Development Fees are an Inefficient Way to Fund City Improvements

The City of LA is proposing a change to its Quimby (parks) development fee, and from the sounds of it, it’s bad news. The recommendation is to implement fees of $12,500 for houses and $7,500 for apartments. Apparently, even the report itself acknowledges that the increased fees – though less than the $18,000 per unit that is purportedly required – will stifle residential development. This will worsen the region’s housing crisis – the last thing we need to be doing at this point. The city is having a public hearing on October 22, and if you care about housing affordability, I strongly implore you to attend and voice your displeasure with the inevitable negative consequences of this fee increase.

Digging a little deeper, let’s think about why the fee increase will worsen the housing crisis. Despite what you frequently hear, development impact fees are not “passed on” to buyers and renters. Rather, they are functionally no different than taxes on developer profits. Since the impact fee is fixed in absolute terms, it is far more burdensome on affordable developments than on luxury developments. If your profit margin is 10%, a very modest $250,000 apartment unit yields $25,000 in profit, of which 30% would be taken by the fee. On the other hand, if you’re building $2,500,000 houses, you only take a 5% hit to your profits.

The outcome is obvious. The increased fees will be little more than a nuisance to luxury developers, but they will push a considerable number of modest market-rate developments into unprofitability. This is not what we want to be doing! We should be making it cheaper and easier for small market-rate development to be profitable, so that more of it is accomplished.

If we keep digging, it’s clear that the rationale behind these development fees – like most of the byzantine schemes passed in the wake of Prop 13 – is preposterous.

The NIMBY argument in favor of development fees is that “newcomers” should pay their own way, and fund new schools, parks, and so on. For this argument to make any sense, you have to make the ridiculous assumption that existing residents never move. If every new housing unit goes to a new household, and the fees for that new development go towards facilities serving only that new household, then maybe there’s a case (though not really, as we’ll see).

This is, obviously, not how the world works. New housing units might go to a family who already lives in the community but is moving up. Existing housing units might go to young people just starting families. Children might move out and start their own households in the same community or a different community. The possibilities are endless. What if your parents paid the fee; should you have to pay it when you move out? What if you already paid a fee to a different community; should you have to pay again? For that matter, what if you never use a city park; should you still have to pay the parks fee? What if you never have kids; should you still have to pay for schools?

As we can see, in a real world situation, the case for development fees doesn’t hold water. There’s no way to possibly correlate a generic new household with a specific need for public improvements. If the argument is that the new resident has access to parks and schools even if they don’t use them, well, the NIMBY in favor of development has access to the new parks and schools even if they didn’t pay for them! A far simpler understanding would be that if a public facility is worth building, it is worth having everyone in the public pay for. If the city’s population grows to the point that we need a new park, then we all should pay for that park.

Not surprisingly, the use of development fees rather than general public funds to pay for public facilities has negative impacts low-income communities. First, low-income communities are denied access to newer housing units, because low-rent projects are the most marginally profitable and are the first to be obliterated by development fees. Second, partly by that mechanism, low-income communities are often denied access to the public facilities in question, because no impact fees are generated in the neighborhood. For example, in 2007, the LA Times found that the city was sitting on $77m in unspent parks fees, and 6 years later, KCET found that little had changed, and no funds were available for parks improvements in low income communities like South LA.

You could perhaps argue that the problem here is the city requirement to spend the parks fees within a mile or two of the development. But in that case, you no longer have a plausible argument that the fees are for parks facilities required by the new development. A new development in Hollywood doesn’t create a backlog of parks maintenance in South LA, or require it to be fixed. I’m all for putting in the money to improve parks in low-income areas, but that’s a societal goal worth pursuing and we should all be paying to help do it.

There is, of course, one class of people who benefit handsomely from the wildly inefficient system of development impact fees: existing homeowners. In a normal housing market, there are about 6 existing home sales for every new home sale. So, assume that an approximate parks fee of $10,000 raises home prices by $10,000. For every $10,000 that goes to parks, another $60,000 ends up going to some of the worst rent-seekers around. This is a really inefficient way to fund city improvements, and in a rational policy scheme, it wouldn’t last for a second.

3 thoughts on “Development Fees are an Inefficient Way to Fund City Improvements

  1. bixnix

    Many good points in the article. How about Quimby fees for every sale in a percentage? Maybe more for new development than for existing home sales. Completely agree about city hall sitting on the Quimby fees… WTH?

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