Rents, public services and the “unearned increment”

I only recently became aware of the leasehold system on residential property in the Australian Capital Territory. This was an interesting attempt to create a city in which rent seekers and speculators would not prosper by allowing the increased value of land to accrue to the government (and by extension the common weal) instead of owners who had not contributed to rising prices. This account describes both the ideals behind the concept and attributes its failure to disinterest and miscomprehension on the part of administrators. Which is a pity, knowing the power of rent seekers, we probably won’t get another chance to experiment like this again.

One of the interesting arguments from the time is that since any rise in land prices in the Canberra region would be due to the building of the capital with taxpayer’s money, it was only fair that this be returned to the government. From the account above:

As King O’Malley (Labour, Tas) saw it, ‘Every dollar spent by the people of Australia in the erection of that capital will create an unearned increment in the property for miles around. The question is, are the people of Australia prepared to spend thousands, yea millions, and then lose the benefit of their expenditure? I say the unearned increment created by the expenditure of the people’s money belongs to the people…”:

This has strong resonance in public policy today, particularly at the state level. A great deal of the services provided by state governments are improved by proximity. People exhibit a strong preference to be close to schools, hospitals and public transport. The premium paid on housing close to transport (particularly rail) is very high[fn1]. This probably explains why CityRail (NSW) passengers have higher incomes that the rest of the state. They have to be to afford access.

This means that a great deal of the value of public services is being appropriated by private landowners who have not contributed. Moreover any extension or improvement of services (for instance building a new rail line) will further enrich private landowners on the taxpayers expense. Objections about equity standing, extending or improving services almost always requires more money, and state budgets have been ruled by narrow financial considerations of appropriate expenditure that have led to a series of dubiously designed Private Public Partnerships. If this private accrual of value was somehow accrued by governments instead, then we might well see a far greater investment in say much needed rail infrastructure because the financial case to the beancounters would be far easier made.

The question is “how?” It’s extremely unlikely that a leasehold system, no matter how well designed and administered could be set up in an already existing city. It’s politically impossible. So what are the options?

We could simply charge more for the services so that the subsidy isn’t incorporated into hedonic pricing. In some cases this is simply impossible because the services are public goods. In other cases I think it will simply be ineffective. Sticking with rail, higher fares would likely effect the price elastic customers who have traded time for money (or space) by living further from the station. They will take to driving instead (with other negative effects) whilst the price inelastic customers who paid more to live close will still push up housing prices and pay the higher fares.

Another option is increase land taxes. Rates could be levied by state governments with local governments funded by transfers from state governments. The rates could be determined by a independent body using hedonic methods to tax land that has accrued in value. This would be efficient taxation on the face of it, but it would also be very politically difficult. Higher rates would impact on existing owner occupiers who do not value the service or are unable to pay. They can move of course, but it’s a strong value in our society that residents should not be forced out easily. This is understandable since we also highly value our localised social and support networks, which also have a great deal of public value. The paper might lead with a heartbreaking story of the pensioner forced out of her home, but the flexibility forced by the rates may cause other disruption to the social fabric. We could grandfather the real value of rates for existing owner occupiers (the government as infinitely lived entity can wait them out ) but this would create even greater disincentive to move, resulting in both lower labour mobility and housing stock filled with empty nesters who would avoid downsizing and losing their lower grandfathered rates.

Capital gains tax may also be increased and given to state governments, but there have proven to be great political difficulties with this.

What other options to we have to ensure that the “unearned increment” accrues to the government whose expenditure raised the prices? It might be the best way to improve urban infrastructure and services.

[fn1] An AFR article on the weekend (not online) cited residential land values around the Chatswood-Epping rail link in Sydney rising higher than the rest of the Sydney market since the link opened. This is the more striking considering how little thought was given to providing access to nearby residents compared to the business park. People are really keen on rail.

About Richard Tsukamasa Green

Richard Tsukamasa Green is an economist. Public employment means he can't post on policy much anymore. Also found at @RHTGreen on twitter.
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Karl Fitzgerald
11 years ago

Unfortunately there are few other options. Japan has kept its rail ticket prices very low because they use tickets to cover marginal costs (driver wages etc). The large fixed costs (providing the tracks) are funded by a form of Land Value Capture (Land Tax). Most stations are placed below retail centres. Private shopping centre owners are given the planning approval to build such complexes if a share of the naturally increasing locational value (reflected in land prices) is recycled back to the railroad operator. Both the shopping centres and rail companies are profitable.

MTR in Hong Kong benefits from a similar LVC system. They now run Melbourne’s metro. If only more knew how train lines were funded in early Oz, ie Glen Waverley.

Fred Harrison’s Wheels of Fortune (free download) explains the history of infrastructure financing.

Bruce Bradbury
Bruce Bradbury
11 years ago

A land tax together with a loan scheme to allow people to delay payment until they sell the property might be feasible for new developments. A vote could be held by those affected to see if the proposed project goes ahead.

I wonder if this would be a case where a plutocratic voting scheme would be equitable. Ie forecast the likely tax required to finance a new project and give people votes in proportion to their likely tax.

James
James
11 years ago

The US method is “Tax increment financing”, where the increase in land tax is put towards paying off the bonds that funded the infrastructure. I’m not sure how well it would work here, as our city councils aren’t big enough to do infrastructure themselves, and the state isn’t set up to collect land tax.

Paul Frijters
Paul Frijters
11 years ago

Richard,

good points. Land taxes are certainly the easiest way to go. Another would be to auction off the right to redevelop land. That wouldnt tax the increase in house prices but would cream off the rents made from property redvelopment.

of course, all these things depend on the Henry Review being alive. I will take a determined effort to introduce land taxes.

Tel
Tel
11 years ago

The premium paid on housing close to transport (particularly rail) is very high. This probably explains why CityRail (NSW) passengers have higher incomes that the rest of the state.

People are on the train primarily so they can to get to work, those who are unemployed, retired, on single parent pension, etc. don’t feel the urge to ride back and forth on the train all day. I’m completely sure that if you did a statistical survey of people in peak hour traffic and people on peak hour trains you would find the people in the cars earning significantly more than the people in trains.

Sticking with rail, higher fares would likely effect the price elastic customers who have traded time for money (or space) by living further from the station. They will take to driving instead (with other negative effects) whilst the price inelastic customers who paid more to live close will still push up housing prices and pay the higher fares.

So on the understanding that people have very little choice about going to work in order to earn a living, you have just pointed out that every single person catching a train to work is in fact contributing to the public well being partly be buying a ticket and partly be choosing not to drive. Having admitted that, might be time to drop the “unearned increment” concept.

Besides, in the very long term, land prices don’t increment much faster than inflation anyhow, so taxing the capital gain is just a way of ensuring that the “tax by stealth” nature of inflation equally bites those who try to hedge against it by buying an asset. Any time government gets their budget out of control they just have to print a bit of money, inflate the currency then hold their hand out for tax on all the capital gains. If the same government fronted up to the same people and told them they were going to extract the same tax directly they would be out on their ear. It’s a scam.

James
James
11 years ago

Paul: There’s already precedent (in WA at least) for councils charging a scheme fee on subdivision when they increase the allowed density, to pay for the increased services required.

L
L
11 years ago

The funny thing about the ACT’s leasehold system is that if the government ever actually tried to take back any of the leased residential land at the end of the lease period there’d be blood on the streets.

Karl Williams
Karl Williams
11 years ago

IMHO, it’s a no-brainer. The capturing of the “unearned increment” for the public purse is not only fair, but it will work against the spiralling houseingunaffordability. Did I say “housing”? No, houses depreciate – it’s the land on which they sit that’s spiralling out of control!

derrida derider
derrida derider
11 years ago

Of course this is classic Henry George stuff (O’Malley knew, and was a fan of, his fellow Californian). It’s why local council rates are based on Unimproved Capital Value – not quite pure Georgism (which should be based on the increment in value), but close enough.

Georgist ideas were very influential in early 20th century Australia – part of our progressivism, now sadly lost. In particular, South Australia, as well as being the first state in the world to give women the vote, based its tax system on land value increment. They even implemented that wonderful self-enforcing mechanism that George suggested: the taxable value of the land was whatever the taxpayer wanted to state it was – the only catch was the state reserved the right to buy it at that valuation!

Nicholas Gruen
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Nicholas Gruen(@nicholas-gruen)
11 years ago

Richard,

Martin Wolf wrote an excellent article attacking the culture of speculation that the absence of betterment taxes sets off and the massive financial damage they do. Until then I saw the issue as you have presented it – a funding issue, an equitable and efficient opportunity to raise revenue, the better to reduce taxes elsewhere. But I think Wolf is right – it’s a kind of original sin at the heart of our financial system. The CIS Peter Saunders who is now firmly ensconced back in the UK used to warn us of the moral hazards of all this – without his institution ever doing much to my knowledge to promote the taxation of betterment.

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[…] taxation“. This is distinct from the idea of governments claiming the unearned increment that I talked about here. TIF doesn’t allow the creator of the infrastructure to claim the increment in property […]