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Auckland Royal Commission: Don't let developers and speculators tax your home!

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Land-Value Rating (LVR) means your Council Rates are levied on the value of your land alone. Capital-Value Rating (CVR) means they are levied on the combined value of your land and your house. Five Councils in the Auckland region adopted LVR by popular vote. Two subsequently abandoned it without consulting the voters. The Royal Commission on Auckland Governance has been established, evidently at the behest of land-bankers and land-speculators, with the declared purpose of recommending CVR for the entire region. This in turn would give the Central Government an excuse to impose CVR on the whole country.

Land-Value Rating (LVR) means your Council Rates are levied on the value of your land alone. Capital-Value Rating (CVR) means they are levied on the combined value of your land and your house. Five Councils in the Auckland region adopted LVR by popular vote. Two subsequently abandoned it without consulting the voters. The Royal Commission on Auckland Governance has been established, evidently at the behest of land-bankers and land-speculators, with the declared purpose of recommending CVR for the entire region. This in turn would give the Central Government an excuse to impose CVR on the whole country.

CVR hurts working families, the economy, and the environment.

Any extension of Capital-Value Rating will be an unmitigated disaster for the following reasons:

- Ratepayers with above-average ratios of building value to land value — such as ordinary home owners — will pay more. Those with below-average ratios — such as developers holding "land banks", and speculators holding vacant or derelict sites in anticipation of capital gains — will pay less. In effect, home owners will be taxed for the benefit of developers and speculators.

- The inequity will concern not only home owners vs. property investors, but also poorer home owners vs. richer home owners, and small investors vs. big investors. Among the investors, "Mums & Dads" who own rental homes will have above-average ratios of building value to land value, and will pay more, while the land-bankers and land-speculators will pay less. Among home owners, poorer households in outer suburbs will have higher ratios of building value to land value (due to lower land values), and will consequently suffer greater fractional increases in Rates, than richer households in inner suburbs. (N.B.: More "expensive" localities are such because the land is more expensive. Locational value is attached to land, not buildings, because the value of a building is limited by the depreciated construction cost regardless of location, whereas land has a location, and therefore a locational value, even if no building yet stands on it.)

- Under CVR, property owners who add to the supply of accommodation by building, rebuilding or extending will be hit with higher rate bills. This will worsen the slump in construction and therefore worsen the shortage of rental accommodation, forcing up rents. LVR avoids this problem. (Note: The incipient collapse in home prices will not reduce rents; on the contrary, it will discourage investment, some of which would have gone into construction, and the consequent reduction in supply will increase rents. CVR would make this problem worse.)

- Under CVR, property owners who allow their buildings to deteriorate will be rewarded with lower rate bills. Derelict buildings will become more common, spoiling neighbourhoods. Buildings that might have been renovated and let to tenants will instead be demolished or boarded up to keep out squatters, further reducing the supply of rental housing. LVR avoids this problem.

- Under CVR, as redevelopment of inner-city sites will incur a tax penalty, there will be less infill development and more pressure for greenfield developments on the urban fringe. That means more urban sprawl, hence longer commuting distances, hence less family time and more pollution. LVR avoid this problem.

- Because building values, unlike land values, are not smoothly-varying functions of location, the valuation process for CVR is more complex, more intrusive (involving more inspections of buildings), and more prone to error.

- Under CVR, families that modify homes at great expense for the benefit of disabled persons will be hit with higher rate bills. LVR avoids this problem.

- The CVR-induced shortage of accommodation will be harmful at all stages of the economic cycle. In "good" economic times, a shortage of commercial/industrial accommodation is a "capacity constraint" and is therefore inflationary, while a shortage of housing forces employers to offer higher wages so that prospective workers can fight their way into the local housing market. The latter is also inflationary; and what the workers gain in the labour market, they lose in the housing market. In "bad" economic times, a shortage of commercial/industrial accommodation means a shortage of jobs, while a shortage of housing prevents some of the few "available" jobs from being filled — and the job-seekers who can't afford to live within commuting distance of the "available" jobs are accused of being "work-shy", or of having made a "lifestyle choice" to remain unemployed.

- Empirical studies overwhelmingly confirm that property taxes on combined values of buildings and land are less conducive to economic activity than those that tax buildings at lower rates or (preferably) exempt buildings altogether; see e.g. Section 3 of The superiority of Site-Value rating — and how to implement it with no losers.

CVR usurps democracy.

Local governments in Aotearoa date from 1876. Initially Rates were based on Annual Rental Value of land plus buildings. Soon afterwards, councils were permitted to adopt CVR by resolution. But from 1896 until 1989, in every municipality, the ratepayers could force a poll to determine the basis of General Rates: a poll would be held if 15% of ratepayers demanded it. Such polls usually chose Land-Value Rating (LVR), not least because LVR meant lower Rates for the majority of ratepayers. An exception was the 1963 poll in Auckland City, where a proposal to change Annual Rental Value to Land Value was defeated because it contained a quirk that favoured downtown landowners at the expense of the suburbs. By 1982, 90% of municipalities had adopted LVR, which accounted for 80% of local government revenue. Moreover, every Council that adopted LVR did so by direct authority of the people.

But the politicians' propertied paymasters disapproved of the people's decisions. So the politicians voted the people out and elected the land-bankers and land-speculators in their place. In 1988, Christchurch reverted from partial LVR to full CVR without consulting the ratepayers. The (Labour) Mayor of Wellington, in defiance of the people's choice and of the findings of the Council's Rates Review Committee, and by a process that had to be retrospectively legalized by an Order-in-Council, abandoned full LVR and imposed CVR, notwithstanding that LVR had been Labour policy since 1948. Dunedin reverted from LVR to CVR (against the wishes of the Mayor) by a process that was not illegal but merely devious: the General Rate was split into "Separate" and "Special" Rates, leaving the voters with no comeback. In 1989, the (Labour) Central Government removed the right to demand a poll. The Minister for Local Government actively promoted CVR and unsuccessfully sponsored a bill that would have made CVR irreversible wherever it was adopted. In 1990, the Mayor of Wellington was knighted.

Since 1989, the fraction of Councils using LVR has fallen from 90% to 42%. In every municipality that abandoned LVR, a system chosen by the ratepayers was displaced by a system imposed from above.

(Across the ditch, the wishes of the people of Victoria have been similarly trampled upon, except that the perpetrators came from the other side of the political divide; see op. cit., Subsection 3.8.)

The Commission is rigged in favour of CVR.

The Royal Commission, according to its Terms of Reference, is obliged to "take into account the implications of the findings of the Independent Inquiry into Local Government Rates for local government arrangements in the Auckland region". Among the recommendations of that Independent Inquiry into Local Government Rates, which submitted its Report on 3 August 2007, was the following:

9. That a common rating system based on capital value be promoted across the country for general rates.

Why capital value? The reason given in the Executive Summary is:

57. The Panel favours the promotion of a common system of valuation for rating purposes and strongly favours the capital value system because of the closer relationship of capital values with household incomes.

But if the Panel had truly regarded "household income" as the best base for local taxes, it would have recommended a local income tax (or a system for sharing the national income tax with local Councils). Moreover, the "closer relationship of capital values with household incomes" is based solely on correlation coefficients (pp.126–7 of the Report). If the progressiveness of the relationship were the criterion, then land values would be preferred — as the Report admits in Table 12-4 (p.197), although the contrary is stated, without support, in paragraph 9.11 (p.118).

Paragraph 9.111 (p.136) is a masterpiece of obfuscation:

In the case of land value (LV) rating, in most areas (particularly urban ones), there are very few land sales upon which rateable values can be generated. This raises questions about the reliability of assessed values under LV rating. Capital value (CV) rating, on the other hand, benefits from the availability of much richer sales information. For instance, in two Auckland cities over the past few years, there were around 50 sales of dwellings for every one sale of land.

Never mind that some of those "50 sales of dwellings" would have been promptly followed by demolition, in which case the land price can be obtained by adding the demolition cost to the sale price. Never mind that in all other cases, the land value can be obtained by subtracting the depreciated replacement cost of the building(s). Never mind that regardless of the rating system, a separate valuation of the building(s) is always needed for insurance purposes. Never mind that you can't estimate the total value unless you can estimate the building value and the land value separately; the former depends on the building(s) while the latter depends on the location, and the combined value depends on both. Never mind that in the absence of significant boundaries, land value per unit area varies smoothly with location, facilitating interpolation and consistency checks, and minimizing the need to subtract building values in order to obtain land values.

While CV rating does not eliminate the need for separate consideration of land and buildings, it does allow the separate values to kept secret. Perhaps that is what the Report means when it claims that "separate assessments for land and improvements would be unnecessary" (paragraph 9.136; p.140). Even then it concedes that "greater emphasis would be required to ensure that all improvements to property were captured, and a more rigorous approach to valuation inspections would be required." In other words, Big Brother will be visiting you.

Comparing this sparse and contradictory logic with the clear economic arguments for not taxing buildings (see above), one can hardly avoid the inference that the recommendation of CV rating was somehow preordained.

The chairman of that Independent Inquiry into Local Government Rates was David Shand, who is also one the three members of the current Royal Commission on Auckland Governance. To appoint to a Royal Commission a person with known preconceived ideas on the subject under investigation is a fundamental violation of natural justice. But, by writing the desired bias into the Commission's Terms of Reference, the Central Government has made a virtue out of what would otherwise have been an abomination.

CVR and poll taxes by other names

Since 1989, the fraction of local government revenue raised from land values has been eroded not only because Council after Council has abandoned the LV rating system chosen by the people, but also because Rates based on property values (of any sort) are being displaced by other sources of revenue, including:

- a Uniform Annual General Charge (UAGC), i.e. a fixed annual charge for each taxable property regardless of value;

- targeted rates, i.e. annual charges payable for access or connection to particular services, but not apportioned to actual use of those services; and

- user charges, which are apportioned to actual use, e.g. volumetric charges for water consumption.

Increasing use of UAGCs obviously makes the system more regressive by shifting the burden from more valuable properties to less valuable properties. Worse, the "taxable property" may be a whole rateable unit or any inhabitable part thereof, in which case the UAGCs reduce the supply of accommodation — like CVR, and with the same ill effects.

While UAGCs sometimes act as taxes on buildings and land, targeted rates usually tax buildings alone, because they tend to be payable per dwelling and are levied on services such as water, sewerage and rubbish collection, which tend not to be needed unless the property is inhabited. If a targeted rate is payable only if a building is present, it is a tax on the building regardless of how it is calculated — even if it is calculated on the land value. But in fact it is often a uniform charge like a UAGC, in which case its greater concentration on buildings makes it even more regressive, as well as more damaging to the supply of accommodation. One should therefore be alarmed to see that the Shand Inquiry called for abolition of UAGCs and extension of targeted rates (Recommendations 5 and 70), advising that uniform targeted rates be allowed to supply up to 50% of Council revenue (Executive Summary, paragraph 52).

Under LV rating, the Rates on an investment property are payable whether it is let to a tenant or not. Hence the owner, in order to cover the Rates, must either seek a tenant, thereby increasing the supply of rental housing and placing downward pressure on rents, or offer the property for sale, thereby placing downward pressure on prices. In contrast, a targeted rate on a service necessary for habitation can be avoided by not building a dwelling or not offering it for rent, until the shortage of rental accommodation allows the tax to be recovered in the rent. Thus a targeted rate is payable not only by owner-occupants, but also by tenants. If, in addition, the targeted rate is uniform, it is effectively a poll tax, except that it is imposed per-household instead of per-head.

The difficulties caused by UAGCs, targeted rates and user charges are compounded by the reduced effectiveness of postponement. Under LV rating (or even CV rating), the people who have trouble paying their Rates are those who are asset-rich but income poor (e.g. pensioners whose homes have appreciated due to gentrification, or farmers whose land values have risen in anticipation of suburban or tourist developments). In such cases the high property value that causes the "problem" also provides the solution: payment of part of the Rates can be postponed until the property title is next transferred (with a large capital gain). But when people have trouble paying taxes and charges that are not based on property values, that simple solution is not necessarily available.

On "user pays" vs. "beneficiary pays"

The market cannot value the benefit of a networked service, such as transport or water supply, except through price. But the price of such a service has two components: the obvious one, namely the charges payable for actual use of the service (e.g. fares, tolls, volumetric charges); and the hidden one, namely the price of living or working in a location where the service is available, as opposed to a location where it is not. The value of a location is reflected in rents or prices of land in that location. So the "hidden" component of the price of the service is the uplift in land values caused by provision of the service. Moreover, the benefit of the service to the public (as distinct from the provider, which is assumed to be the government) is net of charges for actual use, and is therefore equal to the "hidden" component of the price of access. That is, for the public, the net benefit of the service is the total uplift in land values caused by the service. After user charges have been paid, the net beneficiaries are the land owners, not the users.

Hence the economic cost/benefit ratio of the project providing the service is simply the cost/uplift ratio. If the "cost" is understood as the cost to the provider, this is also net of charges for actual use, so that the cost/uplift ratio is the fraction of the uplift that must be recovered through the tax system in order to pay for the project. And if the project passes a cost-benefit test, this fraction is less than 100%.

(Note: Obviously costs and benefits may have lump-sum and annualized components, while uplifts may be expressed in terms of sale prices or rents. For the purpose of the foregoing argument, all terms must be converted to the same basis, e.g. present value or annuity.)

It follows that any public project that passes an economic cost/benefit test can be financed by a tax collecting something less than 100% of the uplift in land values caused by the project. The rest of the uplift is a net windfall for the land owners — who therefore should enthusiastically support this method of funding, because it would finance projects that would not otherwise proceed, yielding after-tax uplifts in land values that would not otherwise occur. Unfortunately, however, the landed class has an unwritten law that the projects that increase land values must be paid for by non-beneficiaries.

Economic theory tells us that the utilization of a service will be socially optimal if the charge for actual use is set at the marginal cost — that is, the cost of providing one additional unit. In the case of a networked service, setting the user charge at marginal cost will not cover the capital cost. So how should the capital cost be covered? Obviously by reclaiming a sufficient fraction of the uplift in land values. In contrast, the Shand Inquiry made the following recommendations:

21. That the Government remove legislative barriers to the funding of transport projects through the use of tolls.

22. That the Government extend the limit of 15 years on contracts with the private sector for water and waste-water services.

30. That actual and reasonable cost recovery for water supply and waste water on a volumetric basis be encouraged.

31. That the Government explore providing assistance for local authorities to install water meters where this is practicable.

33. That councils be permitted to set all fees and charges on an actual and reasonable cost recovery basis, and any Government regulations that limit such fees should be removed.

Recommendations 21 and 22 follow a discussion of Public-Private Partnerships (PPPs) and are aimed at making PPPs more viable (pp.157–8 of the Report). But the Inquiry completely missed the reason why PPPs have failed: PPPs don't tap the uplifts in land values caused by the projects in question, but try to cover capital costs out of user charges. This results in sub-optimal utilization, which in turn prevents the collection of enough user charges to cover the cost. If one tries to finance public transport entirely from fares, too many people will use their cars instead. If one tries to finance a new road entirely from tolls, the use of that road will be sub-optimal — unless perhaps all toll-free alternative routes are closed off. Hence one of the "legislative barriers" to be removed by Recommendation 21 is the requirement that every tolled road have a usable untolled alternative route! And if one tries to finance water supply entirely out of volumetric charges, householders' efforts to conserve water will go far beyond social needs — to say nothing of the discrimination against large families and the hardship for low-income households.

Equity demands that individual contributions to the cost of a networked service be based on capacity to pay, or on the benefit received, or on some combination thereof. There is no justification for placing the entire burden on a subset of beneficiaries called "users" while allowing other beneficiaries to free-ride, especially when being a "user" is not a matter of choice.

IMF / World Bank stooge?

Before Mr Shand chaired the Independent Inquiry into Local Government Rates, he spent more than eight years in Washington DC as a public financial management specialist with the World Bank and the IMF. These organizations are chiefly noted for refinancing the debts of "client" countries (that is, bailing out their foreign creditors), on the condition that the "client" countries:

(i) privatize their natural monopolies (so that monopoly profits that might have been used for much-needed public services fall into rich private hands),

(ii) open their capital markets to "foreign investment" (that is, allow their irreplaceable assets, including the aforesaid natural monopolies, to be bought up by foreign speculators),

(iii) accept "market pricing" (especially the removal of political and legal constraints on the aforesaid monopoly profits), and

(iv) allow "free trade" (that is, enforce the restrictive and monopolistic trade laws of rich foreign countries against home-grown competitors).

All of which, of course, is solely for the benefit of the "client" countries. These points may shed light on the Inquiry's support for PPPs and user charges, and perhaps on some of its other recommendations, including the following:

3. That councils move away from fully funding depreciation, with the development of longer-term funding policies that take better account of intergenerational equity, and the availability of longer-term debt financing.

19. That local government look favourably on making more use of debt to finance long-term assets. This should include the issuance of bonds (including infrastructure bonds) on the capital market, not just shorter-term borrowing from commercial banks.

20. That borrowing in foreign currencies be permitted, subject to appropriate foreign currency hedging arrangements being adopted.

Public borrowing to invest in infrastructure is prudent provided that the economic benefit of the infrastructure yields enough additional public revenue to pay off the loans. This proviso is likely to be met where public revenue is largely based on land values, because the said economic benefit takes the form of uplifts in land values. But if, as recommended by the Inquiry, public revenue relies less on land values and more on building values, targeted rates and user charges, the proviso is less likely to be met, leaving the indebted government(s) more likely to need one of those friendly IMF / World Bank bailouts.

What can you do?

Make a submission or presentation to the Royal Commission. If the Commission is rigged, it must be seen to be rigged. Let no one be able to claim that the Commission recommended CVR, targeted rates and user charges for want of submissions to the contrary. (Particulars of submissions and public hearings are yet to be announced; monitor the Commission website for developments.)

Contact your Councillor and your MP. Explain how your vote will be influenced by CV rating, targeted rates, user charges, or any other measures that tax the roof over your head for the benefit of developers and speculators. While accusations of rigging are not necessarily helpful in submissions to the Royal Commission, they need to be made in other places, including messages to your political representatives.

Get your views into the mainstream media. That includes radio talkback lines, "Letters to the Editor", and feedback pages on media websites.

Spread this article. Email it; blog it; repost it; Digg it, etc. No copyright is claimed on it.

ENDS

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