Report Warns Of “Economic Act Of God” Threatening Boston’s Budget

FEB. 15, 2024…..The persistent popularity of remote work and high interest rates have combined to form an “economic act of God” that puts Boston at risk of losing a chunk of its tax base by the end of the decade, according to a new report.

Warning about the prospect of a “permanently diminished city,” think tank analysts said a sharp and steady drop in the value of office buildings could soon punch a hole in commercial property taxes, which make up a large share of the revenue that Boston uses to fund education, law enforcement, parks and other services.

A report published Thursday by the Boston Policy Institute, a non-partisan think tank that launched late last year, and the Center for State Policy Analysis at Tufts University did not mince words in its assessment of the financial risks that the state’s capital and largest city faces.

Stressing how “tricky” it is to quantify the “precise impact of this slow-motion collapse in commercial real estate prices,” the report estimated that Boston could face a cumulative commercial property tax shortfall of $1.2 billion to $1.5 billion between 2025 and 2029.

“The annual gap over this window is not constant but slowly expanding as the new reality of commercial real estate trickles through the appraisal process and into the tax system,” wrote Evan Horowitz, the executive director of cSPA and the report’s author. “The end result is a new normal where the city collects $400 million to $500 million less each year than the long-term trend implies, amounting to an annual reduction of roughly 10 percent of total revenues.”

While home prices continue to soar to record heights, the commercial property market has been lagging, according to the report. Recent office building sales have featured price markdowns, and about one in five offices are vacant.

That could pose a major threat to the city’s revenue. Lower demand and prices for office buildings could force the city to reduce its assessment of property values, which then means they would owe less in taxes, the report said.

Horowitz identified two drivers behind the trend. The “biggest culprit,” he wrote, is the rise of remote or hybrid work schedules, which have remained popular among many employees nearly four years after the COVID-19 emergency began, reducing demand for office space.

He also said high interest rates play a role in stressing the city’s commercial real estate base by increasing the cost of mortgages and “making it less profitable to own commercial buildings.”

Boston appears especially vulnerable because commercial property taxes represent a large share of the city’s revenue picture. Today, property tax collections make up nearly 75 percent of Boston’s total revenue, a significant increase from the 54 percent they represented in 2002, according to the report.

The Hub also relies on commercial property taxes significantly more than other major metropolitan areas like New York City, Chicago and Washington, D.C., some of which have the ability to impose local sales and income taxes that Massachusetts state government generally prohibits.

“It’s important to emphasize that Boston’s current and former leaders are in no way responsible for this coming crisis. What we face is something like an economic act of God,” Horowitz wrote. “Still, some kind of dramatic political response will be needed. A tax falloff representing 10 percent of Boston’s total spending is too large to be offset by creative accounting or other kinds of financial management. The city will need to raise new revenue or reduce its medium-term spending plans.”

The report said that there are few good options to create new revenue given state law constraining the kinds of taxes cities and towns can pursue. It also argued that imposing a new tax on high-value real estate transactions — something Mayor Michelle Wu has long been seeking to fund new affordable housing development, and an idea Gov. Maura Healey wants to greenlight in any willing community — would be “largely self-defeating, as it would put further pressure on commercial real estate prices and heighten the challenges in that industry.”

“More promising” in Horowitz’s mind is the idea of increasing the tax rate on residential properties, though the report stressed that it would require a major hike to fully offset the decline in commercial property tax revenues.

Horowitz also floated “more creative approaches to consider” that will require state government’s support, like granting Boston new authority to impose additional taxes or introduce a charge on driving downtown.

“And if none of these options sounds particularly appealing, the only real alternative is for Boston to reduce salaries or services, with potentially serious implications for public safety, climate resilience, and efforts to attract future residents,” he wrote. “This is where we push up against the dreaded doom loop, which may not be the most likely outcome but which is more worrisome than it’s been in 50 years.”