Value capture can be desirable, but won’t make bad projects stack up

There was an odd statement about value capture on the front page of Monday’s Australian, in the story about the PM’s grand plan for high speed rail. The statement was that value capture, by which a private consortium would get a share of the potential increase in land values from the project, “would minimise the amount of taxpayer dollars needed to get the much-vaunted project off the ground, and ensure that the cost-benefit analysis for the project stacked up.” Value capture may well minimise the taxpayer commitment, but it will not necessarily make a cost-benefit analysis stack up.

The importance of not getting carried away by the excitement of value capture is put very nicely by my old friend and former Treasury colleague Joe Branigan of the Smart Infrastructure Facility in a submission he made earlier this year to the House of Representatives Standing Committee on Infrastructure, Transport & Cities Inquiry into Transport Connectivity, entitled Value Capture in the Australian Federation: Issues.  Joe notes (p. 15):

“The importance of ensuring the social benefits outweigh the social costs over the life of the infrastructure (in net present value terms) through a robust cost benefit analysis of a transport project is well known. Care is required to ensure value uplift is not a spurious source of additional benefit used to improve the benefit/cost ratio of an unviable project. Estimates of value uplift should be conservative, and net out uplift caused by exogenous factors (such as population growth).”

Broadly speaking, value capture relates to the financing of projects and how its net benefits are distributed, not the overall level of net benefits. It can help with the financing of a project, but it does not necessarily improve a project’s economic viability from the community’s point of view. Value capture is about project proponents, governments or private investors, capturing benefits that would otherwise accrue to others, such as nearby property owners, and thereby helping their financial business cases for the project get across the line.

But the proceeds earned by value capture are not new additional economic benefits from a project; they are a transfer of benefits from one group to another (e.g. from nearby property owners to a project consortium), so they really do not help the cost-benefit analysis. For example, any uplifts in property values attributable to a project would be the capitalised values of streams of benefits into the future, such as travel-time savings to residents or the higher profitability of local businesses, benefits that would (or should) be estimated as part of a comprehensive cost-benefit analysis anyway. If you went and added value-captured revenues to these benefits you would be double counting.

So value capture does not necessarily mean that the overall cost-benefit analysis will reveal a project stacks up from the community’s point of view, and that the project is deserving of public subsidy. Clearly, projects such as Cross River Rail and the PM’s high speed rail project will require heavy public subsidies, even if there is some value capture involved. For a subsidy to be justified for either project, there would need to be net benefits to the community from the project, as established by a cost-benefit analysis.

For readers interested in the economics of value capture, I thoroughly recommend Joe’s submission.

Joe

Joe Branigan,  Senior Research Fellow, SMART Infrastructure Facility, University of Wollongong

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4 Responses to Value capture can be desirable, but won’t make bad projects stack up

  1. Toby says:

    As was learned the hard way during the GFC, in finance, risk can not be created nor destroyed but just shifted around, often from one party to another. Does value capture just shift risk “off the books” to make projects look more viable today? If so, governments need to know who is now holding that risk. It is lurking there somewhere.

    • Gene Tunny says:

      Yes, there is certainly risk there. As Joe suggests in his paper the value capture should be of actual gains that occur, not projected gains. It may be that project proponents capture some gains that property owners never actually realise because the economic benefits of the project were over-estimated. Thanks for the comment, Toby.

  2. Jim says:

    Gene

    A great post. This is the one that should be quoted by the CM.

    I suspect there are a few practical problems relating to how you actually ‘capture’ the value created. Most projects that could be financed in this way provide diffuse benefits (e.g. hundreds of properties benefiting from a new train line), so the transaction costs of collecting more of the benefits could be significant.

    And because most of the benefits flow through into enhanced property attributes that are reflected in market prices, isn’t a portion of the additional value already being captured by local government rates and state land taxes (both calculated on land values). So if we set up a new financing mechanism based on ‘value capture’, are we risking some double dipping from government?

    • Gene Tunny says:

      Yes, thanks Jim, there is certainly the risk of double dipping from government, which is one of the points Joe makes in his article and which I should have mentioned in my post.

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