Smart growth through tax reform
2.1 Mandate site-value rating
2.2 Ban local de facto building taxes
2.3 Tax windfalls, not turnover
2.4 Abolish taxes on property insurance
2.5 Abolish payroll tax?
0. Whether growth
This Review will undoubtedly receive submissions from environmentalists alleging that Victoria's current population is unsustainable and that further growth must therefore be stopped. I offer no opinion on that issue, except that all discussion of it is futile because the vested interests that stand to profit from population growth are too powerful to be successfully opposed, and because, in any case, most of the policies that influence population growth are determined at the Federal level. Accordingly, this submission treats population growth as “given” and considers how best to accommodate it.
1. Whither growth
The fundamental question for this Review, given the inevitability of population growth, is whether that growth is to be accommodated by increasing density within the present urban area or by extending that area — by growing up or growing out; by density or sprawl.
On this question, the forces that unite behind population growth — namely developers, land speculators, and property “investors”, with much overlap between the three — are divided: those with land outside the Urban Growth Boundary (UGB) want the boundary extended to include their holdings, while those with land inside want the boundary frozen to increase the scarcity value of their holdings; and some have a foot in each camp. That the UGB, which was meant to last 25 years, has been extended twice in its first seven years shows which camp is winning.
1.1 The vested interests
The ascendancy of the pro-sprawl camp is no mystery. Any extension of the UGB takes place in a small number of large steps, each of which affects land owned by, or subject to call options held by, a small number of large developers, each of which stands to reap large windfall gains if its preferred tract is enclosed by the UGB. Therefore massive lobbying and PR resources are mobilized in support of each step. In contrast, rezonings and development approvals in established suburbs tend to be more fine-grained, so that the resources behind each proposal are more modest. Moreover, proposals to redevelop sites in established suburbs, unlike proposals to build new suburbs, are opposed by NIMBYists who will exact electoral vengeance on their Councillor or MP if he/she fails to stop the development.
NIMBYists warn about loss of affordable housing, as if housing could be made more affordable by restricting the supply. They demand a certain area of parkland per hundred residents, without acknowledging that this further restricts the supply of housing — unless, of course, the reservation of ground area for parkland is compensated by greater building heights, which they nevertheless oppose. They complain that there are not enough schools and other amenities to handle an increase in population, but fail to mention that greater building heights would make more room for such things. They complain that the available public transport cannot handle more people, as if the lack of public transport were a constraint to be complied with, instead of a problem to be solved. They complain that the streets cannot handle more cars, as if there were no scope for replacing cars with buses or trams, and as if through-traffic to and from new suburbs were less objectionable than local traffic. They greenwash their position by complaining of ecological damage, as if sprawl were less damaging, and as if isolated habitats inside the UGB were greater ecological assets than contiguous habitats outside it. The contradictions in their stated position betray an unstated agenda, whose respectability may be inferred from the fact that it is unstated. So let me state it: they don't want new accommodation competing with their established properties, don't want new buildings blocking their views, and don't want riff-raff moving into their neighbourhoods — or rather the neighbourhoods in which they own property.
Such has been the politics of sprawl vs. density to date. This submission will show, however, that tax reform conducive to density is also conducive to public investment in infrastructure, which in turn enhances property values for the benefit of incumbent owners, including the aforesaid NIMBYists, and neutralizes NIMBY objections related to amenities and transport. Tax reform of that sort would be a game changer because it would swing suburban property owners to the pro-density, anti-sprawl camp.
1.2 The merits
For a given total population, greater density means shorter commuting distances, hence shorter commuting times, hence fewer vehicles on the road at any time. All this means less pollution and fewer accidents. Shorter commutes mean more family time.
New suburbs require new expenditure on infrastructure; all the internal infrastructure must be built from scratch, and the external infrastructure that serves it must be either upgraded or augmented because the new suburb is an additional load thereon. The same is not true of increasing density in established suburbs. The redevelopment of a residential site to house a larger number of people is an opportunity to exploit new technology so as to reduce the infrastructure footprint per person. For each type of infrastructure, the overall load may not increase; and if it does, the increase will be less than if the same increase in population had been accommodated in a new suburb, because the latter option does not involve the replacement of an inefficient user of existing infrastructure.
An exception, as the pro-sprawl camp will be quick to note, is transport, for which the demand per person cannot be greatly reduced by modernizing the housing stock. But geometry comes to the rescue. Population density (for a given total population) varies as the inverse square of the linear dimensions. But when commuting times are allowed for, the density (i.e. the number per unit area) of moving commuters is more like the simple reciprocal of the linear dimensions. So traffic density does not rise in full proportion to population density. The picture improves further if we understand “traffic” in terms of vehicles, especially powered vehicles: as the linear dimensions are reduced, more commuters can walk or cycle to their destinations, and it becomes feasible (even without the tax reforms proposed herein) to provide public transport within walking or cycling distance of a larger percentage of the population. Benefits of less car-dependence include less space devoted to storage and parking of cars, less time wasted by the search for parking spots, fewer accidents in and around car parks, and less waste of household income on parking fees and fines. All these benefits flow from shorter distances.
The pro-sprawl lobby obfuscates the infrastructure savings by claiming that per-capita municipal expenditure on infrastructure is positively correlated with density. This statement glosses over three vital points. First, higher-density municipalities tend to be closer to city centres and therefore to have richer ratepayers, who can afford to be more fussy about infrastructure, which indeed is part of the attraction of inner suburbs. Second, higher-density suburbs tend to be older suburbs, whose infrastructure requires more repairs or replacements on account of its age, regardless of residential redevelopment. If a piece of infrastructure must be replaced, it might as well get a capacity upgrade at the same time; and whether it is replaced or merely maintained, it might as well be used efficiently. Third, not all expenditure on infrastructure is municipal or even public. In a new suburb the developer can be required, as a condition of development, to provide certain internal infrastructure and transfer it to the public sector. But in an old suburb, any necessary infrastructure upgrades will involve public property and will therefore be performed on the public budget. Never mind that the total cost will be lower. Never mind that the actual work will still be done by private tenderers. Never mind that the developer can be required to compensate the taxpayers/ratepayers, so that they are no worse off than if the developer had done the work itself. In short, never let the facts get in the way of a good pro-sprawl soundbite.
The sprawl lobby complains that higher density would “force” people into apartment blocks, but is apparently untroubled that people are presently forced into car-dependent suburbs far from their places of work. It is scandalized when UGBs restrict the supply of housing, but untroubled when building-height limits and other barriers to infill development have precisely the same effect. It protests that not all households want to live in medium-density or high-rise housing, when only some need to do so in order to increase overall density. It accuses the pro-density movement of not letting people live where they like, while the higher land values closer to the CBD bear silent witness on where people really like to live. It attacks the negative spillover effects of local infill development (shadows and interrupted vistas, encoded as loss of “character”), but ignores the negative spillover effects of distant greenfield development (through-traffic, smog, social fragmentation). It defends the car as an icon of freedom, without acknowledging that while having a car adds to freedom, needing one subtracts therefrom. It attacks restrictions on outward growth as inconsistent with free markets, without acknowledging that density can equally well be promoted by removing restrictions on upward growth, consistent with market freedom. Indeed, if the tax laws and the planning system were sufficiently conducive to higher-density development in established suburbs, further spreading of suburbia might be arrested without the need for a UGB. But perhaps the abolition of the UGB is what the beneficiaries of sprawl fear most; if they could no longer make unearned windfalls from expansion of the UGB to take in land that they own, or land over which they hold call options, they would have to do something else for a living.
2. Tax reforms conducive to higher density
All levels of government have some capacity to influence urban development through tax reform. However, as this submission is addressed to an agency of the State Government, it considers only such reforms as are within the legislative power of the State Parliament, whether the taxes in question are collected by the State or by local Councils.
2.1 Mandate site-value rating
At present, in every Victorian municipality except Monash, local rates are levied on combined values of land and buildings, with the result that any property owner who redevelops a site so as to increase its housing capacity is punished with a higher rates bill. The State Parliament could eliminate this problem by amending the Local Government Act so as to require rates to be levied on site values alone.
In Monash, the Council's plan to replace site-value (SV) rating with capital-improved-value (CIV) rating is allegedly motivated by concern that some ratepayers incur steep increases in rates bills after each valuation. But the State Parliament could solve that “problem” by capping real percentage increases in taxable site values. Changing the base from SV to CIV does not cap the increase in the taxable value, but merely dilutes the variable site values with more stable building values; so if steep increases in rates bills are the problem, CIV is an inferior solution. While the proposed cap would eliminate headlines about large increases in rates bills for particular ratepayers, it would not constrain Council budgets (as rate-capping does in NSW) because it would apply to the rating base; the rate in the dollar would be set separately. That said, the Parliament could also cap one-off increases in bills caused by changing the rating base to SV in other municipalities.1 With these caps in place, the political pain caused by mandating SV rating would be less than that caused by each round of valuations under the current system.
(Of course, those who promote CIV by attacking large increases in rates bills never acknowledge that the property owners who “suffer” the biggest increases are actually the lucky ones: their property values have increased the most, and by far more than they lose in rates. Neither do they acknowledge that the biggest rates increases incurred by home owners amount to only a few percent of the increases in the rental values of their homes, whereas a renter, by definition, can be slugged for 100% of the increase in the rental value each time the rent is reassessed. Neither do they acknowledge that CIV rating worsens the plight of renters by deterring the construction of housing. But, as these are issues on which the forces of ignorance and disinformation are invincible, I have simply offered a better way to avoid steep increases in rates bills.)
2.2 Ban local de facto building taxes
In addition to rates on property values, many Victorian Councils levy “service charges” of so much per year per dwelling, or per some other unit whose presence is correlated with that of a dwelling. Such charges, like the inclusion of building values in the rating base, deter construction and should likewise be banned.
The availability of a service in a particular location enhances the locational value as expressed in the site value. Hence a rate on site values is a logical and equitable way to pay for the service.
The pro-sprawl lobby will claim that it is unfair to charge the owner of a vacant lot for a service that is not used, or to charge the owner of a single dwelling for the services used by a high-rise building just because the site is zoned for high-rise (and the site value reflects the zoning). But the need to leapfrog over vacant or underdeveloped lots still creates costs for service providers, while the owner who keeps a lot vacant or underdeveloped is wasting a scarce resource that is needed for housing and business accommodation. Such behaviour should be discouraged.
2.3 Tax windfalls, not turnover
Conveyancing stamp duty, while nominally payable by the buyer, is partly shifted onto the seller because it reduces the buyer's capacity to pay. (Similarly, if it were nominally payable by the seller, it would be partly shifted onto the buyer because the seller would want compensation for the tax.) As the duty is partly paid by sellers, it represents a contingent liability for current owners. And because it is levied on the total transfer price, including the value of any building(s), the contingent liability is increased by construction and therefore deters construction. In cases where construction is contingent on a transfer of title, the duty further deters construction because it is levied on the transfer.
Developers are fond of complaining that lump-sum infrastructure levies are “passed on” in prices of new housing lots. They are not so fond of acknowledging that the market value of land is raised by permission to develop it, and raised again by the public provision of infrastructure “headworks” upstream or downstream of the new estate. So the infrastructure will raise the prices of developed lots, whether the developers help to pay for it or not. But the developers have a point in that, as the present levies are not explicitly apportioned to unearned uplifts in land values, there is nothing to stop the levies from being so high that they make development unviable, in which case development will be delayed until prices rise enough to cover the levies.
A particularly obnoxious variant of infrastructure levies is the growth area infrastructure contribution (GAIC), which is payable by land owners who sell land to developers. Like the older infrastructure levies, the GAIC is not apportioned to uplifts in land values. But unlike the older levies, the GAIC may not be able to be passed on in prices, because the land may be subject to call options that will be exercised if the land is approved for development. Thus the GAIC may spare the developers at the expense of “mum and dad” land owners, who presumably do not give as much money to political parties as the developers.
To overcome these problems, I submit that conveyancing stamp duties, infrastructure levies and the GAIC should be scrapped and replaced by a site windfall tax (SWT) payable by the seller of a site, and proportional to the real increase in the site value since acquisition. In recognition of the role of local government in the provision of infrastructure, a fraction of the SWT collected in each municipality could be refunded to the responsible Council, or the State could allow each Council to impose its own SWT rate on the same base.
Because a transfer tax payable by one party (the buyer or the seller) is partly shifted onto the other, making the SWT nominally payable by the seller would not affect its ultimate incidence, but would be administratively convenient because the seller would know the site value at the time of acquisition, hence the tax implications of the sale. And even if the seller's nominal responsibility did affect the incidence of the tax, this would hardly matter, because the tax on the sale would be compensated by the absence of tax on any subsequent purchase.
The SWT would not tax values of buildings. And it would not inhibit transfers of title to anything like the same extent as the present system, because:
- the SWT liability would only be realized, not created, by the sale; it would accumulate during the period of ownership, and would continue to accumulate if the site were not sold;
- the SWT, unlike the existing taxes, could not make an otherwise profitable resale unprofitable,2 and could not increase a “capital loss”.
The second reason would make the SWT popular: every rational property owner would prefer the SWT to the present regime.
(Indeed the advantages of the SWT for property owners do not end there, as we shall see. For added political advantage, sellers who acquired their properties before the transition to the SWT could be given the option of paying tax as if they had sold and bought back their properties just before the transition; under this option, anyone who pays more tax than would have been payable under a continuation of the old system does so solely because the property has appreciated rapidly since the transition. This would prevent any property owner from being disadvantaged by the transition itself.)
Because the SWT does not penalize any productive activity of the payer, but merely claims a share of an unearned windfall, and because the tax is not payable until the windfall is realized in cash, the SWT could raise much revenue with comparatively little economic or political pain. Thus it would be suitable for replacing not only the existing property-transfer taxes, which I have already described in unflattering terms, but also other inefficient and/or unpopular taxes, some of which are mentioned below.
2.4 Abolish taxes on property insurance
Sites do not burn down or get damaged by storms. Buildings do. Therefore property-insurance premiums are apportioned to values of buildings. Hence a tax on the premiums, ostensibly to pay for fire-fighting services, amounts to a de facto periodic tax on values of buildings, and deters construction in the same manner as CIV rates.
As the availability of a fire service in a particular location enhances the locational value as expressed in the site value, the logical way to pay for the service is some form of site-value taxation. One option is to abolish the fire levy and increase the SWT rate. Another is to abolish the fire levy and increase land tax — another periodic property tax, albeit one that does not penalize construction.
2.5 Abolish payroll tax?
If payroll tax is not the stupidest tax levied in this State, it is surely the one whose stupidity is most obvious. Thus it would be good economics, and probably also good politics, to abolish payroll tax and replace the revenue by raising the SWT rate.
Furthermore, payroll tax arguably amounts to an unconstitutional excise duty in that
- payroll tax applies to labour employed in the production, manufacture, sale or distribution of goods, and feeds into prices of goods, and
- even if, as dissenting members of the High Court have held, an “excise” must discriminate against locally produced goods relative to imported goods, payroll tax satisfies that criterion.
For present purposes the relevance of payroll tax is that it deters construction — because construction involves the hiring of labour, whereas the mere holding of existing property, including vacant land, does not.
3. How such reforms help public transport
Under the SWT, the State would receive a share of every realized uplift in site values. This is a great advantage to site owners because it gives the State an incentive to do things that increase site values for the benefit of the owners. Such things notably include the provision of infrastructure, especially public transport.
3.1 Infrastructure and land values
Fred Harrisons's book Wheels of Fortune (London: Institute of Economic Affairs, 2006) contains a foreword by a successful London property investor named Don Riley, saying in part:
I landed at Dover after a choppy crossing of the Channel in 1962, and for the next 40 years I paid my taxes to Her Majesty's Treasury... I did not dodge my obligations to the public purse. After all, I was married, raising two children and using the public services; so I was happy to pay my share of the costs of the schools and hospitals that my family needed.
Then, as the millennium was dawning, a miracle happened... Taxpayers generously funded the extension to the Jubilee Line, one of London's Underground lines. Two of the stations were located close to office properties that I own. Those two stations raised the value of my properties by more than all the taxes that I had paid ... over the previous 40 years.
A nice windfall for this colonial boy.
In his own book, Taken for a Ride (Teddington, Middx: Centre for Land Policy Studies, 2001), Riley calculated that the new railway, which cost the taxpayers £3½ billion, raised land values by a conservative £13 billion. If only 27% of the uplift in land values had been reclaimed through the tax system, leaving the other 73% for the lucky property owners, the new railway would have paid for itself without burdening any taxpayers who did not share the windfalls.
Riley's example was no fluke. In a market economy, the benefit of a public transport project is worth whatever people decide to pay for it. But what they pay has two components: the obvious one, namely the fares paid for actual use of the service, and the unmentionable one, namely the price of access to locations where the service is available, as opposed to locations where it is not — “location, location.” In other words, the benefit net of fares is manifested as uplifts in site values — not values of buildings, which are limited by construction costs, but values of space, because space has location, and therefore locational value, even if no buildings yet occupy it.
It follows that the cost-benefit ratio of an public transport project, where the “cost” is also net of fares, is simply the cost-uplift ratio.
So, if the tax system claws back a fraction of every uplift in land values, any public transport 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 a surplus of revenue that can be used for other purposes, perhaps including cuts in other taxes.
So every public transport project that passes a cost/benefit test can be financed by clawing back a sufficient fraction of the uplift in property values. The remaining fraction is a net windfall for the property owners. The windfall comes first, and property owners do not pay the tax unless they get the windfall. This method of funding does not mean raising taxes and promising to spend the revenue on public transport. It means changing the tax mix, so that future investment in public transport pays for itself by expanding the tax base without further changes in rates or thresholds. The initial change in the tax mix can be revenue-neutral. Thereafter, property owners are winners they receive windfall gains in site values from projects that would otherwise be stalled for want of funding.
The same tax reform, by turning pipe-dreams about public transport into realistic possibilities, would change the attitudes of property owners to higher-density developments in their suburbs. Such developments would be less likely to be seen as competition or clutter, and more likely to be seen as magnets for new public transport services that would enhance local property values.
3.2 The proper role of fares
Economic theory says that the use of a service will socially optimal if the price paid by the user is set at marginal cost. For public transport, a reasonable approximation to marginal-cost pricing might be free off-peak travel with a congestion charge at peak times. But marginal-cost fares do not bring in enough revenue to cover the fixed costs, including capital costs. So the fixed costs must be met from some other source. Taxing the uplift in land values solves the problem.
(Public-Private Partnerships 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 fares, which are therefore too high, causing low patronage, which may prevent recovery of costs — unless taxpayers come to the rescue. Low patronage defeats the purpose of the service, while public subsidies and guarantees defeat the alleged purpose of private finance.)
The environmental benefits of public transport, like the economic benefits, depend on patronage: a bus carrying one person causes more pollution than a car carrying one person, whereas a bus carrying 70 people causes less pollution than 40 cars carrying 70 people. Thus environmental considerations support the need to keep fares low and to cover fixed costs out of uplifts in site values.
3.3 Infrastructure, home owners, and housing affordability
It is sometimes said that rising property values do not help ordinary home owners, because higher sale prices for their present homes are wiped out by higher purchase prices for alternative accommodation. This argument has merit if rising values are due to (say) scarcity or speculation. But it is not valid if rising values are due to improvements in infrastructure, because home owners can enjoy the infrastructure without selling their homes.
Uplifts in property values due to infrastructure, unlike those due to scarcity or speculation, do not damage affordability, because they represent improvements in amenity — not higher prices or rents for the same amenity. Moreover, as the tax reforms that promote investment in infrastructure also promote construction, they increase the supply of housing and thereby improve the bargaining positions of prospective tenants and buyers. If affordability is understood as a balance sheet with price or rent on the debit side, and amenity and spending power on the credit side, this improved bargaining position must improve affordability even if prices or rents rise in dollar terms.
4. Whether a growth boundary
As hinted at the end of subsection 1.2 (above), I am not convinced of the need for a UGB, because the removal of tax-related barriers to increased density in established suburbs might make it unattractive to develop new suburbs. However, given that the UGB is there, it is there to be enforced — not to be extended for the benefit of speculators who hold titles or options over land in certain locations just outside the present boundary, at the expense of others who hold titles or options over land inside it or in other locations just outside it. Arguing over the placement of the UGB is a zero-sum game, whereas construction and investment in infrastructure are positive-sum games.
It has been shown that the elimination of explicit and implicit taxes on buildings in favour of taxes on site values and uplifts in site values would promote private investment in higher-density redevelopments in established suburbs, and would simultaneously solve the problem of financing public transport, which can prevent the conversion of population density into traffic congestion. In addition, higher density in itself would reduce the cost of comprehensive public transport coverage. The improvements in public transport and in other infrastructure financed by the same mechanism would enhance property values for the benefit of home owners.
1 P.S. (July 18, 2009): Would the latter cap (on the increase in the rates bill due to changing the base) become ineffectual at the next valuation? Not if that cap were effected by limiting the taxable component of the site value. Subsequent increases in that component due to revaluations would be constrained by the other cap. Under the two caps, the ratepayers who “suffered” the biggest percentage increases in bills would be the ones paying rates on less than their full site values. That would make it hard for them to complain.
2 P.S. (July 22, 2009): When capital investment by a site owner demonstrably enhances the site value — e.g. when housing lots owned by a developer rise in value due to infrastructure provided between the lots by the developer — the investment can be allowed as a deduction against the uplift in the site value, so that the tax still cannot make an otherwise profitable investment unprofitable. In the case of the developer, the investment could be notionally divided among the lots. The method of apportionment would not greatly matter, because it would not affect the total tax payable on the lots. Cf. G.R. Putland, “Development levies, stamp duties, and housing affordability”, On Line Opinion, Nov.3, 2006.