Development levies, stamp duties, and housing affordability

Property developers, through their mouthpieces such as the Housing Industry Association and the Property Council of Australia, have waged a vociferous campaign against the increasingly prevalent lump-sum development levies that state and local governments impose on developers for the purpose of financing infrastructure.

The developers blame the levies for allegedly driving up prices of residential land, hence the prices of house-land packages, and demand that the infrastructure be funded instead from general taxation - the GST being often mentioned.

(Of course the developers of a new estate may provide considerable infrastructure within the estate - such as roads, footpaths, drains, sewers, power lines, water mains, and gas mains. But governments or their corporatised utilities still need to provide headworks and incidental works, which connect the internal infrastructure to the rest of the system and ensure that the system has sufficient capacity: the headworks and incidental works are the "infrastructure" that the development levies are intended to pay for.)

In opposing these levies, the developers fail to tell us 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 development levies, more of the uplift in land values would accrue to the developers (or to those who are waiting to sell land to developers; this may tell us where the rest of the opposition to development levies is coming from).

The only way development levies can raise land prices is by discouraging development, so reducing the supply of developed lots.

This sort of bottleneck cannot be removed by funding infrastructure out of general taxes, because that would attach a fiscal cost to every development application so that governments would be less likely to approve development.

It can be removed only by redesigning the levies so that the developer's tax liability is less dependent on the act of development, and therefore less of a disincentive for development.

The obvious way to do this is to make the levy payable on resale of the land (not on development or permission to develop) and to make it proportional to the real increase in the land value since the last sale, with a deduction for the cost of acquiring the land between the housing lots (if this land is to be transferred to the public domain as a condition of development) and for the cost of providing the internal infrastructure. The modified levy will then tax the increase in land values caused by provision of the headworks and by permission to develop, but will not penalise the actual development.

The "modified levy" would be some fraction of the unearned real increase in the site value since the last transfer - the site value (SV) being the value of the ground and-or airspace, including any attached building rights, but excluding any actual buildings or other improvements. Accordingly, let us call the proposed levy a site windfall tax (SWT).

The increase in the land value caused by permission to develop (or, more generally, by rezoning) is commonly called betterment and is automatically included in the base of the SWT. So the SWT could replace not only development levies, but also the betterment levy imposed in the ACT.

Of course, as responsibility for infrastructure is shared between state and local governments, the revenue from the SWT would need to be similarly shared.

Another existing tax that is widely blamed for unaffordable housing is the stamp duty imposed on property conveyancing by each state and territory. If the SWT were applied to all property transfers - not just those involving development or rezoning - it could replace stamp duties.

While the present stamp duties are payable by the buyer, the SWT would be payable by the seller (because the seller knows, or should know, the taxable site value at the time of acquisition, and is therefore able to work out the tax bill in advance, without relying on anyone else's honesty).

This does not mean that the replacement of a stamp duty by the SWT would be a one-off windfall for prospective buyers at the expense of prospective sellers. If the stamp duty on the sale of a home is legally payable by the seller, the seller will try to add it to the price. If it is legally payable by the buyer, the buyer will try to subtract it from the price. In the end, the cost will be shared between the buyer and the seller in inverse proportion to their bargaining power, regardless of who actually remits the tax to the revenue office. And as the final burden is partly borne by the buyer, it damages affordability.

Buyers bear part of the stamp duty because vendors can refuse to sell and can thereby avoid any part of the burden. So it is by discouraging turnover that the stamp duty affects affordability.

With the existing stamp duty, a higher frequency of transfers over the same time frame means a larger total tax bill, and each transfer creates an additional liability; but with the SWT, a higher frequency of transfers merely divides the taxable capital gain into a larger number of smaller steps, and each transaction merely realises an already accumulated tax liability.

Furthermore the SWT, by definition, cannot cause a property investor to make a capital loss, but merely reduces capital gains (and, if allowed to be negative, reduces capital losses), whereas the existing stamp duty can cause or increase a capital loss. Thus the SWT does not discourage turnover as the present stamp duty does, and therefore does not damage affordability to the same degree.

If the SWT were calculated on the total property value instead of the site value alone, it would discourage site owners from adding to that total value by building, rebuilding, extending, or renovating, and would therefore restrict the supply of accommodation and push up prices and rents. The use of the site value avoids this problem.

A vital economic question remains to be addressed: would the SWT cover the cost of infrastructure headworks and incidental works?

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, and so on) payable for actual use of the infrastructure; and the hidden 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 "hidden" component of the price of access to infrastructure is none other than the uplift in site values caused by provision of the infrastructure. Moreover, the benefit of the infrastructure to the public (as opposed to the provider) is net of charges for actual use; that is, it is equal to the "hidden" component of the price of access:

The net benefit of infrastructure is the total uplift in site 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 infrastructure passes a cost-benefit test, this fraction is less than 100 per cent. If the necessary fraction is reclaimed through the SWT, the infrastructure is funded.

More generally, if a certain fraction of every uplift is reclaimed through the tax system (for example, via the SWT), infrastructure 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, for example, tax cuts, while the remainder of the uplifts accrues to the property owners. Thus the property owners make gains that they would not otherwise make, due to infrastructure projects that would not otherwise proceed.

The resulting uplifts for property owners do not represent a loss of affordability, because they are caused by improvements in utility, not higher prices for sites of given utility; moreover, improved "utility" is often realisable as a recurrent cash saving or cash flow, in which case it pays for itself from the viewpoint of potential buyers and renters.

Meanwhile, the SWT (in lieu of other property transfer taxes) improves affordability by lowering the barriers to development (a prerequisite for building) and to property sales (which are correlated with building), thereby loosening the supply of accommodation and improving the competitive positions of buyers and renters relative to sellers and landlords. Improved affordability does not mean a loss for existing property owners - it only means that their gains must come through improvements in utility, not through the desperation of buyers and renters. It is analogous to making a bigger cake so that everyone can have a bigger slice.

But would everyone get a bigger slice? In other words, can the SWT be designed so that it does not create a class of prospective losers who would campaign against it?

If every property sold after a certain day ("D-day") pays SWT on the real increase in the site value since acquisition, even if acquisition occurred before D-day, then the continuing turnover in the property market will cause a steady stream of SWT revenue to start immediately, allowing the immediate abolition of existing property-transfer taxes.

That turnover will also ensure that uplifts due to infrastructure projects are immediately reflected as increases in revenue. But vendors who have received large uplifts before D-day will pay more tax on those uplifts than they would have paid under the old system, and might therefore allege that the SWT is retrospective.

Such complaints will be prevented if a taxpayer disposing of a property acquired before D-day has the option of paying tax as if the property had been sold and bought back (at market price) on the day before D-day. Under this option, any property vendor who pays more tax than would have been payable under a continuation of the old system does so solely because the site has appreciated in value after D-day - in which case the taxpayer is not a "loser" and is not "retrospectively" affected.

The exercise of this option does not affect the financing of infrastructure, because uplifts caused by infrastructure after D-day are still immediately reflected in higher SWT receipts through normal market turnover.

In conclusion, housing would be more affordable if development levies, betterment levies and conveyancing stamp duties were replaced by a site windfall tax (SWT) - that is, a tax payable on the transfer of a property and equal to a fraction of the real increase in the site value since the last transfer, with a deduction for any cost incurred by the taxpayer in contributing to that increase (for example, infrastructure built by a developer).

To avoid claims of "retrospectivity", a taxpayer disposing of a property acquired before the introduction of the SWT ("D-day") could be allowed to pay tax as if the property had been sold and bought back (at market price) on the day before D-day. All legislation necessary for the tax reforms and the sharing of SWT revenue could be enacted at the state or territory level.

These reforms would not only improve housing affordability by lowering the barriers to development and sales, but also bring some consistency and logic to what has been a fragmented and arbitrary area of taxation.