Tax Increment Finance 2

A few months ago the Sydney Morning Herald had an article in which Mike Baird, almost certainly the next treasurer of NSW, suggested the use of Tax Increment Finance. Briefly, TIF refers to the funding of infrastructure by allocating beforehand any increase in tax revenues that may come from rising land values as a result of that infrastructure to the repayment of a bond or to a third party (such as a PPP). I gave a very negative response. Shortly afterwards I decided I was making some assumptions, and it was only sensible to get a response from Baird himself on which strain of TIF he was thinking about. It’s foolish to rely on a newspaper for knowledge of policy, and it was unfair to Baird to do so. Far more importantly, it was unfair to policy discussion in this country and to my own intellectual honesty.

So I picked up the phone [fn1]. A few days ago met with Baird in a cafe at Martin Place, where he was eager to discuss TIF as an option and happy to find someone who cared about policy. Since I know I’m not the only one who does care, I’ll share the discussion with you.[fn2]

The model Baird suggests for consideration (he stressed it was an idea) is inspired my the model in this paper commissioned by the Property Council of Australia. In this proposal local authorities would be created and issue bonds to build infrastructure, and these authorities would be allocated any increase in stamp duty in their designated region in order to pay back the bonds. Here’s a graph I took from the report.

I’m ecstatic that it’s not a way of keeping the PPP zombie shuffling along, but I still have my concerns.

The obvious question, and the one I put to Baird, is why we could use debt to fund the infrastructure deficit, since the state is well positioned to do so [fn3]unlike the small US municipalities that are the main users of TIF, the spending would be investment and not an ongoing expenditure and it would be a cheaper form of funding. [I note that the report assumes an 8% interest rate, whereas current rates on long term NSW debt are around 6%]

He said he was committed to retaining the AAA credit rating. Whilst it was relatively arbitrary as a measure, it was an important sign of commitment to fiscal discipline and said that “the information I am getting” was that funding would be much harder to secure under AA; governments are held to greater standards than corporations, and institutional investors (he proffered Japanese pension funds) would be loathe to buy bonds from a AA government. Whilst funding might be cheaper with borrowing, it may still be difficult to source. He also mentioned that “diversity of funding” was important, but I did not press him on this point

I cited the example of Canadian provincial governments who had in recent history as examples of sub-national governments who had  found little difficulty finding funding when their credit ratings had been downgraded. He said that the climate of today was different due to the GFC and recent history may not serve as a good guide, since risk aversion amongst investors would be higher. I asked that if Queensland experienced little difficulty finding funding under AA whilst rebuilding from the floods he would reconsider debt. He said perhaps, but that it would take a great deal.

I’m still convinced that general debt borrowing is the way to go to tackle the infrastructure deficit. The GFC may have encouraged risk aversion, but this would surely favour traditionally safe options like governments – especially when the governments have comparatively little debt like NSW. With savings that have to go somewhere, there’s a limit to what the ratings agencies can do in their imperial nudity. Additionally, given future stamp duties are uncertain, part of the PCA report suggests placing a government guarantee on bonds offered by the local authorities. This would make them easier to sell certainly, but only by giving them the certainty that would have come from normal government bonds – the state would still be liable, but would gain a layer of bureaucracy.

There were other points however that are more interesting. Baird was keen on the slogan “Local taxes for local infrastructure”, and considered these authorities a possible partial antidote to the tendency to allocate spending on marginal seats. As a Novocastrian, a people whom have spending deprivation due to the safety of their seat ingrained in their identity, I’m inclined to be interested. This is a difficult prospect however. The model putatively would only use the local taxes that were collected as a result of infrastructure being built. Any existing tax revenue is still there for pork barreling wherever political considerations require it. Smaller administrative regions for services also risk the American problem of vicious/virtuous circles, where one region can afford more services, and attract wealthier residents whom pay more tax, whereas other regions cannot afford services, and lose residents who can pay tax. Despite the marginal seat bias of the Australian system, avoiding this is an undoubted benefit.

I also suggested that if the bonds being issued by the authorities could only be paid using revenue as a result of the infrastructure (say, by applying a hedonic formula) and were denied government guarantees, they would be contractually obliged to build the infrastructure well. This would prevent governments coming in and chopping and changing according to political winds – the kind of thing that stunted many rail projects including the recent Chatswood Parramatta links, Metros and going decades back, the Eastern Suburbs line (it’s not a recent problem at all). Whilst the man’s satanic reputation is rather deserved, this was a crucial part of Robert Moses‘ success in completing infrastructure – his authorities’ immunity to political pressure due to the legal protection of the bond contract. Baird made no comment on this.

I think it’s also important to note the funding that the Property Council is proposing will be replaced. Interest groups are always disingenuous, so it pays to see whether their disingenousness makes for bad policy (in some cases it does not). They are especially keen on replacing the existing system of infrastructure levies charged on developers, particularly in greenfield sites in Western Sydney, for example around the intersection of the M4 and M7. This is a terribly flawed system, but it does have the advantage of not subsidising private developers. If they are to build there, they have to take into account the costs of infrastructure that will be required (although provision of this has been patchy). Under the TIF system they propose to replace it however, the tax increment that would have been received by government  anyway is removed from general revenue to pay off a debt that could have come from general borrowing. Except if the debt was general borrowing paid off from general revenue, it would be easily recognised for what it was, a direct subsidy to developers. They get higher prices for their infrastructure served developments, but with an extra layer of bureaucracy they obscure the fact that this infrastructure is now paid for by someone else.

For a long time governments have tried think of ways of capturing the unearned increment in land prices from infrastructure. In Canberra they instituted a system of leasehold I talked about here, and in the US Roosevelt proposed using eminent domain to obtain the land adjacent to any national highways that would be built, so that any value would be returned to those who paid for it, i.e taxpayers. The Canberra experiment died of neglect, and Roosevelt’s came up against a long history of rent seeking in the US, going back to the site of Washington, DC being chosen to increase the value of the lands of Washington, George.

I asked Baird if he would consider using a similar system in Western Sydney, resuming and selling land adjacent to say, the proposed North West Rail link, on leasehold so the government could recoup the value it had produced. He said yes, and that “finance is very keen on leasehold, provided it’s 30 years or so”. Since I think this is the most equitable and cheapest way to do things I’m quite excited, I just hope it proves politically feasible.

But I am far from convinced about TIF. On the other hand I am very happy that despite the corrosive effect of media inanity, we can still talk about policy with our politicians though.

[fn1] I know this upsets the natural order of things.

[fn2] I have not followed the common journalistic practice of checking quotes (i.e allowing the party quoted to vet anything attributed to them, an ethical guard against misrepresentation I guess). Anything in inverted commas comes from notes I made directly afterwards.

[fn3] It’s remarkable that a sense of malaise can give an anti halo effect. If you’d ask most people they’d be certain the fiscal position of the state was dire. I’d argue that the malaise comes in some part from a commitment to the wrong kind of fiscal discipline. It’s remarkable that it is pursued so vigorously, and with unpopular policies, when voters don’t even recognise it’s successes such as continuing, if anemic, surpluses.

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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SJ
SJ
10 years ago

Gotta love the B.S. circular reasoning.

Q: Why don’t you just borrow the money?

A: So we can keep our AAA rating.

Q: Why do you want a AAA rating?

A: So we can borrow lots of money cheap.

Q: But you’re saying that if you actually try to borrow any money, you won’t be able to borrow any money, is that right?

A: Yep.

derrida derider
derrida derider
10 years ago

John Quiggin has written several times (eg here) about the way governments and corporations are held to very different standards by the ratings agencies, and how this seriously distorts infrastructure financing. It makes PPPs viable that ought not to be and government projects unviable that ought to be.

More sophisticated governments that go in for PPPs know this, but it is a fact of life they’re powerless to change and so have to take into account. They would say don’t confuse “is” with “ought” – that government bond financing of infrastructure ought to be more favourable doesn’t necessarily mean that it is.

.
.
10 years ago

“I asked Baird if he would consider using a similar system in Western Sydney, resuming and selling land adjacent to say, the proposed North West Rail link, on leasehold so the government could recoup the value it had produced. He said yes, and that “finance is very keen on leasehold, provided it’s 30 years or so”. Since I think this is the most equitable and cheapest way to do things I’m quite excited, I just hope it proves politically feasible.”

Equitable if they behave themselves. The State has only a legislated requirement to give just compensation, which it can repeal.

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

Thx for this Report from the Frontline Richard. I’d missed it when you posted it. I’ve only seen Baird once but was reasonably convinced he wants to do a good job. We’ll see if he does.