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Value Capture for Transportation Finance

This report to the Minnesota Legislature identifies value capture policies that could be used to help fund transit in the state

Executive Summary

Transportation systems play a pivotal role in enhancing the productivity and quality of life in the United States. Funding for streets, highways, and transit is provided by the joint efforts of federal, state, and local governments; taxation and user fees are the primary revenue sources, along with supplemental methods including loans, bonds, public-private partnerships, and concessions (Committee for the Study of the Long-Term Viability of Fuel Taxes for Transportation Finance, 2006). The Report of the National Surface Transportation Policy and Revenue Study Commission, Transportation for Tomorrow, suggests that the country needs to invest at least $225 billion annually from all sources for the next 50 years to upgrade the existing system to a state of good repair and create a more advanced surface transportation system. The report also notes that present spending is only about 40 percent of this amount (National Surface Transportation Policy and Revenue Study Commission, 2007). To ensure adequate and sustainable transportation investment for current and future needs, policymakers need to reassess the current mechanisms of transportation finance in the United States and explore alternative revenue sources.

One possible alternative is known as “value capture.” Large public investments in transportation infrastructure can substantially increase the value of adjacent land. Capturing the value of this benefit through various tools is gaining interest as a finance mechanism for infrastructure investments. But many questions remain: Does value capture promote or hinder economic development? How high should the tax rate be? How stable is the revenue? This study reviews the relationship between transportation and land values, including the measurement of benefits from a transportation improvement, as well as the legal and economic frameworks for capturing the value gains. It explores the major financing techniques associated with value capture—such as joint development of infrastructure and adjacent private parcels, rezoning and reselling, development impact fees, special assessments, and tax increment financing—and some examples of their implementation. It also evaluates several of the proposed policies and their suitability for implementation locally, based on the criteria of economic efficiency, social equity, adequacy as a revenue source, and political and administrative feasibility.

Transportation and Value Creation

Accessibility to desired destinations by customers and employees tends to play a major role in location decisions and, therefore, drives up the value of land in highly accessible locations. Convenient transportation facilities, depending on use, can come in the form of highway interchanges, public transportation lines or stations, and freight rail facilities. Increases in the capacity of each transportation mode in response to rising demand lead to increases in land value, whereas allowing congestion to worsen leads to declining values.

From Value Creation to Value Capture

A general principle, sometimes referred to as the “benefit principle,” holds that systems are more efficient if their costs and benefits are better related to each other. Given this principle, the long-used gas tax would seem like a reasonable funding source, given the assumption that transportation benefits are proportional to vehicle operations. However, in addition to creating benefits for travelers, transportation improvements also create value for owners and developers of nearby property in the form of higher land values and/or property prices, or enhanced development opportunities. In order to better conform to the benefit principle, a portion of these gains could be recovered to help fund transportation improvements. This is “value capture.” No previous research has systematically compiled and analyzed the full gamut of policy tools that may be used for value capture.

Value Capture in a General Framework of Transportation Finance

Transportation improvements create benefits for three groups of beneficiaries:

  • The general public, which benefits from broad economic and social returns. Such benefits create a rationale for use of general fund financing. Because the growth of the general tax base occurs through the life cycle of a transportation facility, the corresponding general fund revenues are suitable for both initial capital costs and ongoing operations and maintenance (O&M) costs.
  • Transportation users, who benefit from reduced travel times and enhanced safety. Such benefits create a rationale for the use of gas taxes, mileage charges, vehicle sales and property taxes, wheelage charges, tolls, and transit fares. Typically, users receive the bulk of the benefits through the use of facilities, indicating that these types of charges may be assigned to users to cover most (O&M) costs.
  • Property owners and developers, who benefit from increased property values generated by transportation improvements. Such benefits create a rationale for the use of value capture policies such as land value taxes (LVT), tax increment financing (TIF), special assessments (SA), transportation utility fees (TUF), development impact fees (DIF), negotiated exactions, joint development (JD), and air rights. For these beneficiaries, value gains are mostly realized upon the completion of transportation projects; therefore, these strategies may be used more often for capital costs.

While multiple value capture policies can be applied simultaneously, the total level of value capture cannot exceed the total benefits derived from a transportation improvement. Otherwise, the financial instruments would negate the economic rationale for development.

Value Capture Policy Evaluation and Implementation Considerations

The report discusses the aforementioned value capture techniques, examining each in relation to economic efficiency, equity, sustainability, feasibility, and, where required, implementation considerations.

Land Value Tax (LVT) Rather than being assigned to a specific project, land value taxes more generally capture the value created by the provision of public goods, including the accessibility afforded by transportation networks. A tax on land would be preferred to a tax on buildings, as the former would result in less economic distortion due the fixed supply of land. A pure tax on land is possible, though rarely used. While land value taxes are desirable from the standpoint of economic efficiency and sustainability, they would most likely be slightly regressive in terms of ability-to-pay. Further, land value taxes may prove politically challenging due to high visibility and potential unpopularity.

Tax Increment Financing (TIF) Tax increment financing uses taxes levied on the increment in property value within a development to finance development-related costs. Tax increment financing is most commonly used by local governments to promote housing, economic development, and redevelopment in established neighborhoods. Tax increment financing has been used, however, in some instances to finance transportation projects. The paucity of evidence on the effectiveness of TIF districts for transportation purposes makes it difficult to evaluate the efficiency of this tool. Evidence from Chicago suggests that, in certain cases, the increment in property value that can be captured from a transportation improvement may be large, though this case involved some unique circumstances (e.g., a heavy rail system in a very dense, central city area). While TIF districts may promote benefit equity, they may raise some unique issues related to geographic equity, as some overlapping jurisdictions (e.g., school districts) often do not share in the benefit from a TIF district. TIF districts may be limited to specific projects and one-time capital costs. TIF districts may be politically feasible, as they are perceived to promote projects that “pay their own way.” To adopt tax increment financing for transportation purposes in Minnesota, the authorizing statute (469.175) would need to be amended to add the Minnesota Department of Transportation (Mn/DOT) and Metro Transit (or its parent agency, the Metropolitan Council) to the list of authorized users.

Special Assessments (SA) Special assessments impose charges on property owners near a new or improved transportation facility based on geographic proximity or some other measure of special benefit. Various methods have been used to determine which properties receive special benefit and how to allocate charges among these beneficiaries. Some of these methods include measurement of distance from an improved facility, property frontage adjacent to an improved facility, and property acreage. Special assessments generally promote economic efficiency and equity along several dimensions. However, given the location-specific nature of the mechanism, the amount of revenue generated in each instance is relatively small and limited in use to initial capital costs. Political feasibility may be an issue with special assessments, as they are highly visible to affected property owners. In Minnesota, special assessment districts are currently limited to local units of government and are not authorized for application to interstate highways. Allowing the establishment of special assessment districts for transportation purposes would require amendment of state statutes to allow state and regional agencies as authorized users, and to allow special assessments to be applied to interstate highways and public transportation facilities.

Transportation Utility Fees (TUF) Transportation utility fees derive from the notion that transportation networks can be treated like a utility, similar to other local services such as water and wastewater treatment, which are financed primarily from user charges. Transportation utility fees are assessed on characteristics thought to be more closely related to transportation demand than property taxes, which currently account for a large share of local transportation revenues. Utility fees have the potential to improve efficiency by shifting the cost burden from residential to commercial and industrial properties, which tend to consume more transportation services than their relative tax contributions would imply. In principle, transportation utility fees could help promote equity, but only if a link can be established between the various characteristics that form the basis of utility fees and the value of the benefits received from consumption of transportation services, a link that in the past has not been strongly established. The revenue from transportation utility fees would be relatively stable, as the demand for travel is not terribly sensitive to cyclical economic trends. Transportation utility fees are politically feasible, as shifting the cost burden to non-residential properties would most likely be popular among existing residents of a jurisdiction. Enforcement of utility fees may prove difficult, as it would be hard to deny transportation services to a delinquent property owner.

Development Impact Fees (DIF) Development impact fees are one-time charges collected by local governments from developers for the purpose of financing new infrastructure and services associated with new development. They are similar to negotiated exactions in that they are charged primarily to new development to help recover growth-related, public-service costs, but differ in that impact fees can be levied for off-site services, such as local roads, schools, or parks. The efficiency of impact fees can be established to the extent that they pass along the marginal costs of land development, including the provision of transportation infrastructure, to the primary beneficiaries. Impact fees promote benefit equity, but may have other undesirable equity effects if developers cannot recover the costs associated with impact fees and are forced to abandon low-and moderate-income segments of the housing market. Impact fees are not a primary source of revenue for transportation in most jurisdictions, but can help finance the share of transportation budgets attributable to new development. They are also aided by the fact that they are politically and administratively feasible. For development impact fees to be adopted more widely in Minnesota, specific, state-level legislation would need to be passed authorizing their use. The fees authorized by this legislation would need to ensure a nexus between the charges and legitimate state interest, and also ensure a degree of connection between the charges imposed on a specific development and the impact of that development.

Negotiated Exactions Negotiated exactions are functionally similar to development impact fees, with the exceptions that they are not determined through a formal, formulaic process and are typically not applied to off-site infrastructure provision. Exactions can take the form of in-kind contributions to local road networks, parks, or other public goods as a condition of development approval, or can be requested in the form of in-lieu fees. Exactions generally promote economic efficiency and social equity. In most cases, negotiated exactions should be seen as a supplemental source of revenue, rather than a large-scale replacement for more traditional sources of revenue. Negotiated exactions are generally politically feasible, as they are seen as a way to make new residents “pay their own way.”

Joint Development (JD) Joint development, as typically applied in discussions of value capture, refers to the spatially coincidental development of a transportation facility (e.g., a public transit station) and adjacent private real estate development, where a private sector partner either provides the facility or makes a financial contribution to offset its costs. The term “joint development” could also be used to refer to jointness in timing of development or ownership of transportation infrastructure, though for the purposes of this report, the above definition is used to refer to various forms of cost-sharing or revenue-sharing arrangements. JD arrangements generally promote efficiency, as the voluntary nature of the transaction ensures that the expected benefits of the private sector partner exceed the cost (or share of costs) of the transportation improvement that he or she anticipates. This characteristic also promotes benefit equity among participants. Since the nature of JD arrangements is often location-specific, the tax base is rather narrow and the amount of revenue generated is relatively small. Joint developments are often politically feasible, due to their narrow impact, but entail a higher degree of administrative complexity.

Air Rights Air rights are a form of value capture that involves the establishment of development rights above (or in some cases below) a transportation facility that generates an increment in land value. Air rights agreements promote efficiency to the extent that the increment in land value generated by the facility exceeds the cost of its development. The sale of air rights may also promote benefit equity, since the costs of a transportation improvement can be allocated more proportionally among non-user beneficiaries. Similar to joint development, air rights agreements tend to provide a narrow tax base and a relatively small amount of revenue, though they can provide some or all of the initial capital costs of a specific project. The narrow scope of impact of air rights projects indicates that they should be politically feasible, though they share some of the administrative complexities associated with joint development arrangements.