26 February 2011

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

The burden of levies
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 NSW 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. There has been no stability in NSW's policy on development levies at any point in the last 10 years 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 charges 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.

Local council infrastructure charges
In NSW a major source of funding for local government are the rates and charges. The amount that can be raised fundamentally impacts on local governments ability to provide infrastructure and services. Since 1977, council rates in NSW have been regulated by the state government based on a philosophy that was to encourage restraint and exercise control over expenditure. This approach relied upon state government regulation that pegged rates each year to a maximum amount.

Local councils are being asked to do more with less funding, and councils across the state are being forced to make some very hard decisions when it comes to service and infrastructure provision. Without appropriate funding, local councils are either forced to leave existing infrastructure to deteriorate, not provide additional services and/or facilities or seek an alternative source of revenue.

Finding an alternate source of funding has been the preferred option of local councils and unfortunately, the preferred vehicle has been development levies. Development contributions are being relied upon to fund a significant proportion of local infrastructure and services. In some cases, the provision of local infrastructure is being provided entirely by development levies of some type. This type and level of taxation on development has, without doubt, caused a slowing of development activity, particularly in the residential sector, which has contributed to the current collapse in NSW private sector property development.

It has been widely reported that without the extra income the councils will have to let rundown facilities deteriorate further, or appeal to federal and state governments to bail them out.

There are already numerous councils who are carrying an infrastructure backlog that far exceed their ability to fund. Council rates dont come close to providing the funds needed to meet current service and infrastructure needs, let alone meeting future needs. The additional funding from the upper tiers of government has not been forthcoming and the ability to raise additional funds through rate increases has been constrained, hence local governments have sought private funding for public infrastructure.

The Federal Governments independent economic advisor, the Productivity Commission, prepared a report titled Assessing Local Government Revenue Raising Capacity. It revealed that Baulkham Hills Shire Council, Mosman Municipal Council and Willoughby City Council had each admitted that rate pegging creates an incentive to increase fees and charges, as an alternative source of revenue to rates. We have heard the same admission on many occasions in our discussions with council representatives.

There is no denying it: rate pegging has made councils reliant on developer contributions to supplement income for the provision of infrastructure and services.

This is most obvious in the growth areas of Sydney where pressure for additional infrastructure and services is at its greatest. For example, the draft section 94 plan exhibited for North Kellyville proposed a contribution of up to $50,700 per dwelling. Contributions have been used by some councils to stop development in an area by imposing massive taxes, that make it impossible for projects to make a commensurate return on risk.

Regretfully, in NSW there is a very broad basis for councils to recover their costs through developer charges. The Productivity Commission has found that: New South Wales and Victoria appear to have the most flexible legislative arrangements for accessing developer contributions, with legislative scope to levy for a broad range of economic and social infrastructure needs (such as public transport, child care centres, libraries, community centres, recreation facilities and sports grounds) beyond basic infrastructure. Other jurisdictions may not have scope to apply a levy for these facilities.

The recent reforms to NSWs section 94: contributions do little to narrow the scope of the projects that can be funded by these charges. In fact, more than 90 per cent of the funds currently raised by these charges will continue to be raised under the new regime. Any (limited) savings are not being passed back to developers instead councils are simply increasing the contribution required for those matters that are permissible.

The so-called $20,000 per lot "cap" has failed. Nineteen local councils have been given NSW Government approval to exceed the cap on local council charges and are levying as much as $80,000 a home. In June 2010 the NSW Government announced that the cap was to become a hard cap, and all levies were reduced to $20,000 a home. In a back-flip, this decision was, in substance, almost completely reversed, in September 2010.

Seven councils are still imposing a levy of $50,000 or more on new homes. Yass Valley Council has the states highest levy with an impost of $80,000 per home. Sydneys highest-taxing council is Pittwater, where the charge is now $62,000 a home.

Camden Council charges $59,000 a home while Ku-ring-gai and The Hills both charge $54,000 a home. Hawkesbury Council levies new homes at a rate of $51,000 each, while Shoalhaven Council charges $50,000. Twelve other councils are charging well above the state governments $20,000 cap, including Blacktown ($44,000), Campbelltown ($41,000), Leichhardt ($40,000), Wyong ($35,000), Liverpool ($31,000) and the City of Sydney ($27,000).

The most recent cross-jurisdictional data on the relative size of development levies was provided by a 2009 study by the AEC Group. The AEC report pinpoints the average Queensland local council development levy at $22,300 per home; it reports that the low-end of the range is $10,000 a home and the high end of the range is $40,400 a home. Its evident that the key growth councils in NSW are, in many cases, levying well above, even the high end of the Queensland counterparts. 

A study by the consultancy firm Integran examined Victorian greenfield areas and concluded that, for a residential lot yield of 15 dwellings per hectare, infrastructure contributions per lot, excluding state infrastructure contributions, could equate to approximately $14,500 per dwelling. Victorian levies are a mere fraction of the equivalent NSW charges.

Local council levies in infill/brownfield areas should be capped to a fixed percentage of construction costs (1 per cent). This percentage rate is consistent with the intent of the original legislation.

In greenfield areas, local councils should be prohibited from imposing any charge themselves and instead, their infrastructure works should be funded by the state, drawing on the revenue it received from a percentage-based levy state infrastructure contribution proposed below.

In the event that this is unacceptable to the government, the next best solution is for local council levies in greenfield areas, to be genuinely capped by the state government (not the less than effective $30,000 cap now in force). This levy would still only be payable on the final sale of land, along with any state infrastructure contribution. The payment could be made to the Office of State Revenue by the developer, who would in turn, pass it onto the council.

The levy will only be paid once on each parcel of land sold (i.e. no further levy will be payable on subsequent re-sales). Land sales between developers prior to the issue of a subdivision certificate will not attract the levy (i.e. it will only be payable once lots are actually subdivided and sold individually).

Councils should be given greater freedom to use their broader rate base to fund the costs of infrastructure and population growth. This will require either the abolition, or relaxation, of rate pegging. In the absence of council amalgamations, there may also need to be a mechanism to allow rate-payers in councils, with relatively modest growth projections, to contribute to the cost of infrastructure provision in council areas, with extremely high levels of anticipated growth.

In 2007 the NSW government promised that the Minister for Planning or his/her delegate would approve section 94/section 94A plans and amendments to plans. The government has failed to deliver on this commitment. Instead it has only required the Minister to approve items that do not fall into a very broadly defined list or above $20,000. This approach has created incentives for many councils to increase their levies to just short of $20,000, in the knowledge that they have a green light from the state government.