Structuring the Charge

Issue: hidden cross subsidies embedded in DCs
The ultimate objective of the DC process is to establish the dollar amounts that will be charged against new development to cover the cost of the needed infrastructure.

In so doing, we need to recognize the economic role that these DC levels play. They are in fact important price signals. Initially, they signal to developers and builders the relative municipal infrastructure costs associated with alternative development opportunities. But DCs are typically passed on to the ultimate consumer, carried forward in the sale price of the home or business property. As such, they affect the market price of new development and influence consumers’ decisions as well.

In economic terms, prices are intended to reflect costs, so that actors can make informed, rational decisions, and economic efficiency is achieved. In an urban context, this means achieving efficient urban development patterns, and efficient infrastructure investments.

But given the way DCs are typically structured, DC prices do not reflect municipal infrastructure costs accurately. Typically, DCs are based on average costs: for a given type of development – let’s say a single detached house – related infrastructure costs are averaged across all new units and a uniform, city-wide charge is established.

However, in an urban context, infrastructure costs are rarely if ever uniform. They are not only dependent upon the type of residential unit or non-residential use, but are also very much related to urban form factors, especially the location of development, and the density of development. In general, denser development has lower per unit servicing costs than low density development. And development in already-urbanised areas has lower servicing costs compared to greenfield sites. There is a considerable body of research that demonstrates these relationships.

For example, the actual costs incurred by a new single detached house in an already urbanized area are typically less than for a comparable greenfields house. The former can often draw on existing infrastructure – such as roads, sewer & water, fire and police services. The marginal cost to serve this unit is typically very low. In a greenfields setting, all infrastructure must be created anew. Similarly, auto travel varies significantly with location and urban context. Development in more central, denser and mixed use areas generate lower vehicle kilometres travelled per household than new suburban areas. But in most municipalities, a new house on greenfields lands and a new house in an already-urbanised area are charged the same DC.

Similarly, DCs in Ontario do not typically reflect the significant effect of the density of development on costs. For example, smaller-lot singles will impose a lower per unit cost on municipalities than wider-lot singles, and apartments a still-lower per unit cost.

When DCs do not reflect infrastructure cost variations associated with location or density within a municipality, they represent inaccurate pricing. This then creates a market distortion that disincentivises efficient development (e.g. denser, on already-urbanised land) and incentivises inefficient development (e.g. low density, greenfields).

Inaccurate DCs have several further negative implications:

By using an average cost approach, uniform city-wide charges make developers and homebuyers indifferent to real variations in public infrastructure costs. It makes no difference to the developer whether he develops within an already-urbanised area or a greenfields area, if the DC he faces is the same in each case.
In the aggregate, they result in inefficient, overly expensive development patterns and inflated municipal infrastructure costs (in economists’ terms – the efficient use of resources is not achieved).
This is in perfect contradiction to Provincial and municipal planning policy – which aims to encourage more compact, transit-supportive, efficient forms of development and intensification.
The underlying issue is the current method typically used to calculate DCs. Eligible costs are apportioned solely on a per capita basis, then simply multiplied by average household sizes to arrive at the charge per dwelling unit. For some types of infrastructure, such as recreation centres, this approach might be relatively accurate. But for other types of infrastructure, especially any infrastructure with a linear or network component (roads, sewer, water), basing DCs on a per capita charge only will not be accurate. At present, the important effects of density and location are simply not factored into the equation.

To be clear, even when the DCs charged vary by residential unit type (as they typically do today), they do so only because they reflect variations in household sizes. If infrastructure cost variations associated with density and location were also considered, the differences would be more pronounced. For example, even though apartments face lower DCs than other unit types, virtually all apartments are likely overcharged through a conventional DC, as the cost effects of density are not accounted for.

In short, it is not only important that growth pays for growth on an aggregate basis. Of equal or greater importance is that each category of development pays its own way. Here I define “category” of development to include consideration of the cost variations associated with density and location. That is, development charges should be based on accurate costs – reflecting cost variations associated with density and location.

There are many simple and straightforward ways for a development charge to be structured to reflect these cost variations. Municipalities should be allowed flexibility in structuring a system that reflects their unique geography, growth and infrastructure cost profiles.

It is essential for each category of development to pay its own way if market distortions, overspending on infrastructure and conflicts with provincial and municipal planning policy are to be avoided.

This approach does not preclude provision of deliberate and transparent subsidies, through DC exemptions, as is permitted today. What it does preclude is the DC pricing structure harbouring unintended and hidden cross-subsidies between different types of development. With accurate DCs, denser development would not cross-subsidise less dense development; development in already-urban areas would not cross-subsidise greenfields development. In short, it creates a level playing field.

Accurate DCs would also avoid wasting municipal financial resources. This can occur when development that is overcharged by a uniform DC is then exempted, in an attempt to attract development to key locations. Exemptions and the lost municipal revenues that go along with them can be reduced when accurate DCs are put in place.

Proposed Reforms:

Amend the Development Charges Act to require that development charge levels be based on accurate costs – that they reflect significant variations in cost associated with the type of use, location and density.