Prosper Australia is an economic research organisation founded in the Georgist tradition of political philosophy. Our work centres on the monopolistic nature of land and how it shapes our economy and society.

We have a long history of research into property taxation and local government rating systems.  

We wish to raise five points in relation to the third and fourth topics of the inquiry:

• the overall revenue structure of local government; and

• whether the existing revenue structure is sustainable and appropriate or if alternative models of funding would be more sustainable and appropriate.

In summary, we ask the Committee to recognise that:

1. Site value is the more progressive rating base for funding growing revenue needs;
2. Site value rating more equitably reflects the distribution of benefits from council activity;
3. Site value rating encourages greater investment and more housing supply;
4. Development contributions and value uplift capture should be used more extensively; and
5. Rate capping should not lead to greater vertical transfers.

Prosper Australia submission to the Legislative Council Inquiry into Local Government funding and services

1. Site value is the more progressive rating base for funding growing revenue needs

Addressing revenue challenges and supporting housing affordability would be easier with council rates applied on the more equitable basis of site value (SV) rating. 

There is clear evidence that SV rating is more progressive than capital improved value (CIV) rating. This reflects disproportionately high land ownership by wealthier households, who generally occupy larger and more valuable sites, while poorer households occupy smaller houses and apartments with lower land value.

A 2021 analysis by Jesse Hermans of Prosper Australia and economist Cameron Murray, published in the journal Australian Tax Forum, showed the ratio of SV to CIV for Victorian residential properties rises with household income. 

This means shifting from CIV to SV rating reduces the rates burden for lower-income households and increases it for higher-income households. 

Additional revenue to fund rising council costs can therefore be raised with the least impact on households struggling with cost of living pressures by using SV rating rather than CIV rating. 

The political difficulties and affordability concerns associated with increasing local government revenue would be significantly alleviated if the regressive state-wide adoption of CIV rating were reversed.

2. Site value rating more equitably reflects the distribution of benefits from council activity

SV rating is also more equitable than CIV rating when viewed as a ‘beneficiary pays’ means of funding local government. 

Rates do not operate as a quasi-user charge for council services. At best the distribution of rates can mirror the distribution of benefits to property owners from council expenditure.

Rates do not work as user charges because they are not passed forward to the direct users of council services (households) via higher rents or house prices. The economic burden of rates remains with the landowner. This is because rents are set by what tenants are prepared to pay for housing, which does not depend on what tax their landlord pays, and house prices are the capitalised monetary value of not paying rent. 

The financial benefits of council services are also priced into land values, benefitting landowners. This is because higher-quality council services increase rents, house prices, and development profits, which increases land values (regardless of whether the land is developed). Residents in effect already pay or paid a user charge for council services, either to their landlord or to the prior owner.

The argument that more equal rating on a per dwelling or per capita basis such as under CIV rating (and/or with higher fixed per-dwelling charges) is more equitable because it more closely mirrors the pattern of consumption of council services is flawed. It is wrong because landowners, not users, are the ultimate beneficiaries of council service provision and bear the economic burden of rates too.

This makes SV rating a better targeted beneficiary-pays tax than CIV rating. 

CIV rating effectively asks landowners who use their land more productively to pay higher rates than landowners who benefit financially from availability of council services without making the most productive use of their land. CIV rating lets owners of vacant land get away with minimal contribution to funding the services that give their land value and cause that value to appreciate over time. It subsidises unearned incomes at the expense of productive activity.

CIV rating also discourages owners of vacant or under-developed land from developing it, and since council services are largely fixed cost in nature and are supplied to sites whether heavily used or not, this effectively raises the average per capita cost of council service provision. 

The 2020 Local Government Rating System Review recommended abolishing councils’ discretion to use SV rating, without clear reasoning or due recognition of the economic evidence put before it. This recommendation should be ignored by the Committee. 

As the economic issues are too large to be given full justice in this parliamentary inquiry, Prosper suggests the Committee recommend that the investment and cost-of-living impacts of the two ratings bases be examined in a narrowly-scoped review by a suitably qualified economic advisory agency, such as DTF, with the objective of providing clearer, evidence-backed recommendations on the economic consequences of the choice of rating base.

3. Site value rating encourages greater investment and more housing supply

By penalising improvements, CIV rating lowers the returns to investing in housing development and increases the relative return to land banking, making it more difficult for developers to provide affordable housing.

Consistent with other evidence on the investment effects of capital taxation, the previously mentioned study estimated based on the history of SV to CIV ratings base changes by Victorian councils that a CIV to SV shift would likely be associated with a 20-50% increase in dwelling construction investment in the 3-5 years following the change (Murray and Hermans 2021).

At a time when barriers to faster housing supply are the subject of significant public interest, the choice of rating base is important. 

Prosper recommends the Committee acknowledge that the use of CIV rating by Victorian councils penalises housing development, making housing less affordable and making it less likely that state-wide and local housing delivery targets will be met. 

Higher differential rates on vacant land are not sufficient to remedy this problem. 

Under CIV rating, non-vacant but underutilised properties with little to no improvement value are still lightly taxed. In effect these properties are subsidised by landowners who more productively use their land. With CIV rating and differential rates on vacant land there still remains a penalty to investing in improvements, encouraging less housing to be constructed even when vacant land is developed.

The detrimental effects of CIV rating are most stark in rural and regional councils, which are more likely to be in financial stress and socio-economically disadvantaged. In these council areas, the rate in the dollar and therefore the penalty to investment is generally the highest.

For example, Buloke Shire is a highly disadvantaged council, and its residential and commercial rates in 2022-23 were 0.62 cents per dollar of CIV (i.e. a tax rate of 0.62%). By comparison, residential rates in the City of Melbourne are equivalent to 0.19 cents per dollar of CIV (i.e. a tax rate of 0.19%). That is, the effective tax on housing investment imposed by council rates in Buloke Shire is more than three times higher than that in the City of Melbourne. 

These investment penalties, which worsen housing affordability and have a disproportionate impact in lower-income LGAs, are entirely avoidable with SV rating.

4. Development contributions and value uplift capture should be used more extensively

Council and state governments around Australia under-tax the beneficiaries of growth-related infrastructure and favourable rezoning changes and load an unfair burden onto general ratepayers and taxpayers who do not specifically benefit or cause the need for growth-related expenditures.

Facing rising expenses and growth-related infrastructure demands, councils cannot feasibly fund necessary expenditure under this cross-subsidised local government funding model without imposing politically difficult rates increases on general ratepayers.

As the first priority for funding the growth infrastructure necessary to enable faster housing development, councils should utilise developer contributions to the fullest extent legally possible and consistent with the principle of full-cost recovery. 

The Victorian state government should likewise socialise the windfall gains from rezoning in order to fund state infrastructure that enables growth and gives land zoned for additional housing its redevelopment value. 

More ambitious value capture tools are needed than the Rezoning Windfall Gains Tax, which has a narrow base that excludes existing residential properties and therefore leaves in private hands the windfalls from rezoning land for the extensive infill development required to meet the recently-established council housing targets. 

Economic theory and evidence is clear that developer contributions and value capture charges are not a tax on development. Appropriately designed, they do not penalise investment. Instead, they are capitalised into lower land prices.  

Better value capture could also cut out rent-seeking. Fairer sharing of the windfalls from granting additional use rights to landowners and from the infrastructure investment that makes those rights valuable would reduce the returns to lobbying for rezoning or planning permission, and to holding land vacant for extended periods as a speculative investment in search of windfall planning gains. 

To the extent that value capture revenue is recycled into lower general taxes or additional infrastructure that supports higher returns on private investment, it will also induce higher rates of capital investment and economic growth. 

Prosper recommends the Committee acknowledge the strong principled case for full-cost recovery developer contributions and value capture taxation as means of enabling necessary increases in expenditure to proceed without extensive cross-subsidies from non-beneficiary households and an unfair funding burden being placed on general ratepayers and taxpayers.

5. Rate capping should not lead to greater vertical transfers

Prosper acknowledges arguments for and against rate capping. Whatever arrangements are used, an efficient overall distribution of revenue effort means utilising the land value base as much as possible.

State taxes such as payroll tax and federal taxes such as personal income tax penalise productive activity in the form of hiring, work effort, entrepreneurship and investment. Taxes on land do not reduce valuable economic activity in this way. 

State and federal funding of local governments generally displaces good taxes with bad taxes, and should be avoided. Prosper recommends the Committee consider this principle when considering rate capping arrangements.

6. Other matters

Our submission to the 2020 Local Government Rating System Review made a range of recommendations in relation to differential rating, rates deferment, and rates relief (concessions and exemptions).