and non-zone parcels.
Engberg and Greenbaum (1999) examined the impact of enterprise zones on the growth in housing values in 4,107 cities with populations between 5,000 and 50,000, 303 of which had enterprise zones. They found that the impact of enterprise zones on growth in housing values was moderated by the supply of housing within particular cities. On average enterprise zones didn't increase the value of housing, but did have a positive impact on housing values when the existing vacancy rate for housing was lower than average. The empirical results suggest that in a community with a housing vacancy rate one standard deviation below the average, an enterprise zone will cause housing values to grow at a rate one percent higher than otherwise. Conversely, in communities with higher-than-average vacancy rates, the price effect of the enterprise zone is negative. Thus, the price effect of increased demand for land within the enterprise zone varies depending upon the elasticity of supply for land. When supply is inelastic (low vacancy rate) a positive price effect arises. When supply is elastic (high vacancy rate) the positive price effect does not arise, but vacancy rates decline.
As to the impact of capitalization on the incentive effects of enterprise zones, two empirical findings suggest that the supply of enterprise zone sites influences the investment and employment effects of the zones. The conceptual discussion and empirical capitalization results suggest that resource shifting from enterprise zone businesses to zone landowners varies inversely to the supply of zone business sites. Moreover, the conceptual discussion implies that the incentive effect of enterprise zones (the additional profit resulting from the zone tax abatements) diminishes as capitalization increases.
Consistent with these conclusions, Erickson and Friedman (1991) found that size of enterprise zones had a substantial impact on zone performance. Specifically, the number of businesses investing in zone establishments, and the number of jobs created or saved by firms investing in zone establishments, was found to be increasing in enterprise zone size. The employment effect was statistically significant. Albeit not statistically significant, Elling and Sheldon (1991) also found that enterprise zone size influenced zone performance relative to relocating firms. They found that enterprise zone area was positively related to the number of relocating firms qualifying for enterprise zone benefits.
Differences in the size of enterprise zones would be expected to create variation in the absolute level of business activity among enterprise zones. However, a more elastic supply of enterprise zone business sites (via larger zone size) should minimize capitalization and the corresponding drag on the incentive effect of the enterprise zones. The tax abatements provided when the supply of enterprise zone sites is elastic will be retained by recipient businesses and not as readily shifted to owners of enterprise zone land through capitalization. Thus, it appears that enterprise zone policies are most effective when the supply of enterprise zone sites is elastic.
Given the potential for an elastic supply of enterprise zone business sites to forestall incentive and tax abatement shifting and lead to enterprise zone effectiveness, it appears that state policies authorizing enterprise zones should do so liberally. The criteria for establishing enterprise zones should have a broad impact, allowing zones in a substantial number of communities. Moreover, the legal and governmental process under which enterprise zones may be established or altered should consume a minimum of time and resources. The liberal establishment and alteration policies would ensure a large and elastic supply of enterprise zone business sites. For this reason, expansive policies would diminish the capitalization of zone incentives and tax abatements into zone land values.
Expansive enterprise zone policies, however, belie the fundamental purpose of enterprise zones, which is to target development incentives and tax abatements to economically depressed areas. On this point, Anderson and Wassmer (2000) have found that the efficacy of development incentive programs diminishes over time and as a result of intensified use of the incentives by more prosperous communities located on the periphery of urban areas. Their empirical findings suggest that periphery communities are more likely to employ incentives (relative to economically depressed core communities) the longer the incentive program is in existence (Anderson & Wassmer, 2000, 166-67). In so doing, the periphery communities are able to bid development away from the core communities within which blighted and depressed areas tend to dominate. The shifting model presented in this paper implies that prosperous periphery communities would be able to do so with only marginal changes in incentives because of the substantial differences in supply and demand elasticities for business sites that exist between periphery and depressed core communities.
Ultimately, Anderson and Wassmer (2000, 163) found that the increasing use of incentives by periphery communities diminished the efficacy of the incentive programs overall. In particular, they found that as periphery communities intensified their use of incentive programs, the programs were less effective in depressed core communities as measured by growth in population, employment, and commercial and manufacturing property base. Consequently, Anderson and Wassmer recommend strict targeting of incentives only to economically depressed communities. Interestingly enough, the shifting model suggests that capitalization would not occur (or would be severely constrained) in economically depressed communities where the supply of business sites is relatively elastic and the demand for sites is relatively inelastic. Thus, targeting enterprise zones, as opposed to allowing for significant expansion in the number and size of zones, may serve to minimize capitalization while providing for effective incentive programming in economically depressed communities.
Capitalization and the potential for local landowners to act as rent seekers
While the potential impact of enterprise zones on land prices has substantial implications for the efficacy of these programs, it also provides a basis upon which landowners may become advocates for the establishment of enterprise zones. The monetary windfall that local landowners may be able to extract as a result of the establishment of an enterprise zone becomes the political motivation for advocating their establishment and operation. As Bartik (1991, p. 113) suggests with regard to all development incentive policies, enterprise zones may represent "a modern version of 'honest graft,' a way for persons of influence to use government to increase property values." Thus, the "public interest" may serve as the apparent justification for the establishment and operation of enterprise zones only in so far as it obfuscates the rent-seeking behavior of local landowners.
On this point, tests of the monopoly-zoning hypothesis may illustrate the potential for enterprise zones to be utilized to contrive rents for local landowners. The monopoly-zoning hypothesis suggests that communities can increase the value of new housing by artificially restricting its supply through local zoning policies. By creating a small and inelastic supply of land available for financially lucrative development, local authorities may assist such development in obtaining a premium price. Consequently, a substantial portion of the interurban variation in housing values can be attributed to variation in the natural supply of urban land available for development (Rose, 1989; Thorson, 1996).
In particular, monopoly zoning encompasses an assessment regarding the monopoly power of each community to control the use and development of land within its boundaries. The hypothesis suggests that a community's monopoly zoning power declines as the supply of land available for development increases in neighboring communities. Thus, land rents created through zoning restrictions employed by any particular community will vary inversely with the number of autonomous surrounding communities and the supply of land available for development within those communities (Fischel, 1980; Thorson, 1996).
The empirical findings on monopoly zoning are quite consistent with the conceptual shifting model. The monopoly zoning literature suggests that local public officials may be able to manipulate local land prices by severely restricting the supply of land available for location of profitable enterprises, provided there is little or no competition for development from other communities. Likewise, the conceptual shifting model coupled with the empirical analyses of the capitalization effects of enterprise zones suggests that local public officials could manipulate land prices by establishing enterprise zones. In so doing, local public officials could establish a restricted supply of land (the enterprise zone) that firms must occupy to obtain tax abatements. The price effect would provide a rationale for local landowners to pursue enterprise zone establishment through the local public policy process. In particular, landowners in communities where the demand for business sites is relatively elastic may find this strategy most effective because capitalization of tax abatements and other incentives under such supply and demand conditions would be maximized.
As under monopoly zoning, however, the price effects of the enterprise zone would depend on the supply of enterprise zone business sites in surrounding communities. The effect of competing enterprise zones may provide the basis for local landowners and local public officials to obstruct enterprise zone efforts in neighboring communities by pursuing public policies that place overall limitations on enterprise zone establishment. While the analytical results illustrate the potential price effects of enterprise zones, they don't suggest that public officials or landowners are, in fact, using the zones to inflate property values. Rather, the analytical results only suggest that the basis for such activity is present.
The potential for rent seeking by local landowners has implications for criteria and oversight efforts relating to the establishment of enterprise zones. Stringent oversight of enterprise zone establishment may preclude misuse of the enterprise zones to enrich local landowners. However, more stringent reporting requirements and more invasive oversight could interfere with the efficient and effective implementation of enterprise zones by communities. In response communities in need of these policies may reject enterprise zones as a development tool. A better course of action may be to limit enterprise zones only to economically depressed communities where capitalization is expected to be at a minimum. If capitalization related to enterprise zone establishment is zero or close to zero, rent-seeking behavior by local landowners would have little or no basis. Thus, targeting enterprise zones to depressed communities appears to represent a rather effective check against strategies aimed merely at contriving land rents through the establishment of zones.
This paper analyzes the potential impact of land capitalization on the incentive effects of enterprise zones and the potential for enterprise zone establishment to be pursued by rent seeking landowners through the local public policy process. The analysis presented in this paper provides a basis for several important conclusions relating to enterprise zone policies.
First, tax abatements and other incentives provided to businesses operating within enterprise zones will increase the amount of variable production inputs utilized by businesses within the zones. Regardless of the capitalization effect that may arise due to the enterprise zone, the shifting model suggests that enterprise zones will benefit from investment and employment in excess of what would otherwise occur. This result has definite implications for the workforce and suppliers in and around enterprise zones.
Secondly, enterprise zones, and the tax abatements and other incentives provided to businesses operating in them, may drive-up zone land values. The shifting model suggests that if the supply of enterprise zone business sites is inelastic and demand for sites is elastic, tax abatements and other incentives provided to zone businesses will be transferred to zone landowners through increased rental rates or sales prices. Nevertheless, if the supply of business sites is elastic and demand relatively inelastic, the shifting outcome suggested by the model is not expected to arise. Therefore, the capitalization basis for establishing enterprise zones merely to enrich local landowners would be absent in economically depressed communities. Also as a result, targeting enterprise zones to economically depressed communities may be the most effective means of preventing local landowners from pursuing rent seeking strategies.
Finally, the analytical results demonstrate the implications of tax abatement shifting for the efficacy of enterprise zone programs. The capitalization effect potentially could eliminate any cost or profit advantage a business might obtain by operating within an enterprise zone. The existence of the capitalization effect and its variation depending upon supply and demand elasticities for business sites may, in part, explain the substantial variability in investment and employment effects that have been observed in enterprise zones. Furthermore, the shifting model implies that capitalization will diminish the incentive effects of enterprise zones most in prosperous communities. Consequently, targeting of enterprise zones only to depressed communities should minimize, if not eliminate, capitalization effects related to enterprise zone establishment and improve the overall efficacy of the zones.
1 - Information obtained from the World-Wide-Web site of The EZ Project at the University of Richmond School of Law, http://www.richmond.edu/~ezproj/statelaw.htm.
2 - Wolf (1990) indicates that the most common tax abatements utilized in enterprise zones are property tax exemptions for improvements to property, income tax credits for business investment and employment of economically disadvantaged persons, and sales tax exemptions for materials and equipment purchased and utilized by enterprise zone businesses.
3 - Peterson (1981) and Jud and Parkinson (1990) suggest that local development policies arise due to the community spirit of local political leaders. According to this perspective, the primary benefit of development policies like enterprise zones is found in protecting the community tax base and creating jobs for current and future residents of the community. As a result, development policies may be politically popular if community residents also perceive that these policies increase local job opportunities and maintain the fiscal capacity of the community to provide a high level of public services.
4 - While the capitalization (and hedonic pricing) literature has focused almost entirely on housing or residential property values, the applicability of the model to commercial and industrial property and firm location choice is apparent. Linneman (1982, 80-81) observed that demand for industrial sites could be modeled like demand for household locations has so often been modeled. "[F]irms can be viewed as demanding various location-specific traits [including, for instance, local government public services and property taxes]."
5 - The model is an adaptation of a model explaining the effect of property taxes on capital intensity of development by Shoup (1978).
6 - This result was statistically significant at the 0.154 level of significance.
7 - Engberg and Greenbaum (1999) select housing values to measure the efficacy of enterprise zone incentive programs because of the availability of housing value data through the decennial census. Also, if enterprise zones do spur development, they expect the zones to have an effect on housing values. Housing values are expected to increase due to increased demand for housing by workers migrating into the zones or by commercial entities desiring to transform housing within the zones into land for commercial use.
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