Better functioning towns and cities

23 February 2018

The overwhelming majority of Australians live and work in cities¹. About 80 per cent of Australia’s GDP is produced in cities, and 40 per cent in our two largest: Sydney and Melbourne. On current trends, over 80 per cent of Australia’s population growth to 2050 is projected to occur in capital cities — so how cities operate now and in the future is integral to both the quality of people’s lives and national prosperity.

The contribution of cities to growth

• Contributions to total employment growth by decade

  

  Source: (ABS 2017a) Cat. no. 6291.0.55.001 – Data Cube LM1 - Labour force status by Age, Greater Capital City and Rest of State (ASGS), Marital status and Sex, February 1978 onwards.

Many policies that affect how cities function overlap with those that also matter for people to be healthy, for the availability of long-term employment opportunities, for markets to work efficiently and so on. But cities are distinguished by their physical dimensions and high concentrations of people, which means that policies affecting the availability and use of space, organisation of activity and the pace and distribution of population growth particularly affect city liveability and productivity.

How are Australia’s cities functioning?

Indicators show that Australia performs highly on many indicators of wellbeing, but cities are also facing some significant problems as they grow. Among them: increasing traffic congestion, undue restrictions on housing supply and business investment from ad hoc and anticompetitive planning and zoning, some poor decisions on public infrastructure, and an unsustainable funding basis for roads. Stamp duties, while a bonanza in times of rising housing prices, are unfair and inefficient.

Three priority areas for reform

The Commission’s recommended reforms focus on:

• improvements in public infrastructure provision and use. The Commission particularly focuses on roads, where poorly conceived projects and waste are not uncommon, and technological change will make fuel excise an ever-diminishing source of revenue for funding roads. Road pricing and consumer input into decisions will provide coherence to road investment and use, escaping the allure of projects with political appeal but that may not be in the public interest
• planning and land use policies, including the application of competition principles to land use regulation. This sounds like a ‘dry’ matter, but having affordable services and housing options where people want them is central to peoples’ daily lives
• switching from stamp duties to taxes based on land value, which would avoid penalties imposed on those who choose to move (for either work or lifestyle reasons) and provide a more stable revenue source.

Reform priority 1: Change how road services are chosen and funded

Arrangements for determining infrastructure investment priorities and managing the infrastructure, once built, are crucial for ensuring taxpayer funds are well spent, and investments lead to actual improvements in the quality of people’s lives.

There is an urgent need to reform arrangements for road provision

There is scope to improve all transport modes in Australia, but roads deserve special attention.

Roads are the single largest infrastructure spending item for governments in Australia, and they are the most prevalent and widely used form of transport in cities. Yet they are also the most susceptible to poor decision-making and inefficient usage patterns. Governance arrangements over road investment significantly lags other transport modes, with minimal links between charges and the services users receive, the quality and availability of services and road user preferences, and the costs and funding of service provision and prices.

The mechanisms within governments for ensuring that projects with the highest net benefits are chosen for the community are relatively weak. Surveys indicate that the substantial investments in new road capacity in recent years have provided some relief to motorists, but also induced greater use of roads — raising questions about the sustainability of an ever-continuing ‘build’ model.

Not infrequently, road expenditure decisions are reactive, subject to political suasion, and may not be exposed to adequate evaluation.

Poor decision-making wastes billions of taxpayer funds: Victoria’s East-West Link

• The East West Link project was one of the largest transport infrastructure projects proposed in Australia. The project was to be an 18 kilometre cross city road including tunnels connecting Melbourne’s Eastern Freeway to CityLink (stage 1), and the Port of Melbourne precinct to the Western Ring Road at Sunshine West (stage 2). The estimated total cost of the East West Link, had it proceeded to completion, was in excess of $22.8 billion in nominal terms.

  The initial business case indicated that stage 1 of the project would generate costs that exceed benefits. The Victorian Government nevertheless signed a contract appointing the private contractor, East West Connect, to finance, design, construct, operate and maintain stage 1 just prior to the caretaker period leading into the November 2014 Victorian state election. This followed an indication by the then Opposition that it would not proceed with the project if it formed Government.

  The newly elected Victorian Government reached an agreement with East West Connect to terminate the project. The costs to Victorian taxpayers of terminating the project were in excess of $1.1 billion.

  The Victorian Auditor General cited a lack of transparency of the business case for the overall project and the decision to prioritise stage 1 as a driver behind the significant wasted expenditure. The problem of the poor connection between Melbourne’s Eastern Freeway and City Link has since been identified by Infrastructure Australia in its February 2017 Infrastructure Priority List as a ‘high priority initiative’ given this corridor had the highest cost of congestion in Melbourne in 2011.

Current sources of road funding are inefficient and unsustainable

Many motorists are unaware that they pay, on average, over $1 300 a year per vehicle for road services via a range of indirect fees and charges, including fuel taxes and registration fees. These charges are pooled into governments’ consolidated revenue and allocated to roads and other areas through budget processes.

Unlike most other areas of service provision, the charges motorists pay have little relationship to the services they receive. For example, charges play no role in placing pressure on governments to improve the efficiency of service delivery or to better tailor services to road users’ preferences, in informing commuter choices, or in prompting governments to develop better service alternatives by making the costs of road use transparent.

If nothing else, an  immediate driver of change is the continuing slowing of growth in road-related revenues, which will put pressure on current road supply models — since demand for (and the cost of) improvements shows no such slowing.

In particular, fuel tax revenues (the largest single road-related charge, accounting for about 45 per cent of total road-related charges in 2015-16) have declined and are projected to continue to fall in real terms due to the improved fuel efficiency of cars, changes in travel preferences of commuters, e-commerce and the anticipated shift toward electric vehicles (which use no fuel, or little in the case of hybrids) — all of which reduce average fuel consumption. At the same time, automated vehicles and new technologies enabling more convenient ride-sharing are revolutionising transport.

Road-related revenues are in structural decline^a,b

• Road revenues and expenditure to GDP

  

  a Aggregated over all levels of government. b Includes work done for and by the public sector, but excludes that done by the private sector for the private sector.

  Source: BITRE (2016) Australian Infrastructure Statistics Yearbook 2016 .

These trends imply a need to move to a form of funding road expenditure that is responsive to road user demand (rather than simply predictive of it), does not discriminate by vehicle type, and is directly related to actual road usage. The present system displays few of these features.

Better meeting road users’ needs

If the stresses above are to be managed, there should be a shift in focus towards consumer-oriented and directed services. Key features of a better system for road funding and delivery include:

• investment decisions on roads being informed by users’ preferences
• replacement of the current array of indirect fees and charges on motorists with explicit prices, which will make transparent the costs of providing road services and allow the development of sensible alternatives for meeting service goals
• users’ choices between transport modes, and the use of roads, being guided more by prices that help to allocate finite capacity, resulting in more efficient use of the transport network
• public confidence in the price-setting process through independent vetting of proposed expenditure and the quality of service actually provided — so that prices only reflect the efficiently-incurred costs of services that are valued by users.

There is broad consensus on the merits of moving from the current set of disparate charges on motorists to direct pricing for road users. Cost-reflective user pricing should apply to all vehicles.

Much of the benefit from reforms will come from the selection of better road projects. The value of more efficient use of the road network alone, however, is estimated to be equivalent to approximately 0.7 per cent of GDP in the long run, or a permanent increase to the level of annual GDP of approximately $20 billion.

Current technologies make it feasible to create a system of funding roads that is directly linked to demand. Revenue from charges should be pooled and reserved exclusively so that road users are confident they are paying for improved road network services and not for some other function of government. Additionally, pricing mechanisms will need to take into account distributional issues, such as the impacts of pricing on rural and remote roads.

Reform priority 2: Increase the productive potential of land

Planning and land-use policies affect how cities physically develop and function. Planning policies particularly affect the productivity and growth of cities through their determination of possibilities for the use of land, coordination of different activities, and the management of the indirect effects of concentrations of people and activity.

For example, planning rules determine or where and what types of houses can be built, where businesses or recreational places are located and how they operate, people’s ease of movement and cities’ capacities to absorb population growth.

Many State and Territory Governments have made good progress in planning reform over the past five years, and are continuing to pursue changes. However, further action, particularly on restrictive zoning regulations, is required.

Zoning restrictions should be reduced

Most development and land use activities are carried out under authority of local planning instruments that list the types of development allowed in each zone of a Local Government area. State legislation sets out the types of allowable zones (whether residential, business, rural, environmental protection or other), objectives for activity within those zones, and the specific types of developments that may be carried out in accordance with the purpose of those categories of activity.

The multiplicity of zone categories and degree of prescription on allowable activities within those categories are problematic. For example, New South Wales has eight types of business zone categories, each specifying the types of developments that may be undertaken with the consent of the relevant Local Government. Local Governments use these zoning categories to develop specific plans for their areas, which usually include additional requirements to gain consent. This can lead to different treatment of the same types of land use across council areas. By creating barriers to entry and diversification, zoning classes and the prescriptiveness of permitted land uses can limit investment, new employment, productivity improvements, and competition between businesses.

Even the smallest jurisdictions, Tasmania and the ACT, have 5 to 6 types of commercial zones, with each having 23 zone types in total. Victoria stands apart from other jurisdictions in having just two business zones.

Zoning systems should be re-oriented to promote overall community interests

Zoning frameworks should provide as much flexibility as possible in how land is used. This would allow new and innovative firms to more easily enter local markets and existing firms to expand, as well as providing greater flexibility to adjust to changing business activities and community preferences.

Provisions that explicitly or implicitly favour particular operators or set proximity restrictions between businesses should be banned. These policies are at odds with competition policy and used to protect shops and shopping centres in designated areas from competition. Estimates indicate that the potential benefits of reducing the prescriptiveness of zoning systems are significant.

There should be national agreement to apply competition policy principles to land use policies. Like other policy areas, restrictions should only be imposed if they are in the interests of the community as a whole

Reform priority 3: Improve access to housing by removing stamp duties

Stamp duties on residential property add to the price of houses, can discourage people from moving to locations that may be closer to preferred jobs, and lead to less productive uses of land. In Sydney, stamp duty on residential property for the median house price in May 2017 of $1 198 650 was $51 419, representing 4.3 per cent of the purchase price.

The impacts of stamp duties on community welfare are significant. A recent Treasury working paper estimated that each additional dollar collected by way of stamp duties on residential property reduces the living standards of Australian households by 72 cents in the long run due to the lower investment and mobility effects.

Replace stamp duties on properties with a tax based on land values

Given the reliance of State Governments on stamp duty revenue, the removal of stamp duties is likely to require replacement of this revenue source with another. A more efficient tax with much lower costs to national welfare would be a land-based tax. Taxes based on land values avoid the imposition of penalties for moving, and the inequity of tax burdens falling disproportionately on those who choose to move. Tax revenue is also more stable because it is not as exposed to the volatility of the housing market.

The ACT Government has moved away from stamp duties to taxes based on land value. Specifically, it is phasing out stamp duties over a 20 year period, and replacing these with higher general rates for residents and commercial properties. The Commission recommends that States and Territories follow this example.

The tax changes should be revenue neutral, as the aim of the policy change is not to increase tax revenue per se. Analysis by the Commission and others indicates that a switch to land taxes based on an assumption of revenue neutrality would result in generally low land tax rates.

Nevertheless, a shift to broad-based land taxes may detrimentally affect owner-occupier households with low incomes, such as many retirees, who may have less flexibility to move and limited capacity to pay taxes from current income. A new system should ensure that such groups are not unduly disadvantaged. Options for addressing welfare impacts include concessional tax rates, the deferment of tax for eligible landholders, or help via the income support system.

The key elements of the Commission’s recommended reforms are:

• Replacement of stamp duties on property transfers with a broadly-based tax on land values. The shift to a broad base is essential to ensure that revenue is raised efficiently and the tax burden is not disproportionately imposed on a few groups.
• Provision for tax deferral for certain low income groups, so that taxes do not force people with less capacity to move. These include people such as owner-occupier retirees, who may be attached to the family home and their community.
• Low interest rates on deferment of taxes, for example bond rates, consistent with the policy objective of deferment.

State and Territory Governments should move from stamp duties on residential and commercial properties to a broad-based land tax on the unimproved value of land.

Footnote

1. Areas with populations greater than 100 000. Locate Footnote 1 above