The Little Engine That Could (Fund Itself)

January 14, 2021

Can public transit fund itself by building housing on its land? That’s the fundamental question Common Ground California asks in their new white-paper, “Transit Value Capture for California.” The idea from authors Derek Sagehorn and Joshua Hawn is simple: public infrastructure investments, such as transit and other capital improvements, increase land values for everyone in the area, including private property owners. Transit agencies can tap into this wealth as a steady source of revenue without having to rely as much on sales taxes and fares, which fall more heavily on the poor.

Here are the key takeaways:

  1. When US transit agencies develop new infrastructure, they are often leaving money on the table by giving away increased land value to private owners.
  2. Transit agencies in Asia are far more financially sustainable, and can develop infrastructure more robustly, in part because they have more power to own, develop, and tax nearby land.
  3. Based on prior studies, a tax on increased land values in the San Francisco Bay Area could net over $100 million in annual revenue for transit agencies.

Recent ballot measures to fund transit in the San Francisco Bay Area have either failed or passed by narrow margins: Sales taxes in Contra Costa and Marin Counties failed; BART’s bond measure in 2016 narrowly passed; and statewide, the failure of Proposition 15 brings the threat of real austerity to countless transit agencies.

Sagehorn and Hawn argue that it doesn’t have to be this way. “While parcels far from transit are less likely to see direct benefit from this investment, landowners generally have seen massive gains already in a dynamic regional economy even without significant transit investment,” they write. Taxing these gains to fund transit could create a permanent, “virtuous cycle” of public investment in sustainable, affordable transportation.

A study by Dr. Shishir Mathur at San Jose State University found that land values around the newly-completed Warm Springs BART station in Fremont increased by over five times what the station itself cost to build. Meanwhile, New York City recovered only 30% of the uplift in land values from its Second Ave subway extension through property taxes. In essence, the remaining 70% was, in common parlance, a “giveaway” to real estate investors. Sagehorn and Hawn argue instead for giving it back to public transit.

The paper draws on real-world examples of land value recapture financing public transit: in the greater Tokyo area, the seven rail operators there saw 30-50% of their revenue coming from the ground rents of public-private developments surrounding their stations. Hong Kong’s train operator receives no government funding, and relies largely on rental income from adjacent properties and the sales of exclusive development rights on its land holdings. In Taiwan, a “land value increment tax” levies progressive tax rates on the land value delta upon resale. The more a landowner profits on selling land, the higher the tax on the sale: for example, a commercial property sale netting a 200% profit over its original purchase would be taxed at 60%. Meanwhile, owner-occupied property sales remain taxed at 10% across the board.

Sagehorn and Hawn borrow largely from the Taiwanese model and Dr. Mathur’s research to propose a few ways California could capture land values for transit. In one model, the California Department of Finance would establish “Transit Value Capture Districts” (TVCDs) comprised of properties within a close radius of transit stations. These TVCDs would levy a progressive capital gains tax on the sales of real property within the district, with higher rates levied on properties closer to the station, and they could be graduated progressively based on the difference from the original purchase price, as Taiwan does.

Crucially, Sagehorn and Hawn note that implementing this as a capital gains tax through the personal income tax code avoids pitfalls of a Real Estate Transfer Tax (RETT), which can fall partially on the buyer of the property, and can be whittled away through negotiations of the sale. The authors note that the Metropolitan Transportation Commission studied a similar tax structure in 2017 and found that a 3.5% tax rate on property sales in the bay area could collect over $100 million per year.

However, Sagehorn and Hawn caution that “arbitrary tiers according to nominal dollar figures could encourage manipulation of prices to avoid higher tiers. Instead, it may be preferable to graduate rates based on percentage value of land gain over the property tax basis….Such a graduation scheme would target capturing windfall land gains rather than high sales prices in and of themselves.” But the paper also includes a progressive RETT proposal, drawing major inspiration from the research of Shane Phillips at UCLA. Implemented at a regional scale, Phillips’ annual revenue estimates for Los Angeles County range in the billions of dollars.

Sagehorn and Hawn also note that significant political reform will be needed for California to approach. For instance, expanding the voting franchise on new assessments, and lowering the vote threshold required to pass special taxes, would reduce political barriers to value recapture.

California’s voters and leaders face a stark crisis in public transit during COVID-19, as agencies throughout the country face fiscal death spirals. Sagehorn and Hawn’s paper lays out several ways to flip that spiral into a positive feedback loop to cool down not only the speculative real estate market, but our climate as well.