Value Capture: Making Sense of Policy Options – guest post by Brad Rogers

value_capture_conference

I am delighted to publish this guest post from Brad Rogers, Director of DeltaPearl Partners, on value capture, the topic of a conference his firm will run in Canberra in July. Views expressed are Brad’s and should not necessarily be attributed to me. GT

Value Capture: Making Sense of Policy Options

by Brad Rogers

Many state governments in Australia are turning to ‘innovative’ ways to fund new city infrastructure to meet rising demand. Value capture is being widely but loosely discussed in relation to government funding solutions.

Different variations of value capture methodologies have been used by various governments and organisations over time. However, more recently in Australia, governments are seeking new ways which are politically tenable and economically feasible to use value capture mechanisms to fund new large infrastructure projects.

Value capture

The basic value capture approach being considered in Australia is that a government builds an infrastructure item, typically public transport, and then seeks to recover some or all of the capital and running cost of the infrastructure via a charge to those assessed as being beneficiaries of the new infrastructure. The charge is assumed to capture only part of the total benefit accruing to each beneficiary, thus leaving those people with a net benefit from the investment.

However, as with most things in economics and policy, the story is not that simple. Necessarily, economists and policy makers make large simplifying assumptions about many things in their assessment of the benefits, including the size of an individual benefit, responsiveness of demand to price changes, and the attribution of cause and effect.

Other funding methods

Economic efficiency arguments suggest that user pays systems are the most efficient in targeting the value capture of benefits; that is, the users who value the benefits the highest would be willing to pay for the use of the new infrastructure. However, the user pays system (compared with funding by general taxation) can be politically difficult because it can be described by opponents as a tax.

On the other hand, general tax revenue constraints could force state governments to implement value capture mechanisms. The current system of taxation has constrained the ability of state governments to implement taxes and depends heavily on the GST distribution system from the Federal Government. Could amendments to the current general tax system, including the GST distribution, provide state governments with the funding required to underpin good infrastructure and remove the need for value capture taxes by the state? Would these broad-based taxes be a more efficient and effective way of taxing the population for the infrastructure required?

Tax makes up approximately 36 per cent to 44 per cent of the cost of housing in Australia. On top of this, people living in these houses are likely to also be paying income tax (including capital gains tax), GST, company taxes (directly or indirectly in shares), Medicare levy, and any number of other taxes. Thus, the question remains whether adding a value capture charge is only going to add to this burden, and how the cost of value capture options might drive net economic benefits

Funding and finance

There are many questions still remaining about the actual cost to the economy of the value capture funding method as opposed to the traditional government borrowing to fund projects. In the traditional model of infrastructure funding in Australia, the government will borrow at the low government bond rate to build infrastructure. The theory goes that this increases economic activity, which then results in greater tax receipts which it can then use to pay back the borrowed funds over long periods of time.

Depending on how you want to break it down, there are approximately eight stages to developing a government infrastructure project, including strategic plan, project selection, contract development, borrow money, design, build, own, operate, and capture value. Each stage of this project development process could be completed by the government or by private contractors.

Value capture mechanisms are being tied to Public Private Partnerships (PPPs) and other related project financing arrangements – for example, the Hong Kong Mass Transit Railway (MTR)[1]. The MTR value capture example is often used as the model for Australian governments, where the Hong Kong Government decided on the strategic plan and project selection; then Hong Kong’s Mass Transit Railway Corporation’s (MTRC) purchased the right for a period of 50 years to develop property above railway stations and depots, as well as on land adjacent to the railway. The “land premium” paid to the government did not consider the value creation from the transport project (the ‘before rail’ land premium). The MTRC sold the development rights to private developers with profit share arrangements for the life of the contract; therefore, capturing the post-development value created.

Another option for value capture funding includes user pays, which has the benefit of providing a feedback between demand and price. That is, if you take a train or bus you get the benefit and therefore you should pay the full cost recovery fare; rather than the current heavily subsidised fare.

Road costs could be recovered via a road toll. Congestion charging, and road tolls, in place of simple car registration costs are one of the biggest policy ideas that governments face. The cost of congestion on the economy is getting larger by the day and the cost to build our way out of the problem would be far too expensive due to the inevitable induced demand. When a road becomes congested on a regular basis the cost to the individual for using the road is mostly the time spent waiting in traffic, as there is no toll to pay for each use.

If a government spends money to widen the road to allow more traffic to flow it will lower the cost to individuals due to reduced time lost, therefore, more people will use that road. That is, the government supplying more road space encourages or induces more people to drive on that road (demand) until it is again congested. This cycle continues until there is no room to expand and a more expensive option is required like a tunnel. However, if people face the cost of decisions they make it would encourage the community to make better decisions that would lead to a more efficient and productive economy.

Of course, politically a toll on roads would be very difficult to implement as people can see the cost of a toll as they pay it, but the large tax increases are hidden, distant, and assumed to be paid by someone else. However, a user pays system that includes road tolls would put pressure on the entire community to make better decisions about the locations of businesses and housing. Over the long-run the community would restructure itself to a more efficient town planning and transport system.

Attribution of Benefits

Economists have developed some level of measurement to attribute value creation to particular actions of government at a broad community wide level of detail; for example, increase in consumer surplus (through travel time savings), productivity gains, agglomeration benefits, reduced congestion and lower greenhouse gas emissions. However, as with many things, it works from the helicopter view but may not actually play out on the ground.

A key method of estimating the value created is by measuring the value uplift of property in the geographic area in question using hedonic pricing studies; that is, how much did the property values increase around the new infrastructure when it was built[2]. However, we are not able to separate all the thousands of things that happen in a community that affect property prices in a way to be able to attribute a specified value to one action for the hundreds of households.

There is some leading thought leadership taking place.  My recent work with Arcadis, the world’s largest engineering consulting firm, has introduced me to their proprietary MODex3 model. Arcadis has experience from around the world in the development of transport hubs and its methodology for maximising value creation, and it has used this experience to develop MODex3 to estimate the value of transport hubs and to assist in value capture modelling. The model depends on a data base of information collected from projects around the world. The data was calibrated to be able to compare projects. The output of the model is 10 indicators that are derived from 70 variables.

In reality, when the government comes calling on your home to ask you to pay a value capture tax their understanding of your individual willingness and capacity to pay is very limited. However, every household will have a different perception of value, capacity, and willingness to pay. Governments making a sweeping assumption about an entire community are going to make errors that impact on some sections of the community much more than others.

Conference

DeltaPearl Partners’ conference Value Capture: Making Sense of Policy Options 9 July 2018 in Canberra will seek to explore these and other related issues with the support of government, institutional, industry and academic speakers from around the world. Please see more information about the conference at this website:

The Value Capture conference is aimed at exploring the key issues related to value capture in Australia by hearing from experts from Australia and around the world who have experience in the application of value capture and academics with current analysis of the issues. Also, note all Economic Society of Australia members are eligible for a 10 percent discount to attend the value capture conference. For registration to the Value Capture conference please follow this link: https://consec.eventsair.com/value-capture-conference/delegate-registration/Site/Register

End notes

[1] Mathieu Verougstraete and Han Zeng, July 2014, United Nations Economic and Social Commission for Asia and the Pacific, Land Value Capture Mechanism: The Case of the Hong Kong Mass Transit Railway, Viewed 29 January 2018, http://www.unescap.org/sites/default/files/Case%204-%20Land%20Value%20-%20Hong-Kong%20MTR.pdf

[2] Jonathon Clark-Jones, Nicholas Harvey, Filip Milosavljevic & Preeti Singh, Under Guidance of Flavio Menezes, November 2016, Implementing Value Capture for Transport Infrastructure Applicability for South-East Queensland, Viewed 5 February 2018, http://uq.edu.au/economics/documents/Implementing%20Value%20Capture%20for%20Transport%20Infrastructure.pdf

Brad Rogers is Director of DeltaPearl Partners and President of the ACT Branch of the Economic Society of Australia.

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3 Responses to Value Capture: Making Sense of Policy Options – guest post by Brad Rogers

  1. Jim says:

    Brad

    Interesting post. I think there are some genuine opportunities for the astute use of value capture. However, like PPPs and other relatively complex funding models, I see a fundamental risk where there is an overemphasis on ‘clever’ funding models that can be funded off balance sheet (e.g. via value capture), rather than selecting the the best actual option via robust CBA.

    Perhaps someone on this blog could remind me of any public infrastructure projects undertaken in Queensland that were funded via ‘clever’ funding models that actually turned out to be economically viable. I can’t.

    Are we just really bad at CBA, don’t understand risks, or are ‘clever’ funding approaches skewing attitudes to risk and resulting in poor project selection?

  2. bjreconomics says:

    Hi Jim
    Thank you for the comment. Yes, there does appear to be some real opportunity out there to improve the funding models; but, as you point out, there are clever funding models that just hide the real cost. The devil is in the detail. I think people are getting better at asking technical people to evaluate a specified scope in a CBA that is likely to provide a desirable answer. Highly complex multifaceted projects are very difficult to evaluate and almost impossible for the public to comprehend the real outcomes. The Value Capture conference is going to try and get to the bottom of how value capture can be used in a productive way for infrastructure projects in Australia. Hope to see you there.

    Thanks
    Brad

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