Just like previous Development Land Taxes, the Planning Gain Supplement is bound to fail

Town & Country Planning Association : Dave Wetzel

It is commendable that at last the Government are beginning to draw attention to the land question.

Consider a farmer who seeks planning permission to build houses on a field worth £9,000 per hectare. She succeeds and the field is now worth £2.5m per hectare. Obviously, we should tax this unearned planning gain with a development land tax – right?

NO... WRONG!

But the Government thinks it is right and is planning to introduce a Planning Gain Supplement (PGS) to collect a “modest” part of this unearned windfall.

At a time when almost everybody’s earned income is taxed; when VAT hits consumers; the user or owner of buildings are charged rates, Stamp Duty or Council Tax; Inheritance Tax is paid; savers are taxed; the profits of entrepreneurs who provide goods or services and often risk all are taxed – the Government is right in their intention to collect a share of the unearned gain made by landowners.

Wrong tool for the job

However, the PGS is the wrong tool for the job. Instead of using a non-inflammable blanket to smother a fire, the Government is proposing that we throw buds of cotton wool onto it!

PGS will only capture the gain made at the time of planning consent. This “planning gain” will be measured by the current use value of land and buildings immediately before planning consent, being deducted from the planning value of the site with planning consent. But of course, even the land value already existing on the site is an unearned value also created by the provision of services (public and private) around the site.

The major problem with a development land tax like PGS is if you tax an event, one can easily avoid the tax by avoiding the event. In the case of PGS, the Government is proposing “the event” should be the commencement of development. So, to avoid the tax, landowners only need to defer the development.

As land does not perish, an unused site does not lose its value and can even generate cash flow when sold on or used as collateral against a bank loan, there is no penalty in deciding not to develop – but with PGS there is a real tax penalty if development commences.

Remember, some of this undeveloped land has been held by the same families for centuries, continuing to keep it unused or in its current low-yielding use, for a few more years or even decades is no great deal, especially as the activity of others makes it likely that the site will continue to increase in value and will still offer a profitable development opportunity for the landowners’ children or even grandchildren.

If land is withheld from use in this way the effects are damaging to all of us. There will be fewer homes built where people most want to live; there will be fewer factories, offices, hotels or shops in the very areas where they are most needed. This means that competition will be reduced, consumer prices will rise, there will be fewer job opportunities, fewer homes and the cost of land will rise, making homes even more unaffordable and marginal firms unable to expand.

I’m not suggesting that the effect of PGS will be as extreme as the following example, but to appreciate the effect it will have and the trend PGS will create (however modest and subtle the tax) just imagine a city with half the hotels it currently has and a tax system which discourages new ones to be built – the room rates charged would rocket and so would the cost of buying a hotel. Of course, it is not the bricks and mortar, the slate tiles, the wooden floorboards or the window frames, which would be more expensive; it is the location value, the land price that will have increased.

Deterring development

The disappointing thing about the PGS effect is that you don’t need a crystal ball to judge what might happen, all you need is to look at the four previous development land taxes introduced in the past 60 years. In all cases they deterred development and the better use of land, encouraged land hoarding by owners, created an artificial scarcity of sites and forced land prices up.

Even if the Treasury has no interest in history, surely they could read the Financial Times of Thursday February 23 2006 which under the heading “Planning Gain Supplement – Development Tax Alarms Landowners” they describe how already, without waiting for the PGS to be enacted, “Landowners have started to pull out of deals to sell land to developers because of government plans to introduce a development tax in 2008. ….The Home Builders Federation, representing 80% of the sector, said it supported the government’s housing objectives but the PGS tax was in danger of slowing the supply of land for development. ……Alan Collett of Allsop & Co said “Landowners will be put off selling their land. They will simply sit on it. Some have been sitting on the land for 17 generations, so they can wait a few more years”!

Hence we have a situation where the PGS will (and already is) slowing development leading to fewer and more expensive homes, fewer jobs, a lower GDP and encouraging urban sprawl as developers move onto less suitable sites which otherwise would not have been considered.

There are many factors which increase land prices. A new development itself can and does increase the price of neighbouring sites which structurally may not have changed but benefit from the general improvement of an area created by the development, or the attraction of more visitors, more customers or a suitable labour force. Transport gives the sharpest example of this. The Underground railway’s Jubilee Line Extension in London was built at a cost of £3.5bn provided by taxpayers, but the landowners within a radius of 1,000 yards of the eleven new stations have seen their land value increase by a staggering £13bn a massive unearned income which PGS would fail to collect from sites with no need for redevelopment.

The free-market think-tank, the Institute of Economic Affairs (IEA) has just published a new book by Fred Harrison The Wheels of Fortune, Self-funding Infrastructure and the Free Market Case for a Land Tax, which emphasises that the nation’s tax regime needs reform. He describes the shortfall in the UK’s infrastructure (especially transport) as a result of the tax system acting as a disincentive to business and creating a deadweight loss of revenues which any new transport or infrastructure financing scheme has to overcome before the scheme is considered “viable” by the Treasury and wins approval. The IEA has published Harrison’s alternative proposal for an Annual Land Value Tax on all sites as they can see that this initiative could work in harmony with the free market and that without this reform we will always be under-investing in transport and our other infrastructure needs.

Whereas the PGS will only collect the increase arising from planning gain (the tip of the iceberg above the waterline) an Annual Land Value Tax (LVT) would include the current use value and, like planning gain, is also created by the actions of the community and not by individual landowners themselves. PGS will also miss future increases that may arise immediately after the planning consent has been granted or at anytime in the subsequent years that the new building lasts.

Location Benefit Levy

For this reason I prefer to call LVT the Location Benefit Levy as it collects annually, a share of the total location benefit that a landowner receives from the surrounding community. Location Benefit Levy would share the total value of all sites, built and undeveloped, urban and rural, collecting a share of the total land value each year - unlike PGS which only falls on a part of the land value (planning gain), on less than 1% of the land in the UK and is only paid once in the lifetime of the building (say 60 years).

To appreciate the merits of valuing all sites for their optimum permitted use and then charging an annual poundage (similar to the business rates on buildings) as opposed to PGS; one only has to consider an absurd proposition that income tax should only be collected once, on next year’s pay rise (ignoring the current salary and future increases) and not collected from the individual for another 60 years.

Just consider how land values in East London have risen, without any effort by landowners, since the announcement of the successful 2012 London Olympics bid. PGS will not attempt to collect any of this unearned gain as it is not related to the planning permission and will be deleted as part of “current use value” from the figure to be taxed.

Other items to be deducted from the PGS tax include wider Section 106 benefits, small-scale developments, the admin costs for Government and developers, lower capital gains tax receipts from landowners, a lower rate for brownfield sites, lower taxable profits from developers as they not only deduct their administration costs but also the PGS payment itself from their tax bills and transitional relief for the owners of land banks.

With all these deductions from a “modest” tax – one wonders if the game is actually worth the candle?

If all these objections were not enough, PGS will hit the developer at a time of major risk and tight cash flows. Interest rate changes may deter potential tenants or eliminate the developer’s own funding calculations, the architect or builder may go bankrupt, oil prices or the international economy may have an adverse effect on possible tenants, fashion or market trends may make the space being created unsuitable for changing market conditions.

In contrast, the alternative Annual Land Value Tax not only collects a share of all land values, but it cannot be avoided, is cheap to collect and will redress the issue of high interest rates and even out the property cycle.

Before supporting the PGS, planners need to ask the Government a few pertinent questions: