Simplest solutions should be tried first

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By Brendon Harre*

New Zealand should take the Occam’s Razor approach to fixing the housing crisis. The simplest solutions should be tried first, such as, reducing taxes and removing impediments on building decent housing.

This keep it simple approach to urbanism does raise some interesting points. Such as, if a city has a shortage of bread, no one thinks a good response is to tax bread production. So why does local government tax house production in the middle of a housing crisis? Why not reduce taxes and make it easier to build homes?

Source: The Rent Controller’s tweet – Not enough bread? Too expensive? Bake More

Local government development contributions and impact fees of various kinds are taxes on house building. Not only are they taxes, they are very inefficient taxes. They unnecessarily complicate the task of building better and more affordable urban environments.

Given that local government adds taxation expenses to the cost of house building, this raises the question of ‘do they add other expenses too’? For instance, by poorly regulating land-use, land-banking, intensification etc so that the increasing cost of land (absolute or as a percentage of build costs) results in house prices or rents inflating faster than wages.

There is a myth in New Zealand that development contributions are assessed for each development. All the downstream costs for the community are assessed, weighed against the future benefits, including providing additional rate (property tax) paying dwellings and the resulting balance is then charged to the developer, as a development contribution.

I call bullshit on this process. There are too many unknowns to allocate costs and benefits down to individual cases. It is a pseudo-science.

Auckland Council for instance, has arbitrary categories for determining how much tax different types of urban development are charged. It is highly unlikely these categories match the best use of scarce urban land supply. The economic impact of collecting taxes based on the type of house being built may have distorting effects like the infamous window tax of the past. Although restrictive planning rules are likely to have the greatest effect.

In 1696 the King of England implemented the window tax because it was easy to collect. People avoided paying the tax by blocking windows. People also felt robbed of their hard earned income. These two factors led to the expression “Daylight Robbery”. The tax was finally repealed in 1851. Source

Development contributions are not an effective tax for local government. For instance their unpredictability over time means councils cannot borrow against them as a revenue stream to fund infrastructure. Surely a fatal flaw when their purpose is to help fund a cities infrastructure deficit.

Auckland city council economists have attempted to state that development contributions are unlikely to result in higher house prices (and therefore higher rents). I find their arguments unconvincing as they do not objectively compare development contributions to other taxation options. Also it is illogical to suggest that taxing the landowners who build, but not the landowners who don’t, has no effect on the supply of new housing.

Development contributions and impact fees are an regressive tax on renters. It generates a relatively small amount of revenue from approximately 1% of the housing stock which is being built, whilst allowing the prices and rents on the remaining 99% to rise. It allows landlords to raise rents because it adds tax and uncertainty to landlord’s competition -affordable house construction. This is the main reason New Zealand should unwind its inefficient system of development contributions.

LetsGoLA runs through the numbers to show that development contributions and impact fees is not a progressive policy option for California (see below article). California is reliant on impact fees because Proposition 13 prevents other more effective taxation choices being used to fund needed infrastructure.

LetsGoLA’s basic argument is that anything that raises the cost of building new houses, increases rent not just for new housing but also existing housing.

It seems unfair to me that house producers pay additional taxes, especially as shelter is a basic necessity of life. In New Zealand building a house costs hundreds of thousands of dollars in wages, profits, building materials and land purchases. A 15% tax is paid on those costs in the form of goods and services tax (GST). Note land sales only incur GST charges before it becomes residential land.

House builders make a significant contribution to the public purse. Why is it necessary to pay more than this?

A land value property tax system would be a better option than development contributions. It taxes the land, not the construction on the land. In New Zealand at the local government level we call this unimproved value rates. There is some deep economic philosophy underlying this point about taxing unproductive capital (rentiers) rather than productive labour or capital.

Henry George the 19th century political-economy theorist, who famously advocated for land value tax, is quoted as saying: “Like a flash it came over me that there was the reason of advancing poverty with advancing wealth. With the growth of population, land grows in value, and the men who work it must pay more for the privilege.” The above illustration of Henry George is by Walter Russell.

Regardless of the philosophical arguments -pretty much any tax would be better than taxing house building in the middle of a housing crisis.

Renters in New Zealand face a lot of difficulties. Comedian Robbie Nicol or White Man Behind a Desk makes a strong argument for New Zealand making policy changes, so that renting becomes really really good for millenials, who according to Robbie Nicol will never buy a house.

Robbie Nicol’s proposed solution is to incentivise density -the defining feature of towns and cities compared to countryside or wilderness areas.

In other words Robbie wants to incentivise the building of more houses in urban areas.

Recent media reports indicate New Zealand’s previous government minister in charge of building and construction believes the current government can’t grow housing any faster than his government did. Also reported is the Auckland Council defending the compact city virtues of the 2016 Unitary Plan approach to housing supply.

There are elements of truth to Auckland Council’s position. Auckland does need to address the escalating road building costs of its current urban growth model (see the congestion tax section of this paper), but there is also a whiff of belligerence. This is a problem because belligerence prevents acknowledgement of strengths in other opposing viewpoints -such as the need for more affordable house construction by removing taxation and regulatory costs.

Belligerence can become contagious, leading to a gordian knot of opposing views which cannot be resolved. Read my paper Unravelling the strands of the urbanisation debate:To improve urban performance for further discussion of the gordian knot problem.

If the government wants to deliver for Robbie Nicol’s renting millenials, it will need to increase New Zealand’s house building rate, in a way that delivers affordable housing, so that rent inflation becomes slower than wage growth.

The importance of New Zealand building more houses that are more affordable goes to the heart of whether the public perceive the government as one of transformation or the modified status quo.

Anecdotal evidence indicates that building affordable housing is of huge public concern.

Mike Hosking is a well known New Zealand right-wing pundit. His facebook post on the slow ramp-up of the government’s KiwiBuild scheme received a big response in the form of likes, shares and comments.

Empirical evidence confirms New Zealander’s believe affordable housing is the most important issue facing the country.

Source: The NZ Ipsos Issues Monitor -April 2018. Housing affordability was the highest concern for all incomes, sexes and age groups in New Zealand, except for the retired where healthcare had pushed housing down to second place. This differs from Ipsos Australia’s results where housing affordability was of much lower concern.

Housing and Urban Development Minister Phil Twyford has responded to these criticisms and public concern by explaining that KiwiBuild will deliver more affordable housing by four channels;

  • Converting existing Crown land and purchasing additional land from the private market (under the Land for Housing programme), which will be on-sold to development partners who commit to delivering KiwiBuild homes.
  • Identifying and leveraging opportunities to deliver KiwiBuild homes through existing Government-led housing initiatives, such as those being undertaken by Housing New Zealand (e.g. McLennan development).
  • Doing the groundwork to enable a new urban development authority (once established) to undertake major urban redevelopment projects in partnership with iwi, councils and the private sector.
  • Purchasing or underwriting new affordable homes off the plans (under the Buying off the Plans initiative), to de-risk suitable developments led by the private sector and others, in exchange for accelerating the delivery of a greater number of homes at KiwiBuild price points.

Phil Twyford says the Government’s Kiwibuild ‘Buying off the Plans’ initiative attracted “overwhelming” interest. He says “almost 100” proposals have been received from developers in response to the tender conducted by the Government, which closed last Friday, the 8th of June.

My suggested policy changes to incentivise building more affordable houses, addresses the third option of an urban development authority working in partnership with local government, iwi and the private sector.

I believe this could be best incentivised by implementing the following policies;

  • In New Zealand’s towns and cities with high demand, create a network of urban growth corridors -using the Making Room for Urban Expansion concept. This network is both within the existing urban footprint and extends out into greenfield areas.

  • Replace development contributions with a targeted rate on land values, by calculating a per sqm charge on land in private ownership within the urban growth corridors, so that there is no net loss of revenue to local government. Charge at least that as a land value targeted rate and take into account the following points.

The majority of Auckland’s rapid transit services are within the city -so intensifying existing low density suburbs along these growth corridors is naturally a focus. But the corridors do extend out past the city fringe in the northwest, north and south so there is also greenfield opportunities too.
  • Build congestion free rapid transit systems in the growth corridors using the targeted rate, government grants and fare revenue to pay for it. These rapid transit systems can be public/private ‘special purpose vehicles’, such as the government is considering since the SuperFund and a Canadian infrastructure provider made the offer to own and operate the proposed light rail system in Auckland.
  • Use an urban development authority and legislation to remove unnecessary density and greenfield planning restrictions along urban growth corridors. The urban development authority can also coordinate the provision of trunk infrastructure for these growth corridors.
  • Estimate the housing growth potential for the corridors and build the underground trunk services -for sewer, storm and fresh water and any other local government services that are needed -traffic management systems for increased populations, cycleways, libraries, swimming pools etc. Again use the targeted rate and expected increase in general rates to pay for this.
  • Encourage the use of innovative hyperlocal solutions such as Master Planned Blocks to improve intensification, as they have the additional benefit of opening up the urban form with new laneways to give greater access for walkers and active modes to the rapid transit network.

A through lane in the above picture of a typical ‘sausage flat’ NZ intensification suburb would use less space than existing driveways (in red). Laneways would benefit the wider community by improving connectivity. So it would be a good idea to purchase such lanes for the public good.

  • Budget for local government to purchase new hyperlocal laneways, where they improve walking and active mode connectivity for the wider growth corridor, using the revenue from the targeted rate. See my paper – Can Great Design Help Solve the Housing Crisis? -A Master Planned Block Proposal – for further description of the benefits of hyperlocal solutions.
  • Consider alternative tax sources or government grants for local councils with high demand from excessive population growth, rampant tourism or other demand pressures that have resulted in infrastructure deficits due to insufficient revenue to supply the needed infrastructure.

There are lots of moving parts in an urban environments regulatory system and it is easy to get overwhelmed by it all. I would suggest a simple rule of thumb -using the spirit of Ockham’s razor -for policy makers attempting to fix the housing crisis.

Policies that make it easier to build decent homes are good and policies making it difficult to build are bad.

Further discussion of taxes and subsidies in urban areas

One of the five key questions for the Tax Working Group is “can tax make housing more affordable”. The working group stating that;

Making housing affordable is one of the biggest challenges we face. Rents are rising faster than wages and many Kiwis find themselves locked out of the housing market.

The problem of wages rising faster than rents is a problem found in many, but not all cities around the world. A recent US economic paper by Richard Hornbeck and Enrico Moretti found;

when a city experiences productivity gains… there are substantial local increases in employment and average earnings. For renters, increased earnings are largely offset by increased cost of living; for homeowners, the benefits are substantial.

In my opinion, in New Zealand there is a huge thicket of taxes, subsidies, quotas and rationing around urban development that is so confusing it has lost all purpose. If this system was simplified so that houses could be affordably built close to economic activity, then house prices and rents would increase at a slower rate than wages. This will benefit renters and those who do not own property yet, as they will profit from moving to areas of economic growth.

The Tax Working Group has asked for submissions from the public, my thoughts are;

Alternative tax sources for local government.

  • There are a large number of different revenue sources that would be better than development contributions because they would not directly tax house production i.e taxes that would have less effect on the marginal cost of building additional residential space.
  • Local government do need effective revenue sources, so they can provide needed housing related infrastructures, in a timely manner that supports elastic housing supply, which underpins affordable house prices and rents. Targeted rates on land as discussed in the main body of the paper are a good revenue source and should be used in the first instance.
  • If another revenue source is required, I agree with a proposal advocated by the NZ Initiative, whereby GST on local construction projects is allocated to local not central government, in exchange for local government not using development contributions. It is important that only the GST revenue on construction costs, not from land sales, be allocated to local government. This is to incentivise local government to competitively regulate land-use planning and keep land price inflation to a minimum.
  • A further variation on this is that accommodation supplements paid to renting beneficiaries and low-income earners could be taken off the GST construction revenue for each municipality. Accommodation supplements was increased last year by the previous government against official advice and costs the taxpayer over $1 billion a year.
  • Accommodation supplements and similar housing demand subsidies, given current market conditions in New Zealand, are poor policy solutions that benefit landlords more than renters. The use of such demand subsidies should therefore be limited and the policy making focus should be on making housing supply as elastic as possible. Economist Eric Crampton explains the economics of why when housing supply is inelastic the accommodation supplement is a landlord subsidy in this paper. He further explains why the NZ Initiative supports construction GST going to local government.
  • These combined policy initiatives would provide a revenue source to address infrastructure deficits, whilst providing clearer consequences for local government decision makers, so they are incentivised to better regulate land-use to provide more affordable housing and rents.
  • A partial counter argument to these proposals is that although they help address the housing crisis -which is a major structural weakness in the economy -it would increase procyclical spending. Which can exacerbate boom/bust economic cycles. To remedy the pro-cyclical problem an infrastructure trust could be formed to hold over some of the funds in economic good times, so they can be allocated in bad times, as a way of evening out infrastructure spending over time.

Capital gains tax

  • Might help in some parts of the property cycle to ease speculative pressures but it isn’t a silver bullet.

Road congestion charging and car parking metering i.e congestion taxes

  • It makes no sense for urban spaces in high demand to be expensive for housing yet free for automobiles to either drive or park, especially when the limited supply of road and parking spaces becomes congested from the growing demand. Pricing these spaces is necessary to incentivise a change in transport behaviour to more space efficient transport modes, routes and times of the day so that roads are less congested. This will allow more people in urban environments to have better access to places of importance and economic activity.
  • Any revenue collected from such schemes (which is not its primary purpose) should be used to assist low income earners, so they can affordably transition to more space efficient transport modes too.
  • If congestion taxes are not used, especially in congested cities such as Auckland, the result will either be; costly blow-outs of transport budgets as ever bigger and more expensive road schemes are constructed through existing built up areas, or longer productivity sapping delays in the existing road network.

Auckland’s automobile dependent urban growth model as it currently exists is on an fast growing cost curve. A change to a more spatially efficient multi-modal transport urban growth model will be necessary.

  • A more in depth discussion of road congestion charging, car parking metering and how various other scarce urban spaces are allocated can be found in my Successful Cities Understand Spatial Economics paper.

Further reading:

A report titled Missing Teeth details why it is easier to build on smaller sites in France than in England. It explains that by keeping the planning system simple and predictable it is easier for smaller developers to build in the missing gaps of the urban fabric.

Californian study says development fees quashes Bay Area housing – uncertainty being as bad as the taxation charges.

Cities Are Trying to Make Housing More Affordable -by Making Some Rents More Pricey is another report detailing the research indicating impact fees add to the cost of housing.

Impact Fees: An Urban Planning Zombie in need of Slaying – Eight reasons why impact fees thwart the creation of equitable, sustainable cities.

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