The Case for incentives - Donovan Rypkema

24 Y E A R B O O K 2 0 1 6 that investment can be attracted and, often more importantly, how loans can be secured. ‘Social value’ or ‘educational value’ does not generate an income stream that can be used to make a mortgage payment. This matters particularly when there is an imbalance between two factors – cost and (financial) value. ‘Cost’ is the sum that will have to be spent between the idea (‘I could take that old building, restore it, and rent it out as an office building’) and the completed project. ‘Value’ in financial terms, is what the marketplace is willing to pay in rent or purchase price for that restored building. Capital is neither slow nor stupid. When value exceeds cost, investors will act and will receive their returns in net rents or in sales proceeds. In that case no incentives are necessary. But frequently with heritage buildings the reverse is true – cost exceeds value. The amount of money required to acquire and restore the heritage building is £1 million and the financial value upon completion is £800,000. For us as heritage advocates to simply say ‘We’ll do it anyway’ is to argue for an economically irrational act. When cost exceeds value the difference is called the ‘gap’. And closing the gap (that is making an otherwise irrational act rational) is the primary purpose of incentives. So closing the gap is the practical rationale for incentives. But there is a second, more abstract but perhaps even more important reason. As noted above, we heritage advocates proclaim that heritage buildings have many more values than just the financial value. But here’s the problem: the non- financial values – aesthetic, social, environmental, etc – do not flow to the owner of the building but to the rest of us. In economic jargon this is a public good. We the public are the beneficiaries of those additional values, but we are essentially saying to a building owner, ‘We want all of those values from your heritage building but we want you, Mr or Ms Property Owner to pay all of the costs on our behalf’. There is something fundamentally unfair about that position. Now if the financial returns are sufficient to justify the investment, the property owner is content to let us be free-riders (another bit of economics jargon). But that is often not the case with heritage buildings. So incentives should be seen as our partial payment for the values that we, not the property owner, receive as a result of his or her investment. Of course there is a public cost to incentives, whether they are given directly as a grant, for example, or indirectly through a tax savings approach or other method. But in many cases the government level which provides the incentives recoups some or all of the outlay in the intermediate term. Sometimes it even turns a profit. In the United States we have had a historic rehabilitation tax credit for over 30 years. In an oversimplified explanation, if I spend $1 million in the rehabilitation of a listed building and do the work in an appropriate manner, I receive a 20 per cent, or $200,000, credit against my federal income tax liability. More than 1,000 heritage buildings are rehabilitated each year using this incentive, many of which would have stood empty or been demolished without it. But Rutgers University has tracked the implications of the tax credit over three decades. What they have found is that for every $1.00 the federal government provides in the incentive (called a tax expenditure), it ultimately receives $1.26 in taxes from those very projects – money it would not have received if the buildings went without the investment. That particular incentive may or may not be appropriate in the United Kingdom. But three things are as true in the UK as in the US: • thousands of heritage buildings need reinvestment • most of those buildings are in private hands • the vast majority of the investment needs to come from the private sector. Given those three realities there is one more imperative: incentives will be necessary both to close the frequent gap between cost and value and to pay for part of the public good that the rest of us receive. Further Information JM Schuster et al, Preserving the Built Heritage: Tools for Implementation , University Press of New England, Hanover, 1997 Donovan Rypkema is president of Heritage Strategies International, a Washington DC-based consulting firm which works at the nexus of the built heritage and economics. The firm has had public and NGO sector clients in more than 45 countries. He also teaches a graduate course in preservation economics at the University of Pennsylvania and is the author of The Economics of Historic Preservation: A Community Leader’s Guide . Replacing these unsightly uPVC windows above a high street shop with sash windows might restore something of the building’s historic and aesthetic value, but to whose advantage? The owner would bear all of the cost while the heritage benefit would overwhelmingly be enjoyed by the non-paying public. (Photo: Jonathan Taylor)