By Dr Nigel Stapledon and Prof Kevin Fox, Centre for Applied Economic Research, University of NSW. This article draws on the authors’ report, Value Capture Is Not a Magic Pudding: options for funding infrastructure, prepared for the Urban Taskforce.

With major new transport infrastructure being built in our major cities, the idea of value capture has been in the news as a potential source for assisting in the financing of these big capital projects. Value capture refers to a broad range of user charges linked to, or taxes on, the rise in land value.

A first broad point is that transport infrastructure (or lack thereof) is a prime influence on the value of land in cities. As cities’ populations grow, additional rail/road infrastructure is needed to accommodate the increased population. The new transport infrastructure can add significantly to the value of land in the proximity of say new stations, when it reduces commuter times and improves accessibility, so it seems reasonable that these landowners should share some of this gain with the government (broader community). However, there can also be losers. The value of land directly next to a new or widened road corridors could be adversely affected by, for example, noise and pollution with the increased traffic volumes.

The presence of both winners and losers makes a land tax an obvious candidate to capture this variation and there is substantial support for this. The Henry Tax Review (HTR, 2010) argued that the current tiered land taxes should be broadened from covering some business and investor residential property, to a land tax on all urban land, including on owner-occupier properties. The ACT is leading the way, widening its land tax base and (as recommended by the HTR) phasing out stamp duties. The ACT combines state and local government which means fewer political obstacles than the States would face but it also highlights that Local and State Government land taxes should be integrated and collected together, along the lines of the Canadian model.

The London Cross Rail has been hailed as an example to follow. The Greater London Council charges a supplementary land tax with proceeds hypothecated to funding the new Cross Rail but significantly it applies only to large business properties. The politics are clear but the exemption means that there is little value capture.

To the extent possible, direct charges on users of new infrastructure should be a default option because they provide a price signal for optimal capital spending decisions and commuter use. Tollways should be the default for major new roads. There is an economic case for subsidies for public transport but given the importance of density for profitability, it follows that new rail lines should be contingent on allowing high density in proximity to new stations.

There are other elements of value capture in the current system. Where land is owned by businesses or investors, capital gains tax will apply which will capture a portion of any gain. However, a big portion of the gain, that made by owner-occupiers is untaxed. A first best ‘value capture’ solution would have this exemption removed but the Henry Tax Review acknowledged that this was politically too difficult.

There is also an element of value capture where the (State) government owns the land. In that regard, the Hong Kong model has been touted as the way to go. However, in Hong Kong the government owns all the land. In Australia, governments do not and compulsory acquisition on a large scale would be problematic politically.

Then there are taxes on new developments. There are a raft of existing development contributions/taxes imposed by Local and State Governments, with the NSW State Government proposing a $2,000 per m² density tax for redevelopments in vicinity of the proposed Parramatta Light Rail. These taxes need to be seen in the context of current controls over the quantity of development. Restricted supply lifts prices and creates the capacity for governments to extract contributions from landowners via developers offering less. If policymakers are concerned about housing affordability, a policy regime with a combination which is less restrictive with a development tax will be more efficient and lead to more affordable housing.

The most controversial tax on developers would be a betterment tax, with the Parramatta Council proposing a 50% tax on the lift in value of the land. Betterment taxes have a history of failure leading to stalling of development and sharp rises in land prices. In design they are an indirect capital gains tax on landowners, indirect in that the liability falls on the developer to extract the gain from the landowner. The key problem is that developers need to pay a premium above land value to encourage landowners to sell. Add in measurement and other issues, and it is easy to see why the Henry Tax Review dismissed this as an option.

In short, the idea of value capture is an attractive one. It is when you dig deeper and flesh out precisely what is meant by value capture that things become harder.