The Government has proposed three funding and financing changes to deal with the historic problem of new development not paying the full cost of the infrastructure it needs. David Norman, the Chief Economist at GHD for NZ and Australia has advice for councils on this opportunity.
Because councils have historically undercharged new development for growth infrastructure, developers have tended to overpay for undeveloped land on the rational expectation (based on previous experience) that general ratepayers will foot the bill.
This transfers wealth from ratepayers to undeveloped landowners, with developers as intermediaries, because developers work out what they can sell a development for, then work backwards through all their costs to what they pay for land, with the value they pay for land being the residual after all anticipated costs are accounted for.
If infrastructure costs don’t reflect the true costs of development, they tend to overpay for land, passing the infrastructure subsidy on from ratepayers to landowners.
Conservatively, we estimate this wealth transfer at $500 million or more a year across the country, based on current under-recovery of development contributions (DCs) to infrastructure.
This wealth transfer means councils are left with massive financial holes that must be filled by ratepayers, making inaccurate growth charging a major contributor to councils’ severely constrained infrastructure programme.
A further consequence is that councils are restricted on where they can afford to develop. There is no money to develop infrastructure ahead of an area being live zoned for new development, and so councils are saying “no” to many development opportunities.
Charging more accurately
Charging inaccurately not only hollows out council finances and transfers wealth from ratepayers to landowners. It sends wrong signals to the market so that growth happens where it is less affordable to do so because the true cost of developing land in a location where infrastructure is expensive is not reflected in the development’s infrastructure contributions.
Some councils have started charging more accurately for growth infrastructure. But challenges with the DCs regime remain. Councils still must try and predict where and when development will occur and forecast when DCs revenue may be received. Because of the uncertainty of the property business cycle, councils cannot borrow against DCs like they do with rates revenue (which is far more certain). This limits the ability of councils to leverage DCs to get more infrastructure built faster.
New old tools
The Government has proposed three changes. The first is the replacement of the DCs regime with a Development Levies (DLs) scheme. Detail is limited, but broadly DLs will improve upon DCs by allowing councils to calculate a generalised levy that can be charged for development in areas where growth has not been planned, based on average costs in areas where growth has been planned.
In this way, unplanned new growth will pay for its theoretical share of infrastructure capacity used. This is primarily a mechanism to support the government’s requirement for councils to open more areas to growth even where councils have not determined what growth infrastructure will be needed.
There will be fewer infrastructure “zones” across urban areas, with more use of that generalised cost by infrastructure type. Councils would charge “top up” DLs where they think the true cost of infrastructure will be higher, and charge DLs on expected infrastructure needs over the long term. This explicitly allows councils to include infrastructure projects beyond the typical 10 years. That said, some councils have recently trialed using 30-year timeframes for DCs.
It also involves a standardised, national methodology for calculating DLs fairly. It is unclear whether the national methodology will require all councils to apply DLs or if they will still opt in. Some councils have historically not used DCs at all on the false belief that using them pushes up house prices (they don’t). As the government has correctly said itself; “In the long term, any increases in infrastructure charges should be reflected in lower bulk land prices, rather than impacting costs for developers.”
The second change is to expand the scope of the existing Infrastructure Funding and Financing (IFF) Act so that targeted levies can be used more often to fund growth infrastructure but kept off council balance sheets.
The IFF today allows greenfield development to happen out of sequence by building front-end infrastructure funded by a central government agency rather than the local council, but there is no onus on the developer to deliver that development to the market within an agreed timeframe.
This allows developers to drip feed land to the market if they think land prices will continue to rise enough to offset the targeted levies they pay. To get the most out of the IFF model, agreements need to impose time limits for delivery on developers who benefit from this model. It is unclear if this change is included in the proposal.
The third and most exciting change involves expanding the role of targeted rates so they can apply specifically to new developments. I have long argued that targeted rates overcome the disadvantages of DCs already described. They provide certainty on when the council will receive the revenue, allowing them to borrow more and get on with infrastructure delivery.
Together, these are encouraging steps to improve the funding of infrastructure. Having a mechanism to ensure growth pays its way in areas where specific projects have not been defined, will help councils pay for infrastructure as it is needed, assuming that the money collected still has to be put aside specifically for new infrastructure.
More use of the IFF approach that keeps debt off councils’ balance sheets is welcome.
Clarifying and expanding the use of targeted rates, still the most transparent and effective tool we have at local government level, is great.
But the devil is in the implementation. Communication of charges will need to be clear, and the methodology for calculating DLs will need to be robust and transparent. More importantly, councils will have to clearly and consistently adopt DLs, access a widened IFF process, and make much more use of targeted rates to improve infrastructure outcomes.