Financing Urban Living

Speech by Chris Huhne MEP delivered to the conference on 'Financing Transport Infrastructure through Land Values: Making it Happen', CBI Conference Centre, London on Tue 6th Jul 2004

My contention is that our system of land use conspires to create a vicious cycle in which we systematically under-invest in social infrastructure, particularly urban transport. My point is that the building of, say, underground lines in London leads to vast increases in wealth and income as property values near the improved line rise in value. However, those rises in value currently accrue wholly to the private individuals who own the property. The result is that the public sector has less incentive - and worse, no means - to invest to the level that citizens would like. In theory, those who enjoy windfall gains from new projects benefit most. But in fact fewer people enjoy windfall gains because fewer improvements are made. Even property developers are losing out. The system is clearly sub-optimal. By improving transport more, more people could benefit from rising property values, and those increased values could be shared.

We are not talking about insignificant amounts. Let me give the example of Hong Kong. By historical fluke, the former British colony contained little freehold land. In fact, the only freehold land on the island itself was the Anglican cathedral. Almost everything was - and is - sold leasehold so that it eventually reverts to the state. The result is that the state has a regular - if not always steady - income from the sale of leases that can account for up to a quarter of the territory's total government revenue. Hong Kong is able to enjoy substantially higher levels of public spending - notably on transport infrastructure - than countries with a similar level of direct taxation. (Alternatively, you can say that it has much lower levels of direct and indirect taxation thanks to its ability to take revenues from land leases or rents). Much of the Hong Kong miracle has been built on the low levels of income tax to which the territory's unique system of land tenure has contributed.

Another example is the building of the Jubilee line, which the property developer Don Riley estimated to have added more than £13 billion to property values in direct consequence of improved transport and shorter journey times . Given that the cost of the Jubilee line was just £3.5 billion even with its substantial over-runs, the net gain was very nearly £10 billion. However, only an insignificant part of that gain - just £180 million - was paid by the developers of just one small area affected by the line - Canary Wharf - towards the cost. The vast majority of developers along the route enjoyed a large windfall gain with no extra contribution whatsoever. A similar windfall is operating for property owners around London Kings Cross, Ebbsfleet and Stratford because of the construction of the high speed link. And property prices have been catching up with the south east average in east Kent because of the prospect of rapid commuter services using the high speed link from Ashford.

Of course, Section 106 of the 1990 Town and Country planning act empowers local authorities to reach agreements with developers. But the difficulty is that the gains are dispersed too widely for any realistic negotiation. Short of developers actually buying land around the line that they built - the situation with the Metropolitan line suburbs between the wars - it is difficult for companies or public authorities to capture the potential land value gains from their investment. Stephen Glaister and Tony Travers have proposed an infrastructure fund for London financed by a hypothecated levy on the national non-domestic rate, and that would at least have the benefit of spreading the cost across the whole of the capital's business community. Similarly, CB Hillier Parker has suggested that Crossrail could be financed by a levy of 2p per pound on the rate. But in both cases, the proposal spreads the extra burden of tax too widely.

These proposals fail to recognise the particular value of locations close to new infrastructure, which should surely make a greater contribution that some remote business that will be barely affected. Moreover, both proposals completely ignore the gains made by owners of residential housing, whether for owner occupation or for rental. Only a tax system that allow public authorities to tax the rental value of land will capture these specific gains. By periodic revaluations, any rises (and falls) in land prices due to changes in physical infrastructure such as new tube lines would be reflected in the rateable value and hence in rating income. Such a site value rate allows a precise tailoring of contributions to the benefits that property owners actually receive.

At this point, there should be an important caveat about what any potential tax could raise. Clearly, it cannot raise as much as Hong Kong without owning all the land, and benefiting from all of any increase in value. That would be politically and economically impossible given where most market economies start: people own land as just another asset like any other, and many have recently bought land. It would be morally and politically capricious to confiscate most or all the value of that land instead of any other asset. However, there is no reason why the public commonwealth should not participate in increases in the value of land, particularly those that outstrip normal increases thanks to social improvements. The case is therefore for a tax that takes part of the increase in land values, rather than part of the total land value.

There is a second caveat. The tax must be levied in such a way that it does not cause holders of land to bring forward such a rush of land sales that the market collapses. That would, of course, be counter-productive for any attempt to raise revenue for social improvements. That argues for gradualism. It may be possible to replicate the Hong Kong model by taking some slice of the increased value of leases once they are renewed. Otherwise, any site value rate must be a fraction of the likely on-going revenue accruing to the landowner, or the land itself is likely to be sold. Therefore the tax must be able to be met from income, not capital values. And the wilder estimates of what a site value rate or land value tax might raise should therefore be heavily discounted.

Nevertheless, such a tax could be an important contributor to local authority revenues. Some back of the envelope calculations on the basis of Don Riley's figures show how much of a contribution to infrastructure financing such a land value tax could make. If developers make a return on their extra land value of just 10 per cent a year - rather lower than their likely target rate of return - then the extra flow of income from the construction of the Jubilee line alone is worth about £350 million a year. And if that flow were to be split half to the public exchequer and half retained privately, we would be talking about £175 million a year available to service debt to build new infrastructure. At current ten year bond yields available to the Government , that would be enough to provide debt service on £3.47 billion of new debt. In other words, the entire cost of the Jubilee line including cost overruns could have been financed by capturing just half of the extra annual return to property owners.

Of course, such calculations will vary according to the project. Other infrastructure projects may not have the same impact on property prices. Moreover, the above calculation assumes that there is a government guarantee on the new borrowing so that the debt service charges are the same as if the Government itself were borrowing. If instead the borrowing vehicle is free-standing without guarantee, and were rated by the rating agencies at low investment grade (BBB instead of AAA), then the interest charges would currently rise by about 150 basis points a year . Reworking the financing figures on that basis, the tax would be able to finance interest charges on £2.7 billion of new debt, the vast majority of the cost of the Jubilee line project.

It would not be sensible to propose, and nor would it be feasible to construct, a tax that targeted literally half of the increased flows from a given project. But a general application of site value rating would ensure that public authorities have the capacity to capture a large part of socially-generated land value returns, and that this would happen naturally as growth proceeds. As I have argued, periodic revaluations would pick up any particular differences in land value both up and down, ensuring that those who benefit from the creation of new physical infrastructure do indeed pay more for it. Nor is the tying of personal gains to social contributions the only benefit of such a proposal. It is worth dwelling briefly on some of the other implications.

One of the mysteries at the heart of the British economy is the co-existence of enormous increases in house prices with unused land. House prices in the South East have doubled in the last five years. On the other hand, the National Land Use Database finds that 12,000 hectares of previously-developed land is available for residential use even in London, the South East and the East of England. The potential build total, according to the planning authorities, amounts to 360,000 houses , quite enough to stop the house price boom in its tracks. Moreover, a substantial part of this land is currently completely unused, being either vacant or entirely derelict. What accounts for this apparent failure in the housing market? What accounts for this paradox of unused and underused land amid soaring demand for it?

If we are to believe the Barker review of housing supply , it is all a question of the planning system. Certainly, that is part of the answer. Some of the Barker ideas for streamlining the system are worth taking forward. By comparison with continental countries and with the United States that have much lower population densities, our planning procedures are cumbersome and time-consuming. But I simply do not believe that it is all of the answer or even as much of the answer as the Barker review seems to think. Anyone who has been on the receiving end of a planning application knows that there is always a struggle between private and public interest even if all Nimbyist motives are put to one side, as they often are not. There are still issues about the proportion of affordable homes or key worker housing. About the proportion of planning gain that may be extracted for the local authority. About the provision of facilities such as playgrounds and leisure centres. About parking and road access. And it is also the case that developers are still more interested in greenfield sites than in taking on brownfield sites that may have problems with clearance, contamination and a less attractive neighbourhood. Developers are also more interested in new build than in renovation.

I do not believe that this reflects popular preferences, as opposed to the interests of developers in churning out standardised units. The implication of developing on greenfield sites, and just abandoning brownland, is surely that we ultimately arrive at the state of some American cities where vacant land can take as much as 45 per cent of the total area . Such a policy will gradually empty our cities - leaving decaying urban cores of the under-class - while suburbanising what remains of the countryside in the South of England. For many reasons - not least the provision of health, education, social and transport services - it makes sense to re-use urban land that no longer fits its first or previous use. Barker seems neutral between greenfield and brownfield, because the review entirely failed to take into account the social costs of providing infrastructure for greenfield development, and the social costs of decaying infrastructure in the dying communities it leaves behind. Urban densities in Britain are low compared with our continental peers - London for example has a density half that of Paris - even though the population density of England is among the highest in Europe. Public policy should be aimed at regenerating and reviving urban areas, and encouraging developers to bring forward more initiatives that will do so.

So my first disappointment with the Barker review is the analysis. My second disappointment is the prescription for tax changes. The Barker review rightly points out the enormous increase in land value that accrues to the land-owner once planning permission has been granted for formerly agricultural land. The price of arable land is given at £7,534 a hectare. The price of residential land per hectare is £1,230,000. The net gain from a simple administrative decision is thus £1,222,466 per hectare. No wonder that planning negotiations are often so fraught. The Barker solution is to introduce a planning gain supplement, which is a tax on the increased value, payable in order to receive the planning permission. Although administratively more simple, it is surprisingly similar to several previous attempts to impose development gains taxes such as the 1947 development charge, the 1967 Betterment Levy and the 1973 Development Gains tax followed by the 1976 Development Land tax all of which died through asphyxiation by their own complexities.

The essential problem with the Barker proposal, as with its predecessors, is that it gets the economic incentives wrong. Indeed, the Barker review itself implicitly admits that its tax proposals would reduce supply when it says 'taxation of anything tends to reduce its supply. However, in the case of land it is the restrictions of the planning system that are the main constraints on land use for housing. The effect of the package of measures in the review as a whole is expected to increase supply' . And the review is far too dismissive of a tax on the value of land - or a site value rate - that would uniquely get the incentives right. A site value rate would levy the same amount whether the site was used to its full potential (as allowed by the planning authority) or not. If it was not developed, the landowner would have a regular charge to pay - a carry cost - that he or she does not have today, and would therefore have an incentive either to develop or to sell to someone who will develop it.

The significance of such a site value rate for urban areas would be enormous. Landowners would have an incentive to develop immediately sites that fell into disuse, limiting the possibility of spreading blight. They would also have an incentive to develop fully under-used sites. Another urban paradox is the frequent coexistence of very undeveloped sites alongside skyscrapers: single storey shops in the Tottenham Court Road in London, alongside the multi-storey Centre point. By fostering private activity, we would eliminate the need for state giantism - the solution of the Docklands Development Corporation in the East end of London, when decrepitude had gone so far that there was no alternative. Communities employing such a tax have an ongoing incentive to foster organic growth. And experience suggests that this organic patchwork of growth that urban dwellers like most, precisely because it involves a myriad of decisions of people thinking hard about the maximum use and enjoyment of their own property. Many of the most attractive historical cities - Venice, Amsterdam, Bruges, Paris - have this carefully woven feel to their development which is the exact antithesis of post-war new town planning or the Disneyworld attempts to recreate such a feel at developments like Poundbury.

And there is no doubt that site value rates - or land value taxes - have exactly the necessary effect. In the United States, they are known as split rate property tax because there is a high rate on the land value, and a zero or low rate on the capital value of the building on it. As John Norquist, the president of the Congress for the New Urbanism who was the acclaimed New Democrat mayor of Milwaukee from 1988-2003 said: 'It's been great for Pittsburgh. You almost can't find an empty lot in downtown Pittsburgh. They've done a lot of things wrong in Pittsburgh but one thing they did right was having this land value taxation so there's no incentive to have an empty lot'. The Pittsburgh experience has already spread to many other cities in Pennsylvania such as Philadelphia and Harrisburg, and other US states are looking at enabling legislation. Similar tax systems operate in Denmark and Australia.

If owners have to pay an on-going cost for holding onto land with potential, they are far less willing to hoard land. If introduced in the UK, this would also help to curb the single greatest cause of the instability of the UK housing market. In normal markets, a rise in price leads to an increase in supply. But in asset markets - including the land and housing market - a rise in prices may simply foment expectations of a further rise, and reduce the holder's willingness to sell. This then further reduces supply, and increases prices again. By introducing a carry-cost for land, there is a price for hoarding it. There may, of course, still be obstacles in the planning system. But at least there would be a clear incentive on owners to develop to the full extent allowed in their local plan. The Barker review implicitly assumes that developers want to develop every last thing we would want them to develop plus some, and that planners just get in the way. In fact, developers need incentives to bring forward plans that are socially valuable.

Let me sum up. The advantages of a tax on land values are several. It may help dampen down the cycle of boom and bust in British property prices by introducing a carry-cost that discourages the hoarding of land in price upswings. It can make an important - indeed crucial - on-going contribution to the financing of social improvements including public transport infrastructure. It can shift private incentives so that areas do not fall into unfashionable disuse because of blight, and it can encourage the full use of urban property to the extent that planners intend. It therefore provides an incentive for developers to bring forward plans that are tailored to social needs. Where such taxes are applied, there are higher levels of construction activity and a better-looking urban environment. This is not a small list of potential gains. Land value taxes are an important element to put into the toolbox of all those who care about the effective functioning of cities and towns.