Getting development incentives right

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By Leith van Onselen has published a thought provoking article today quoting the New Zealand Initiative’s executive director, Dr Oliver Hartwich, who argues that the key to improving housing supply and affordability is to shake-up local government financing so that they receive funds in proportion to their populations. Such reforms, Hartwich argues, would align local government incentives so that they become pro-development.

Hartwich using his native Germany as a model that New Zealand should look to emulate. There, real house prices have not risen for around 40-years (see next chart), speculation and “panic buying” from first home buyers affraid of missing-out is non-existent, and most buyers instead choose to rent.

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“In Germany councils have a very limited role in actually setting taxes. They can’t just easily introduce new taxes or set tax rates. But they can certainly influence their tax base,” Hartwich said. “What I mean by that is they can try to attract people and businesses, and the more people and businesses they attract, the more the council will have in its budget.”

“In Germany you pay your taxes to the state government. The state government redistributes your taxes and the councils compete for a share of the income taxes collected at the state (level). Councils get it according to how much income tax is generated locally and how many people they have within their council’s boundaries”…

Because the councils receive money per person in their area, they want to attract people and businesses, and thus tend to work closely with property developers rather than have “antagonistic” relationships with them, he said.

“The councils are all happy to take you because you can see the euro signs in their eyes.”

“Germany has built some very attractive cities, some very green cities. They haven’t had any house price inflation for 40 years, they’ve had deflation. There’s a lot of competition between councils, they all want you, they see you as a customer. It has made Germany a tenant’s paradise,” added Hartwich.

He suggested home ownership rates were low in Germany compared with many other developed countries because it simply doesn’t pay to “jump into” the property market.

“You cannot realise any capital gains in the housing market (so) why would you jump in? Why would you do it in your early 20s? There’s nothing to be gained. You can easily wait until your 30s or 40s until you buy your first home. I think that makes it quite a relaxed housing market”…

Looking at New Zealand’s housing conundrum, Dr Hartwich believes that it needs to “Focus almost exclusively on the supply side”:

What we need to do is co-operate with local government, to change their mindsets to make them proponents of growth, to make them positive about growth.”

“I want (NZ) local government to be as positive about growth as in Switzerland and Germany,” added Hartwich. “(There) they pretty much behave like an entrepreneur in a sense because they can see development as a profit maker. That means we have to change the way we tax things. We also have to change the way we fund local government. I generally believe we have to tax things that have legs and therefore not land.”

“I don’t think property rates is the best way to fund local government because it makes them very lazy. You can always tax land, it can’t run away. I think the Swiss model of taxing people rather than land is better because you actually have to make sure you attract people and keep them there and keep them happy. You can also tax businesses because they also have the choice to leave if they don’t like it,” Hartwich said.

Hartwich’s approach is certainly valid, and would likely lead to far better housing outcomes than are being experienced presently in both Australia and New Zealand. The problem, in Australia’s case at least, is that I don’t believe that it is possible to change current fiscal arrangements whereby the Federal Government receives the lion’s share of the revenue, whereas the state and local governments responsible for land supply and planning are burdened with the majority of the costs associated with bigger populations. In short, vertical fiscal imbalances are entrenched and will remain.

As such, we are left working within the constraints of the current system, which is why I advocate that Australia look to emulate the Texas model of permissive land supply and planning, combined with its innovative MUD infrastructure bond financing system in order to relieve the strain on state and local government budgets (see here for details). It is also why I support the states shifting away from inefficient and inequitable stamp duties towards broad-based land taxes.

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  1. Germany population growth (and always been pretty close to zero) has been negative for over 10 years, I m pretty sure that did something to their house price, they did not need to build over 4 million houses (1.5% growth differential wiht NZ, 2.6pop/house).

  2. I can’t see the Federal govt changing the system. I they control the funding, they have the power.

    Why would they change that?

  3. Hartwich’s German model would better suit NZ where there is just the two tier system of Govt. Much simpler.

    If only we could wipe the slate clean and start again.

  4. It is NIMBY’s who want no more development in their council area. (and I don’t use NIMBY disresectfully).

    They paid a price for an ambience, level of services etc and don’t want it diluted.

    Evidence is the upper North Shore of Sydney where Kuringai fought against higher densities along the railway until the NSW govt started the process of removing their planning powers so that all municipalities in Sydney bore a share of the burden of population and density growth.

    • “….They paid a price for an ambience, level of services etc and don’t want it diluted….”

      Quite so. So the solution is not allowing BANANA-ism.

      BANANA-ism and NIMBY-ism are actually antagonistic to each other. Development has to happen somewhere. If you allow BANANA-ism to prevail in “regional” planning etc, and elect local politicians that stand for growth containment, it is irrational to expect no conflict to them arise on the NIMBY-ism front.

      As I keep saying, the people of heartland and southern USA would seem to be a lot smarter than they are given credit for by the rest of the world, on this and several other issues.

  5. Yes, well the point has already been made on MB a couple of times that the funding arrangement whereby States who have to provide and maintain infrastructure and the Commonwealth that sets immigration quotas needs to be changed to provide just these incentives.

    So we beat the Kiwis. At something. Well, pointing it out at least. The crafty buggers across the ditch will probably beat us to actually doing anything about it though. Sigh.

  6. State and local governments should be all over this and land taxes. This would be the equaliser for small metropolitan centres to expand.

    • Good idea. However, the Feds have to be involved since there is no point in instituting land taxes if the Federal Government merely reduces State Grants to compensate. It has to be a national initiative involving all levels of government.

      Not sure if I can hold my breath long enough for that to happen.

  7. Neville Gearless

    How much room does Sydney have to expand anyway? The place is enclosed by a ring of national parks for a start. Most countries have the one basket case major city where immigrants want to crowd out. UK has London, we have Sydney. The important point is that the rest of the nation’s towns & cities dont have geographic constraints and should be allowed to grow.

    • Absolutely fair enough point. Paul Cheshire and colleagues at the LSE have been trying to persuade the Poms to let just one or two cities outside of London, grow.

      Throwing subsidies at growth-contained cities for decades in an effort to stimulate them and “take the pressure off London” has been a miserable failure.