Edward Davey MP, Lib Dem Chair of Campaigns, and Dr. Tim Leunig explain Lib Dem proposals for a two-stage land auction system to help resolve the crisis level shortage of housing

[This article first appeared in the Financial Times.]

The politics of British house prices have changed. For years, rising house prices were an electoral asset. No longer. Many homeowners who once welcomed this situation now face having to pay for their children's houses. For the middle classes, rising house prices have become an affordability crisis.

No one wants falling house prices. What we want instead are house prices increasing more slowly than earnings, making housing more affordable over time. Given rising household numbers and incomes, only more housebuilding can deliver that goal. The government now understands this. After a decade of pitifully low levels, it has announced new housebuilding targets.

If only it were that easy. The government has missed such targets for years. There is no reason to think that Britain will build 240,000 houses next year. It may even fail to hit the previous target of 190,000 houses.

The reason is simple: central government has created a planning system that gives local authorities no incentive to grant planning permission. Local people generally oppose new housing and the gains councils make from "section 106" payments - made by developers to help offset the cost of local infrastructure created by a new project - are tiny.

The government has proposed a planning supplement to give councils a "modest" proportion of the rise in land values from development. Yet when this was tried before, it failed. When one company owns the land continuously its value is hard to ascertain. Further, landowners can sit on the land until the planning supplement is abolished. This policy could mean less, not more, housebuilding. No wonder the government's green paper, published in July, promises not to introduce the supplement until at least 2009 and then only if government is unable to come up with a better plan.

So what incentives would encourage landowners to offer land and persuade local authorities and communities that development works?

Gordon Brown, prime minister, and Yvette Cooper, housing minister, should look to auctions, which proved so profitable in the sale of 3G mobile phone licences.

We propose a two-stage land auction system to replace the way planning permission is granted. It aims to encourage more land to come to market and give communities new incentives to accept more homes.

In stage one, the council asks any local landowners to submit sealed-bid letters stating the price at which they are willing to sell their land. Without existing planning permission - which would make the land more valuable - many landowners would be delighted to sell for five times current value. The landowners' price would be binding, giving the council a call option for, say, one year.

In stage two, the council, in consultation with the local community, decides which land, if any, should be granted planning permission. It then auctions the call options to developers, thus capturing almost all of the increase in the land-value created by allowing development. With agricultural land averaging £10,000 and residential land about £3.2m a hectare, the council could potentially reap a profit of £3.1m a hectare from, in effect, selling its planning permission. Similar margins are available in urban areas. The council can spend these profits in any way, from subsidies for affordable housing, better local services to lower council tax.

Four things stand out.

First, the council makes far more from this than from a planning supplement, giving it greater incentives to allow housebuilding.

Second, the higher house prices are in an area, the greater the council's incentive to act. (We will also get houses where people want them, not where Whitehall bureaucrats think they should be.)

Third, higher densities of housing increase the council's potential return per hectare, giving an incentive to avoid sprawl.

Fourth, it is democratic: councils that prefer no development to better local services or lower council taxes can make that choice.

This scheme goes with the market, it is localist and will deliver far more houses than any other proposal. It has received favourable reviews from the Barker review and the Town and Country Planning Association. There is also the prospect of cross-party consensus, with some leading Conservatives backing it.

If Mr Brown is serious about reaching across the party divide, this plan can help him prove that. The era of top-down targets is over. The era of effective local incentives has arrived.

This article, written by Edward Davey and Tim Leunig, first appeared in the Financial Times on 25th July 2007