Most of us don’t think about infrastructure until it stops working. But roads, bridges, and broadband cables are vital to a functioning civil society; and they don’t come cheap. Tunnels, airports, roads…etc can easily cost billions of dollars to build and millions to maintain. As a consequence, many projects never turn a profit, or break even, leaving future generations saddled with debt. There are better and more sustainable means of funding vital infrastructure.
Today, much infrastructure is funded through taxation and/or debt. A portion of your income tax, for example, might be used to fund an expressway project. But due to the indirect nature of this financing, it is hard for taxpayers to see the connection between their hard-earned money and the facilities they actually use.
Understandably, some might wonder why their money is used to finance a road that they will not benefit from. This makes raising funds for infrastructure politically difficult, leaving many bridges, roads, railways, and tunnels chronically underfunded.
On the other hand, those that do benefit from an infrastructure project, such as a hotel located near an expressway exit, reap disproportionate benefits in the form of higher land values, better business opportunities, and convenience.
In short, infrastructure funding is often a game of funneling money from one group to another, from those who pay taxes to those who reap the rewards. And more often than not, there is little overlap between these two groups. Ideally, we want a funding structure that doesn’t weigh the government down with debt and imposes the cost of financing upon those who benefit most, and not on those who don’t.
User fees are the simplest means of funding infrastructure. User fees can take the form of tolls on roads, fares on subways and trains, or fees in water/electricity use. This concept is certainly intuitive. Why not charge the very people who use a road to pay for its maintenance and recoup the cost of construction?
The problem is that the cost of that road is so astronomical, the commensurate high tolls would discourage the road’s use in the first place. User fees alone cannot pay for infrastructure because direct users aren’t the only beneficiaries. This is where value capture becomes vital.
To fully fund infrastructure, we need a mechanism to capture the positive externalities created by it. This, ideally, would come in the form of a Land Value Tax (LVT) or tax on the unimproved value of land. An LVT is one of the most efficient forms of taxation known, it is progressive, impossible to evade, and engenders zero deadweight loss on the economy.
As an example, once a road is built, the value of the adjacent land rises. An LVT captures this increased value, which may then be transferred to the owner of the road. Suddenly, you have a recurring revenue stream outside of user fees, allowing reduced tolls and/or profitability.
An LVT isn’t strictly necessary, however, so long as the value added is captured in some manner. A great example of the power of balancing user fees with value capture comes from the 1890s. At that time, Chevy Chase Land Company (CCLC) bought 1,700 acres of land on the border between Washington, DC and Maryland. This undeveloped land was cheap because it was located far from town.
CCLC, at its own expense, built a streetcar system that connected its landholding with the downtown. To help pay for that expensive system, CCLC charged a few pennies fare for its use. They did not, and certainly could not, recoup the cost of the streetcar system through fares alone. They made up the cost, and more, through the greatly increased value of their land, which they could now sell or rent out at a premium.
A contemporary example can be found in the Hong Kong Metro (MTR) system. The MTR, one of the busiest subway systems in the world, is unique in that it is perhaps the only profitable underground transit system in the world. How does the MTR succeed when others fail? Value capture.
The MTR employs a strategy that they call “Rail + Property.” The Metro partners with developers of land adjacent to their metro stations and depots. Since the presence of a newly constructed metro station raises the value of the land nearby, the metro captures some of this value by selling or leasing the property around the station.
The MTR uses value capture so well that, not only is it the world’s sole profitable subway system, it does so while charging significantly lower fares than those in other major cities, such as Tokyo or New York. Additionally, the MTR requires no government subsidies. On the contrary, because the MTR is partly owned by the Hong Kong government, it pays the government hundreds of millions of dollars in dividends every year.
This is the power of value capture. Lower fees, better infrastructure, profit, and no debt. There is no reason that such a model couldn’t be employed to finance better roads, bridges, and airports across the board. Once we learn to fund infrastructure in a sustainable and logical way, it loses its political potency. No longer are roads and bridges subject to political winds, and economic growth and development are all the better for it.