A Business Model for the City
City governments should be in the platform business
Hat tip to (The New Urban Order) and Alex Armlovich (Niskanen Center) who each had a hand in inspiring me to write this post. Good work begets more — hopefully — good work, thank you both.
There’s an old conservative line that government should be run like a business. In the case of municipal government, I think this is actually true — but not in the way you might think.
Nickel-and-diming residents for every little service, charging exorbitant fees for permits and inspections, or imagining silly things like forcing people to pay for admission to public parks is bad. It’s bad because no one wants the feeling you have when you pay $30 for cotton candy at a Disney Land to be a daily part of their life. It’s also bad because it’s an ineffective way to recoup the very real value that city governments create for their residents.
Before we get into better ways for municipalities to fund everything we want them to do, though, we ought to discuss how they create value and where that value actually shows up.
Platform Cities
To understand the right “business model” for a city, we can look at the way existing platform services work. Companies like Youtube, Tiktok, and Substack all create infrastructure that brings people together. They facilitate interactions between users, and their networks become more valuable as their user populations grow. In tech, we call these network effects, but it’s the same idea as the agglomeration effects that economists refer to in the case of cities.
City governments play much the same role.
Municipalities provide services (police, fire, sanitation) and infrastructure (roads, parks, transit) that facilitate urban life. They don’t directly create the economic growth that we see in high productivity cities (NYC’s government doesn’t run the finance industry), but they provide the necessary foundation that local economies depend on to function and grow.
City governments create a lot of value and this value shows up in a specific, tangible place — directly underneath our feet.
As a city’s economy grows, it becomes increasingly advantageous to live and do business there. More people and more money flow into the city, driving up the demand for space. And although we see that increasing demand reflected in real estate prices generally, it’s really the land that’s becoming more expensive.
Remember, a building is something like a refrigerator or an industrial machine accumulating wear and tear over time. It’s not like wine, it doesn’t become more valuable with age. So, when real estate prices shoot up, it’s not the building that’s becoming more valuable, it’s the land (which can account for as much as 67% of total real estate value in some places).
City governments support land prices in both direct and indirect ways.
Indirectly, generalized services like sanitation, or law enforcement provide broad-based support for urban growth. New York’s first urban planners set the stage for what the city would become by drawing the first property lines and laying down the first road grid. That didn’t directly make the city what it is today, but it laid the literal groundwork for the subsequent things that did.
City governments can also drive land values in more direct, localized ways via physical infrastructure.
Consider mass transit. In California, the Bay Area Rapid Transit (BART) system increases land values around each of its stations. Looking at historical data, we can see that housing within a half-mile radius of a BART station is on average 11-15%1 more expensive. This same group of properties also appreciated 7%2 faster than properties outside that half-mile envelope. Areas serviced by BART stops aren’t just more valuable, they become more valuable faster than other properties when the economy is expanding.
This isn’t a Bay Area phenomenon, either. Transit increases property values everywhere from New York to Hong Kong to Paris. Neither is this limited to transit; other location-specific amenities like public parks have the same effect.
So, we’ve established that city governments (can) create a lot of value and land prices are where that value shows up. I’d like to make the further argument that this is what cities ought to monetize to fund the public purse and keep the party going.
Why Land Values?
There are a myriad of economic reasons to base municipal finances on recapturing land values; so many, in fact, that we’re going to gloss over them today. Instead I want to focus on an institutional rationale for our land value-based “business model”.
When city government understands land values as its main source of revenue, it will do things to increase those values (as opposed to just skimming off the top via sales taxes or permitting fees). It creates a political-economy in which a municipality gets to directly internalize some of the value it creates and is therefore oriented towards entrepreneurially creating more value.
In the same vein, it biases local government towards growth. Remember, land values are a function of economic activity—more people, more physical development, and more commerce result in higher land values.
Now, this is not a call for cities to only do things with clear financial ROI. There are plenty of responsibilities we might want government to take on that are non-revenue generating (homeless shelters or cooling stations are absolutely legitimate uses of public resources and we don’t need to justify them on the basis of financial return).
That said, making it easier for city government to understand expected returns on investment activities should also make it easier to recognize when we’re cross-subsidizing non-revenue functions that we’ve decided are important all the same.
Monetization Strategy
At this point, some of you are likely gearing up for a very specific punchline. Something that perhaps rhymes with rand malue vaxation.
Well…sorry.
This is not, in fact, a long-winded plug for land value taxation (LVT). For those unfamiliar, it’s worth reading up on (there’s a lot of lore). For folks already in the know, my view is that the existing political economy of land use (at least in the states) is generally hostile to LVT. Yimbyism will gradually ameliorate that over time, but there are other ways to skin a cat, and one of those other ways is what I’d like to present.
Instead, dear readers, I’m here today to spread the good word about land leasing.
What’s a land lease you ask? It’s what it sounds like. A city leases municipally-owned land out to a developer who puts said land to use but continues to pay the government (who's basically acting as the final landlord).
From an economic perspective, there’s not that much of a difference between land leasing and land value taxation.3 Politically, though, it helps bypass the problem inherent in taxing property holders directly; namely, that people uniquely hate direct taxes on real estate and this often results in tax revolts.4
Also, there are already existing examples.
Battery Park City in New York is owned and managed by a public benefit corporation, the Battery Park City Authority (BPCA). Skipping over the institutional minutiae of how the BPCA is set up, I want to zero in on how (financially) successful it is. In 2021, it generated $219.7 million in excess revenue5, of which it remitted $178.4 million back to the New York City general fund.
In other places, much of that value would first pass into the hands of private landowners who would then fight about how much they ought to remit back in taxes. One way to look at land lease arrangements is that it cuts out (some of) the middle men, resulting in more publicly-created land value going back into public coffers for reinvestment. And Battery Park City isn’t the only example.
The Boston Planning and Development Agency (BPDA) largely self-funds via its real estate portfolio.6 Believe it or not, the aforementioned Bay Area Rapid Transit system is slowly turning its acres of surface parking lots into revenue-generating mixed-use developments.7 Outside the U.S., the governments of both Hong Kong and Singapore use land leasing as a core part of their public finances.
This model is commonplace and well understood. And while we started out by invoking the metaphor of online services like Youtube, this is also just how a mall works.
Final Thoughts
If we can recognize where and how municipalities actually create value, we can start to imagine better ways to fund public expenditure at scale and in perpetuity.
And while land leasing isn’t a silver bullet — those don’t exist — it's a good place to start, both to fill the public purse and also do it in a way that inclines local government towards growth, development, and building towards a positive-sum vision of the future.
For my deep land value tax knowers, I know, there are caveats. Discussing the policy implications of incompletely expropriating the full rental value of land would take more space than what’s available in one post (feel free to take me to task in the comments, though).
Namely, voters like lower taxes on real estate (see: Prop 13 in California and Pittsburgh’s repeal of it’s partial LVT).
Read: profit
I’m using the BPDA as an example of a land lease funded government agency, but I’m emphatically not endorsing American redevelopment agencies or their sordid history.
BART’s Role in the Region, page 17 (of the report, not the pdf).
Well done, sir! I like where you are going here! :)
Great post, Jeff! I think the mental model of cities thinking about the ROI on their infrastructure is really key, and *not* thinking about this is how many cities have gotten in budget trouble: requiring low value development then building high value infrastructure to serve it is a great way to get in a hole.