What price value capture?

19 Mar 2017


Construction of Hong Kong’s metro railway was funded solely from the sale of development rights around stations. Close to one third of London’s CrossRail is being funded by levies on nearby businesses. ‘Value capture’ is back in fashion, and the calls are growing louder for Australia to tap into these seemingly wonderful revenue streams.

The Australian Government is decreeing that the states should routinely consider value capture opportunities in all future public infrastructure projects. But what exactly does this mean? And is value capture better or worse than the current way we fund infrastructure?

At its core, value capture is a tax on the increase in land values that results when a new or upgraded piece of infrastructure improves an area’s accessibility. Despite the hype and optimistic notions of ‘free money’, in reality infrastructure must be paid for either by users or by taxpayers of one kind or another.

The theory is very attractive. Value capture is marvellously fair, because it only applies to those who benefit from the particular new project. So the people of western Sydney do not help fund a new railway station on the North Shore – or vice versa. And because value capture only taxes windfall gains, it generally shouldn’t discourage people from buying and selling, developing land or investing in their businesses.

But putting all this into practice is hard. Property prices go up – and down – for many reasons. Drawing a boundary around a new piece of infrastructure to distinguish those who must pay the new tax from those too far away to benefit is bound to involve rough justice. It’s not easy for governments to convince people that the new tax bill they receive still leaves them better off – homeowners receive the benefit of the new project on paper but have to pay the tax bill in cash. And value capture is very hard to apply to projects such as roads and hospitals where the benefits are more diffuse. The apparent fairness of value capture evaporates if the beneficiaries of rail projects pay extra while the beneficiaries of other government projects do not. These challenges may explain why value capture has been used so rarely in Australia.

While many financiers are keen on “Tax Increment Financing”, the arguments in favour of it are specious. Ultimately such innovative financing mechanisms cost more than governments borrowing for themselves, don’t necessarily improve risk management, and still involve taxing landowners.

As a result, state governments should generally avoid value capture taxes because better, fairer and simpler taxes are available to them. They would serve their constituents better by imposing broad-base low-rate taxes, such as land taxes, instead of reaching for narrow-base high-rate value capture taxes.

But if, despite this, a state government does introduce a value capture tax, it should not cherry-pick projects but instead legislate standard criteria to apply consistently. A single flat rate of tax should be imposed on the increase in unimproved land value of affected properties.

Whatever the taxation arrangements, governments can create additional value from infrastructure projects by joint development around them. They can sell government land that is no longer needed after construction, or sell new development rights from rezoning land in the neighbourhood. But the value of such schemes will depend on how much the government already owns, and the demand for new intensive development.

Attractive enough in theory, there is nothing easy about capturing value.

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