Britain's use of our greatest natural resource - our land - suffers enormous problems. The first is that social improvements such as the building of tram or underground lines create vast increases in private wealth and income, but these gains in value currently accrue wholly to private property owners. The result is that the public sector has little incentive - and worse, no financial means - to invest. Because of our inability to connect social costs with private benefits, we systematically underinvest in the public transport infrastructure that would benefit both landowners and citizens.
Take the building of the Jubilee Line in London, which, it is estimated, has added more than £13bn to property values. The cost of construction was just £3.5bn and the net gain nearly £10bn. An insignificant part of that gain - some £180m - was paid towards the cost of the line by the developers of one small area affected by it: Canary Wharf. The vast majority of landowners along the route enjoyed a large windfall with no contribution whatsoever. A similar windfall is operating for property owners around London King's Cross, Stratford and Ebbsfleet because of other public investments such as the Channel Tunnel Rail Link.
The second problem arises when public authorities award simple planning permission for a greenfield site. This can provide the owner with a huge windfall. The figures supplied to Kate Barker's review of housing policy for the Treasury indicate this can boost the value of a hectare of land from £7,534 to £1.23m. It is a gain created wholly by society, yet almost all goes to the owner of the land. If the local authority is savvy, it can use Section 106 of the Town and Country Planning Act 1990 to negotiate concessions from the developer, but the process is random.
Faced with these problems, the Barker review recycled one of the Treasury's old hobby-horses, and it is a fair bet that the government is about to ride off on the old nag again. The Treasury's overwhelming interest is in anything that raises money easily for the Exchequer. And there is hardly a better example of a stealth tax than some payment for a big, one-off gain from the granting of planning permission. This "planning gain supplement" - a tax on the increased value, payable in order to receive the planning permission - is similar to several previous attempts to impose development gains taxes such as the 1947 development charge, the 1967 betterment levy and the 1973 development gains tax, followed by the 1976 development land tax. All died through asphyxiation by their own complexities.
There are two problems with the Barker proposal, as with its predecessors. First, it does nothing to help fund infrastructure through existing built-up areas. Any developer who sees gains in rents and values as a result of a new Tube line can rest easy: the profits would all still be theirs. The second problem is that the "planning gain supplement" would, as the Barker review itself implicitly admits, actually reduce the amount of land coming forward for development, because the profits would be lower than they are now. Yet the priority, particularly in London and the south-east, is to increase the amount of new housing, particularly affordable homes for those on low incomes.
An alternative proposal - a tax on the value of land, or a site value rate - would take longer to implement, but would address the fundamental problem, not its symptoms. It would levy the same amount whether or not the site was used to its full potential. If the land was not developed, the landowner would have a regular charge to pay - a carry cost - that he or she does not have to pay today. He or she would therefore have an incentive either to develop or to sell to someone who would develop it. By periodic revaluations in rateable value, any rises (and falls) in land prices due to changes in physical infrastructure, such as new Tube lines, would be reflected in the tax base and hence in rating income. Such a site value rate allows a precise tailoring of contributions to the benefits that property owners actually receive.
Look at the Jubilee Line again: if the value of land increased by some £13bn, the extra rental value would in time be at least 5 per cent of that total, or some £650m a year.
Less than a third of that annual gain - about £175m - would have been enough to fund the interest on bonds to finance the whole of the construction, including overruns. And a tax of one-third of land value would still leave two-thirds of the gains in the hands of private landowners. No other proposed tax would be either as fair or as effective in funding public transport investment.
A land value tax would also tackle a large market failure in many depressed urban areas. House prices in the south-east have doubled in the past five years. But the National Land Use Database finds that 12,000 hectares of previously developed land are available for residential use even in London, the south-east and the east of England. According to the planning authorities, 360,000 houses could be built on that land - enough to stop the house-price boom in its tracks. Much of this land is now completely unused, being either vacant or derelict. What accounts for this apparent failure in the housing market, for this paradox of unused and underused land amid soaring demand?
If we are to believe the Barker review, it is all a question of the planning system. Certainly, that is part of the answer. But what is also important is that the market does not provide adequate incentives for landowners and developers to redevelop where they should - in existing urban areas - rather than by sucking in ever greater swathes of green fields. At present, many owners of urban land allow it to fall into disuse or underuse because there is no cost in failing to develop. The significance of a site value rate is that landowners would have an incentive to develop immediately sites that fall into disuse, limiting the possibility of spreading blight. Paying an annual charge for land, regardless of what is built on it, concentrates minds wonderfully.
In the American cities that tax buildings less heavily than land, the effect has been dramatic. As John Norquist, the president of the Congress for the New Urbanism who was the acclaimed Democrat mayor of Milwaukee from 1988-2003, said: "It's been great for Pittsburgh. You almost can't find an empty lot in downtown Pittsburgh. They've done a lot of things wrong in Pittsburgh, but one thing they did right was having this land value taxation so there's no incentive to have an empty lot." Other cities in Pennsylvania are already copying Pittsburgh. Similar tax systems operate in Denmark and Australia.
A tax on land values can dampen the cycle of boom and bust in British property prices by discouraging the hoarding of land during price upswings. It can make a crucial contribution to the financing of social improvements. It can shift private incentives so that areas do not fall into unfashionable disuse because of blight. It provides an incentive for developers to bring forward plans that are tailored to social needs. Where such taxes are applied, there are higher levels of construction activity and a better-looking urban environment.
These potential gains are not inconsiderable. Land value taxes can hugely improve our cities and towns.
Christopher Huhne is a Liberal Democrat MEP for the south-east of England