Confronting the Great Enigma
Similar to today, the 19th century suffered from extreme levels of inequality, in their case spawned by the industrial revolution. Massive amounts of wealth were generated from steel trusts, railroad, mining and other monopolies. Meanwhile others struggled mightily to get by. The epicenter of these disparities was not surprisingly located in the nascent cities. The ethos of this era is captured by Henry George in his highly influential “Progress and Poverty”. George himself endured tremendous financial difficulty through the course of his life, and it was these experiences that drove him to question the nature of these excessive inequalities present in a technologically developed society.
To George the problem and solution was land. Provided by nature, and finite in quantity, land, to George should be a resource that benefits all. To clarify, not necessarily having land be held in commons, or the destruction of private property, but he advocated that the value of land, that is largely driven up by societal factors such as: infrastructure, public goods, roads, railroads, canals, proximity to schools, etc., should be enjoyed by the entire community.
A quote from the man himself should do justice: “By taxing land values, society could recapture the value of it’s common inheritance, raise wages, improve land use, and eliminate the need for taxes on productive activity.” H. George
One can easily imagine that quote alone lending support for causes ranging from the Marxist-socialist to free-market libertarian and any type in-between. As it did. Except for probably absentee land-owners. To them George was Satan.
Anyway, since most of these large-scale projects were financed from the public’s purse, George questioned the fairness of absentee land-owners or speculators who owned surrounding land to reap enormous gains and ground-rents by doing nothing. And fairness aside, he even argued it was detrimental to the functioning of a healthy capitalist society outright. His simple proposal was the Single-Tax. As the name suggests, one tax would be placed on land-values nation wide leaving productive forces unscathed and protected from Uncle Sam.
George looked around and considered… what are we currently taxing? Well in modern days, we tax labor with income/wage tax, we tax capital with corporate taxes, we tax consumption with sales tax, properties which are man-made improvements, with property tax, but we do not directly tax that which is naturally provided by earth.
The man who owns an empty plot of land- the value of which has skyrocketed thanks to the laying of railroads largely subsided by the government (in cahoots with rail monopolies) and thus burdening surrounding communities, is able to reap incredible wealth either by charging rents for others to put it to productive use, or by selling it at an incredible gain. Meanwhile the productive forces employed to build the railroads is taxed. To George, this seems just a bit backward.
That’d be like spitting in the face of our troops and praising politicians who sat in their comfy offices, for defeating Nazi Germany.
Without digressing into a discussion of the nature and role of the state to justify its existence and thus the need for taxation, or the discussion of political forces at play fighting such reforms or the distortionary economic effects of taxes, it is sufficient to remark that a majority of economists recognize that a land-tax would theoretically be the one and only tax that is efficient and non-distortionary in terms of Pareto analysis. It’s been dubbed as “the perfect tax” since the 18th century. Quite the compliment if I’ve ever heard one.
Now… One can answer the brutal question whether such a tax is politically possible by asking yourself if you’ve even heard of the idea. And if so, have you ever heard it discussed by politicians in a serious manner?
My inclination is no, but that’s no call for nihilism.
And let us not be mistaken, a perfect, ideal Single-Tax as proposed by George would not come close to funding the entirety of the government in 2021 and was to an extent simplistic, hailed as the solution to all our problems. But, the idea of it as the basis, and foundation of our tax-system is intriguing when considered in terms of prioritizing human agency, creativity, and effort over speculative privilege or extortionary rents. Something worth exploring another time.
For practical and political purposes, the wide-spread effort to achieve George’s idealized solution has waned and Georgist political efforts in the 1800’s failed to gain traction. Yet there are modern innovative solutions that as a group are referred to as “value capture”. It’s a type of public finance aimed to recover all or some of the value that public infrastructure generates for private landowners. It retains the essence of Georgism but typically at the local/municipal level.
What we will consider here is a peculiar example that has been utilized heavily in Brazil to varying degrees of success since the turn of the century. We will consider it’s effectiveness drawn on studies by economist Paulo Sandroni and Julie Kim of New Cities Foundation. A full exposure to the instrument will inevitably give rise to questions whether it is viable for a fully-developed country such as the U.S to consider, and if so, what political circumstances could aid its implementation.
What we are dealing with here is an exciting acronym — CEPACs also known in the ‘biz’ as Certificates of Additional Construction Potential bonds. How and why did these new instruments come about? And what are they?
History Time:
These financial tools were first introduced in tandem with what were essentially private-public partnerships (referred to as Urban Operations in Sao Paulo) designed to transform parts of cities for urban development in the late 1990s (although CEPACS were not implemented in an auction until 2004). For Sao Paulo, the reality that Henry George expressed as “the association of progress with poverty is the great enigma of our times” once again reared its ugly head. Ignacio Amigo’s account of Brazil’s land value capture in the latest release of the free quarterly magazine, “Land Lines” explains it honestly: “across the Sao Paulo region, affluent areas with luxurious houses adjoin crowded, economically precarious neighborhoods where residents have built their own houses out of brick and metal”. Two different realities within miles.
As mentioned, CEPACS were introduced as another form of value capture. They are a market-based instrument, meaning they are electronically-auctioned to private developers, with the issuer setting a minimum “face-value” price. These developers bid on the right for additional building rights on a given plot of land/area that is enabled by rezoning laws and/or public investments. Thus providing direct revenue to municipalities that can be earmarked for specific objectives and public projects i.e., affordable housing or build key infrastructure and transportation.
One of the crucial benefits of CEPACS over previous “value capture tools” in the context of urban development, is that with CEPACS the revenue provided to municipalities does not depend on the timing of the construction from developers. Whereas in the past, the timing of construction of the infrastructure was similar to the development of the project. Any delays were mutually reinforcing. With CEPACS, not only do governments get their funds upfront before building begins, but once private developers obtain their rights, they can choose when to build, so as to pick the optimal point in a real estate or business cycle. Added flexibility for both parties.
Case in point, the first ever implementation raised the equivalence of $15 million US Dollars, which helped to construct a cable-stayed bridge over the Pinheiros River and 600 affordable houses to urbanize a local slum in Brazil. Most importantly it required no municipal indebtedness, which could free up other budgetary space for other crucial public goods, or to eliminate the size of the budget altogether depending on your fiscal philosophy. Furthermore it was estimated by Sandroni, that the first 5 years of auctions resulted in revenues 50–80% higher (adjusted for inflation) than previous tools.
Please Tell Me More About CEPACS:
The experience in Brazil provides some anecdotes on the success and failures as well as an overall understanding on what conditions must be met to correctly implement the instrument.
To start with the foundation, these instruments required years- approximately 16 years from the Constitutional establishment in 1988 to first issuance in 2004, of laying the legal and institutional groundwork. Much of this included developing city planning, land use planning and the laws that went into that.
To move onto the technical- based on their use in Brazil, they are in essence a bond (financial security), so they do carry systemic risk that originates from the health of the overall financial system. Their prices can fluctuate with market conditions and expectations, as after all their prices depend on supply and demand conditions. For example, when the legally-designated amount of area is close to being met, the price of a CEPAC will tend to rise in response to the reduced supply of area for development in a region. The reason for a legal limit, is because building density and taller buildings simultaneously necessitate stronger infrastructure in the form of power grids, wider roads, higher water pressure, etc.
Also developers who try to speculate on the price of CEPACS can experience tremendous losses. Yet, as developers begin to better understand these relatively new instruments a secondary market could possibly form, meaning more liquidity for these instruments outside of the initial auctions.
And although these instruments are technically bonds, they are a special type. In the sense that they do not act as a credit against the local government. Since governments are paid up front in exchange for the right to build, if the building project falls through the developer can not demand their money back. So there is no risk of failing to receive revenues for public finance.
Sardoni warns that implementation of this instrument to other countries should be done with extreme caution. It is not a mechanical process. It’s success depends on local conditions as well as rising real estate markets and a strong and sophisticated financial market. And it goes without saying, competent and expert public servants are needed to execute auctions in favorable conditions and to ensure the proceeds are used properly. This latter remark is especially the case for CEPACS linked to affordable housing projects designed to mitigate the gentrification tendencies of development. For this reason it is crucial for public servants from an internal agency to optimize around real estate market conditions.
Why Should America Care?
Many American cities are in financial free-fall. The 2020 Truth in Accounting Report on the financial stability of cities, claimed that 63 out of the 75 largest cities simply don’t have enough money to pay their bills, racking up $323 billion in debt. I can not imagine things have improved when you throw a generational pandemic in the mix. So we know that public finances at practically every level of government are in terrible shape. We also know that the U.S has long neglected their infrastructure and are in dire need of modernization and improvement. And that’s to say nothing of climate change, and the potential for infrastructure investment to largely address it. A closer look at the debt obligations of municipalities will highlight that almost all of it is related to pension funds and retiree health benefits. Leaving no room in a shrinking budget for the local and urban infrastructure improvements that are so desperately needed.
I mean, our cities are practically screaming for a solution, no? Yet commentators and pundits continuously beat the drum of “HoW aRe wE goIng tO fUnD iT?”
As stated previously, CEPACS have no effect on municipalities debt limits and obligations nor on tax-payers, surely a refreshing sign. From the investor stand-point they offer diversification in their risk-return portfolio and new means to invest in real-estate. Also, the primary beneficiaries of the new development and increased land values are those who will fund the new public goods, as opposed to the general tax base which is comparatively more regressive. Providing another tool in the tool-box to begin to address massive wealth disparities in American cities by using an innovative, local, market-based mechanism.
The added bonus of being a potential local-vehicle for turning towards green infrastructure with out infringing on the tax-payer is a beautiful thing.
The increasing demand for up-zoning in high-population, high-growth cities such as San Francisco and New York City are prime locations for initial implementation and experimentation. Especially considering the surging cost of real-estate.
Sounds great but is it possible to see these utilized in American cities?
Local Implementation and Political Obstacles:
For one, politically motivated challengers could disrupt confidence in the operation by threatening to remove or overturn any legal steps made towards implementation. Which is especially of concern in our extremely partisan environment. If the institutional bedrock is shaky, sure enough the market response and it’s confidence will be. Possibly thwarting the whole plan before it gets off the ground.
On top of that, it seems that general trust and faith in government is at an all-time low. There’s just not much faith in problems being solved by bureaucrats. I believe the fact that this tool would in no way depend on the federal government could work in its favor. Local implementation, where the boots are on the ground could facilitate a more intimate relationship with all parties involved: municipalities, developers, landowners, investors and citizens impacted by new public goods. As well as the fact that it’s a market-based tool where funding for the government is provided upfront and does not depend on budgetary constraints.
In terms of the general public there will surely be opposition from lack of knowledge, or ideology rigidness. The complexity and newness of the concept and implementation will surely raise suspicions and give rise to misunderstandings or misconceptions for political reasons or just ignorance. Some may spin it as the forfeit of power and control of local governments to private agents by relinquishing the ability to change zoning laws in the future by selling the building right. Other’s as another way for Uncle Sam to pick the pocket of hardworking Americans. Additional economic research and general distribution of information would be of tremendous help in this regard.
Once immediate rejections are hurdled, the next obstacle at the local-level is to have investors and developers buy in, without which, nothing happens. In that sense, implementation may call for flexibility in some of the provisions depending on investor needs.
Regardless, the first step towards making this a possibility is general education on the tools available and what problems those tools can solve. It seems evident enough to the casual observer that the economic predicament that the U.S and its municipalities finds themselves in would mean they are open to new, innovative solutions that at least on the surface appear to fill a glaring hole. But at the same time it may require a shift in the political environment as well as additional research to make confronting a piece of the great enigma a practical reality. Which won’t solve all or even most of our problems, but is a step in the right direction.
In the name of Henry George, I leave you with this information.
