Andrew Sancton on development charges

Who pays for them?

Changes on new housing in Vancouver, Toronto, and Montreal

Reassessing the Case for Development Charges in Canadian Municipalities. Andrew Sancton, September 2021.

Do the benefits of development charges on new housing (like Community Amenity Contributions in Vancouver) outweigh the costs?

On the positive side, it’s common to hear from planners that “growth should pay for growth” - that imposing development charges on new housing makes sense as a way to pay for the cost of public infrastructure to support that housing. In particular, in Vancouver it’s common for the city to take 70-80% of the “land lift” whenever rezoning a site for higher density.

On the negative side, people point out that development charges are a tax on new housing. Just as the carbon tax means that you get less carbon emissions (as people look for ways to cut emissions which are worth less than the tax), taxes on new housing mean that you get less of it (as the economic viability of housing projects decreases).

The recent MacPhail Report recommends replacing development charges with other funding. It doesn’t provide details, but one option would be greater municipal borrowing repaid through property taxes.

Who pays the tax?

Sancton, an emeritus professor at Western University, reviews the debate. His comments on who actually pays the tax (“incidence”) are particularly interesting. Is it the landowner (since the developer can pay less for land), the developer (who has to accept reduced profit), or the homebuyer (who pays a higher price)?

A more common argument is that development charges are passed onto purchasers of new housing (Blais, 2010: 97–100). Stegman (1987: 5) writes that “[W]hen most communities in a market adopt roughly equivalent impact fees, the developers’ costs will likely be passed on in the form of higher prices or rents [thereby] significantly diminish[ing] the affordability of housing.” He then claims that “this is only half the story.” As new and existing housing are located within the same regional housing market, higher rents and prices for new housing due to impact fees have the knock-on effect of increasing those of existing housing.

He quotes Stegman on the cost for renters:

The higher prices at which established homeowners can sell their houses will compensate them for higher prices they may have to pay for houses in the same market. Renters, on the other hand, receive no such capital gains. Their higher rents are, in effect, an uncompensated burden that stems from the private financing of infrastructure to serve new residents. That current renters, who do not create a need for new infrastructure, indirectly bear some of the costs of its financing is an important equity issue that merits serious attention by local policy makers. (Stegman, 1987: 5)

Rent control helps long-time renters, but not anyone who has to look for a new place.

The conventional wisdom in Canada: development charges drive up housing prices. The main circumstance in which this would not be true would be if there were two neighbouring and growing municipalities, one of which levied development charges and the other did not. To offer competitively priced housing in the jurisdiction with development charges, either the original landowner or the developer or both would have to absorb the cost. In the real world, including in the Greater Toronto Area, such a circumstance is unlikely to exist (because there is no reason for neighbouring growing municipalities to forego maximum-level development charges), so the costs of development charges get passed on to the new homeowners.

In other words, when all competing projects have to pay development charges, they can raise their prices to pass on the cost to homebuyers. It’s not the costs paid by a single project that determine its prices: it’s the costs paid by its competitors.

You’re not going to automatically get lower prices from a single housing project by reducing its development charges. You get lower prices from a project if you reduce the development charges of its competitors - and if those competitors bring down their prices, because each of them doesn’t want to be the one left with unsold inventory. (Sancton notes that we should not assume this will happen.)

Cost of switching to municipal borrowing

Sancton notes that by charging new homeowners up front, rather than issuing municipal bonds and paying them off from property tax revenue, we’re replacing public borrowing with riskier, higher-interest mortgage borrowing.

What would be the impact on property tax of switching to this approach?

We have already seen that the highest development charges in Canada are in the suburbs around Toronto, with Halton Region having the highest charges of all [about $90,000 for a new single-detached house]. Combining development charge revenues from the Regional Municipality of Halton and its four constituent lower-tier municipalities in 2018 (Ontario, 2021), we find that the total amount raised was $258 million (excluding development charges from school boards, which, in 2020, added about $8,000 in charges for each new single-family house [Oakville, 2020b]). Total property tax revenue was $896 million (Ontario, 2021). If the $258 million were financed at 2.5 per cent over 20 years, the annual amortization payment would be $16.4 million, which translates into an average property tax increase of 1.8 per cent across the Region.

Policy recommendations

Sancton points out some of the risks of eliminating development charges entirely, and recommends a gradualist approach:

Eliminating development charges, however, would likely be unfair to recent purchasers of new homes who are still paying for the charges through their mortgage payments. A possible undesirable outcome might be that prices for new homes would not come down because developers and/or landowners would reap the benefits by not passing the “savings” along to new buyers. Furthermore, some municipalities would face significant disruptions to their plans for future capital financing and would undoubtedly be concerned about more long-term borrowing even though, at current interest rates, such borrowing would not have dire consequences for property-tax bills.

Given all these factors and the fact that other countries facing similar pressures to facilitate infrastructure financing in fast-growing areas have also effectively levied taxes on new development that look somewhat like development charges, the wisest course of action would probably be to freeze them at current levels and plan for their gradual reduction over time, perhaps to be eroded only by inflation. … Calling for a freeze and reassessment is not a dramatic solution, but it does recognize that it was easier to stumble into development charges than it is to get out of them; that there is still a lot that we do not know about their effects; and that policy reversals can have unintended consequences, so it is sometimes better to stick with what we know.

More:

• Previously: an explainer on Community Amenity Contributions.

• The Economics of Community Amenity Contributions (June 2021), by Thomas Davidoff and Tsur Somerville. Observes that even if landowners absorb the full cost of development charges (assuming that they’re fully known in advance and that developers therefore offer a lower price for land), this reduces the land available, reducing the supply of new housing and raising the price.

• Development Charges and Housing Affordability: A False Dichotomy? Adam Found, November 2021. Argues in favour of development charges as a way of helping with the “lumpiness” of capital spending.

• Exactions and Value Capture with Minjee Kim, August 2021. An episode of the UCLA Housing Voice podcast, discussing public exactions (development charges). Kim and Michael Manville also point out that value capture is being triggered only when new housing is being built - it's not triggered for someone who's just sitting on land and seeing its value increase. Manville suggests that the optimal policy would be an annual land value tax.

• Financing Local Government and Development in Canada in the Aftermath of a Global Pandemic: Continuity and Change. Almos Tassonyi, Canadian Tax Journal, March 2023. A general overview of municipal finance.

• Inflation Confusion, or When Can Waffle House Raise its Prices? Brian Albrecht, February 2023. Explains the general principle that a firm can only raise prices to cover increased costs if its competitors are facing the same cost increases.