The Value Capture Debate in Latin America

Value capture is an increasingly popular concept that seeks to capture for public benefit all or part of the increments in land value resulting from community, rather than private, investments and actions. Yet, based on the Lincoln Institute’s experience in sponsoring many educational and research programs dealing with value capture policies in Latin America, it is also quite controversial.

This article addresses some of the contentious and persistent issues that have engaged participants in the ongoing debate over value capture, ranging from basic concerns, such as the proper understanding of the legal basis for land property rights, to larger political questions raised by new or higher charges on real estate property. Technical issues also are involved, such as distinguishing land value increments (or plusvalías) attributed to specific public investments or planning decisions from other more general sources or factors that influence land markets, as well as pragmatic challenges that arise in selecting the right instrument for the right circumstances at the right time.

To gain a better understanding of value capture, one cannot rely simply on technical arguments or expert authorities. At the same time, one cannot dismiss the issue on purely political grounds by attributing the main obstacles to the implementation of value capture policies to well-positioned interest groups. Rather, a considerable share of the “unexplained variance” in the application of value capture seems to be the result of inadequate information or misunderstanding held by major stakeholders in the debate.

Figure 1 summarizes 10 contentious value capture issues; items 1, 2 and 3 are discussed briefly below.

Unfair Charges for the Poor

Although support for direct subsidies or grants to the poor is waning in Latin America, many still believe that the poor should not pay for urban services, or should be exempted from taxes and other charges on their land, as is required by many of the more progressive value capture policies and laws.

A common argument in favor of exempting the poor from such charges raises an intergenerational dilemma: since wealthy residents for many years have enjoyed urban services that they did not pay for, why should the poor be charged now for services that they need and deserve? Another argument centers on the idea that most land value increments in poor areas have in fact been generated by the poor themselves, through sweat equity or private schemes to access basic services in their areas, not through public intervention. Some recognize that urban upgrading programs simply bring poor settlements to the first stage of the urbanization process, which is a bare minimum for participation in regular land markets. Others believe that even a socially neutral value capture instrument may produce a regressive result, perpetuating the disparity between the rich and the poor in the context of inequitable access to urban facilities and services, as is the case in most Latin American cities (Furtado 2000).

On the other end of the spectrum are those who argue that value capture payments are part of the poor sector’s claim to full citizenship, including the right to demand attention from the government. There are many examples where the poor have been eager to pay for receiving services (such as water systems, public lighting and flood control) since the cost of not accessing them is perceived to be higher than the actual payment. This was the case in Lima, Peru, in the early 1990s when more than 30 poor communities participated in a public service program that included payment for the cost of the services provided.

A more theoretical and perhaps less intuitive argument considers the capitalization effect of any charge on land prices. That effect is the reduction (or increase) of the current market price of land by the capitalized or discounted sum of the costs (or benefits) affecting the future earnings the property is expected to generate. To the extent that value capture charges on regularized or upgraded areas are integrated in the expectations regarding the future burden imposed on unserviced land bought from illegal or pirate subdividers, they would tend to be capitalized in the price that buyers would be willing to pay or the subdivider was able to charge (Smolka 2003). Although the poor would end up paying the same amount over time, the money would go to the local public treasury rather than the subdivider’s pocket.

Incidently, a common but mistaken view holds that such charges (value capture or land value taxes) are inflationary or increase the market price of land. Although the capitalization effect is complicated, most people can understand a situation comparing two otherwise identical apartments, where the one located in a building with a higher condo fee would get a lower rent in the marketplace than the apartment with a smaller fee. The same line of reasoning may be used to explain why there is no double taxation between value capture and the property tax. The relevant land value increment resulting from some public intervention accumulates or adds to an observed base market price that already is net of the capitalized effect of any anticipated future benefits or burdens, including the property tax.

Acquired Rights When Changing Land Uses

Although few would argue that expectations play a crucial role in determining land prices, it is widely considered unfair if price compensation falls below current market prices. This idea is now beginning to change, as reflected in recent legislation. For example, Law 388 of 1997 in Colombia allows for public acquisition of land at fair market prices, but not including the increment of land value resulting from previous public investments or changes in regulatory land uses (see article by Maldonado and Smolka, page 15). The same principle is stated in Brazil’s new City Statute (Law 10.257 of 2001) when land expropriation is used as a sanction against a landowner who is not complying with social uses of the land. Many lawyers agree that expectations do not create rights; therefore, expectations not realized should not be compensated. The social unrest around public land acquisition that led to the postponement of Mexico City’s proposed new airport mega-project vividly illustrates this problem.

It is hard for the typical landowner who in good faith bought a piece of land with the expectation of using its development potential to understand why he should not be compensated for the loss of that land at the current market price or at least the acquisition price, even if the development rights had not been exercised. However, the result often depends on the extent to which the new policy is actually implemented. In practice, prices reflect expectations regarding the (usually weak) enforcement of existing legislation, including legal variances or loopholes in the relevant fiscal and regulatory environment. This has been the case in most court decisions regarding fair compensation on public land acquisition processes and on claims from landowners (or developers) on whom local administrations impose plusvalías charges. A more pragmatic argument is that rights may indeed be restricted by a new legislation or zoning code, as long as it is accompanied by adequate transition rules to protect the rights of those who had previous legitimate claims. Others defend the transition process as an indispensable step toward allowing the market to gradually absorb such changes.

Economists struggle to convey the importance of expectations in determining the structure of current observed land prices. How the future affects current land prices is in fact harder to express to the general public than the notion that current prices reflect rights as realized in comparable properties in the past. In Latin America expectations associated with land uses are not always related to zoning or building codes, but rather to land speculation. It may be of interest to note that whereas speculation in Latin America is associated with long-term retention of land, in North America it is associated more with rapid turnover of properties. The phenomenon of land retention for future development, with the consequent private appropriation of unearned increments in land values, has stymied urban planning and development ever since cities began expanding rapidly over many decades.

Asymmetrical Compensation for Wipeouts

The debate over value capture (i.e., capturing land value increments, windfalls or plusvalías) inevitably raises the question: What about the wipeouts (minusvalías)? The common perception is that governments are more eager to approve legislation to capture land value increments than to provide legal protections for citizens against takings or arbitrary compensation for equally predictable losses (minusvalías). The Latin American record has shown, however, that the balance between the plusvalías captured and the minusvalías paid for is clearly negative. The amount paid in compensation to landowners surpasses by far the small and sporadic gains the public has been able to recover from the direct benefits it generates for private properties.

All rents, and land prices for that matter, are in essence nothing more than accumulated plusvalías, or land value increments, over time, echoing Henry George’s argument for full confiscation of land rents. Thus, the alleged minusvalías are considered incidental and just part of a value to which individual rights are not (or should not be) absolute. The debate on this asymmetry bears directly on the proper definition of wipeouts and on how those losses are understood, which raises the issue of development rights. While some are willing to restrict the compensation for land and building improvements that the owner may lose, others argue that development rights are permanently built in as an inherent attribute of the land.

In practice it is not easy to make these arguments. What may be valid in the aggregate does not necessarily hold true for the part, since individual landowners consider it a loss in land value when, for example, a walled expressway cuts across their back yard or a viaduct blocks their view and produces noise and pollution. The average citizen is not easily convinced by the above arguments. The quest for symmetrical treatment is too socially and culturally sensitive to be ignored.

Transfer of development rights (TDRs)—an instrument originally conceived for compensating minusvalías from historical, architectural, cultural or environmental preservation ordinances for plusvalías somewhere else—has now been extended to mitigate other legitimate claims for minusvalías compensation. Some argue that regular compensation for wipeouts is a guarantee, making it easier to accept payments for windfalls. Under the equity principle, planning decisions including zoning schemes are recognized as potentially unfair with regard to the distribution of values in land markets. However ingenious the TDR instrument may appear, it does not help clarify the issues at stake. On the contrary, it adds to the debate since it simultaneously recognizes the right for minusvalías to be compensated and sanctions the right of individuals to plusvalías, reintroducing the question of private appropriations of community values.

Final Comments

The complex debates over value capture policies and instruments in Latin America indicate that much remains to be researched and learned. If the issues do not necessarily have a single answer, the arguments discussed here demonstrate that a significant portion of the resistance to such ideas may be attributed to misconceptions and insufficient information. Although the positions taken by different groups are not as clear-cut or coherent as expected, perceptions and attitudes do change, as the accompanying article indicates.

Martim O. Smolka is a senior fellow and director of the Lincoln Institute’s Program on Latin America and the Caribbean. Fernanda Furtado is a fellow of the Institute and a professor in the Urbanism Department at the Fluminense Federal University in Niteroi, Brazil.

References

Furtado, Fernanda. 2000. Rethinking value capture policies for Latin America. Land Lines 12 (3): 8–10.

Smolka, Martim O. 2003. Informality, urban poverty and land market prices. Land Lines 15 (1): 4–7.

Figure 1: Contentious Propositions and Commentaries on Value Capture

Proposition Commentary

1. It is unfair to charge the urban poor who benefit from regularization or upgrading programs. Evidence shows that expectations regarding publicly funded future upgrading programs lead to higher markups or premiums on current land prices in irregular or illegal settlements. Charging for such benefits would simply switch the recipient of a payment burden that is already being imposed on the poor from the subdivider to the government collecting the charge.

2. Urban land policy must take into account previous development rights, for they are acquired rights. Although expectations are an important part of land market prices, they do not create rights. Zoning designations or development rights, when not realized, are not acquired rights and therefore they can be taken without compensation.

3. Minusvalías are not compensated for; the asymmetry between plusvalías and minusvalías is unfair. Minusvalías are the exception in Latin American cities where land value increments are much higher than the cost of servicing land. In practice, however, public compensation to private owners usually far surpasses collection through value capture policies.

4. Land value capture policy is “communist.” Paying for “free rides” is certainly not a communist idea. One is reminded of mainstream economic theories regarding the merits of a system where individuals and social costs and benefits converge at the margin.

5. Value capture over and above the property tax implies double taxation. In effect, observed land prices to which land value increments apply are already net of the capitalization effect of property tax on land values.

6. Value capture distorts the functioning of the land market. In actuality, it’s the opposite: uncontrolled land value increments distort the behavior of agents. The presence of plusvalías is as distorting a factor for urban development as inflation is for economic development in general.

7. Private appropriation of land value increments is no more objectionable than similar windfalls obtained in capital markets. There is a fundamental conceptual difference. In capital markets equity and bonds are issued against productive investments as collateral for increases in productivity in individual businesses. In the land market, by contrast, land value increments result from the community effort, not individual effort.

8. Value capture is technically impractical because it is impossible to measure the land value increment. With the technical resources available today it is ludicrous to think it “can’t be done.” Ingenious and practical solutions have been developed in Cartagena, Colombia, and Porto Alegre, Brazil, for example.

9. Value capture is overwhelmingly rejected by the citizens, and therefore is politically impractical. The privileged few are the main source of rejection, not the poorer majority of the population who often are charged higher prices in order to access public services through informal arrangements.

10. The amount that can be collected with supplementary value capture instruments is a negligible amount in the public budget. Because of limited collection of the property tax in Latin America, value capture resources can assume an important role in financing urban development. Besides, use of value capture brings to light plusvalías, which has traditionally been a key source of corruption, and thus contributes to a healthier fiscal environment.