Book Chapter
Public Policy toward Social Overhead Capital

The Capitalization Externality

When land is developed, one of the benefits is captured in the value of land. The chapter argues that while capitalization is a real benefit in some circumstances, it cannot be attributed to private development: rather it is a reflection of an improvement in social overhead capital. The chapter begins with a model of the economy that can be used to examine policy issues related to land and land values. The traditional view in welfare economics is that changes in land values should have no net effect on social welfare (as gains to gainers are offset by losses to losers). This view is challenged on the grounds that this applies only when benefits and costs reflect any externalities, i.e., impacts associated with non-market variables such as environmental quality. In the case of land development in crowded areas (such as large cities), it is argued that projects that lead to increased land values or rents impose an important external cost. While private benefits may be positive, social benefits may be negative. To the extent that private development increases transport costs and congestion, it should be taxed just as any externality.