Selling the Rights to Greater Density

At Next American City, Mark Bergen has an interesting long-form piece on municipal infrastructure financing. He argues that the property owners who benefit from public policies, such as infrastructure investment, should be required to fund these policies. He suggests infrastructure improvements should be paid for with Tax Increment Finance or value capture (PDF). I don’t necessarily agree with his infrastructure funding prescriptions, and may take these up in a future post. What I found even more interesting, though, is his suggestion that developers should pay for zoning changes.

The basis for this proposal comes from the Georgist land tax. Because in urban settings, land’s value largely comes from the amenities surrounding it, landowners do not have the exclusive rights to this value, according to Henry George. The suggestion that developers should pay for the rights to build on the land they own is based, Mark explains, on a policy from São Paulo, called Certificates of Additional Construction Potential (CEPAC). These bonds, representing rights to build, are transferable and are publicly traded. He quotes Gregory K. Ingram of Lincoln Institute of Land Policy:

“They’re essentially selling zoning changes,” explained Ingram. Crucially, the building fees have not eaten away at developers’ profits. By some accounts, the rates of return for real estate in the districts increase.

[...]

The notes, sold by municipalities, are one of the world’s most innovative public financing techniques. Across many sections of São Paulo, if a developer hopes to build or do nearly anything with her property — adjust its uses, expand outward or upward — she must first buy a CEPAC.

On a fairness level, selling zoning changes seems wrong to me. Current zoning policies are an arbitrary starting point, so it doesn’t make sense that developers should have to pay for permission to change a policy that is limiting their rights. Additionally, the overarching objective of value capture, as Mark explains, is to facilitate progress toward Smart Growth objectives. To the extent that these objectives include affordable housing, walkability, and permitting denser development, great progress can be made toward these goals with upzoning alone without significant public investments.

On the residential side, increasing the housing supply is the only feasible path toward large numbers of affordable homes. On the commercial side, walkable neighborhoods cannot be achieved without permitting more mixed-use, dense development. From this angle,  São Paulo’s CEPAC policy would act as a tax on Smart Growth.

From a political perspective, it seems that the CEPAC policy would be subject to abuse. Those who oppose density on the conservative side would lobby for the issuance of few CEPAC bonds. Those on the progressive side who support increased public revenue for their favorite causes may also support the issuance of few bonds, requiring developers to pay high prices for the rights to build.

Despite these problems, though, as Mark points out in Brazil the program has led to increased developers’ profits indicating the program has not had these detrimental effects. I was not familiar with the program before reading Mark’s article, and I don’t know much about how CEPACs have played out politically in Brazil. However, I can imagine that paying for the rights to build would be an improvement for many U.S. developers, even though they act as a tax on density.

Currently, to achieve the zoning changes necessary for increasing density and market-rate affordable housing, developers have to spend significant resources of time and money to go through an uncertain political process. In some cities, as-of-right development is so limited that  the rule of law does not extend to urban development. Given this status quo, CEPAC bonds could benefit developers by removing some of the uncertainty surrounding zoning variances. Rather than spending money on lobbying for property rights they may never achieve, developers could simply buy these rights on the open market. This might also benefit small-business development if buying the needed bonds is cheaper than investing in a lobbying arm.

While I think many market urbanists would prefer to see more housing and walkable development allowed as-of-right, perhaps selling these rights is a second-best solution. Additionally, by compensating taxpayers for the damages to their light and air, CEPAC bonds could reduce the validity of NIMBY arguments. Is anyone more familiar with how the CEPAC program has changed land use rights in Brazil or other ways in which value capture has changed land use policy?

  • Alon Levy

    If developers are making large profits, it means that the system is broken, not that it’s successful. Markets without barriers to entry – say, suburban sprawl in Texas – have actual competition, which means developer profit approaches zero.

    Anyway, correct me if I’m wrong, but the CEPAC policy looks like it has this exactly backward. Instead of taxing unimproved land, it taxes further improvements. The theory that urban land prices come from nearby amenities predicts that the government should do the reverse: instead of taxing people for building more, it should subsidize them, or at least tax the surrounding properties, for the benefits that development brings to the surrounding area.

  • http://twitter.com/jm_mcgrath John Michael McGrath

    I agree that it’s a second-best solution, but (a) if it gets density actually built as opposed to not, that’s a big deal and (b) it seems like a natural compliment to Schleicher’s “density budget”, no? Issue enough certificates to meet the budget, make some money off of it, give a chunk to buy off local NIMBYs, and move on?

  • Alex B.

    Is there a reason I’m not seeing this post on the main page – or is that merely an issue on my end?

  • http://marketurbanism.com MarketUrbanism

    Uh oh… Thanks for bringing that to our attention. Let me see what’s causing that.

  • Emily Washington

    It is similar to a density budget. I’m not super familiar with Schleicher’s recommendation. Does it involve selling bonds, or setting a desired number of new housing units to put a limit on restrictions?

  • Emily Washington

    Not to channel recent SCOTUS decisions, but I think you could interpret it as a tax on development or as a tax on the expanded rights attached to the land ownership. On the amenities, while you and I would see increased development as an amenity I think the tax is supposed to make up for the loss of amenities like open space, light, air, etc.

  • Alex B.

    Or to simply pay for the needed upgrades that denser development requires – new transit lines, additional utility capacity, etc.

    Sure, a city could just upzone and then finance those things after the fact with general tax revenues, but that’s the whole point – this is a financing mechanism for infrastructure.

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