Last Thursday Catherine Cashmore and I addressed the Select Committee into the Scrutiny of Government Budget Measures. Read the Hansard transcription.

We felt it important to put on the public record the various value capture mechanisms with commentary on their potential utility. Following is the inquiry submission.

Select Committee into the Scrutiny of Government Budget Measures

Infrastructure Financing Tools – the Options

Historically, Australia’s infrastructure was financed using municipal bonds repaid by municipal rates. Importantly, these rates were based on the site value (land value). Today bonds used for these purposes are called infrastructure bonds, but the repayment method has strayed away from the building of infrastructure at least cost.

World’s best practice would see the bonds repaid via municipal rates on the land over the lifetime of the 20 year asset. Value is captured by the increase in land prices derived from publicly financed infrastructure. Thus we prefer the term Land Value Capture.

However, there are a number of different mechanisms claiming to be a value capture mechanism. Policy makers must be alert to potential ‘sculpting’ by vested interests.

Land Value Capture/ Site Value Fee
This is the purest form of value capture where all land owners contribute a little to the financing of public infrastructure over time. This implies the value capture region is as broad as possible. A process of attaching a Land Value Capture element to the Site Value component of municipal rates is most beneficial. This ensures a widening of the tax base with the market valuation acting as a proximity vote to effective infrastructure i.e. location, location.

Such a form of revenue raising is in essence a form of Land Value Tax. This acts to ensure land is used at its best and highest function. Under current settings, the speculative incentive sees good infrastructure undermined by property investors outbidding families for homes. If set at an appropriate rate, speculative incentives are reduced.

A current example sees an average Melbourne $330,000 block of urban land pay some $440 in Land Taxes and $1,200 in municipal rates. Average rents are $18,000. However the year on year capital gains dwarfed this at $95,000 (APM). Under these conditions, the behavioral incentives are grossly in favour of property investment over productive family use. A $1,600 holding charge is not going to coax a site into use when windfall gains have increased from $30,000 to $95,000 per annum in recent times.

Not surprisingly, the number of speculative vacancies in Melbourne has oscillated from 44,000 to 90,000 homes over the last seven years. Speculative vacancies are vacant homes that do not exist according to mainstream vacancy methodologies. These mechanisms have been formulated under the expectation that all housing is for homeliness and none hoarded by rent-seekers manufacturing lightly taxed capital gains. Prosper Australia calculates speculative vacancies as those homes using abnormally low water levels over 12 months.

The mechanics of holding charges like Land Value Capture sees it act as a counterweight to mortgage debt. As a cost of ownership, property buyers incorporate effective future value capture charges and reduce their purchase price offering by the according amount. This acts to channel the naturally rising value of prime locations away from property owners and towards government. In effect, this is directly inverse to current behaviour, where buyers and investors incorporate expected future capital gains into a purchasing price that is often triple what net rents OR wages can justify. In the process, the property market is manipulating the Great Australian economic miracle into a pincer manoeuvre where all politicians can do is accept private households will fall deeper and deeper into debt.

LVC revenue can repay Infrastructure Bondholders at least cost. The sovereign guarantee provides bondholders with the confidence to buy at lower yields than those in the open market. Bondholders may also be willing to invest in the knowledge such investment makes the nation not only more productive, but minimising (speculative) risk. Additionally, the community benefits from:

• Common sense: Those that benefit, pay
• Can be revenue neutral
• Cheaper public transport ticket prices
• Expands public transport and public services as financed with minimum leakage
• Spreads load over the entire community, rather than slugging commerce (i.e. trucks).
• Encourages urban density by providing a dis-incentive for leapfrog development.
• Can deter future Global Financial Crises by deterring land speculation.

In Victoria, the utilisation of municipal rates to capture the rising value of infrastructure has been greatly hampered by Premier Daniel Andrews. His populist move to cap local council rates has handed property investors a significant windfall. Compounding this has been the willingness of his administration to re-zone Parkville and Fisherman’s Bend, both regions neighbouring the Metro Rail Loop project. This is a project that is coincidentally struggling for funding.

In terms of budgetary pressures on all levels of government, more analysis needs to be placed on the expenditure side, in particular the rising costs associated with 30 years of privatisations. With reports of $2,000 fees by private operators to clear one single drainpipe, no wonder council, state and federal budgets continue to feel the pinch.

Special (or Benefit) Assessment District
In best case scenarios, this is a Land Value Capture mechanism limited to a set geographical region surrounding a new infrastructure assessment district. Increasing evidence points to the fact the immediate 500 metre radius surrounding train stations enjoys the greatest land price windfall. Commercial property is expected to benefit the most, where the density potential is most likely to be realised.

Under this mechanism, land values within a 500m radius would be charged an additional value capture levy to finance the infrastructure. Some urban planners desire different set percentages for distances, categorised into zones. We advocate this adds an unnecessary level of complexity that locational land values naturally reflect. The flat percentage charge picks up the land price increase. Those who benefit the most, pay the most.

As Lucy Turnbull said in an article entitled We Spend, You Win, You Pay “You could argue that property owners are getting a windfall gain from the provision of infrastructure without making some kind of contribution from the property value rise that they enjoy,” Mrs Turnbull said. “In an ideal world, they would pay a fair and reasonable component of the infrastructure which they directly enjoy. You couldn’t argue that’s not a fair proposition” (AFR, July, 2012).

The tax base for the assessment district is an essential element to the mechanism. Distortions can impede the value capture process by levying on the building only. Such imperfections lead to a value transfer, rather than a value capture. It is a transfer because the levy is based on the productive building (the bigger, the more they pay) rather than the locational benefits of land.

This adds perverse incentives deterring precisely what should be encouraged – greater density. We see this at the local council level where the family home pays more in council rates than the neighbouring land banker. Improvements to one’s property such as solar panels, water tanks or renovations are penalised with higher council rates. This drives ratepayer frustration and undermines what is continually adjudged the most efficient public revenue raising measure. Instead the public has been convinced to look the other way as they pass a vacant block of land neighbouring a train station, often for a decade or more.

The political machinations are also complicated with assessment districts, with controversy centering on the last property inside the VC assessment district and the property just outside it. One can expect those outside the district to enjoy a free ride on those taxpayers contributing to the project. Additional factors supporting a wider VC net include those property owners commuting to and from work through the region. Their property values will also increase, but at a lesser rate.

Tax Increment Financing (TIF)
As the name suggests, this revenue raising mechanism looks at the increase in tax revenue attributed to the density increase enabled by the new infrastructure. A set area surrounding new infrastructure is measured for increases in the tax take from company, GST and payroll taxes for example. A tax benchmark is needed from which to adjudge the future tax take that can be attributed to the infrastructure enabled density.

There is no increase in the tax rate, it is simply a means of redirecting revenues from the general fund and allocating them to the related infrastructure debt. With tax evasion a growing trend, the reliability of such a measure to meet debt provisions needs close monitoring.

It must be recognised that this is nothing more than a tax on the productive sector and does not recoup the value property owners benefiting from the newly built public amenity enjoy. Therefore this is another form of cost recovery and certainly should not to be confused with value capture. TIF’s should infact be characterised as a form of revenue segregation to promote infrastructure financing, rather than infrastructure funding.

Joint Development / Transit Connection Fees
The MTR company operating Melbourne’s trains benefits greatly from land value capture capacities in Hong Kong. They are given development rights to build and develop the land surrounding a new train station – essentially capturing the land rezoning windfalls with associated air rights. Acting as a middle-man, MTR then on-sell the development rights to local developers at a market price. A form of profit sharing ensues. This has resulted in MTR delivering yearly dividends to shareholders for the last 13 years. Additionally, passengers enjoyed fares frozen at 1997 prices for many years. Of great interest to government is that rail development comes at zero budgetary cost. (Wheels of Fortune, Fred Harrison, 2006)

Transit connection fees are access fees paid for private access points to new infrastructure i.e. accessing a transit facility without the utilisation of a public right-of-way.

Either of these revenue mechanisms are best served by ensuring the state (or public transit operator) receives a yearly payment based on the current market access rates. One-off sales should be avoided as a means to improve budgetary finances as the future uplift in locational value is missed.

Betterment Levies
Some international experts state this is an old term for one-off fees based on the betterment of land in the vicinity of new infrastructure. Due to a perceived difficulty defining the difference between land value appreciation due to infrastructure and the general rate of increase, a conservative ‘betterment’ rate has been used to capture some value.

However in the Australian context, we have arguably the best land valuation data and land valuers in the world. Such an uplift can easily be calculated and cross-referenced amongst the seven main valuation methodologies. The benefits of geo-spatial analysis and automated valuation methods will only make this easier in the future.

The National Library has archived a prominent betterment example regarding the extension of the Glen Waverley train line:

“It will be necessary for residents to provide the land for the construction of the railway. The amount necessary for this purpose was estimated in November, 1925, as £30.200; in May, 1920, as £41,500; and when the land is actually resumed it will probably, amount to £50,000. In addition to providing the land free of charge the residents of the district will be called upon to pay a betterment rate amounting to a maximum of £10,000 per annum for five years, or a total of £50,000, subject, however, to the maximum rate for any year not exceeding the loss on the new line for that year. It is calculated that there are 6,000 acres within one mile of the new line, and on an average rate spread over five years in the case of the betterment rate, and for 15 to 20 years in regard to the land compensation rate, the tax per acre will be £16/13/4. This works out at £4/3/4 per quarter-acre allotment, or approximately 1/3 per foot frontage. It is not intended that a uniform rate shall be charged on each property, but that the rate should be varied according to the distance from the line (emphasis added).” (The Argus, Thursday, July 1, 1926)

This example hints at the widespread understanding of the social contract between infrastructure provision and financing. Residents were willing to hand over land free of charge and pay a significant betterment fee over ten years.

Works-in-Kind
Also known as exactions, this is a system of exchange where developers are asked to provide public infrastructure in-kind for certain development rights. It is an element of planning law designed as an offset to mitigate perceived negative effects of a development. A 30 story apartment block may be asked to include a ground floor childcare centre as part of the development process.

Quality control issues become a matter of faith unless carefully managed.
As a one-off contribution, this is a form of cost-recovery rather than value capture. Such exactions actually force the developer to help himself to the value the infrastructure created, often at multiples above the cost of facility.

Development Impact / Transportation Utility Fee
Similar to works-in-kind, Impact Fees address the footprint new residencies place on existing public infrastructure. They are related to ‘adequate public facilities ordinances’ and mandate the developer to finance additional public infrastructure. They differ from exactions in that they are usually one-off cash payments rather than the building of new facilities.

Due to the one-off nature, they cannot be classified as a form of value capture but rather a form of cost-recovery.

Public Land Lease/ Sale
If the sale in land is made after the announcement of the infrastructure project, this would qualify as value capture. However, the short term privatisation of a resource to improve budget finances comes at the long term cost of the ever increasing value of land.

Public land leases act as a value capture measure but face complexity regarding land valuations. Land should be valued yearly and the appropriate land lease fee charged. However, these best practices are often watered down at great cost to public finances. For example, the Canberra Land Lease system was undermined by 20 year valuations. Every 20 years there was a predictable outcry by the public at the cost impost. Unfortunately the chasm between the role of such a measure in not only returning revenue for the recoupment of infrastructure provision but also the encouragement of fair and efficient behaviour saw the leases ended in 1971.

Superannuation as an infrastructure financing vehicle
This concept is quite simply horrifying. Recent infrastructure developments financed under PPP models were an unmitigated disaster.

Brisbane’s Clem Jones tunnel fell into receivership and was sold for just one fifth of the build cost. The Brisbane airport link went bankrupt in a matter of months. Sydney’s Lane Cove tunnel was sold for $1 billion under cost and the Cross City tunnel has also failed to be profitable. The infrastructure financing model is broken.

Compounding these costs are the Concession Deed agreements signed to protect private interests over community development. The NSW government’s willingness to sign away public transport options on the Hills (M2) Motorway and other more recent compensation payouts to tollways for improving neighbouring public roads are mounting compliance costs rarely measured in cost-benefit analysis. With Transurban owning 90% of Sydney’s motorways, how long will it be until we see the mimicking of the opening of the Austin Texas SH 130 Tollway, the fastest in the US, with a simultaneous reduction in speed on the neighbouring freeway?

With investors smelling a rat, are workers are being lined up as patsies to foot the bill via their precious superannuation? Is it not already enough that super drives sharemarket growth, dividends and stock option payouts? Workers savings cannot be asked to fund a failed infrastructure model that makes the housing they are trying to afford more expensive.

Even if traffic numbers were not overestimated by well-paid consultants, the user pays model puts a huge burden on participants, whilst those land owners in good locations do not need to even set onto the tollway to enjoy a windfall that is magnitudes greater than a few minutes shaved off a commute time.

Conclusion
In a common sense world, land owners would see the rationality of giving something back for the publicly funded amenity they enjoy. A mix between land value capture, user pays and grants could greatly accelerate infrastructure provision at least cost.

The area where politicians have been most wary of cost is in the opinion polls. The need for genuine statesmen and women to lead this debate with a skill for cutting through the Murdocracy has never been more vital. A well thought out and sustained public education program must be developed to chip away at the self-interest property speculation garners via reality TV, local papers bought out with real estate adverts and ICAC related lobbying powers. This campaign faces a public that has been convinced to vote against its own best interests by a lavishly funded property lobby.

I thank the committee for the opportunity to present these important facets to the public interest.

Karl Fitzgerald
Project Director

Special thanks to Rick Rybeck from Just Economics for his advice on this submission.