Gavin R. Putland,  BE PhD

Friday, June 30, 2006 (Comment)

Self-funding infrastructure

The New South Wales government has announced that property developers will pay $33,000 per lot towards the cost of providing infrastructure for new suburbs. This levy will cover an estimated 75% of the cost, the rest being funded out of general taxes.

Predictably, representatives of the development industry have condemned the levy, claiming that it will increase the cost of land for first home buyers, especially in the more affordable outer suburbs.

What these self-appointed defenders of first home buyers fail to tell us is that the provision of infrastructure, by itself, increases the value of the serviced land. So even if the infrastructure were funded out of general taxes, first home buyers would still pay for it in the prices of housing lots and house-land packages. The difference is that in the absence of the development levy, more of the uplift in land values would accrue to the developers — or, if the developers do not yet own the land, to those who are waiting to sell the land to developers (which tells us where the rest of the opposition is coming from!).

If development levies raise land prices, they do so only by discouraging development and thus reducing the supply of developed lots. Funding infrastructure out of general taxes, as suggested by the vocal opponents of development levies, does not avoid this problem, because it attaches a fiscal cost to every development application so that governments are less likely to approve development!

But supporters of development levies are also culpable because they play along with the assumption that infrastructure must be paid for either by home buyers or by general taxpayers. Why should anyone have to "pay for it"? If it's worth building, shouldn't it pay for itself?

The hidden value of infrastructure

The market cannot value the benefit of infrastructure except through the price of access to the infrastructure: market value equals price of access. But the price of access has two components: the obvious one, namely the charges (fares, tolls, etc.) payable for actual use of the infrastructure; and the unmentionable one, namely the price of living or doing business in a location when the service provided by the infrastructure is available, as opposed to a location where it is not available.

"Location, location!"

The "unmentionable" component of the price of access to infrastructure is none other than the uplift in property values caused by provision of the infrastructure. This in turn means the uplift in land values (because the value of land reflects the monopoly value of its location even if no buildings yet occupy the land, whereas the values of buildings are limited by competition between builders.) Moreover, the benefit of the infrastructure to the public (as opposed to the provider) is net of charges for actual use. So:

The net benefit of infrastructure is the total uplift in land values caused by the infrastructure.

It follows that the cost/benefit ratio of an infrastructure project is simply the cost/uplift ratio, which in turn is the fraction of the uplift that must be recovered through the tax system in order to pay for the project.

If the project is worth building, its cost/benefit ratio is less than 100%; that is, the fraction of the uplift that would pay for it is less than 100%; that is, the project can be paid for by recycling part of the uplift through the tax system, leaving the rest of the uplift in the hands of the affected property owners, who are therefore still better off than they would be if the project had not been built — as it probably would not have been if the owners had been waiting for other taxpayers, who get none of the benefit, to foot the bill.

Conclusion: If an infrastructure project is worth building, it can be funded out of the resulting increase in land values, leaving a net benefit for owners of property in the affected area, at no cost to other taxpayers.

Indeed, if a certain fraction of all uplifts is reclaimed through the tax system, projects whose cost/benefit ratios are equal to that fraction will be self-funding, while projects with lower cost/benefit ratios will be more than self-funding, yielding a net contribution to revenue which may be used for, e.g., tax cuts!

[Reposted (with textual correction) June 27, 2012.]

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