Value Capture Taxation as an Infrastructure Funding Technique

Abstract

A legitimate argument is that the public sector must restore its contribution to the financing of the new infrastructure. However, for both political and economic reasons, an increase in broad-based taxes or debt seems to be off the table; new funding vehicles are clearly necessary. This essay identifies value capture taxation as a partial solution to this infrastructure funding problem. Value capture is a set of techniques that take advantage of the increase in property values to finance service and infrastructure improvements.

Keywords

value capture taxation land tax public–private partnership tax increment financing assessment districts

Introduction

Funding the US$3.6 trillion (American Society of Civil Engineers [ASCE], 2013) infrastructure deficit by 2020 is an extraordinarily task. Since the deficit came about, in part, because of federal, state, and local cutbacks (Sherraden, 2011), a legitimate argument is that the public sector must restore its contribution to the financing of the new infrastructure. However, for both political and economic reasons, an increase in broad-based taxes or debt seem to be off the table (e.g., see Harrison & Gillers, 2016). New funding vehicles are clearly necessary. This essay identifies value capture taxation as a partial solution to this infrastructure funding problem. Value capture is a set of techniques that take advantage of the increase in property values to finance service and infrastructure improvements.

What Is Value Capture Taxation

The value of land is determined by three variables: demographic factors, regulations, and infrastructure investment. Demographic factors include population growth or decline, as well as the income, the age distribution, the mobility, and the consumption patterns of the population. Regulations, which usually originate from government, often determine how the land can be used. While zoning (and zoning variances) are the principal regulations determining land use, other such influences as government ownership and private contracts (as in Houston) also fall into this category. This brief article will focus on the third factor—infrastructure investment. This investment may be public investment, private investment, or the hybrid form of public–private partnerships (PPPs). In general, the larger this investment, the greater the value of land.

Land value is a suitable base for taxation. To use land as a tax base, a property tax must be enabled and implemented. Most (but not all) local governments in the United States use the property tax as part of their fiscal base and nearly all include both improvements and land as part of this base, using the argument that it is difficult to separate the value of the land from the value of the improvements upon the land. In other countries (see “Some Examples of the Implementation Value Capture” section) some variant of the property tax is used at the national level. To the extent that the tax is on land and since land is in fixed supply, the incidence of the tax is on the land owner when the tax is imposed, and many economists now regard the land portion of the property tax as progressive, because wealthy people tend to own more land than poor people. In addition, it is also argued that the land tax is efficient because there is no economic behavior that can be changed to avoid the tax.

Value capture taxation can be thought of as a sub-component of a land tax (Ingram & Hong, 2012, p. 3). Value capture is designed to tax the increase in land value that occurs because of public investment. Value capture taxation is both efficient, because the beneficiaries are required to pay some of the investment costs of the infrastructure, which therefore prevents the undervaluing of the public good, and equitable, because those that receive the benefits of the increased land value pay in part for the benefits of the improvements. In some instances, some of the captured value can be used for other public services or providing housing for low-income residents.

Although value capture taxation in the United States is used primarily at the local level, it is worthwhile for the national government to investigate its use for some infrastructure investments.¹ The national government will continue to face fiscal constraints, and will potentially ameliorate these constraints by shifting costs to the local governments, and therefore infrastructure provision often has both a national and local dimension. In particular, the Department of Transportation has begun to study seriously this technique of expanding roadways (Vadali, 2014). Because other countries have used value capture techniques, this device should not be off the radar for the U.S. government. However, an important caveat is that, in general, value capture techniques will not generate enough revenue to cover the complete costs of the new infrastructure, although they can be a major contributor to its financing. They are thought of as being a complement to national government financing, not as a substitute.

Examples of Value Capture Techniques

There are a variety of techniques that have been developed under the value capture rubric. They typically vary by both timing and incidence. Vadali (2014) identifies 10 mechanisms of value capture. The following are brief examples of a very few of these techniques.²

Over the last 25 years, there has been greater private-sector involvement in the funding of public-sector infrastructure projects, including involvement with their design, construction, and operation through the use of public-private partnerships (PPPs). In part, this has occurred because of lack of resources of the public sector and the political belief that the private sector is more efficient in the construction and operation of the projects. These are almost always voluntary arrangements. From the viewpoint of value capture, PPPs allow the private benefits created by the infrastructure improvement to be captured by the private sector and used to support the initial costs of the improvements. In these arrangements, the public and the private partners can structure legal agreements to allow cost and revenue sharing as well as risk sharing. These PPPs are almost all negotiated on a project by project basis. In the United States, there are two kinds of PPPs: One in which there is public ownership of land in which, for example, the public sector may sell or lease public-owned properties for funding and one in which there is private ownership of land, in which case the public entity may exact land from private property owners who receive, in exchange, property improvement benefits (Vadali, 2014).

Special assessment districts (sometimes called benefit assessment districts) help to fund local infrastructure by providing a mechanism to add a fee or tax on a politically defined district that receives benefits from the improvements that come from the new infrastructure. The goal is to cover the costs of the new infrastructure that generates the increase in land value. Typically, there may be difficulties in defining the boundaries of the district (exactly where the benefits end) and the level of the tax to levy on the property owners in the district. There are a large number of varieties of special assessment districts, including downtown improvement districts, and transportation benefit districts. Because the levy is designed to equal the benefit, this is a form of benefit-based finance, and incidence is on the resident at the time of the initial implementation of the tax. The implementation of a special assessment district often involves a vote of the residents of the proposed districts, and the tax is often included on the property tax bill. Finally, some special assessment districts may issue bonds with the payments coming from the special tax revenues.

Tax increment financing is a pure ongoing value capture technique. Under this technique, initially, an area that needs infrastructure is geographically defined. The property tax base of this area is then calculated and then bonds are issued to generate funds for infrastructure provision. The debt service for these bonds comes from applying the property tax rate to the increase in property value (the increment) that comes from the infrastructure provision. In theory, once the bonds are retired, the entire property tax base becomes available for all the overlapping jurisdictions. While there has been some questions concerning the equity and efficiency of the use of this technique, it has been extremely popular, and 49 states have allowed some variant of this tool.³ This technique can be used to finance a large variety of infrastructure, including transit, affordable housing, water projects, and parks and open space. It can also be used in conjunction with special districts and impact fees. However, without special care, it may be misused to provide economic development that would have occurred even if the district did not exist.

A tax on the increase of land value is another example of value capture. In this situation, the value of a site is divided into the value of the land and the value of the improvements that are on the land. A property tax is then applied to both, and the revenues from the increase in the land portion are used to finance the infrastructure. The property tax rate should be higher on land than on improvements. Although it is sometimes argued that in practice it is extremely difficult to separate the value of land from the value of improvements, it has been shown that even with extreme errors, there are efficiency improvements when this technique is used (Chapman, Tyrrell, & Johnston, 2009). Pennsylvania has used a land tax for several decades, and it does appear to have some efficacy in stimulating development. A land value tax is a progressive tax and is consistent with the smart urban growth movement (Vadali, 2014). Dye and England (2010) have found that it is in use in 40 countries.

Some Examples of the Implementation of Value Capture

Austin, Gurran, and Whitehead (2013) examine how value capture techniques, combined with a correct land use planning system, can boost supply of affordable housing. In England, affordable housing policies are directly linked to value capture and are used to cross subsidize affordable housing without a direct subsidy. Value is generated by giving planning permission and then through contractual arrangements that allocates land to affordable housing but still maintaining a project’s economic viability. However, they also note that increasing housing prices are a necessary condition for this technique to work.

Zhao, Das, and Becker (2010) identify several methods of funding transportation systems in Minnesota. Included in the analysis is an extended discussion of the use of value capture techniques. They argue that using value capture as a source of funding for transportation could help support “massive” construction efforts, including the financing of capital improvements. Ko and Cao (2013) find that light rail transit has induced significant price premiums for the properties that are nearby this type of transit, with the strong implication that value capture could be a successful financing technique. A final example examines the use of value capture in Chicago (Schlickman, Snow, Smith, Zelalem, & Bothen, 2016). Noting that the Chicago region faces a regional backlog of at least US$20 billion for transit, they examine value capture as one instrument to use. Using the value capture technique of tax increment financing, they examine six case studies and determine that tax increment financing can cover anywhere from 2% to 100% of the costs. They also note that continued communication between all the participants—public, private developers, and the community—is a crucial component of success.

There is a world-wide increasing interest in value capture/land tax methods of financing infrastructure. For example, Aleknavicius (2011) and Aleksiene and Bagdonacicius (2008) study land taxes and their problems in Lithuania; Alexander (2012) analyzes value capture techniques in park finance in Tel Aviv; Alpanda (2012), using a neo-classical growth model, examines land prices in Japan; Altes (2009) discusses an open-space tax (which was ultimately not implemented) to prevent the development of open space in the Netherlands; and Barbu (2013) assesses the implications of moving from a property tax to a land tax to finance public transit in Ontario and Toronto regions in Canada. There are also studies on land or land value capture focusing on Kenya, Australia, Armenia, China, Germany, Guatemala, India, Hungary, Nepal, Scotland, South Africa, Great Britain, Poland, Ukraine, Spain, the Czech Republic, and many other countries (Chapman, 2015).

Some Conclusions

There are several prerequisites to ensure the viability of value capture practices. Fiscally, there must be a careful delineation of which types of state and local debt issued during these practices would be income tax exempt. In addition, clear rules of the game and regulations are necessary. For example, it is important to develop accounting systems indicating future liabilities of participating governments as well as the private sector. The national government must encourage the use of these whole of government accounts (Connolly & Wall, 2016). State and local governments must also encourage the use of the tools of value capture by developing enabling legislation that makes the responsibilities of all participating parties clear. Finally, all levels of government must become aware of the entrepreneurial potential of value capture. For example, for government-owned property, government can provide the infrastructure and then sell the property to repay its investment. The national government might help in two ways in this category: First, it might help finance projects in the short term with direct funding; second, it can develop tools to offset the risk in some of the potential projects, perhaps by tax relief. Of course, all levels of government can engage in PPPs.

At least four conclusions come from this brief analysis. First, value capture is unlikely to cover the full cost of the infrastructure (although see Walters, 2012). Second, local value capture techniques can be used to fill in the gaps that exist because of the inadequacy of funds coming from the national government. This implies that there can be a federal–local partnership to fund infrastructure. Third, value capture practices are being used throughout the world, including in some cases, at the national level. It is possible to learn from these experiences how to improve the financing of infrastructure projects. Finally, its use in helping finance infrastructure, with the possible exception of tax increment financing, is probably being underutilized. The exploitation of these practices should increase.

Footnotes

Acknowledgements

The author thanks Richard Little and Fred Silva for their advice.

Author’s Note

Any mistakes are the responsibility of the author.

Declaration of Conflicting Interests

The author(s) declared the following potential conflicts of interest with respect to the research, authorship, and/or publication of this article.

Funding

The author(s) received no financial support for the research, authorship, and/or publication of this article.

Notes

Author Biography

Jeffrey Chapman is foundation professor emeritus at Arizona State University. In addition to four books, he has published journals such as Land Economics, Public Administration Review, The Journal of Urban Economics, Public Budgeting and Finance, National Tax Journal, and Public Finance Quarterly. His research focuses on state and local public finance.

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