Concern about loss of prime farmland has long been a major public policy concern. Many of the policies enacted in efforts to slow conversion along the urban fringe originated shortly after World War II as rapidly transforming cities expanded resulting in farmland being converted to residential, commercial, and industrial uses. One of the policy instruments that remains today is the use of preferential tax treatment of agricultural and forested lands. The process of adopting farmland’s preferential tax treatment took place at state and local levels and over several decades. As a result, many are unaware that such policies exist, or unaware of the differential property tax treatment that occurs for agricultural land.
All 50 U.S. states provide some form of preferential treatment for agricultural land. Most states do so through a form of use-value assessment. Under use-value assessment agricultural lands are taxed according to the potential earnings from agricultural production, rather than the full market value of the property. The market value of farmland, like other productive assets, is determined by the net present value of expected earnings associated with all future uses of the parcel. Although farmland in rural areas is principally valued by its ability to generate revenues through agricultural production, farmland values also reflect other potential streams of revenue, such as conversion to other uses, or through natural amenities and recreational opportunities. For example, farmland along the urban fringe is often sold at a premium that reflects the potential future returns from housing or commercial activities after the parcel is developed. In other areas, farmland derives much of its value for its access to natural amenities or recreational activities, such as bird hunting along pastures or access to trophy trout streams in the West.
The original proponents of use-value assessment argued that farmers were subject to an excessive tax burden, and that the revenue generated from agricultural production was often insufficient to service the taxes associated with the market value of agricultural land. The imbalance between market values and use values would therefore encourage farmers to develop farmland prematurely in order to service the increasing tax burden of farming in areas with high market values for farmland. In addition, many proponents argued that farmers were paying for a larger portion of public programs than they were consuming.
Farms typically cover a large share of land yet consume a relatively smaller share of public programs associated with the tax basis. For example, a farm may cover several hundred acres, but the farm household sends only a few children to school and consists of only a few buildings that require the protection of area police and fire departments. In contrast, a house in a subdivision may occupy less than an acre of land but require similar levels of public services. By taxing farmland at its market value, farmland owners were paying for a larger portion of public programs supported by real estate taxes.
Maryland was the first state to adopt preferential tax programs for agricultural land in 1957 in response to the rapid urbanization from neighboring Washington, D.C, with other states adopting similar programs in the decades that followed. Today, the policies that govern the tax treatment of agricultural land vary from state to state. For example, some states require enrollment, while others are automatically applied to all agricultural parcels. Some states require the payment of back taxes or substantial penalties if agricultural land is developed to other uses; others do not.
Further, the methods used to calculate the associated use-value vary substantially from state to state. Use-value assessments rely principally on two key components: (1) estimates of agricultural returns and costs of production, and (2) a capitalization or discount rate to reflect the time value of money. The use-value is then generally determined as the present value of discounted future net cash flows associated with the property. States typically rely on farm records or analyses conducted by government officials to calculate the expected costs and returns of the production of various agricultural commodities. Similarly, states mandate the use of a common discount rate for agricultural returns, though the discount rates are collected from a number of sources, such as major farm lenders, Federal tax code, or some other statutorily mandated rates.
Official statistics suggest that the share of the nation’s land base devoted to agricultural production has remained relatively stable since the 1950s, but empirical assessments of farmland taxation policies find limited impact of such programs on the retention of agricultural land. As a result, some have argued that the programs represent an expensive way to encourage the retention of agricultural land and argue in favor of other programs, such as the purchase of development rights.
Further, others have argued that preferential tax programs shift the burden toward other taxpayers, principally homeowners, to support tax breaks afforded to the owners of agricultural and forest lands. On the other hand, there are no clear ways to ascertain what irreversible conversion might have occurred in the absence of preferential tax policies, or what other tax shifts might have occurred in the absence of differential taxation policies.
Taxation is a policy area of constant negotiation and adjustment, as taxpayers, public policy administrators, and interest groups debate the appropriate levels and forms of taxation and the provision of public goods. The taxation of agricultural real estate is no exception. A number of states continually reexamine and renegotiate farmland taxation programs. A prominent recent example was New Jersey’s 2013 effort to eliminate the manipulation of farm tax policies by “fake farmers.” The debate centered on suburban homeowners who would sell the minimum amount of farm products ($500) in order to enroll their property as a farm and benefit from the significant tax savings. The new policy doubled the minimum sales requirement to $1,000 and set stricter guidelines for what qualifies as legitimate production practices.
Current expectations suggest that farm incomes throughout the country are expected to decline in 2014 and beyond. However, the agricultural use-value of farmland in a number of states may not decline as quickly because the income expectations are set as a moving average of several years. As a result, the recent prosperous years will still be included in calculating the expected earnings for farmland as incomes decline, and many farmers are again concerned that the tax burdens associated with agricultural land may be too much to bear despite the use of use-value assessments