Property Tax Abatements: Incentives and Their Costs

What an abatement is

A property tax abatement is a temporary reduction in the property taxes owed on a site, offered by a government to encourage a particular kind of investment. Typically it applies to the added value from building or rehabilitation, not to the existing value of the land. Terms vary a great deal: the length may be a few years or several decades, the reduction may be full or partial, and the break may fade out gradually.

The thinking behind it is straightforward. A site that sits vacant or underused produces little tax revenue anyway. If a tax break helps trigger a project that would not otherwise happen, then the government gives up revenue it would not have collected, and later gains a larger tax base. In that case the public might come out ahead.

Rules differ widely by country and locality, and many places restrict or prohibit such breaks, so this is a general description.

How it is supposed to work

The logic runs in steps.

1. A site is rundown, vacant or too costly to improve under normal conditions.
2. The expected income from a new project is too low to justify the cost, which is the problem described by the financing gap.
3. A tax break lowers the project’s yearly expenses, which raises its net income and makes lenders and investors more comfortable.
4. The project goes ahead, adding jobs, housing or activity.
5. When the abatement ends, the property pays full taxes on the improved value.

The key assumption is step 3: that the break actually changes the decision. If the project would have gone ahead without it, the abatement is a gift of public revenue rather than an incentive.

A hypothetical example

Suppose a new building would normally owe $200,000 per year in property taxes on its improved value. A city grants a 10-year abatement of 50 percent of that amount.

• Taxes forgone per year: 50% × $200,000 = $100,000.
• Over 10 years: 10 × $100,000 = $1,000,000.

The owner pays $100,000 per year during the abatement and $200,000 afterward. The public gives up $1 million over the decade. Whether that is a good trade depends on what the building brings that otherwise would not exist. In this invented example, the question would be whether the project, say, houses people, employs workers or lifts nearby property values enough to justify $1 million, and whether it would have been built anyway.

Present-day dollars are also worth more than future ones, and the break matters more to a developer deciding early than the full-tax years do later. Real evaluations account for that, using discounting methods that vary in their details.

What the break costs the public

• Direct revenue loss. Money not collected cannot pay for schools, services or debt.
• Shifting burden. In many systems, local governments must still raise a set amount of revenue, so other taxpayers can end up covering what an abated property does not pay. The effect depends on how the local tax system works.
• Other taxing bodies. An abatement can reduce revenue for school districts, counties and other agencies, even if only the city agreed to it. Some places let each body opt in or out.
• Administrative costs. Monitoring compliance and verifying promises takes staff time.
• Opportunity cost. Money forgone could have funded something else, such as direct grants whose results are easier to see.

Questions for judging an abatement

Because outcomes are uncertain, a handful of tests help.

• Would the project happen without it? This “but for” test is the hardest and most important. An independent review of the project’s finances, such as a look at its development pro forma, can show whether the numbers truly fail without help.
• How large is the break relative to the project? A modest reduction on a major project is easier to defend than a deep one on a marginal gain.
• What does the public get in return? Specific commitments, such as affordable units, local hiring or public space, are easier to enforce than general promises.
• Is there a clawback? Agreements sometimes allow the government to end the break or recover money if promises are not met. Their strength varies.
• What is the time limit, and does it end? Open-ended or repeatedly extended breaks are more costly.
• Who else loses revenue? Check whether schools and other agencies are affected.
• Is it targeted? Breaks aimed at places where investment is weak differ from those offered in already strong markets, where they may simply reward what was coming.
• Is reporting public? Regular reports on jobs, units and tax impact allow later review.

Criticism and defense

Critics argue that abatements often go to projects that would have occurred anyway, that they create competition between neighboring places to offer bigger breaks, and that they can leave local services short. Supporters respond that in weak markets nothing would be built without them, and that a rebuilt site will eventually pay more than a vacant one. Research findings are mixed and depend on local conditions, so neither side’s claim should be taken as settled.

Abatements can also be compared with other tools. Rehabilitation incentives, grants and tax increment financing all try to close a project’s funding gap in different ways, with different costs and different visibility. An abatement hides its cost in revenue not collected, which makes it easy to overlook, and good practice treats it as spending even though no check is written.