Let infrastructure pay for itself!

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Creative Commons License photo credit: dsearls

Gavin R. Putland

Everybody wins when we tax the benefits of infrastructure to cover the costs

DON RILEY owned properties near two stations on a new section of London’s underground Jubilee Line. The rise in the value of his properties outweighed all the tax he paid in the previous 40 years.

In his book, TAKEN FOR A RIDE (2001), Riley calculated that the new line, which cost taxpayers £3.5 billion, raised land values by a conservative £13 billion. If 27% of the uplift in land values had been reclaimed through the tax system, leaving the other 73% for the lucky property owners, this project would have paid for itself without burdening any other taxpayers.

Riley couldn’t help noticing that if the tax system reclaimed a share of ALL uplifts in land values, property owners would be the biggest winners, because numerous infrastructure projects that were stalled for want of money would suddenly become self-funding.

In a recession, this is just what is needed to reverse the decline in property values and create jobs without trashing the Budget. Moreover, such uplifts in land values are compatible with affordability in that they represent improved amenity, not higher prices or rents for the same amenity.

The benefit of an infrastructure project is measured by the price that people are willing to pay for it, and whatever part of that price is not paid in user charges (fares, tolls, etc.) is paid for access to LOCATIONS serviced by the project. In other words, the benefit (net of user charges) is manifested as uplifts in LAND VALUES — not building values, which are limited by construction costs, but values of land (or space), which has a location and therefore a locational value even if no buildings yet occupy it.

Therefore if the benefit of an infrastructure project exceeds the cost, then the cost (net of user charges) can be covered by taking back a sufficient fraction of the uplift in land values.

More generally, the COST-BENEFIT RATIO of a project is the COST-UPLIFT RATIO. If the tax system claws back a fraction of every uplift in real land values, any project whose cost-benefit ratio equals that fraction is self-funding, and any project with a lower cost-benefit ratio is more than self-funding, yielding net revenue that can be used for (e.g.) cutting other taxes or retiring debt. The remaining fraction of the uplifts is a net windfall to property owners.

Economic theory says the utilization of infrastructure will be socially optimal if user charges are set at marginal cost. But in that case, the fixed costs must be met from some other source. Taxing the uplift in land values solves the problem.

Public-Private Partnerships (PPPs) do NOT solve the problem, because private providers have little or no ability to recover uplifts in land values. So they try to cover capital costs entirely from user charges, which are therefore too high, causing low utilization, which may prevent recovery of costs — unless taxpayers come to the rescue. Low utilization defeats the purpose of the infrastructure, while public subsidies and guarantees defeat the alleged purpose of private finance.

Financing infrastructure out of uplifts in land values does NOT mean raising taxes now to pay for infrastructure later. It means changing the tax mix so that future investment in infrastructure pays for itself by expanding the tax BASE without further changes in rates or thresholds. The initial change can be revenue-neutral, and can be managed so that property owners don’t lose in the initial change or the subsequent operation of the new system.

Of all existing taxes, the one most conducive to investment in infrastructure is land tax. This does not burden land buyers, because it is discounted in prices: the higher the tax, the lower the price. Thereafter, if the rates and thresholds are left well alone, your tax bill doesn’t increase unless your land value does, and your land value doesn’t increase unless, in the judgment of the market, you are better off in spite of the tax implication.

But the rates and thresholds are not left well alone; they are repeatedly adjusted to “compensate” property owners who are paying more tax because their assets have increased in value. Never mind that the asset appreciation dwarfs the tax! By demanding such “compensation”, property investors effectively tell governments: “Don’t build infrastructure, because we won’t share the uplifts in land values.” So the infrastructure isn’t built.

Conveyancing stamp duty, which raises revenue in proportion to total turnover of land and buildings, is inefficient at taxing uplifts in land values. It would be far more efficient if it were payable by the vendor and proportional to the “capital gain” on the land since the last transfer of title. (And if the seller of a property acquired under the old system had the option of paying tax as if the property had been sold and bought back on the last day of that system, there would be no losers in the transition.)

But when NSW introduced a 2.5% stamp duty on capital gains in 2004, opposition from property investors forced the Government to drop the infrastructure-friendly new duty and keep the old one.

The tax most conducive to infrastructure provision by LOCAL governments is SITE-VALUE RATING, whereby Rates are levied on land values only. But property investors want to reduce the sensitivity of Rates to land values — the very feature that makes Rates suitable for funding infrastructure — by including values of buildings in the rating base (“Capital-Improved Value” or “CIV” rating) and by further diluting the Rates with various “service charges” that don’t depend on property values. The last remaining site-value-rating council in Victoria is Monash, and that domino seems about to fall.

In general, if a certain percentage of every real uplift in land values is reclaimed by taxation, every infrastructure project with a cost/benefit ratio not exceeding that percentage becomes self-funding or revenue-positive, and still delivers net windfalls to the affected property owners. The owners gain because they receive uplifts in land values from projects that would not otherwise proceed.

Why then do property investors sabotage this kind of taxation? Could it be that passive rents and capital gains, like passive welfare payments, dull the brain?

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