Putting a dampner on boom and bust

The building of the Jubilee Line in London, it is estimated, has added more than £13bn to property values. The cost of construction was just £3.5bn and the net gain nearly £10bn. Some £180m was paid towards the cost of the line by the developers of one small area affected by it: Canary Wharf. The vast majority of landowners along the route enjoyed a large windfall with no contribution whatsoever.

The second problem arises when public authorities award simple planning permission for a greenfield site. This can boost the value of a hectare of land from £7,534 to £1.23m, according to the Barker report. It is a gain created wholly by society, yet almost all goes to the owner of the land. If the local authority is savvy, it can use Section 106 of the Town and Country Planning Act 1990 to negotiate concessions from the developer, but the process is random.

Faced with these problems, the Barker review recycled one of the Treasury's old hobby-horses - the 'planning gain supplement'. This tax on the increased land value, payable in order to receive the planning permission, is similar to several previous attempts to impose development gains taxes such as the 1947 development charge, the 1967 betterment levy and the 1973 development gains tax, followed by the 1976 development land tax. All died through asphyxiation by their own complexities.

Planning Gain Supplement does nothing to help fund infrastructure through existing built-up areas. Any developer who sees gains in rents and values as a result of a new Tube line can rest easy: the profits would all still be theirs. The 'planning gain supplement' would actually reduce the amount of land coming forward for development, because the profits would be lower than they are now. Yet the priority, particularly in London and the south-east, is to increase the amount of new housing, particularly affordable homes for those on low incomes.

An alternative proposal - a tax on the value of land, or a site value rate - would take longer to implement, but would address the fundamental problem, not its symptoms. If the land was not developed, the landowner would have a regular charge to pay - a carry cost - that he or she does not have to pay today. He or she would therefore have an incentive either to develop or to sell to someone who would develop. By periodic revaluations in rateable value, any rises (and falls) in land prices due to changes in physical infrastructure, such as new Tube lines, would be reflected in the tax base and hence in rating income.

A land value tax would also tackle a large market failure in many depressed urban areas. The National Land Use Database finds that 12,000 hectares of previously developed land are available for residential use even in London, the south-east and the east of England. According to the planning authorities, 360,000 houses could be built on that land - enough to stop the house-price boom in its tracks. Much of this land is now completely unused, being either vacant or derelict. What accounts for this apparent failure in the housing market, for this paradox of unused and underused land amid soaring demand?

If we are to believe the Barker review, it is all a question of the planning system. Certainly, that is part of the answer. But what is also important is that the market does not provide adequate incentives for landowners and developers to redevelop in existing urban areas. At present, many owners of urban land allow it to fall into disuse or underuse because there is no cost in failing to develop. The significance of a site value rate is that landowners would have an incentive to develop immediately sites that fall into disuse, limiting the possibility of spreading blight. Paying an annual charge for land, regardless of what is built on it, concentrates minds wonderfully.

A tax on land values can dampen the cycle of boom and bust in British property prices by discouraging the hoarding of land during price upswings. It can make a crucial contribution to the financing of social improvements. It can shift private incentives so that areas do not fall into unfashionable disuse because of blight. It provides an incentive for developers to bring forward plans that are tailored to social needs. Where such taxes are applied, there are higher levels of construction activity and a better-looking urban environment.

These potential gains are not inconsiderable. Land value taxes can hugely improve our cities and towns.

Chris Huhne MP is the Liberal Democrats’ Shadow Environment Secretary