Rebuilding Place in the Urban Space

"A community’s physical form, rather than its land uses, is its most intrinsic and enduring characteristic." [Katz, EPA] This blog focuses on place and placemaking and all that makes it work--historic preservation, urban design, transportation, asset-based community development, arts & cultural development, commercial district revitalization, tourism & destination development, and quality of life advocacy--along with doses of civic engagement and good governance watchdogging.

Thursday, July 02, 2015

Why Mayor Bowser is right to be leery of systematic lowering of taxes

DC is about to significantly lower its income tax rates ("Meet the Democrat in D.C. who is cutting taxes for the rich" and "DC takes final step toward sweeping tax reforms, accelerates cuts," Post) out of a belief that DC's tax structure could work better, needs to be more competitive with the suburbs, and most residents need a tax reduction.

The Mayor isn't behind the change, while by contrast the Washington Post editorial board is all in ("By not lowering tax rates, D.C. is shortchanging its residents").

But the reality is that it is mostly "urban myth," that DC's taxes are significantly higher than the suburbs, although Maryland's taxes being higher than Virginia's, there are some differences.

It's not that I don't think it's great to lower taxes, but I know that the city is hard pressed financially despite the comparatively great economic times ("Wall Street's opinion of D.C. is at all-time high," Wall Street Journal).

Despite the city's "huge" budget (about $12 billion annually, 40%+ comprised of funding for and from federal programs, like health care), most every dollar is called for, and it is difficult to come up with money to improve roads ("U.S. roads, bridges are decaying despite stimulus influx," USA Today), to fund much in the way of small cost innovative efforts and other needs ("Boom or bust? D.C. lawmakers try to make sense of budget," Washington Post).

The bonding debt cap (bonds are used to finance capital improvements) is close to being reached ("D.C. in debt: Never before has the city owed so much" and "D.C. Council report suggests District may need to raise its debt cap," Washington Business Journal) which means that it will have to increase its debt cap.  In the meantime, the city is driven to financial engineering stratagems, such as trading land for a new soccer stadium ("A Safe Bet?," Washington City Paper) to reduce the need for capital funding,

(Although I argue for increasing the building height limit downtown as a way to increase property tax revenues and to pay for necessary infrastructure, such as Metrorail improvement and expansion.)

Plus, some of the long term trends for the city's economy, if not unfavorable, at the very least, should raise serious concerns and reflection:

1.  DC's economy is not very diversified.  It is dependent on the federal government.  And the federal government is shrinking.  Concomitantly, the DC (and metropolitan) economy is shrinking too ("Washington's Boom Goes Bust," New York Magazine; "Federal Government Downsizing Sends D.C. Region Tailspinning," Falls Church News-Press).
  • First, the Republican-controlled Congress has been cutting back on government spending. Since a disproportionate amount of these expenditures are in the Washington region, this slows down and shrinks the metropolitan economy.
  • Second, the Republican-controlled Congress is dialing back regulation, actively thwarting the expansion of various government agencies, such as the Consumer Financial Regulation Board.  This affects the DC and metropolitan real estate market.
  • Third, the Republican-controlled Congress is less willing to invest in government and therefore government agencies are shrinking, not growing, and they are moving out of more expensive real estate submarkets like DC proper to more distant locations.  This affects the DC and metropolitan real estate market and DC especially.
  • And the Republican-controlled Congress isn't very interested in investing in the creation of a Department of Homeland Security campus on the St. Elizabeths west campus--which DC touts as the anchor of investment and revitalization East of the River, and the reuse of the St. Elizabeths east campus.  ("Will Congress Pull the Plug on Homeland Security's Move to St. Elizabeths," Government Executive).  This has a huge impact on the DC commercial real estate market.
  • Plus, fewer government workers and use of less well connected locations for federal activities means less demand for transit, dropping WMATA revenues, and increasing financial exposure of local governments for supplemental appropriations to the transit authority.
Proximity to the federal government drives the city's commercial real estate market in the Central Business District, and certain key submarkets arguably outside of the CBD: Union Station/NoMA; Capitol Hill; Southeast; and Southwest.  

More than 20% of DC's property tax revenue stream comes from commercial real estate property taxes in these districts.

2.  A shrinking metropolitan economy reduces the attractiveness of DC as a place to live. Residential population growth is slowing down.  Recent trends favor urban living, which has stoked demand for in-city housing.  But it has also been driven by large population growth associated with the post-9/11 growth in the federal government sector.

For a couple years during the Gray Administration, DC was adding more than 1,000 new residents each month.  That number is now about one-third lower ("Washington-area population increase slowing down," Washington Post).
  • This reduces the demand for DC residential real estate.  Some people might say that's a good thing, that it will reduce velocity within the market, which thus far has led to a rapid run up in housing prices.  On the other hand, it means that some areas where the city is trying to add population will not grow as fast or grow at all, and the ability to revitalize those communities declines.
  • Reduced numbers of high wage earning residents reduces city property, income, and sales tax revenues. and has negative impact on the city's quality of life also. 
3.  Plus an expected rise in mortgage interest rates will likely have negative consequences on population in-migration and could threaten the success of the residential real estate market.
  • Right now, a $1 million mortgage on a house worth $1.25 million--houses in Capitol Hill, Columbia Heights, Dupont Circle, Georgetown, Logan Circle cost this much or more--costs between $6,000 and $7,000/month, including taxes and insurance.  That requires a household income of approximately $250,000.  
  • If interest rates increase by 50% -- approximately 6% -- or 100% -- approximately 8%, the monthly payments would be $10,500 to $14,000/month, requiring household income of $375,000 to $500,000 respectively.
  • but it would increase interest in multiunit housing in both the rental and owner markets.
In such a financing environment, the city's residential real estate market could crash.  This will be less of a problem for people who already own housing, but it will be difficult for new residents to buy, and likely the owned real estate market, at least for single family housing, will become stagnant.

This will lead to more support for accessory dwelling units, because more people will need additional income from their property in order to make the mortgage payment.

4.  Organizations of all types: business; nonprofit; government; are using less office space per employee. ("Changing Office Trends Hold Major Implications for Future Office Demand," CoStar Group).

Yes, it's true that there is a rise in demand for in-city and in-edge city locations, which will help the city somewhat vis-a-vis the suburbs ("The suburban office park is a relic. Here's the damage it's done to one D.C.-area county," Washington Business Journal) but the general reduction in s.f./worker eliminates a fair amount of demand that is unrecoverable except through growth..
  • The old metric was that it took 250 square feet (s.f.) to support one employee.  Now the number is 200 s.f./worker, trending further downward to 160 s.f  to 180 s.f. per worker. 
  • That is a reduction in demand of 50,000 s.f to 90,000 s.f. per 1,000 workers.  That opportunity cost in the loss of leasing activity gets big fast and is why area vacancy rates are climbing, from 10% in DC to higher in the suburbs.
  • This could reduce DC's demand for office space by many millions of square feet.
  • This is also why there is increased interest in converting older office buildings to housing ("Will D.C. area developers turn more office buildings into apartments," Washington Post) to repurpose otherwise unwanted space.
5.  Law firms are contracting, merging and going out of business.
Conclusion.  Given these indicators, I'd be very leery about reducing significantly DC's ability to generate tax revenue from income, property, and sales ("Poll: D.C. residents favor mayor's sales tax increase," Washington Post) taxes.

Lower rates reduces the city's financial flexibility in potentially turbulent economic circumstances, which I don't think can be ruled out.

In this matter, I am firmly in Mayor Bowser's court.

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At 8:33 AM, Anonymous charlie said...

There is a lot to unpack here.

And I'll admit to being blind sighted by these income tax changes. DC needs to raise the exemptions for lower income, not lower the higher marginal rates. Then cut sales tax.

And a quick point, an increase in interest rates would mean the DC debt cap would be hit quicker.

That said, I didn't know Congress limited the debt rate to 17%, and that the city budget in 1995 before the control board took over was under $4 billion.

(Side note, I'm surprised you haven't commented on the IG report on DC school spending)

DC and debt is a fascinating case study. Much like Puerto Rico. My reading is that DC is not able to use Chapter 9. It is a sovereign state either. That is why it is inevitable that we'll have another debt crisis. Probably the best argument for statehood.

I do think the implications of a higher interest rate on the mortgage markets and DC is going be larger than predicted. A lot of people are going to be stuck. That means more rentals, which is going hurt construction. Real estate agents are sanguine about this, but it in an issue -- even more so when you look at 1% of 10% down loans.

You may be overstating the federal employment problem a bit -- it is a cut in the growth rate. I still think the real issue is lack of hazard pay, which drove up a lot of people's income for the past 10 years. I know at least 25+ people who managed to save up close to quarter million for down payments while there were overseas.

It is federal baseline pay that that creates the floor here -- and that isn't going to change. Hence my basic rule that if you're not making 100K you don't belong in the area.

(We went to City Center last weekend, and I finally saw another customer! Restaurants are doing ok)

At 9:49 AM, Blogger Richard Layman said...

1. haven't had a chance to look at the schools report, but I was thinking about it when I wrote this piece, but you already know my general point that we've wasted a lot of money on ill thought capital improvements.

Because the building is "$130 million" like for Dunbar, but the interest costs will double the cost (net inflation of course).

... am involved in a "hail mary" type economic development proposal which is occupying a fair amount of time.

2. I do agree with your suggestions on how changes to the tax structure should be handled, although I am fine with a 6% rate, since that is the same as the surrounding jurisdictions.

3. I hope you're wrong about another debt-financing crisis for the city, but I have to believe it will come. That's why we need to be judicious with the tax structure, keep attracting high income residents who pay income taxes to the city, add housing, AND BE INTELLIGENT ABOUT CAPITAL BUDGETING.

We've already jumped the shark on capital budgeting, and will pay the price for decades to come.

4. Again, increasing the height limit is the way out, because it will over time significantly increase the value and hence the property tax revenues from commercial property downtown.

... but it would only be fair to phase in the new values, because at first no one would be taking advantage of the change.

At 9:54 AM, Blogger Richard Layman said...

oh, about restaurants... we like Dino's Grotto and we've gone there a couple times when we have guests. But even on a Thursday night, I am surprised at how few seatings there are. I do wonder if there is overcapacity...

and I had a conversation with a restauranteur about a year ago, and he mentioned being uninterested in the 14th St. corridor because of the competition and Le Diplomate--their $15 million in revenue comes in large part at the expense of other restaurants.

OTOH, in Takoma, Busboys and Poets seems to be doing well (but the food, after two visits, just isn't worth the price), and Republic too, but it is "too expensive" for the value as well. The new Thai place, after some problems at the beginning, seems to be a winner. But we still like Middle East Kitchen.

We don't have access to the embarrassment of restaurant riches that you have in the core...

At 10:29 AM, Anonymous charlie said...

Right, my "debt crisis" isn't about the current capital structures but just that the District is in a unique place.

States are sovereign, can't do bankruptcy. Pension protection written into the consitution.

I can see Rhode Island or Illinois default on their debts, and it would be a mess.

But again, DC is different, and in the end there is a federal backstop, which in an incentive at some point it push the limits of default.

I don't know if there is good source of information on the 95 control board and what happened there. I don't think Dream City does a good job of explaining it. But just as in the 1800 (boss shepherd), 1900 (Barry) we'll have another one within the next 100 years.

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