Windfall tax backlash misunderstands property rights

Posted June 25, 2021

  • State government
  • Business
SGS Economics and Planning Marcus Spiller PIA Award

The Victorian Government’s decision to introduce a 50 per cent tax on rezoning windfalls, announced in its 2021-22 Budget, made many peak industry bodies froth at the mouth.

An outraged Property Council of Australia vowed to ‘fight this on all fronts’. These bodies variously claim the windfall tax is lazy and inefficient, will be fully passed on to homebuyers and stop development dead in its tracks.

The windfall tax certainly touched a nerve, particularly for a measure that is expected to raise only $40 million annually, according to the Budget Papers. It seems some industry leaders find the mere idea of a tax on planning gain to be repugnant.

Why this visceral response to a modest move that most ordinary people down the pub would judge to be common sense?

Could it be that it connects with an unspoken Australian right to make easy money out of land?

Making easy money out of land: cultural expectation or legal reality?

Perhaps in our settler society, there is a deep-seated expectation that land ownership brings the privilege of unfettered use, to enjoy our castle and to make a killing in property market trades if we possibly can. If this is a cultural expectation about the rights attaching to land ownership in Australia, it is completely at odds with the legal reality.

The only right that property owners have is the continued enjoyment of lawfully sanctioned uses of their land, and to trade in the land, within these limits, if they so wish. This right cannot be taken away without compensation, as we see when governments compulsorily acquire property for roads, airports, hospitals and other public purposes.

Every other right as to how land may be used or developed is reserved by the community through planning laws.

There are two means by which the community may grant permission or a licence for uses and development other than that which is already lawfully established on a site:

  • One is by requiring compliance with permitted uses as set out in codified rules embedded in local zoning. For example, in some areas, the suburban house owner may be allowed under planning rules to construct a granny flat in the backyard without special approval from Council. However, this is not a right that attaches to land ownership. The zoning rules could be changed at any time to prohibit granny flats or to make them subject to stricter development standards, and no compensation would be forthcoming for the lot owner.
  • The second means by which the community grants a licence for uses and development is through the town planning permit or development approval process. In these situations, the only time the landowner can count on having a development right is when they have a duly issued permit or a development approval (DA).

That the community reserves, and licences access to, development rights is down to basic economics. In a theoretical world, if property owners could use their land for whatever purpose that provides the greatest satisfaction to them without consulting neighbours or other affected parties, we would inevitably get less functional and less livable neighbourhoods, suburbs, towns and cities. This is because of externalities.

Land use and development regulation is inevitable if we want great cities

The commercial choices made by individuals acting in their self-interest will only coalesce into a good outcome for the community if there are no externalities, that is, adverse consequences for third parties. Urban development is rife with externalities, both positive and negative.

They include overshadowing, overlooking, noise intrusion, air pollution and discharges to environmental assets like creeks and streams, disruption of neighbourhood character, loss of heritage values, cultural values and other distinctive and appreciated features of a place, loss of native vegetation, aggravated heat island effects, saved congestion and vehicular emissions through the creation of public transport friendly and active transport friendly urban forms, productivity gains made by building clusters of related firms and formation of vibrant town centres by managing retail and related flows into hierarchies of activity nodes, to name just a few.

Development rights are reserved by the community to correct these externalities. Access to them is rationed in accordance with a community endorsed plan for a neighbourhood, suburb, town or city. Not doing so would lead to immense value destruction.

While regulation of land use and development is essential in the face of externalities, it can be done in a smart way, or it can create unnecessary costs by unduly constraining what can be done with a property.

The trick is to carefully hone land use and development rules to mitigate negative externalities and promote the desired urban form (positive externalities) while giving developers ample scope to identify and meet market preferences.

Whether we are good or bad at striking this balance is a topic for another day. The key issue in the current debate over a planning windfall tax is that regulation of land use and development is inevitable if we want a good city, and this necessarily means community reservation – ‘nationalisation’ if you like – of development rights.

The community should be able to extract a fee commensurate with the value of development rights

If access to development rights must be rationed, it makes sense that the community should extract a fee commensurate with the value of these rights when they are awarded through the planning system. Otherwise, we can expect serious adverse consequences for productivity and fairness.

A piece of land that carries permission for more remunerative use – for example, building an apartment block or a shopping centre – will be worth more than an otherwise similar piece of land that carries no such permission due to the limits embedded in the planning scheme. The difference in value between these two properties is the value of the additional development rights.

If there is no charge made for these rights, market players will have a great incentive to spend a lot of time and money securing them, whether or not they are actually interested in building the apartments or shopping centre. Their prize is the windfall associated with the planning permission. They can realise this by selling on the site to bona fide developers.

Chasing windfalls associated with unpriced planning permissions absorbs entrepreneurial effort and administrative resources on both the proponent and regulator sides. This expenditure results in zero extra value for the community. We still get the same apartments and shopping centres and so on, albeit perhaps with a marginally different spatial distribution. In other words, not charging for development rights wastes resources that could be used productively elsewhere in the economy.

In some circumstances, the chase for windfalls associated with unpriced planning windfalls leads to outright corruption, as is evident in the Independent Broad-Based Anti-Corruption Commission’s (IBAC) investigation into the rezoning shenanigans in the City of Casey in Victoria. Such behaviour is not only abhorrent in civilised society; it will likely lead to tighter regulation and higher transaction costs which will weigh on the development sector for years to come.

Criticism of the windfall tax does not consider basic economics and a common-sense view of fairness

From a fairness perspective, the simple fact is that development rights are owned by the community, in the same way as the community owns access to any economic resource which must be regulated to ensure best and sustainable use. These include commercial fisheries, state forests, the water in streams and rivers and the minerals beneath our feet.

As the owners of development rights, the community should, in principle, gain the full financial value from them when they are awarded. Full financial value in a planning sense is that proportion of the uplift in land value which leaves just enough on the table for site owners to release their land to bona fide developers.

The strident criticism of the windfall tax by industry peak bodies does not square with basic economics and a common-sense view of fairness. Take, for example, the critique offered by Craig Whatman of Pitcher Partners, which was reported in the Financial Review on May 17 this year.

“Mr Whatman said a farming block in an area such as Armstrong Creek south of Geelong that could ultimately house 700 residential lots could see its value jump to $40 million from $5 million overnight upon rezoning as Urban Growth Zone land.

The average sales price of each 300-square-metre lot would be around $275,000 per lot, but the windfall gain tax of $17.5 million (half of the $35 million uplift) would add $25,000 to the cost of each lot, he said.

Alternatively, a developer facing the extra impost – with a stamp duty bill boosted by the separate decision to lift the stamp duty rate for properties worth more than $2 million – could just decide not to proceed, leaving a landowner with a site they cannot afford to develop.”

Industry bodies such as the PCA, HIA and UDIA have issued similar dire warnings. However, land development is not a ‘cost plus’ business. Developers are price takers, not price makers; they will charge the best price that the competitive market will allow them.

The notional Armstrong Creek developer is in no position to simply pass on the windfall tax in higher end-user prices. It is difficult to make out a logical underpinning for the predicted $25,000 lift in prices headlined in the article.

The logic behind the Armstrong Creek farm being withheld from development because of the windfall tax is also difficult to fathom. Why would a landowner not trade an asset worth $5 million under current zoning for one worth $22.5 million or $20 million after Stamp Duty?

The windfall is smaller, but there is still a major incentive to release the land into development. As for the bona fide developer, one would expect that they would be indifferent as to whether they pay $40 million for the site wholly to a private landowner or pay $40 million partly to the landowner ($22.5 million) and partly to Government in a windfall tax ($17.5 million).

The strident critique of the planning windfall tax mounted by industry peak bodies does not bear scrutiny. At best, it signifies a lack of understanding that individual rights are wholly subordinate to community rights in land use and development. At worst, it signifies rejection of this principle.

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