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Urban Taskforce | Policy Agenda

Fact sheet: Bearing the burden of levies

26 February 2011

Development levies are complex, opaque and are often set too high. They discourage investment in housing, lower the overall supply of housing and raise its price.


Ad-hoc levies are a particular problem. They require negotiation, add delays and discourage investment.


Many levies are nothing more than disguised betterment taxes.


Development levies need to be significantly reduced and made more transparent. Rationalising levies would encourage more efficient land use.


Who bears the burden?

 

Those that argue for levies are mistaken if they believe that developers bear the costs of new or increased developer charges.

Modern capital is very mobile. It flows to wherever it gets the best return. A local developer will not be able to secure equity capital for a local development if he/she cannot offer the rate of return that is available for investments of a similar risk profile in other states or countries. In order to ensure that a market rate of return is still achieved, a developer will either reduce the amount of money he or she pays for undeveloped land, or increase the price paid by the home buyer.

 

It is not often possible, in practice, to pay less for undeveloped land for several important reasons. Many developers have already acquired the land and factored in all the charges known about at the time of purchase in these cases it is too late to adjust the price paid to landowners for new or increased charges, yet the development cannot proceed unless the necessary rate of return can be earned. In some states there has been little stability in levy policy on and the policy framework remains uncertain and laden with risk today.

 

There is also a natural floor to land price, below which the owners of undeveloped land will not move. This floor does, in part, reflect the opportunity cost for other uses of the land such as rural lifestyle blocks (in greenfield) or low density housing (in brownfield). This is a major factor preventing the development of fragmented land parcels, say, on the edge of Sydney.

 

Even when development of land is the highest and best use in the long-term, in the short and medium term those expectations may not be realisable. When land holders are very patient, hold minimal debt and/or originally acquired the land at very low prices, they may be prepared to wait years or decades before they decide to sell their land. Our experience to date, is that such land owners have no difficulty in waiting for prices to rise to the level consistent with their expectations. Economic models eliminate the short and medium term, and simply look at the long term. This may ignore the fact that the long term could be a 20 year plus horizon. That kind of delay in development would carry enormous social and economic consequences.

 

In this debate, economic purists tend to overlook the disproportionate market power given to the landowners by planning laws. For this reason, landholders are often able to resist developers efforts to pass the cost of development charge onto them through a lower land acquisition cost. Land owners enjoy disproportionate market power because appropriately zoned land (both in greenfield and brownfield areas) tends to be drip fed by the planning system into the market.

 

This generally means there is only one party left who must pay for an increased developer charge the home buyer (or commercial/retail/industrial end user).

 

However, often a home buyer cannot afford a new or increased levy. Thats because there is a ceiling on the price that home buyers are able to pay, i.e. their borrowing capacity. The maximum amount that home buyers are able to borrow is, in turn, based on their income. Without increases in income, home buyers are unable to pay more for new homes. As a result, any project, which cannot be delivered at a price home buyers currently can afford, simply doesnt get built. An increase in costs from a new developer charge cannot be passed onto a home buyer until home buyers borrowing capacity increases enough to pay for the levy.

 

Where a portion of the market can afford to pay the levy, developers may need to release serviced lots (or stage higher density development) more slowly so as to ensure that the price does not fall below the threshold necessary to recover development levies.


Betterment taxes disguised as infrastructure levies


This lack of any intimate relationship between the use of the money raised and the development that bears the cost of a levy suggests that many so-called ˜infrastructure levies are simply a tax.


Indeed this issue was canvassed in the Henry Tax Review, released in 2010: "A particular form of tax used when land is re-zoned for alternative use is a ˜betterment tax which attempts to capture some of the increase in land value. Betterment taxes are not infrastructure charges since the objective is to tax economic rent, although sometimes the revenues are hypothecated (that is, earmarked) to infrastructure provision."


The Henry Review goes onto observe that "[i]n general, infrastructure charges will operate more effectively if they are set to reflect the cost of infrastructure, not to tax the profit of development. "


According to the review, the consequences of a tax on the "profit" of a development are clear: "Where the charge exceeds the cost of providing infrastructure, it acts like a tax and can discourage development. This is more likely to occur where the size of the charge is not set relative to the cost of infrastructure but the developers capacity to pay. In these cases, the charges may attempt to capture part of the increase in value resulting from the provision of infrastructure or from changes in zoning, that is, to impose a betterment tax ... ".


Additionally, "having a betterment tax in place may encourage governments to create economic rent through additional zoning restrictions or delays in land release, in order to raise more revenue. Where zoning is used in such a manner, it is likely to stop land being developed to its most productive use ” at least in the short run. "


The Henry Review therefore concludes that " ... where infrastructure charges are poorly administered ” particularly where they are complex, non-transparent or set too high ” they can discourage investment ... lower the overall supply .. and raise ... price[s]."



Ad-hoc levies

 

In recent years governments have been moving steadily to introduce more onerous levies.

The Henry Tax Review concluded that development levies were only justifiable when they reflected the avoidable costs of development. The report explained that "... where infrastructure charges are poorly administered ” particularly where they are complex, non-transparent or set too high ” they can discourage investment in housing, which can lower the overall supply of housing and raise its price."


The recently fluid nature of levies and the apparently random levels of levies, has created considerable uncertainty. The Henry Review observed that: "Where developer charges are set in an ad hoc fashion or are subject to unexpected changes, they can create uncertainty around new developments. If infrastructure charges are increased after a developer has bought land from its original owner, they cannot be factored into the price previously paid for the raw land. In this case, the charge would lower the expected return from the development. In addition, general uncertainty about charging is likely to discourage development activity, which could reduce the overall supply of housing and increase the price of housing."


OECD concerns

 

An international organisation representing the governments of the worlds developed nations has slammed the role development levies play in Australia.


The OECD Economic Surveys: Australia, Volume 2010/21 November 2010, Supplement 3 was made publicly available by the Organisation for Economic Co-operation and Development (OECD) in late 2010.


The report highlighted the serious medium term risk our economy faced as a result of restrictive planning laws and inefficient infrastructure charges on new homes


This credible international organisation gave us an early warning that Australias inadequate housing supply needs to be fixed. Reform is crucial if we want see non-inflationary growth and a sensible allocation of resources.


The OECD report says that "[s]trengthening supply especially in infrastructure, housing and labour markets is needed to ensure non-inflationary growth and smooth reallocation of resources".


In terms of the housing supply, the OECD explains that: "Reforms are needed to boost housing supply. Housing supply is failing to keep up with strong demand growth, driven largely by immigration. Price-to-income and price-to-rent ratios exceed levels in other countries and historical averages in Australia, but at this point seem to be broadly consistent with fundamentals. However, a rising share of the population is being priced out of the market. Measures should be adopted to stimulate supply and more efficient use of the existing housing stock, as recognised by the Council of Australian Governments ... ".

 

Rationalizing infrastructure charges with nationally consistent principles would encourage more efficient land use and reduce delays and cost of negotiation between developers and local governments.


The OECD explained that: "Charging developers for other types of infrastructure that would in any case have to be supplied because of population growth is not justified, nor can the different levels of development charges levied by different jurisdictions for the supply of similar infrastructure. Adopting nationally consistent principles for setting infrastructure charges would improve transparency."

 


More information

For more information (and source details) please read our fact sheet:

 

Fact sheet: Bearing the burden of levies



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