Taking Sides When Bearing the Economic Cost of a Policy Change

A good rule of thumb in debates on who bears the economic cost of a policy change is to look at the positions taken by vested interests in the matter. If anyone is going to know if he or she bears the cost, those pay. In the case of infrastructure charges on new property developments, the vocal objections from the property industry are a sure sign that they bear the economic costs.

Local governments levy infrastructure charges on developers of new land estates, based on an increased load on essential infrastructure services for which the council is responsible.

A good rule of thumb in debates on who bears the economic cost of a policy change is to look at the positions taken by vested interests in the matter. If anyone is going to know if he or she bears the cost, those pay. In the case of infrastructure charges on new property developments, the vocal objections from the property industry are a sure sign that they bear the economic costs.

Local governments levy infrastructure charges on developers of new land estates, based on an increased load on essential infrastructure services for which the council is responsible.

A research paper reported in The Conversation recently claimed that property developers could pass on these charges in the price of new homes with a mark-up of 400%. The paper also claimed that these charges had the same price effects on existing homes, meaning that new homebuyers ultimately bear the cost of infrastructure charges, rather than developers.

However, one should challenge the logic of this and it is not borne out in the results of other rigorous academic studies of infrastructure charges, which have in fact found the opposite.

The idea that cost of developer charges passes on through new home prices sounds intuitive. However, its basis is an incorrect notion that costs determine prices.

In fact, developers already charge the maximum the market will bear. If they did not, it would be the equivalent of selling your house for half the market price, just because it only cost you that amount 10 years ago when you bought it. You would not do it, and nor would a developer.

Using a statistical analysis of a simple regression of home prices with developer charges, along with many hedonic control variables – as this study has – will find a positive correlation simply because charges are set in proportion to housing size. Nevertheless, that is not a causal relationship.

As Ian Davidoff and former academic economist, (now the ALP’s shadow assistant treasurer) Andrew Leigh succinctly describe in their study on how stamp duty affects the market:

…if one were to simply regress the sale price on the tax payable on that property, the coefficient would capture both the mechanical fact that the tax amount is a function of the price, as well as any behavioural impact of taxes on prices.

It is true that observations of this mechanical relationship have been widely interpreted as a behavioural effect in the literature on developer charges. However, the best analysis does not interpret such results in this way.

A better way to observe behavioural impacts is take advantage of natural experiments, such as when there is an increase in a developer charge in one area but not in a comparable adjacent area, then look at any subsequent price changes compared to the “control group.”

Alternatively, one can attempt these types of natural experiments with statistical controls, and a recent paper does just that when looking at the house price effects from additional costs imposed to finance infrastructure.

They find that not only are proper statistical controls very difficult to implement, but that prices decrease per dollar of additional infrastructure charge by somewhere in the range of $0.33 to $2.09.

This range captures the standard view that costs do not pass on in prices, which in the case of developer charges means that the developer or previous landowner bears the full cost of the charge, and not the homebuyer. Davidoff and Leigh’s controlled results support this view on the incidence of stamp duties in Australia.

These more properly controlled results are consistent with the political actions of the property industry who oppose developer charges because they bear the full cost.

Why is all this important? Vested interests benefit from any illusion of unsettled academic debate. In the case of developer charges, the property lobby can maintain an intelligent-sounding “Goldilocks” view in public debates that goes something like this: “The research is not settled. Nevertheless, it is likely that we do not pay the full charge, nor do we pass it on completely in home prices. The cost is probably shared between us and the homebuyer.”

They capitalise on this apparent uncertainty by claiming that they are aligning their interests with the home-buying community, a seductive “Goldilocks” view that is hard for politicians to ignore.

Property developers pay developer charges that is why they argue against them is republished with permission from The Conversation