A carrot for the council

Housing affordability has rightly climbed rapidly in political priorities. It has attracted less attention but, as the 2006 Barker Review showed, there is also an increasing problem of the price of commercial space. New development imposes costs. If you back onto open space and it gets built on, you lose not just access but value from your house. New houses or businesses mean transport and local amenities get more congested and new schools and other facilities have to be built.

People are not daft and they know that more likely than not they will pay for it. It all seems so unfair. Even more unfair is the fact that, given how tightly we have restricted the supply of land for development, landowners become overnight millionaires if they succeed in the planning permission sweepstakes.

So it is not surprising that we are looking for new sources to compensate local communities for development and redistribute some of the amazing wealth planning permission generates. The trouble is we have been looking at it the wrong way round.

There are two quite distinct and separate logics supporting charging developers for planning permissions. The first is the long established principle of betterment. The case for Planning-gain Supplement (PGS) is based on the logic of betterment. The second is the much more recent idea of community impact. The logic for Impact Fees rests on this and where Impact Fees are imposed in the USA, legally they have to satisfy a ‘rational nexus’ test: that is, for them to be legally valid there has to be a clear connection between the development and the need for additional infrastructure. The level of fees has to be a function of these costs.

Betterment goes back to a case of 1427 and rests on the idea that if the community has created a part or all of the (increase) in land values, then it should benefit from that increase.

The idea of an Impact Fee rests on the argument that if development imposes costs on the community in the form of additional necessary infrastructure (using ‘infrastructure’ as a shorthand for all costs imposed on the community — including open space provision, schools, medical facilities, utilities such as water supply, libraries, transport, etc) then these costs should be thought of as a part of the costs of the development and paid for by the developer in the form of an Impact Fee tied to the permission to build.

In practice, where such fees are charged, they are 100 per cent capitalised into the price paid by developers for land, so their ultimate incidence is the same as would be the ideal-world case for the proposed PGS.PGS may be based on an old-established concept, but it has an almost equally long history of failure; and failure reinforces failure.

Impact Fees are not tainted with failure and have many obvious advantages:

1. They do not require establishing land values before and after the granting of planning permission;

2. Their basis in natural justice seems (even) firmer;

3. They are entirely transparent;

4. Partly because of real difficulties of implementation, charges based on betterment have a long history of failure. This is likely to create expectations of repeal and so could lead to a reduction in land supply for quite an extended period;

5. So long as revenues from Impact Fees go to the bodies responsible for providing the required infrastructure — including Local Authorities — they create an incentive to permit development, whereas there is a danger that a PGS might create a perverse incentive to make permissions even scarcer;

6. The level of Impact Fees should be set in relation to nationally determined formulae calculated to reflect actual community development costs in different locations; and

7. The revenue from Impact Fees should be applied to the purposes which gave rise to them, so infrastructure would be constructed where it was most needed (following the recommendations of Eddington, 2006).

The first advantage is obvious. The level of Impact Fees would vary from place to place depending on the extent to which existing infrastructure was locally/regionally congested. They would be calculated on the basis of formulae designed to reflect actual infrastructure costs of new development.

Levying any charge based on betterment requires an accurate estimation of the increase in land price uniquely associated with granting planning permission. This is fraught with difficulty, has to be done on a case by case basis and is subject to challenge. It is one of the reasons each attempt since 1947 to impose a ‘betterment tax’ has been subsequently repealed.

With respect to natural justice one of the problems of invoking betterment, given the actual system we have, is that most of the uplift in value from planning permission comes not from expenditure of effort and resources by the community (such as improving access with new transport facilities) but from the constraint on land supply imposed by existing planning regimes.

If development imposes extra costs on the community, it is reasonable to argue that these should be paid by the developer and ultimately — because of the incidence — by the landowner.

Moreover, a danger of any tax (including Section 106 Agreements) based on value uplift is that, under plausible assumptions, it could create a perverse incentive for Local Planning Authorities (LPAs) to keep land (even) scarcer since that could increase net revenues from granting permission.

The advantage of Impact Fees is that not only do revenues only accrue if development goes ahead but their value depends not on land values (which can be kept high by keeping land in short supply) but on the costs of necessary, complementary infrastructure. US research shows that, where they are applied, Impact Fees reduce NIMBYism and planning restrictiveness.

Because of the long history of failed attempts to levy taxes based on betterment, landowners and developers might actually hold back from development in the expectation of future relaxation. It is claimed that this is what happened last time a betterment-based development charge was imposed (in 1976).

A strong strand of the Eddington thinking was the need to ensure that transport infrastructure supports development and economic growth rather than attempting to ‘lead’ it.

One recommendation was that decisions on transport projects should be based on estimated returns and existing congestion of transport facilities, with higher local land and labour costs being taken into account since they indicate potential agglomeration economies not otherwise accounted for.

If Impact Fees were calculated on the basis of formulae designed to reflect local and regional infrastructure congestion, and the revenues were used to relieve that congestion, then that would be consistent with the Eddington principles. It would also eliminate a major source of the negative incentive LPAs currently face in granting development permissions — particularly for commercial development.

There is a serious negative incentive in the present system because LPAs have to assume more expenditures to service any development but get no revenues. It would also eliminate a negative ‘political economy’ incentive for local voters — they would not suffer increased infrastructure congestion as a result of development but would get better, more modern, facilities.

Finally, it would seem essential not to reform Section 106 Agreements but to eliminate them if Impact Fees were introduced. One further advantage of Impact Fees is that they would apply to all development on a common and transparent scale.

Section 106 Agreements have numerous disadvantages — they are not so much a second best solution as a 42nd best. They are highly variable and opaque and, because of transactions costs, apply only to larger developments.

One paradox is that our planning system is generating smaller and smaller developments because of densification and smaller site sizes, so presumably a falling proportion of developments are actually incurring Section 106 Agreements (or transactions costs are absorbing more of the potential community gains). Smaller LPAs do not have the necessary skills to negotiate them on favourable terms.

The largest developers have a built-in advantage because they have the skills, experience and information about the various foibles of local councils necessary to get the best deals. Section 106 Agreements are in effect a barrier to entry to the development industry, making it less competitive. Impact Fees would be transparent and universally applied and so would favour competition.

Paul Cheshire, Professor of Economic Geography, Geography and Environment Department, London School of Economics.