The Mixed Messages and Misplaced Burden of Taxes on New Development

Note: This post is part of an informal series that addresses the interplay between development, regulations, housing supply, and affordability. See the rest here.

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In a previous post I probed the dark depths of Seattle’s Land Use code to critique the convoluted, but lawyer-approved logic that is officially put forth to make the case that additional development capacity causes adverse impacts that must be mitigated by developer fees. But most people who support exacting developer fees to pay for public benefits have a rationale that’s less arcane, though trickier to unpack.

The basic idea is that when a city changes regulations or makes public investments that increase the value of development, then the public has a right to capture some of that value to use for much-needed public benefits such as affordable housing. It all sounds quite reasonable on the surface, but unfortunately, upon closer examination it becomes hard to ignore that this approach is likely to be self-defeating.

The most common instance is when a city changes zoning to allow more development capacity, which lets a developer build a larger building and presumably make more money. That value is a viewed as a public gift to the developer, which justifies the public taking some of it back in the form of a special fee.

One hole in the above rationale is that an upzone doesn’t really create any value at all—it merely removes regulations that were preventing value from being realized. The actual source of the value is demand for new buildings from people who want to better their lives by living and working in a great city. Furthermore, existing zoning was not written in the sky—it’s a more or less arbitrary restriction that destroyed potential value when it was enacted.

But the fundamental flaw in the rationale for charging a fee for additional development is that the reason upzones are done is not to benefit developers, but to enable outcomes that benefit everyone—at the local, regional, and even global scales.

The debate is over: Absorbing growth in urban centers is the first and foremost strategy for sustainable development in growing places such as the Puget Sound region. That’s why cities upzone.

But when we put a toll on the additional capacity granted by an upzone it totally contradicts the original intent. The reality is that such encumbrances can be expected to either drive up rents or, if the fees are high enough, cause developers to opt against building additional capacity. And every new housing unit that is not built in a dense, transit-rich urban center means one more housing unit that is likely to end up in a less sustainable place. And every potential housing unit that is not built in a high-demand market such as Seattle means housing supply becomes more restricted and prices rise faster, hurting everyone, especially the poor.

Likewise, public investments in roads, light rail, or parks benefit everyone, not just developers who have projects nearby. In fact, one could argue that businesses gain a lot more than developers do from mega road projects such as Seattle’s deep bore tunnel, since transportation improvements are all about providing better access to jobs for commuters. Of course all businesses—including development firms—already help pay for public investments through existing taxes. And the higher property value and new jobs that result from development projects generate even more revenue from those existing taxes, property tax in particular. Indeed, for any given piece of land, the greater the development capacity, the greater the potential tax revenue. Here again, developer fees discourage maximizing the public benefit from a given piece of land.

Seattle’s expanding light rail system will boost the value of surrounding property, but that doesn’t mean it should be a target for extraction. It’s actually a good thing if increased value makes development more attractive, because those areas are exactly where we want development to happen. Light rail investments remain vastly underutilized until there’s lots of housing and jobs built up around the stations. But at the future light rail station in Seattle’s Capitol Hill neighborhood, for example, the City has encumbered the adjacent properties with a heavy list of public benefits—including affordable housing—that will be required as a condition of additional development capacity. Time will tell how realistic those expectations are. (As an aside, a similar scenario of inflated expectations is currently playing out in Yesler Terrace, but that’s a long story.)

For some perspective on what Seattle’s current regulations require from private developers to subsidize affordable housing, the developers of a recently proposed downtown hotel/convention center project would have to write a check for $12.4 million to be allowed to build their desired additional capacity. For comparison, that $12.4 million burden on a single development project is equivalent to almost 10 percent of Seattle’s total seven-year Housing Levy. The burden of the Housing Levy—shared between all of the hundreds of thousands of property owners across the entire City of Seattle and spread over seven years—looks pretty puny in comparison.

All property owners in Seattle are seeing huge personal gains in terms of property value appreciation that is being driven by the success and desirability of Seattle. At the same time, that appreciation is the cause of Seattle’s housing affordability challenges. And that’s why the Housing Levy is a defensible source of affordable housing subsidy that ought to be expanded—it spreads the burden fairly among all those who are basically hanging around and benefiting from Seattle’s success just because they got in first. In contrast, taxing new development unfairly dumps the burden on a very small subset of newcomers who are actually part of the sustainability and affordability solution.

But guess what? Right now, the Seattle City Council is in the process of raising Seattle’s downtown developer fees even higher, just like they recently did as part of the South Lake Union rezone. Neither the Council nor the Mayor’s office seem to be interested in thinking about whether or not taxing new development is a sound policy, or if it could do more harm than good. The only debate is over how much more they can squeeze out of developers.

All in all, it’s pretty simple: A sustainable future hinges on accommodating as many people and jobs as possible in urban centers, and we have no choice but to rely on private developers to build what that requires. That means it’s just really not very smart to treat developers as adversaries. Yet the message Seattle’s policy makers are sending to developers is this: Please build our city so that we can meet our goals for sustainable growth, but we will behave as though your developments are adverse impacts that need to be mitigated, and while you take on all the financial risk, we will impose fees that determine how much profit you can make.

The message ought to be: How can we work with you so that everyone wins? And for one example of that approach look no further than Tacoma, where the lack of development gives quite a different perspective on developers, and where the City is pursuing downtown Subarea Plans that will provide State Environmental Policy Act (SEPA) pre-approval for all development projects. They also removed all off-street parking requirements in their downtown, and created a development authority for the Foss Waterway. In other words, Tacoma is being as proactive as possible to make it easier for developers. And that’s what it’s going to take if Seattle doesn’t want to wait a lifetime for significant development to happen in key locations such as the southeast Seattle LINK light rail station areas, for example, where the real estate market is marginal.

Will making it easier for developers increase developer profit? Yes. But if the increased potential for profit leads to more development projects moving forward, leads to more buildings going up in urban centers where they belong, leads to less underdevelopment of invaluable urban sites, leads to increased housing supply and the resultant downward pressure on housing prices, leads to greater tax revenue that can be used for public benefit such as affordable housing or other social services, leads to more efficient transit and reduced greenhouse gas emissions from cars, leads to a reduction in sprawl swallowing up farms and forests, well, maybe they deserve it?