Vincent Orr is building wealth the old-fashioned way: scrimping, saving, and sweating. A Detroiter and Fiat Chrysler production supervisor, Orr made his first big investment in 2017, when he bought a brick house with a caved-in roof at auction for $2,100. After months of renovations, it was ready for his mother to move in to. In 2019, he paid $1,200 for the place next door for himself and started all over again.
In addition to countless hours of labor, Orr invested $100,000 of his own money for the materials needed to rebuild his little corner of the Motor City. Taking out a loan wasn’t really an option. As he told the Wall Street Journal, “cash is king because nobody can deny you. The houses that require a mortgage, a lot of people are reluctant.”
It’s tempting, therefore, to blame Detroit’s disinvestment crisis and long decline on credit markets that have malfunctioned—perhaps due to racial prejudice. But the reality is more complicated. Even if Detroiters had full access to easy, equitable, and abundant credit, the city would still struggle to attract the tsunami of investment it needs to renew and prosper.
To understand why, imagine yourself in Orr’s position, with a burning desire to rehab one of Detroit’s once-grand properties and the ability to borrow, say, $180,000 (the median home value in Michigan). The good news is that, on a 30-year mortgage at a 3 percent fixed rate (and zero down), your monthly principal and interest payment would total just $758.
But this is Detroit, which has the highest effective property tax rate of any major city in America, at 3.58 percent of market value. If the tax man assesses your house at its full renovation cost, this would add $537 to your monthly mortgage bill, bringing it to $1,295.
That hefty charge might not look too bad if the quality of local government services is top shelf. As Charles Tiebout observed in his classic 1956 article on local public finance, people “vote with their feet” and shop for their preferred combination of services and prices among various localities. Some happily buy at the public services equivalent of Neiman Marcus, others at Walmart.
From public safety to education to infrastructure, however, Detroit is no Neiman Marcus. To be charitable, let’s suppose the city’s services are on par with those of other Michigan cities, where the average property tax rate is 1.54 percent. Elsewhere, then, a comparable $180,000 investment comes with a monthly mortgage bill of just $989, or $306 a month less than in Detroit.
In that case, as many studies have shown, property values must fall in the higher-tax jurisdiction. Rational buyers will refuse to take on a mortgage payment that delivers less value than is available in rival locales; economists refer to the discounting that results as tax capitalization.
What does that mean for your rehabbing plans? To offset Detroit’s confiscatory tax rate and match the monthly mortgage/service bundle available from the competition, your $180,000 property would have to be discounted almost 24 percent, to about $137,000 (on which the principal and interest charges would be $577 and taxes $409, for a total monthly payment of $986).
That 24 percent tax penalty delivers a brutal financial hit to rehabbers. If every dollar’s worth of investment in Detroit creates only 76 cents of market value, there should be no mystery why lenders are reluctant to invest there and why so many of the city’s treasures are now ruins.
Nevertheless, economists commonly label the property tax as progressive in impact and applaud its use in local government finance. Owners of residential or business property, after all, tend to have above-average wealth and income, and this tax can be a dependable means to finance public education and other key municipal services. Like any good thing, though, it can be harmful when used to excess.
Many commentators identify the 1967 riots as Detroit’s turning point and blame the acceleration of its decline on the racially divisive rhetoric and policies of Coleman Young, who began five terms as mayor in 1974. In truth, Detroit’s disinvestment crisis and white flight began much earlier. Racial prejudice clearly played a role in that trend, but so did some economic fundamentals.
Even at its zenith in 1950—when only Chicagoans enjoyed higher average incomes—Detroit taxed real property aggressively. Per capita, its residents paid more than twice as much property tax as those in Chicago, Philadelphia, or Los Angeles. Young simply took that up a notch. By 1980, the middle of Young’s second term, Detroit’s effective property tax rate topped 4 percent of market value—roughly triple the national average.
It seemed like a good, progressive idea at the time: take from relatively well-off property owners and redistribute the proceeds to more needy constituencies in the form of social programs and generous compensation for the government workers administering them (including pension promises that would ultimately bankrupt the city).
As Young rose to power, whites still represented a narrow majority in the city and owned an even greater share of its real and commercial property, so one might think of a high property tax rate as a tool of racial justice. And if high taxes accelerated white flight, that just made Young’s predominantly black political base relatively stronger. (This is known as the “Curley Effect,” in honor of the pre-World War II Boston mayor who similarly taxed his city’s propertied classes and, as they fled, strengthened his base among poorer Irish voters.)
But good short-run politics is usually bad long-run economics. Over time, Detroit’s tax penalty repelled new investment and drove away residents and jobs. And as the city became majority-black, the racial justice argument for aggressive taxation of property flipped. Today, the city’s tax penalty has disparate impact on young black strivers. With homeownership being the top contributor to household wealth, it’s clear that Detroit’s property tax policy is a major obstacle to its black citizens’ upward economic mobility.
Removing that obstacle is a necessary condition for the city to recapitalize, repopulate, and expand economic opportunities for residents. There’s a way to do it without slashing short-term spending. By imposing a binding tax-rate cap to be delivered after a phase-in period, the city can accumulate reserves while new investment and rising property values expand the tax base. Those reserves will then supply cash on delivery of the tax cut. It would require budget discipline, of course, but as Detroit’s bankruptcy showed, failing to attract investment and retain residents inflicts far deeper, more enduring fiscal pain.
Detroit can flourish again, but relying on flashy downtown development projects won’t make that happen. The Motor City needs to attract small-scale investors like Orr—and to do that, it needs to stop penalizing them and start rewarding them for their efforts.
Photo by Joshua Lott/Getty Images