Thoughts on economics and liberty

Towards a theory of infrastructure – what is infrastructure and who should pay for it

This has been a vexed issue that’s beset by close to utter confusion in the economics literature.

I wrote about this issue here last year but I’m unable to locate any consistent first-principles approach to this question.

The issue of infrastructure is closely inter-related to town planning and zoning. Unpacking the matter is now becoming important since town planning has failed in the West and there has been a chronic under-supply of infrastructure.

My FB comment:

The reason government was given the task of supplying public goods such as infrastructure is that private sector ownership may lead to an undersupply.

But because the government doesn’t charge like a perfectly discriminating monopolist, the problem of undersuppy has not been resolved.

In addition, we now have the various inefficiencies associated with government supply. It is therefore unclear whether society has become better off in this process.

I’ve also been exploring this issue here: Optimal taxation, levies, fees and charges.

Here’s a Planning Institute December 2017 paper:  INFRASTRUCTURE AND ITS FUNDING: IMPLICATIONS FOR PLANNING

It argues:

The costs of infrastructure are met in different amounts by the public, the indirect beneficiaries of new infrastructure and other users. Establishing what infrastructure costs fall into the domains of each funder group should be the first step in negotiating a fair mix:
• State Government: for enabling ‘State’ infrastructure for a public good (via consolidated revenue)
• Local Government: for enabling ‘local’ infrastructure delivering a public good (via rates)
• Land owners / developers whose proposed development gives rise to – or benefits from:
− uplift in land value – and increased future development prospects as a result of the provision of new infrastructure capacity
− related State and local infrastructure needs (via state development contributions and local infrastructure contributions)
− an impact that requires mitigation (via conditions of consent, offsets and development contributions)
• Other users via user charging (via eg tolls, parking fees, access fees)

As part of this exercise I’ll make some notes here and hope that I can find some existing literature to assist the analysis. I’ve downloaded a lot of papers on this topic and will try to highlight the good ones if time permits.

This is a placeholder post and I’ll update as time permits.

EXTRACT FROM NICOLE GURRAN’S BOOK, “Australian urban land use planning: Principles, systems and practice“.

Provision of local and regional infrastructure

An important component of the development control toolkit is the capacity to require contributions towards the shared infrastructure on which urban development depends. These contributions may be required on a compulsory or negotiated basis depending on the legislative provisions within each planning jurisdiction. These provisions also determine the range of facilities that such contributions may fund – ranging from car parking to open space to community centres or subsidised housing for low-income people. The contributions may be levied through a defined formula or plan, or negotiated through the development process. Many jurisdictions specify the way in which certain contributions must be provided – either as a monetary contribution or as land, buildings, or another ‘work in kind: Obviously the imposition of such requirements is contentious and developer contributions are often viewed as a ‘tax’ on development.

Accordingly, there is a substantial literature on the rationale for development contributions (Been 2005; Crook et al. 2002; Evans-Cowley & Lawhon 2003; Fensham & Gleeson 2003). A clear justification for the collection of such contributions has become very important. It is obviously important in policy terms, because if there is too much opposition from developers or the community, elected governments will not support the mechanism. A clear rationale for the establishment of specific contribution requirements is also necessary when levying individual fees on particular developments because most jurisdictions enable developers to contest these requirements in a court of law.

Impact fees

There are two basic approaches to the justification of development contributions. The first focuses on the impact that the new development has on the need for public services, and seeks to recover a contribution towards offsetting this impact. Contributions levied on the basis of this approach, are often called ‘impact’ or ‘linkage’ fees in the US. When compelling developers to contribute towards the costs of essential infrastructure or services on the basis of the impact their development will make on the need for such services, the amount of the fee must be clearly linked to the impact of the development (Gurran et al. 2009). This link or connection is described as a ‘nexus: Typically planning legislation requires that there must also be a nexus between the development and the use to which the impact fee is put.

Windfall gains and taxing planning ‘betterment’

The second approach seeks to capture some of the financial benefits that accrue to private individuals following a beneficial planning decision. By substantially changing the way in which a parcel of land may be used (for instance, by rezoning it to enable more concentrated or profitable forms of development) its potential value in the land market is substantially increased. This type of positive change to land value associated with a planning decision is often described as ‘betterment’ (the converse, when a parcel of land is assigned a more restrictive use due to heritage or other reasons is often described as ‘down-zoning’ and compensation or acquisition may be required).

The benefits accruing to individuals through planning betterment are frequently referred to as a ‘windfall gain’ because unlike cases in which land value increases due to direct ‘improvements’ to the land (erecting a building, for example), the increase in land value occurs at the stroke of a bureaucratic pen. Many argue that a proportion of this ‘windfall gain’ should be recaptured for public benefit, but in practice there are many difficulties associated with doing this in a formal way.

A short-lived experiment in NSW in the early 1970s highlights the political difficulties associated with introducing a betterment tax. The Land and Development Contributions Act 1970, introduced by a conservative government, required landowners to pay a levy of 30 per cent of the ‘increased price or value of re-zoned land … on the sale of the land or on the issue of a development consent’ (Roseth 2003, p96). Funds were collected by the State Planning Authority and held in a dedicated Land Development Contribution Fund to pay for physical infrastructure. However, not surprisingly, the levy was unpopular with landowners and the Labor opposition party promised to remove it – a promise that was matched by the re-elected Liberal government who repealed the levy in February 1973. The substantial $16 million that had been collected was distributed to outer Sydney councils (Roseth 2003).

There have also been several attempts to introduce a betterment tax in the UK. In practice, contributions for development in the UK have been justified on the basis of betterment or planning gain. In the UK there is a clearer sequential connection between favourable planning decisions and betterment because all proposals are considered ‘on their merits’ and development approvals are negotiated in relation to specific proposals and sites. However, it has proved difficult to measure the theoretical increase in land value associated with a particular planning decision, let alone to develop an accurate tool to tax this (Oxley 2006). Even with both of these approaches in place, the contribution requirement is triggered by a specific development proposal and the timing of this proposal may not always coincide with a beneficial change in planning controls. The question has been resolved through the introduction of a flat levy to apply to all development (Department of Communities and Local Government 201lb).

In the Australian Capital Territory (ACT) a type of betterment tax has been applied in the form of a change of use charge when development is approved. However, this is peculiar to the ACT system of leasehold land tenure, discussed further in chapter 6.

In sum, the practical difficulties associated with implementing a formal betterment tax mechanism in most jurisdictions, let alone opposition from landholders and developers, have meant that the approach has not been used widely. But the concept of ‘windfall gain’ can be used as an additional policy argument to justify developer contributions, without needing a formal measure for calculating or hypothecating this gain in precise terms. There are limits to this approach, however. In general, it is difficult to rely on the concept of ‘windfall gain’ and high development contributions to finance major regional infrastructure items. Irrespective of the hypothecated windfall, development contributions alone are unlikely to provide a sufficiently reliable source of upfront funding to ensure that important facilities precede, rather than follow, significant urban growth. It is also important to recognise that while development contributions may provide an efficient source of funding towards the infrastructure and services required by local residents and businesses, the mechanism is largely inadequate in contexts with significant short term or seasonal fluctuations in population, such as resort or mining towns. In these situations, other resources are often needed to fund services to meet ‘peakload’ requirements.

EXTRACT FROM INFRASTRUCTURE AUSTRALIA’S Infrastructure Decision-making Principles

These principles are found here.

Key point –

6. Proponents should assess the viability of alternative funding sources for each
potential project.
Proponents should look to minimise the call on public funds through consideration of a range of funding options, and determine a fair funding split between taxpayers, users and other beneficiaries.

EXTRACT FROM Planning, government charges, and the costs of land and housing
by Nicole Gurran, Kristian Ruming, Bill Randolph and Dana Quintal

2.3 The neo-liberal turn in Australian urban governance and implications for planning and infrastructure provision

In recent years there has been increasing pressure within some parts of Australia to use the development contribution system to fund major regional infrastructure needed for new growth areas, such as rail systems or police stations. Strategic spatial planning processes play an important role in coordinating this infrastructure provision, and ensuring that new development patterns support and follow the existing and planned roll-out of infrastructure. However, expectations that the  development process itself can generate the funds needed to provide this infrastructure represent a significant shift in economic and spatial planning policy. To understand this shift and potential implications for the costs of housing development, it is helpful to briefly discuss the neo-liberal turn in Australian urban governance.

2.3.1     Neo-liberalism and urban governance

Despite the increasing shift towards neo-liberalist agendas in many policy arenas, the Australian state (at its various levels) has retained some of its socio-democratic service functions, especially in arenas of traditional high state intervention such as employee entitlements and welfare support for women and ethnic minorities (see Gough 2002). In spite of this maintenance of social service provision and Keynesian welfarism, neo-liberal policies have significantly changed the level and type of state involvement in these areas (Searle 2002). Urban development and planning and infrastructure provision are areas that have experienced an ostensible shift away from state involvement to increased privatisation and market functioning (Bell 1997; Troy 1999; Cook and Ruming 2008).

At its core, neo-liberalism signifies a framework of  political and  economic authority that champions market operation and efficiency over a wide range of social relations (Brenner & Theodore 2002). As a guiding principle, neo-liberalism seeks to remove the state-centred bureaucracy and executive forms that characterise the socio- democratic tradition of Keynesian-ism. The market is positioned instead at the centre of public management (Larner 2000). Neo-liberalism promotes a core image of the economy as a self-regulating system, where self-interest is seen as a more productive mechanism for optimising national wealth by comparison to government initiatives that promote the ‘common good’ (Beeson and Firth 1998). As such,  the neo-liberal agenda would seem profoundly antithetical to planning.

The political agenda of neo-liberalism has been marked by a shift away from Keynesian welfarism and a regulated economy, to an environment of unfettered markets (Larner 2003). Under Keynesianism, the state was constructed as the provider of goods and services to a national population, which in turn ensured an adequately high level of social wellbeing (Larner 2000). The privatisation and dissemination of the states’ role was seen to allow for a more efficient use of the states resources, and allowed for a reduction in public sector waste (one of the primary critiques levelled at Keynesian welfarism) (Leitner & Sheppard 2002). It was also argued that increasing privatisation would allow urban problems to be sorted out in a businesslike way (Gough 2002).

2.3.2     Keynesian economics and housing production in the post war era

Historically, Government intervention into residential development was perhaps greatest at the end of the Second World War, where housing production became a major element of the broad program of war reconstruction. This was due to a distinct lack of housing options and via the establishment of Keynesian economic policies (Berry 1999). The state used housing as a tool for shaping broader economic activity as a whole, with large areas of housing being planned and developed on the fringe of most of Australia’s capital cities. Much of this housing was constructed by the state. However, private developers raced to make their own residential subdivisions, voluntarily bearing the basic costs of subdivision while leaving the state to construct and fund social services and major infrastructure (Troy 1995). By the mid-1960s land developers were beginning to contribute to public expenditure on water and sewage for new suburbs. Meanwhile, the state government attempted to confront the service shortages in established areas (Neutze 1997). In this period local councils began requiring developers to provide drainage and sealed roads within their developments as a condition of approval and, in terms of hydraulic services (sewerage and water), to cover the capital costs of connecting their development to the existing networks (Neutze 1999).

2.3.3     Privatisation of services and user pays

In the late 1970s, reduced funding to the states from the Commonwealth encouraged a shift towards private provision of transport infrastructure (Searle 1999). This had an impact upon new areas planned or developing on the urban fringe. At the same time, the planning system facilitated the speedy development and sale of dwellings in outer urban suburbs, without requiring or providing services or transportation infrastructure to release areas. This trend accelerated for much of the 1980s (Gleeson and Low 2000). In order to fund major transportation infrastructure, the states turned to privatisation through toll roads and private bus services, passing the costs of servicing the developments back to consumers (Black 1999).

Over the last two decades, this neo-liberal shift has increasingly extended to housing and spatial planning policy (Beer et al. 2007). Funding for urban infrastructure has become increasingly pressing over the last two decades as traditional sources of funding have declined (Searle 1999). Increasing emphasis has been placed on the private sector to provide the services and infrastructure required by rapidly expanding urban growth in most Australian states (MacLeod et al. 2003; Troy 1999; Searle 1999). The shift towards neo-liberalism has influenced the provision of social services as well as physical infrastructure (Gleeson & Low 2000a&b). Consistent with the ideology of market liberalism, the government has moved to withdraw from fields of concern by privatising services or to ‘distance’ themselves from the financing of services by corporatising them wherever possible (Troy 1995).

Consequently, private land developers are increasingly responsible for this social infrastructure, which has led to a new round of privatisation where the state is actively pursuing market involvement in the co-ordination and provision of housing and employment, direct investment in transport, remediation of brownfield sites, preparation of greenfield sites, and co-ordination of community development and human services delivery (Troy 1999). Ironically, while urban policy has increasingly drifted toward neo-liberalism, with the full support of the property and development industry, the industry is now calling for a revival of traditional government investment in the urban infrastructure upon which future growth depends.

2.3.4     Policy rationales underpinning different approaches to infrastructure funding in Australia

Different infrastructure funding regimes can be used to achieve different urban policy objectives (Neutze 1997). We have observed this already in relation to impact fees in the US, used as a financial deterrent for undesirable residential developments in areas that are difficult or expensive to service. This subsection further explores these different policy rationales in the Australian context.

As discussed above, Australian governments have shifted away from the traditional model of funding urban infrastructure through a revenue stream that is generated by taxation, borrowing or, at the local government level, through rate revenue. User pays funding and development contributions represent two additional approaches. User pays models shift the costs of infrastructure or services to the end user (existing or new residents), but a source of up front capital funding is still needed. If the private sector provides this up-front funding, they will need a charging regime that enables them to recoup their investment plus profits. If the public sector provides the up front funds, the imperative to recoup investment through charging may be less — however, a source of up front revenue will still be required. A third approach is through public- private partnerships, where costs and risks are shared, but the private sector seeks the profit (associated with the revenue generated from a user pays charging regime).

When contributions are sought through the planning process for the shared or public infrastructure requirements associated with a development, the charges will add to the production costs of new houses. These costs may be offset by improved amenity and services, which are capitalised into the increased value of the home. As we have stated, while there is not necessarily a direct relationship between the imposition of development contributions and house prices, which depends on short term market conditions, there may be long term impacts associated with discouraging residential development if charging regimes are set too high. What are the policy implications of these different approaches to urban infrastructure provision?  Firstly, it makes  sense to draw on government funding through revenue supported by payments by end-users for goods that should be used sparingly (like roads, water or energy). At local levels, this upfront public expenditure could be supported by developer contributions, provided these contributions support facilities in proximity to the development and are collected in an efficient way (Neutze 1995). The user pays approach sets a price signal to discourage use. However public ownership of the infrastructure removes the perverse situation where increased use of scarce resources is needed to ensure their profitable management by the private sector. Consumption or use of other types of shared goods, such as recreational areas or public transport, is associated with social benefits. Thus provision and use of these items should be encouraged by low or no charges, rather than a negative price signal.  Lastly, when developers must contribute to the infrastructure needed to support development – local roads, footpaths, utilities and so on — they are more likely to provide these facilities in an efficient way, and arrange their developments accordingly to maximise cost effectiveness and  benefits to home buyers that improve market appeal (Neutze 1995; and see Table 4).

Table 4: Summary of policy objectives underlying options for urban infrastructure provision in Australia

ApproachObjective
Government funding (general revenue)Maximise access to and use of public good (e.g. recreation areas, footpaths / cycle-ways, public transport
User pays (up front funding, recouped from user charges)Discourage use of resource associated with significant externalities (e.g. use of roads by private cars; reliance on non renewable forms of energy; waste disposal rather than re-use or recycling)
Developer contributionsProvide basic services and infrastructure in efficient way
Development ‘impact fees’Recoup costs associated with significant negative impacts / externalities of private development

Source: Adapted from Gurran 2007, p.131

2.3.5     How much should developers contribute?

Impact fees in the United States are intended to work on the premise that development should pay the full marginal cost of providing facilities necessary to accommodate growth (Carrion and Libby 2000). These fees should in turn reflect the characteristics of each individual development, for example, the distance from existing roads, or whether its topography leads to difficulties in reaching water and sewer mains (Been 2005). Further charging the marginal cost of providing services (as opposed to the average cost), however, may encourage developers to operate in areas already serviced by under-utilised infrastructure, such as infill and urban consolidation, rather than fringe greenfield locations. Equating development charges to marginal costs also potentially reassures existing residents that as a result of the development, their property taxes will not increase or the quality of service decrease (Been 2005, Brueckner 2001).

One of the major economic considerations of urban infrastructure and service provision is their inherent ‘lumpiness’ – that is, the need for upfront construction and payment as a more long run cost effective pricing mechanism than gradual increases in service (Carrion and Libby 2000; Neutze 1997). According to Neutze (1997), ‘lumpiness of capacity’ means it is more efficient to add to capacity in large lumps than in marginal increments. Most economic models make this assumption. It is generally more expensive to add capacity to existing infrastructure (especially physical) than to provide excess capacity at the time of development, and thus, the marginal cost of capacity is higher in the short-run than in the long-run (Neutze 1997). Some argue that while marginal cost pricing requires that the full cost of service provision (i.e. capital and operating costs) should be included in the equation, when it comes to developer charges, contributions should cover the capital costs while operation costs should be covered by fees for service use (Dollery et al. 2000). In practice development contribution regimes can be structured to recoup capital expenditure incurred by planning authorities as subsequent development takes place. They can also encourage collection for items planned in the future.

 

RESEARCH/REFERENCES ON THIS TOPIC

Ken Henry tax review.

Productivity Commission report on infrastructure.

 

Fixing American Infrastructure

Who Should Pay for Infrastructure?

Sanjeev Sabhlok

View more posts from this author