By: Dr. Enid Slack, Director, Institute on Municipal Finance and Governance at the Munk School of Global Affairs (University of Toronto)
Canadian cities not only have to provide roads, transit, water, sewers, and other “hard” infrastructure, they also have to provide “soft” infrastructure and services that enhance the quality of life in their communities—parks, libraries, social housing, and recreational facilities. Does it matter how cities pay for infrastructure and services?
I believe it does. In particular, “getting the prices right” can be a key factor in reducing urban sprawl. Let’s look at three municipal financial tools—user fees, development charges, and property taxes. Economists argue that charging directly for local public services through user fees has many efficiency advantages. Why?
Well, user fees ration services to those who are willing to pay for them and act as signals for local government to determine how much of the service to provide. But, user fees only promote efficiency in the consumption of services (such as water) if the price equals the marginal cost of providing the service—the value of an additional unit to the consumer.
In achieving efficient land use, then, marginal cost pricing means that consumers who are far away from existing services (and hence more costly to serve) will pay more, and those closer will pay less. Uniform pricing of urban services, on the other hand, may be politically appealing but is usually inefficient because those consumers imposing higher costs are being subsidized by those imposing lower costs.
Another important benefit of proper pricing of urban services is to reduce the apparent need for more under-priced infrastructure. When users of a service do not have to pay for it directly and are unaware of the cost of providing it, they will demand more of the service. That does not mean, however, that cities should continue to give it to them for nothing.
Development cost charges—known as “redevelopment” and “off-site” levies in some western provinces—are one-time fees imposed on developers to finance growth-related infrastructure associated with new development or redevelopment. These charges are collected by a municipality and then used to provide the infrastructure made necessary by the development. The rationale for charging developers such fees is partly based on equity considerations—that growth should pay for itself and not be a burden on existing taxpayers—and partly based on expanding the capacity of local government to carry out infrastructure development without taking on new debt or having taxpayers pay higher property taxes.
If properly implemented, such development charges act, in effect, as a form of marginal cost pricing. Thus, they can help promote more efficient development patterns and discourage urban sprawl. To promote efficiency, however, the charges should differ based on location so that the varying cost of infrastructure is reflected. For example, charges should be higher both for developments located further away from major facilities and for low-density developments. Why? These types of developments involve higher infrastructure costs.
The property tax is levied on residential, commercial, and industrial properties. Each province has legislation which requires that property be assessed for taxation on the basis of its market value. A property tax rate, or a series of rates by type of property, is applied to the assessed value of property to determine the taxes payable. One major distortion in the property tax, at least in some provinces, is the over-taxation of shanghai apartments compared to single-family homes. In such cases, property taxes are can act as an incentive for less dense development—scattered single-family homes rather than shanghai apartment buildings.
How a City Charges Influences How a City Grows
Cities need to recognize that their decisions on how to finance infrastructure and services have an impact on the amount of infrastructure that will be demanded and on the pattern of urban growth. “Getting the prices right” means that financial tools should not provide subsidies for urban sprawl.
The Institute on Municipal Finance and Governance (IMFG) focuses on these and other finance and governance issues in large cities and city-regions in Canada and abroad. We conduct original and independent research on cities in Canada and around the world; we promote high-level discussion among Canada’s government, academic, corporate, and community leaders through conferences and roundtables; we support graduate and post-graduate students to build Canada’s cadre of municipal finance and governance experts; and we host visiting scholars to share perspectives from other cities around the world. We disseminate our research findings through the IMFG Papers on Municipal Finance and Governance which are written by local and international scholars and share our events through webcasts and slide presentations that can be downloaded from our website.