Chapter 11. Taxing Immovable Property: Revenue Potential and Implementation Challenges
- Benedict Clements, Ruud Mooij, Sanjeev Gupta, and Michael Keen
- Published Date:
- September 2015
- John Norregaard
Property taxes are widely regarded as an efficient and equitable means of raising revenue, but this revenue potential is largely untapped in many countries.1 Property taxes generally yield relatively modest revenue, particularly in developing countries and emerging market economies, but there are also large disparities across countries that signal popular opposition as well as technical constraints in their administration—but also the possibility for enhanced utilization. The differences of opinion on property taxation are probably starker than on most other taxes. Although economists tend to strongly favor increased reliance on property taxes owing to their attractive economic properties, there is widespread popular and hence political resistance to their increased use, stemming in part from their transparency and relatively limited scope for tax avoidance and evasion.2
Increased use of property taxes could conceivably help ease problems with taxes levied on mobile bases. Much policy debate in recent years has focused on the revenue losses and efficiency costs stemming from levying taxes on highly mobile tax bases in a globalized setting. For example, tax competition, aggressive tax planning, and the use of tax havens to shelter income have eroded tax bases and invited the introduction of a plethora of often costly policy and administrative measures to safeguard national tax bases and powers.3 Less attention has—until recently—been directed at the alternative policy route of meeting revenue objectives by strengthening “immobile” tax sources such as, in particular, taxes on immovable property.
Property taxation is now the subject of strong and renewed interest around the globe. This new interest clearly manifests itself in numerous reform initiatives recently adopted or considered in different countries (Box 11.1) and in a rich recent literature focusing primarily on developing and transition economies (for example, Bahl, Martinez-Vasquez, and Youngman 2008, 2010). The revived interest may have different motivations in different country groupings. For example, the devolution of fiscal powers to strengthen local democracy is a driving force in some transition economies, while in many developing countries the lead motives are revenue mobilization and the provision of incentives for better land use. Property taxation (along with taxation of capital more generally) has also played an important role in the recent discussion of increasing income inequality and its causes in both developed and developing countries—a debate that received strong impetus with the publication of Capital in the Twenty-First Century (Piketty 2014).
Box 11.1Recent Property Tax Reforms and Plans
Egypt adopted a new real estate law with a rate of 10 percent applied to estimated rental income, effective 2009 but with delayed application until 2012.
Liberia reformed the rate structure of the real property tax, effective 2011, and is contemplating further reform measures to strengthen property rights and the revenue potential of the real property tax.
Namibia starting in 2002 gradually introduced a central government land tax on the value of agricultural land (with a basic rate of 0.75 percent) to supplement the existing municipal tax on urban property, with the primary aim of encouraging efficient use of agricultural land.
Asia and Pacific
Cambodia introduced a new property tax in 2011, based, in principle, on assessed market values of land and buildings. The tax is being piloted in a limited number of urban areas.
China decided to introduce residential property taxation starting in 2011, in part aimed at reining in speculation and strong price appreciation in the property sector, and in part to address the country’s widening wealth gap and provide local governments with a significant revenue source. Pilot projects are under way in two cities, Shanghai and Chongqing, to be followed in due course by other cities.
Hong Kong SAR introduced in early 2013 a special property transaction tax (the buyer’s stamp duty) at 15 percent of the transaction price, covering nonlocal buyers and all corporate buyers, aimed at curbing speculation and high property price appreciation.
Singapore increased stamp duties on certain home buyers, which, together with a broader set of measures, is aimed at curbing property price increases and preventing an asset price bubble.
Vietnam adopted in June 2010 a new area-based tax on nonagricultural land (excluding housing) and is considering further reform in this arena.
Kyrgyz Republic introduced a property tax for companies and individuals on top of the existing land tax, effective January 1, 2009.
Croatia introduced in 2013 an ad valorem property tax at a uniform tax rate of 1.5 percent, to replace existing utility fees and the second home tax.
Greece adopted in late 2011 a new square-meter tax at varying specific rates, collected via electricity bills; this tax was later replaced by a succession of new reform measures.
Ireland abolished the residential property tax in 1997 (leaving the local rates on commercial property as the only recurrent property tax). A new market-value-based property tax came into effect in 2013 to replace the annual household charge of €100 put in place on January 1, 2012, as part of a broader fiscal package.
Latvia implemented reform measures in 2010 by introducing a residential property tax on buildings to complement the existing land tax, and additional measures are being considered.
Serbia is considering an in-depth modernization of its property tax system to replace the system of taxes based on property rights in tandem with a planned land privatization reform.
Latin American and the Caribbean
El Salvador is one of the few Latin American countries (together with Paraguay and Costa Rica) at present without an immovable property tax, but is considering introducing one.
Several Caribbean countries are contemplating introducing or strengthening property taxes, in part because their highly open economies are exposed to regional tax competition.
This chapter provides the case for, and ways to overcome obstacles to, strengthening or (re)introducing property taxes. The next section discusses the nature of property taxes and their yield in different countries, and is followed by a section that presents the economic rationale for increased use of the tax. The obstacles, both political and administrative, facing policymakers when reforming property taxes are then examined. Finally, the contours of an action plan for the implementation of property tax reform are presented.
Property Taxation—Concepts and Yield
Although generally associated with the notion of recurrent (annual) taxes on immovable property, property taxes in practice encompass a variety of levies on the use, ownership, and transfer of property. Each of these taxes has very different objectives and varying yields. According to standard international tax classifications,4 property taxes encompass recurrent taxes on immovable property, measured gross of debt, and levied on proprietors or tenants; recurrent taxes on net (of debt) wealth; taxes on estates, inheritances, and gifts; financial and capital transaction taxes on the issue or transfer of securities and checks, or sale of immovable property; and other recurrent or nonrecurrent taxes on property. Recurrent taxes on immovable property are the key focus of this chapter; however, the remainder of this section presents information on the broader concept of property taxes.
How much do immovable property taxes generally yield? Because of deficient data coverage and quality, summarizing the importance of and trends in property taxes on a global scale is not a straightforward exercise, and information on levels and trends is sensitive to the choice of data sources, periods, and regions analyzed. Data are particularly scarce for developing and transition economies—not least with regard to consistent time series—whereas data for Organisation for Economic Co-operation and Development (OECD) countries are comprehensive. The data set compiled for the purposes of this chapter covers generally the period 1990–2012. The data for 2012 are reproduced in Annex Tables 11.1.1 and 11.1.2, while available data for selected OECD and Latin American countries for 2013 are presented in Annex Table 11.1.3. This section presents information about key features of property taxes across countries, focusing first on their composition and then on levels and trends. It also discusses the importance of property taxes for local governments, and the issue of how much an immovable property tax could potentially yield.
The Broader Concept of Property Taxes
Depending on their policy objectives, countries differ substantially with regard to their use of the various property tax sources. Some countries emphasize the provision of a stable and substantial source of revenue for subnational governments through immovable property taxes, while others prioritize raising general revenues (by using mainly capital transfer taxes),5 or enhancing the progressivity and fairness of the overall tax system (by relying on taxes on net wealth or inheritances and gifts).6 The property tax structure for the few countries presented in Table 11.1 reflects the large variety among OECD countries in the weights attached to these different policy objectives. Countries such as New Zealand, Poland, and the United States (together with Canada, Japan, and the United Kingdom, not shown) levy property taxes mainly on immovable property, whereas Germany uses a variety of sources including inheritance and capital transfer taxes. Greece is also using a variety of sources, but by tapping mainly property and property transfers as tax bases (as do Italy, Korea, and the Netherlands). In contrast, Luxembourg (together with Switzerland and Norway) is among the few remaining OECD countries that continue to raise significant revenue from the taxation of net wealth. Among developing, emerging market, and transition economies, the recurrent immovable property tax is the only property tax source in Azerbaijan, Georgia, Mongolia, and Ukraine. All countries covered by the data set raise revenue from immovable property on a recurrent basis (Annex Tables 11.1.1 and 11.1.2).
|New Zealand||Poland||United States||Germany||Greece||Luxembourg|
|Recurrent Taxes on||98.0||98.5||95.9||49.2||57.0||2.8|
|Recurrent Taxes on Net||0.0||0.0||0.0||2.8||11.2||74.9|
|Estate, Inheritance, and||0.0||1.5||4.1||17.6||2.5||5.9|
|Taxes on Financial and||2.0||0.0||0.0||30.3||20.8||16.4|
|Total (percent of GDP)||2.1||1.2||2.9||0.9||1.9||2.7|
According to available data sources, property taxes are far from being a mainstay of the revenue systems in developed, developing, and transition economies. Bahl and Martinez-Vasquez (2008) emphasize that the average revenue raised from property taxes is modest in all three main country groupings, but seemingly with a slightly upward trend since the 1970s (Table 11.2). The data also suggest that reliance on property taxation (similar to most other taxes) is strongly related to economic development, with the average revenue ratio to GDP in OECD countries being triple that of developing countries. These data, however, cover total property tax revenue and thus not only taxes on immovable property.
|(number of countries)||(16)||(18)||(16)||(18)|
|(number of countries)||(20)||(27)||(23)||(29)|
|(number of countries)||(1)||(4)||(20)||(18)|
|(number of countries)||(37)||(49)||(59)||(65)|
More recent and detailed data with wider country coverage suggest that, at least for developed countries, total property tax yields have been broadly stable since the mid-1960s. Figure 11.1 shows that for OECD countries—the only group for which accurate and detailed time series exist—the average revenue ratio has been broadly stable at slightly less than 2 percent of GDP since 1965, albeit with a slight dip during the 1970s and recovery thereafter. The figure also shows that recurrent taxes on immovable property, at roughly half the total, constitute by far the largest subcomponent, also with a broadly stable revenue ratio of about 1 percent of GDP during this period (although little is known about the relative importance of the policy changes and property prices underlying this trend). Similar data for transition economies and developing countries are not readily available.
Figure 11.1Property Taxes in OECD Countries as a Share of GDP, 1965–2012
Source: OECD, Revenue Statistics.
In contrast, when measured as a share of total general government tax revenue, the yields of property taxes in OECD countries have declined. The decline took place during the late 1960s and 1970s, with the share stabilizing thereafter, and is mainly a reflection of the trend in immovable property taxes (Figure 11.2). This decline is the result of buoyant income and consumption taxes and, in particular, social security contributions during this period.7
Figure 11.2Property Taxes in OECD Countries as a Share of Total Tax Revenue, 1965–2012
Source: OECD, Revenue Statistics.
Tax Revenue Raised from Recurrent Taxes on Immovable Property
Reliance on immovable property taxation is broadly (albeit imperfectly) correlated with country income levels. The data for 2012 were compiled for OECD and a sample of non-OECD (developing, emerging market, and developed) countries and then classified into high-income and middle- and low-income countries.8 The average yield from immovable property taxes in high-income countries, 1.06 percent of GDP, is more than three times the average level of 0.32 percent of GDP in middle-income countries9 (which, in turn, is 0.27 percent for lower-middle-income and 0.36 percent for upper-middle-income countries).10Figure 11.3 presents the correlation between immovable property tax revenue as a percentage of GDP and per capita income levels.
Figure 11.3Immovable Property Tax Collections across Income Levels, OECD and Selected Non-OECD Countries, 2012
Sources: OECD, Revenue Statistics, and IMF, Government Finance Statistics.
As is evident, cross-country variation in immovable property tax collection increases sharply with income level. Among the high-income countries, reliance on immovable property taxes varies from close to nil in Croatia and Luxembourg to heavy reliance (revenue equivalent to 2 percent of GDP or more) on this source in Canada, France, Israel, Japan, New Zealand, the United Kingdom, and the United States. In contrast, more middle-income countries rely only modestly on immovable property taxes, such as El Salvador, Peru, Tunisia, Moldova, and Mongolia. In this group, Bulgaria, Georgia, and South Africa stand out by relying on immovable property taxes to an important extent (close to or greater than 1 percent of GDP). The difference between high-income and middle-income countries with regard to the dispersion of yield ratios is striking and abundantly clear from Figure 11.4.
Figure 11.4Distribution of Yields from Immovable Property Taxes, 2012
Sources: OECD, Revenue Statistics, and IMF, Government Finance Statistics.
Although the immovable property tax may not have a central position in the overall revenue systems of most countries, it frequently contributes significantly to the financing of local governments. Hence, one defining aspect of property taxes is their assignment predominantly to lower levels of government, indicating that increased reliance on this source of revenue involves important issues of intergovernmental fiscal design. Annex Tables 11.1.1 and 11.1.2 shed some light on this particular role of immovable property taxes for high-income and middle-income countries: the penultimate columns show, for example, that the share of the immovable property tax in total local taxes is 100 percent in Australia and the United Kingdom, with an average of 38.3 percent in high-income countries, and slightly less (35.9 percent) in middle-income countries; and the last column of each of the two tables demonstrates that all of the immovable property tax revenue collected by government accrues solely to local governments in the majority of both high-income and middle-income countries.
Decentralization in itself may provide incentives for increased revenue mobilization from property taxation. Bahl and Martinez-Vazquez (2008) provide empirical evidence of “reverse causation” in the sense that the demand for property taxation is driven by the level of decentralization. This finding supports the notion that increased reliance on property taxation ideally should be part of a clearly formulated strategy for strengthened decentralization (an issue beyond the scope of this chapter). But the fact that developing, emerging market, and transition economies broadly are less decentralized than advanced economies may help explain the fairly modest reliance on property taxes in these countries.11
How much could the immovable property tax potentially yield? Absent accurate estimates of tax capacity and tax effort in this particular area,12 a benchmark for revenue collections—admittedly simplistic—reflects the average revenue ratios of the best performers in each income group.13 For high-income countries, that would yield a collection potential of about 2.7 percent of GDP when based on the five best performers; the similar target in middle-income countries would be a much lower 0.9 percent of GDP. If these simple benchmarks are applied to the other countries in each group, the potential average revenue increase among this group of 33 high-income countries would be 1.9 percent of GDP, while 30 middle-income countries could raise, on average, an additional 0.7 percent of GDP.14 This exercise suggests the availability of substantial untapped revenue potential from the property tax in many countries, although the net gain in some countries would be tempered by the need to scale back the use of distortive property transfer taxes (discussed below).
Key Determinants of the Level of Recurrent Property Taxes
Preliminary regression analyses suggest that the level of economic development (as measured by GDP per capita) and urbanization play substantial roles in determining the level of recurrent property taxes across countries and over time (Box 11.2). But countries’ openness, as measured by relative trade volumes, as well as their legal origin may also play important roles in determining property tax revenue. It also appears that, as countries develop and grow richer, property-tax-to-GDP ratios tend to increase.
The Case for Property Taxation
Efficiency Considerations in Favor of Property Taxation
Considerations of economic efficiency strongly underpin the case for exploiting property taxes to their fullest potential. Their well-known efficiency-enhancing properties derive mainly from the immobility of the tax base, which, when accompanied by efficient and accurate valuation systems, entails clear benefits in different respects as outlined in this section. Recurrent taxes levied on land and buildings are generally considered to be more efficient than other types of taxes because their impact on the allocation of resources in the economy is less adverse—they do not affect decisions to supply labor and to invest (including in human capital) and innovate. The immobility argument must be qualified, though, because only land is truly immobile; capital invested in structures (or “improvements”), particularly nonresidential structures, is indeed mobile, and a higher property tax can conceivably drive capital to lower-taxing jurisdictions.15 In particular, if a newly introduced (or an increase in an existing) property tax is fully capitalized in property prices, present property owners would suffer a one-off loss in wealth, while new property owners would not be affected: once introduced (or increased), property taxes do not affect the rate of return and are therefore considered neutral to investment behavior.16 This quality follows from the fact that the property tax, to the degree that it is a tax on accumulated wealth, does not alter future behavior.
Box 11.2What Determines the Level of Property Tax Revenues?
Based on panel data for 64 countries generally covering the period 1990–2010, two regression models are applied to test the significance of variables that could potentially affect the levels of per capita revenues from recurrent property taxes across countries and over time. A priori, the level of development (or wealth) as measured by GDP per capita, the degree of urbanization, openness of economies as measured by trade, corruption levels, and cultural or legal heritage are examples of such potentially important variables. The results reported here are preliminary.
Between-Effects Model. This exercise tests the cross-sectional effects of various variables on recurrent immovable property tax revenues. The main variables of interest are the level of development (or wealth) of the country measured by GDP per capita in U.S. dollars (GDP PC), the level of urbanization as measured by the proportion of the population living in urban conglomerations of more than 1 million people (P), the openness of the economy measured as imports plus exports as a share of GDP (O), and the country’s legal heritage as reflected by a variety of dummy variables.
To capture cross-sectional effects (that is, the average effects over time in each country), a between-effects model is applied:
In equation (11.2.1), R represents recurrent immovable property revenue per capita in country i expressed as a function of GDP per capita, urbanization, openness, and a dummy variable (AS) with value 1 if the country is Anglo-Saxon in origin.
All explanatory variables shown are significant in the between-effects model with a p-value of less than 0.05 (a dummy variable for Commonwealth countries turned out to be insignificant). The implication is that the cross-sectional or by-country effect of development, urbanization, openness to trade, and legal heritage is positive and significant with respect to general government recurrent immovable property revenue per capita, in support of a priori expectations.
Fixed-Effects Model. The between-effects model does not account for variations in any of these variables over time. For this purpose, the fixed-effects model is used. It accounts for the over-time effects on the per capita level of recurrent immovable property taxes for each country:
Because the legal origin dummy variables do not vary over time, they are dropped from the model. It is worth noting that the coefficient of the openness measure, while positive, is not statistically significant in the fixed-effects model, and therefore is not included. The possible implication is that countries that change their policies to institute openness in trade over time do not also experience an increase in immovable property revenues, but countries with generally open trade policies over time experience larger recurrent immovable property revenues overall than do countries with a lesser degree of openness. Thus, the conclusion is that countries tending to be more open also tend to rely more on recurrent immovable property tax revenue, but one policy decision does not necessarily follow the other. This concept might be worth exploring in future research.
Furthermore, the analysis explores whether the supposed effect of development on recurrent immovable property revenue is meaningful. Because increases in recurrent immovable property tax revenue per capita following from increases in GDP per capita may be purely descriptive, it is worth examining whether GDP per capita squared is significant in recurrent immovable property revenue per capita:
The coefficient of GDP per capita in U.S. dollars is now statistically insignificant, while the coefficient of GDP per capita in U.S. dollars squared is statistically significant with a p-value of 0.02, suggesting that the effect on immovable property tax revenue of an increase in development is exponential. This model therefore suggests that an improvement in a country’s level of development over time (as measured by GDP per capita) will result in an increase in the share of recurrent immovable property tax revenue as a percentage of GDP.
In summary, the preliminary statistical experiments conducted here suggest that economic development (or wealth) combines with the degree of urbanization in explaining an important part of the variation across countries and over time in property tax revenue per capita; that the degree of openness and legal origin may well constitute important additional explanatory factors; and that as countries develop, the probability is that the property-tax-to-GDP ratio gradually increases. Data limitations do not allow an analysis of the possible impact of corruption.
International evidence suggests that immovable property taxation may be more benign than other tax instruments with respect to its effect on long-term growth. In recent studies, in part based on a broad review of the literature, OECD (2008, 2010) establishes a “tax and growth ranking” that shows that recurrent taxes on immovable property (residential property in particular) are the least distortive tax instrument because they reduce long-term GDP per capita the least, followed by consumption taxes (and other property taxes), personal income taxes, and finally corporate income taxes as the most harmful for growth. Hence, a revenue-neutral growth-oriented tax reform would involve shifting part of the revenue base from income taxes to taxes on consumption and immovable property.
Property taxes are considered good local taxes but raise intergovernmental issues. In addition to its considerable revenue potential, the property tax is generally considered an ideal source for local governments by virtue of being borne mainly by residents, with few spillovers. Also, property values to some degree reflect services supplied by local governments, strengthening the argument that it is reasonable for this base to be tapped to finance local activities. It is also considered to be a stable and predictable revenue source (see discussion in “The Cyclical Resilience of Property Tax Revenues”). Furthermore, the immovable nature of its base, which may be especially appealing at a time when other tax bases become increasingly mobile, renders the property tax particularly useful as a benefit tax at the local level, with rate differentials across jurisdictions providing the price signals required to induce improved resource allocation and hence economic efficiency in a multilevel government setting. Allocative efficiency is, though, conditional on a number of supporting assumptions, including some degree of local autonomy over rate-setting on at least one key tax such as the property tax as well as efficient equalization of tax capacity across jurisdictions.17 Also, through the political accountability that its transparency induces, the property tax may improve the quality of the overall public finance system. In short, the property tax very well fits the criteria for a good local tax (Bahl 2009).
However, the use of property taxes on business raises particular problems and requires attention. Taxing an important factor of production will—if the benefit tax principle is not strictly adhered to—raise costs disproportionately on businesses that use relatively more property as a factor input. To some degree, this imbalance explains why countries apply special relief to agriculture through full or partial exemptions or lower tax rates.
Strengthening property taxation could also help reduce the dependency of local governments on transfers, thereby enhancing economic efficiency by improving local accountability. However, bolstering local finances—for example, through a broadening of property taxation—would not necessarily improve the overall fiscal balance. However, in the majority of intergovernmental fiscal systems that cover vertical fiscal imbalances by transfers to subnational governments, a broad-based strengthening of local property taxation could be compensated for by scaling back transfers (or shared taxes), thereby improving the overall fiscal balance with a simultaneous—and possibly efficiency-enhancing—strengthening of local fiscal autonomy. Conversely, large fiscal transfers to local governments have been found to work as a disincentive for local governments to devote resources to improving revenue raising from property taxation. Reduced fiscal transfers could help address this disincentive.
Property taxes can promote efficient use of land, thereby further stimulating development and growth. By imposing a “tax cost” on land ownership or use that to some degree may be independent from the actual use of the land (particularly if market-price valuation is applied), property taxes provide an important incentive for property owners to secure more efficient use of land and buildings (for example, OECD 2008).18 This is an important consideration in many countries, and lies behind the use of property taxes to promote development, especially in the agricultural sector, in many developing countries (the agricultural land tax in Namibia being one clear example). If better land use is the driving motive, a pure site (land) tax on land value would offer the best tax design since—being independent from actual land use—such a tax would maximize incentives to apply the land to its optimal use.
Property taxes could conceivably reduce efficiency costs generated by other parts of the tax system. In many developed countries, owner-occupied housing receives favorable tax treatment compared with other forms of investment. This tax bias is generated through exemptions for imputed rent and capital gains combined with full or partial deductibility for interest costs. This treatment may—in addition to adding to mortgage debt levels and housing prices, and perhaps their volatility—distort capital flows and lead to overinvestment in housing (OECD 2008; IMF 2009). In these circumstances, although not first-best, raising taxes on immovable property could conceivably reduce the tax bias in favor of housing and improve efficiency and growth. This could induce an outflow of capital from residential property toward more profitable uses (OECD 2010).
In a similar vein, increased property taxes may help reduce reliance on distorting property transfer taxes.19 Capital transfer taxes, which are popular in many countries as a buoyant tax handle, may reduce turnover of property and hence distort the allocation of this important component of capital. Furthermore, a key tenet in the optimal tax literature is that taxes of this nature impose efficiency costs through resource misallocations to the extent that their incidence rests on business inputs. For these reasons, some countries (for example, Ireland and Portugal) have considered replacing transfer taxes—totally or partially—with recurrent immovable property taxes, and the IMF’s Fiscal Affairs Department tax policy advice has supported a move away from property transaction taxes.
Property taxes may also potentially be effective in countering speculative housing price booms and house price volatility. Examples of countries using property taxation (including transaction taxes) in this respect include China and Singapore (Box 11.1). However, whether property taxes represent an efficient tool in this regard remains on open empirical question. To the extent that property taxes are predominantly capitalized in housing prices (driven by the net present value of future taxes), property taxes may at best have a one-off effect on price levels (and not on sustained house price inflation), and countercyclical use of property taxes to reduce house price volatility may not be efficient (a notion further complicated by its use mainly as a local government revenue source).20 It also appears that factors other than tax were dominant in driving the precrisis house price bubble and subsequent bust, although tax biases may have accentuated the crisis (Keen, Klemm, and Perry 2010); and nontax policy instruments such as limits on loan-to-value and debt-to-income ratios may in some cases be more effective than tax measures.21
Property taxation in small and highly open economies, particularly those exposed to intensive tax competition, could be considered a means of rendering tax systems more resilient to external shocks. This resilience would come from exploiting an immobile tax base in a period of globalization.22
Finally, but not exclusively related to economic efficiency, a particular advantage of higher reliance on taxes on immovable property is the absence of any need to improve international tax coordination as a prerequisite for their efficient use.
Equity Considerations: Are Property Taxes Fair?
Perhaps somewhat surprisingly for a tax as ancient as the property tax, its implications for fairness is a long-standing and contentious issue—and will probably remain so.23 The equity case for broader use of property taxes rests on the notion that they are generally assumed to be progressive—an assumption that is still not underpinned by a clear consensus.24 The so-called new view—now about 40 years old—that property taxes are borne mainly by owners of capital and landowners appears to have some support. Studies based on this view find generally that property taxes are progressive because land and capital are owned predominantly by higher-income individuals.25 The different views on the issue are summarized in Box 11.3.
Fairly limited work has been done to formally model property tax incidence under conditions compatible with those in developing and transition economies. It has been argued that key assumptions of the model underlying the new view, such as full capital mobility and a fixed supply of land, typically are not met in these countries, and that the predictions of the new view therefore do not hold. Based on simulations with a computable general equilibrium model tailored to more accurately represent the conditions in developing and transition economies, Sennoga, Sjoquist, and Wallace (2008) find that the burden of property taxes imposed on capital and land is borne by the owners of capital and land and is not significantly influenced by the assumptions regarding the mobility of capital. Hence, the property tax is progressive, with the burden borne predominantly by middle- and high-income earners. Since wealth and the earnings of high-income individuals can be hard to tax in these countries, a property tax—appropriately administered—could address vertical equity concerns in these countries.
Box 11.3Views on the Incidence of Property Taxation
According to the old (or traditional) view, the property tax combines a tax on highly mobile capital and immobile land, with the tax on capital being shifted fully to renters, consumers, and labor, while the tax on land is borne by landowners. Incidence studies based on this view, which put the emphasis on the shifting of the tax, generally find that the property tax is regressive.
In contrast, the new view (attributed to Mieszkowski ) assumes that capital is in fixed supply, but perfectly mobile across sectors and geography. The tax on capital is seen as a combination of a basic (or average) tax rate applied to all capital (which capital owners cannot escape since it is levied on a fixed supply of capital) plus a local differential that varies across jurisdictions—thus working as an incentive for capital to reallocate among jurisdictions until net after-tax rates of return are equalized. Incidence studies adopting this view find that the property tax is progressive (or at least not as regressive as under the old view) because land and capital are owned by higher-income individuals.
The benefit view provides an alternative, but not necessarily mutually exclusive, view of property tax incidence, and argues that the property tax is a benefit tax equal to the benefits received from the public services funded by the tax. The property tax thus acts as a price for local public goods, and individuals will choose the locations that offer services best in line with their preferences (the so-called Tiebout effect). By being, in essence, a user charge for local public services, the property tax is inherently fair based on the benefit principle. It has also been argued that property values capitalize the benefits provided, and hence that a tax on values represents a fair burden-sharing arrangement. By seeing the tax as a price for services received, the benefit view has the important implication that immovable property taxes are efficient taxes that do not interfere with the savings, investment, and labor supply decisions of individuals and companies.
It follows from the discussion that the relevance of each of these views may differ across countries depending on, among other factors, the degree to which property taxes actually reflect benefits received or are perceived to do so.
Adoption of a specific incidence view is needed to interpret distributional data. Data on the distribution of the property tax burden are rare, but Table 11.3 provides an example for Denmark that demonstrates some of the problems involved. The table provides a decile distribution of taxpayers with per capita averages of gross income, disposable income, and property taxes within deciles—as well as share of ownership (that is, the share of individuals in each income bracket who own immovable property) and effective tax rates. The data reflect actual tax liabilities from tax returns, that is, amounts to be paid by property owners within each decile. But the legal obligation to pay the tax does not necessarily provide an accurate reflection of its final, effective incidence, in the same manner as the obligation on traders to pay the value-added tax is not an accurate reflection of who ultimately carries the burden of the value-added tax. When observed through the prism of the new view, the property tax in Denmark appears regressive for the first two deciles—presumably because the populations in these deciles typically are quite heterogeneous26—and becomes progressive from the third decile up. This result occurs in part because property ownership, as shown in the table, increases strongly over the deciles; however, application of the new view assumes that renters are not carrying any of the property tax burden, which may not be an accurate assumption.
|Income||Class||Gross Income per Taxpayer||Average Disposable Income||Income tax||Property Taxes||Share of Ownership||Effective Tax Rate (percentage of gross income)||Effective Tax Rate (percentage of disposable income)|
Finally, it is generally assumed that the use of market values, by securing a minimum of variation in effective tax rates across property owners, will maximize fairness of the property tax, particularly to the extent that market values broadly reflect the capitalized benefits provided by local services that are financed by the tax. In contrast, alternative approaches, such as area-based taxation (for example, specific square meter taxes) unrelated to actual property values (or related only imperfectly so), typically entail variations in effective tax rates across properties, which may violate equity considerations.
The Cyclical Resilience of Property Tax Revenues
Although the property tax may be an efficient and fair tax, high cyclical volatility could render it less appropriate as a local tax. The deep 2008–10 recession and the high growth period that preceded it provide a unique background for studies of the cyclical sensitivity of the property tax—especially because of the crucial role of the housing market in that recession. Figure 11.1 for OECD countries—displaying basically a flat revenue ratio during the boom years leading into the recession—appears to indicate a low cyclical sensitivity of property taxation. This low tax buoyancy of immovable property during a period of very rapid asset price appreciation from the early to mid-2000s seems at first surprising.
However, recent empirical research for the United States has cast more light on the issue of the cyclical volatility of property taxes (in particular, Lutz, Molloy, and Shan 2010; Lutz 2008). As in many other countries, state and local government revenues in the United States dropped steeply following the most severe housing market contraction since the Great Depression; for example, state and local tax revenues fell by almost 5.5 percent in 2009—only the second year (along with 2002) since the Great Depression that state and local government tax revenues had fallen in nominal terms. However, the fall was driven by sharp declines in receipts from the individual income tax and the sales tax (of 17 percent and 7.5 percent, respectively) while, in sharp contrast, property tax revenues held up remarkably well, growing more than 5 percent in both 2008 and 2009, thereby serving as a significant buffer for the decline in other tax sources (Figure 11.5), although property tax revenue stopped growing in subsequent years. Figure 11.5 also illustrates that property taxes generally tend to be less volatile than other tax sources—long seen as one of the primary virtues of the property tax.27
Figure 11.5State and Local Tax Revenues, United States, 1993–2014
Sources: Property, sales, individual income tax data from US Census Bureau, Quarterly Summary of State and Local Tax Revenue; total tax revenues from OECD, Revenue Statistics.
The resilience of property tax revenue is, according to recent research, in part attributable to two factors. Using both time-series data and micro-level panel data from individual governments, Lutz (2008) estimates that the elasticity of property tax revenue with respect to home prices equals 0.4, indicating that policymakers tend to offset as much as 60 percent of house price changes by moving the effective tax rate in the opposite direction of the house price change (Figure 11.6). In other words, during the house price boom, local governments tended to spend part of the “rent” on popular rate reductions, while during the recession budgetary pressures forced them to raise property tax rates (possibly reflecting the relative ease with which base and rates can be adjusted as compared with other taxes). Furthermore, house price changes have an effect on property taxes only after a lag of about three years, reflecting three basic features of the tax: (1) assessments take place in a backward-looking manner because the current year’s taxes are based on the assessed property value in the previous year; (2) assessed values often lag market values, in some cases by design or legal mandate and, in others, because of poor administration (which may be intentional, particularly in jurisdictions that elect their assessor); and (3) most states have a cap or other limit on increases in revenues or taxable assessments (or even in rates). These factors would, during periods of rapid house price growth, prevent revenues from growing at the same pace as market values, and could create a stock of untaxed appreciation.
Figure 11.6Property Tax Revenues and House Values, United States, 1993–2014
Source: U.S. Census Bureau, Quarterly Summary of State and Local Tax Revenue.
Issues of Policy Design and Implementation
Several policy aspects and administrative challenges explain the dismal revenue productivity of immovable property taxes in many countries. Two policy variables and three administrative variables determine the yield of any property tax, as reflected in the basic revenue equation, which also provides a good structure for the ensuing discussion:
The equation expresses collected revenue (R) as the product of the legally defined tax base at actual prices (B), the average tax rate (t), the ratio of properties actually covered in the tax roll relative to all properties (C), the ratio of assessed to actual value of property in the roll (V), and the level of enforcement measured as actual collections as a share of liabilities or invoices (E). In an ideal world, C, V, and E would each take on the value of 1 but very rarely (if ever) do so in practice. These variables are discussed in turn in what follows.
Policy and Administrative Issues
Property Tax Base
There are numerous approaches to defining and measuring the property tax base (B), which can be classified broadly along three basic dimensions. The first dimension is the approach to assigning value to property. These approaches can be grouped into (1) market-price-based methods, encompassing valuation based on rental values or capital (market) values, and (2) area-based methods (see Box 11.4 for brief definitions; the practical issues are discussed under valuation (V) below). A second key dimension relates to the property components included in the base (land only, buildings [or other improvements] only, or combinations of the two). The final key distinction relates to the use of the property, since different uses can be treated differently for tax purposes, such as residential versus business property, or urban versus agricultural land.28 The specific property base definition adopted depends in part on the objective of the tax (such as financing local governments, securing better use of land, or financing urban development), and in part on the depth of local property markets and administrative capacity in individual countries.
Box 11.4Property Valuation Systems1
Rental value systems are used in many countries (particularly former British colonies) and define the tax base as the rent that can reasonably be expected in a fair market transaction. These systems are used in countries as diverse as India, Nigeria, Malaysia, and Trinidad. Although simple in concept, rental systems have serious practical challenges: a scarcity of data on actual rent payments makes base assessment difficult; some properties are rarely in the rental market (for example, owner-occupied housing, industrial property, vacant land); and some countries operate rent control systems. Estimates of the base may rely on rent surveys for different areas, often combined with expert judgment; estimated capital values of the property (from sales data or based on construction costs), converted to rental equivalent; or estimated (net) profit for the property. Rental values typically reflect the present use of the property, and may, therefore, not reflect the best alternative use of the property—with the lack of incentives that entails.
Capital value systems define the base as the market value of the property (land and improvements or structures) in an open market. This is the system used in most Organisation for Economic Co-operation and Development and Latin American countries, and there seems to be a shift toward this method. Many jurisdictions value land and buildings separately (Botswana, some Brazilian cities), while others base the assessment on the total value of the property (Cyprus, South Africa). Also conceptually straightforward, this system avoids some of the problems of the rental value system (for example, the value of vacant land, reflecting its value in best alternative use), and it may be the most equitable method—particularly to the extent that property value reflects the benefits of public investment. Key problems include, again, scarcity of data on market transactions and underdeclaration of such prices (for example, due to high property transfer taxes as discussed in the “Property Valuation” section in the main text). Valuations may be provided by expert assessors, who are often in short supply, and administrative costs can be high.
Land (or site) value systems tax the market value of land alone. This system is used in a variety of countries (Australia, Denmark, Estonia, Jamaica, Kenya, and New Zealand). Apart from raising revenue, it could be argued that the land value tax provides the strongest incentive for the most efficient use of land, although, because of the smaller base, the nominal tax rate must be higher to yield a given amount of revenue. This tax also entails lower administrative costs than a capital value tax. The system suffers from the same type of administrative shortcomings as the capital value tax, in addition to the complexities of assessing just the land in highly urbanized areas.
Area-based systems comprise the simplest methods. Such systems tax each parcel at a specific rate per unit area of land and per unit area of structures. It is used in many central and eastern European countries and a number of developing countries (such as, in different forms, in Nigeria and Vietnam). It is a simple, transparent, and fairly easily administered system, which allows imposition even in countries or localities with no—or only an embryonic—property market. The system ranges from a “pure” form based only on physical area, to hybrid forms that aim to better proxy capital value by also using other inputs such as zoning and indicators of quality (as used in a variety of forms in, for example, Chile, Indonesia, Poland, and Serbia), which are more complicated and often involve a significant amount of judgment. Other disadvantages include that it is generally not considered a fair tax, owing to potentially sharp differences in effective tax rates, and its buoyancy may be limited since it may not trace market price developments very well.
Although all property ideally should be subject to property taxation, a particularly urgent issue in many developing countries is the need to better capture the rapidly growing base of urban property to finance infrastructure. According to United Nations projections, Africa’s urban population will more than double between 2000 and 2030, creating an urgent need for local tax structures that can grow in tandem with the need for urban infrastructure (AfDB, OECD, and UNDP 2010). Property taxes are considered to be a natural candidate since they are progressive, administratively feasible, and scale up automatically with urban expansion. Similarly, global demographic forecasts indicate that the world’s urban population will double from 3 billion in 2000 to 6 billion in 2050, with nearly all growth occurring in developing countries. Most affected cities will see their populations grow several-fold over the next few decades, and will need to plan for future expansion and identify financing for needed arterial road networks and other basic infrastructure. One proposed strategy that may work well in developing countries with some large (and growing) cities but that are still heavily agrarian may be to introduce a combination of a capital value system for urban locales and an area-based system for more rural districts (Bahl 2009, 12).
The diversity across regions in the methods used for measurement of the property tax base is evident from Table 11.4. The table illustrates the relatively widespread use of area-based approaches among African, Asian, and transition economies.
|Region||Number of Countries||Land Value||Capital Improved Value||Land and Improvements||Improvement Only||Annual Rental Value||Area||Flat Rate|
|Central and South America||16||2||14||1||0||1||0||0|
Regardless of the method adopted to measure it, the property tax base is often porous, corroded by multiple exemptions and varieties of relief. The list of exemptions and special treatment is often long and frequently costly in revenue forgone. Typical exemptions include government property (roads, railroads, and pipelines, and central government property in local jurisdictions, for example) as well as merit uses such as schools and religious establishments. Many countries also use the property tax for broader social policy purposes, and—in addition to the use of basic property tax thresholds to protect the poor—a particularly costly (and regressive) exemption is that provided for owner-occupied housing in many countries.29
Property tax incentives for businesses have also escalated in some countries.30 Some countries provide special relief depending on family structure. In Serbia, for example, owner-occupiers receive a 40 percent tax reduction, increased by 10 percentage points for each member of the household up to a ceiling of 70 percent—potentially, contrary to intentions, rendering the tax regressive. In Uganda, in addition to the standard exemptions for government-owned property as well as property used for religious purposes, civil servants (police, military), unemployed persons, peasants, and people living in poverty unable to earn the minimum income are also exempt (Ecorys 2010). Many countries also provide tax preferences (including tax deferrals) to pensioners. Agriculture is another segment that generally receives very favorable property tax treatment, either by outright exemption (partly or fully, such as in Nicaragua, Guinea, and Tunisia [Bird and Slack 2005]) or by special treatment leading to a negligible liability (such as in Serbia). Perhaps an exception with regard to taxation of agricultural land is Namibia, where the central government land tax is designed mainly to encourage better land use. And few countries, if any, undertake systematic tax expenditure budgeting pertaining to the property tax to determine the true budgetary costs of the tax relief offered. The bottom line is that taxes frequently are paid on a base that bears little resemblance to the true level of property values, and yields could be substantially enhanced by scaling back excessive exemptions and relief.31
Similarly, the tax rate—(t) from equation (11.1)—can be structured in different ways. If capital value is the base, a flat or progressive rate is normally applied, although, as noted above, progressivity in some countries is secured through a basic property deduction. A flat rate is typically applied if the base is rental value; under area-based taxes the norm is a specific flat rate plus a given amount per unit of area (square meter or hectare of land, buildings—or both, such as in Vietnam). Tax rate levels and structures, including for different types of properties, also vary substantially across countries (and across jurisdictions within countries). In Namibia the central government applies tax on agricultural land at a basic rate of 0.75 percent of estimated market value while urban municipalities apply very modest rates to local property.32 Serbia uses a progressive rate structure, set by local governments, starting at 0.4 percent up to a maximum of 3 percent, while Cambodia is considering a uniform 0.1 percent tax. In the Kyrgyz Republic, a dual rate system (0.35 and 1.0 percent) is applied depending on the type of property. In many countries the authority to set rates is assigned to local governments, often within a fairly narrow band or below a ceiling set by law. In Uganda, for example, rates are determined by municipalities but with a maximum of 2 percent of rateable value. In other countries rates are set by a higher level government.
A simple, transparent, and hence fairly uniform rate structure has critical advantages. It minimizes administrative complexity and the risk of tax avoidance or evasion through misclassification of properties. It also minimizes the risk of misallocation of capital because different types of capital are not taxed at different tax rates. The use of reduced tax rates for residential properties may be politically convenient, but could lead to overinvestment in this type of property, and may reduce the accountability of local elected officials.33 Reduced rates obviously also will have a detrimental impact on the revenue yield. If the main reason for low rates is to protect the poor, a better solution would be to use a basic threshold for the taxation of residential property. In practice, many countries tend to tax business property at higher rates (sometimes at much higher rates) than residential and agricultural property.
Any viable property tax administration must ensure that almost all land and improvements are included in the tax register and that efficient methods are in place to keep it up to date—(C) from equation (11.1). A significant administrative problem, particularly in developing and transition economies, is the low ratio of parcels or properties in the tax register. In Kenyan municipalities, for example, coverage ranges between 30 and 70 percent, and in Chile a large share of new construction has not been included (Bahl 2009). In Serbia, according to some estimates, between 40 and 50 percent of real estate was previously not in the property register, although the situation seemed to improve significantly following the devolution of administration of the property tax to local governments in 2007 (USAID 2010). Possible reasons for these past administrative weaknesses in Serbia include lack of effective office and field control, lack of enforcement of sanctions for not filing, and the fact that a large number of properties fell below the threshold for the property tax. In contrast, in Latvia according to one measure, more than 98 percent of properties are included in the tax register, although this measure could be somewhat distorted because of the privatization process. Apart from the obvious direct revenue consequences, low coverage may have a significant indirect impact by adversely affecting the perception of the tax’s fairness and thereby property tax compliance.34
Valuation is a major administrative problem, particularly, but not exclusively, in many developing countries and transition economies—(V) in equation (11.1). A number of reasons cause this problem: a lack of trained valuators,35 generally weak administrative capabilities, and a “thin” or underdeveloped property tax market that generates insufficient transactions to provide a continuous flow of input to the valuation system (often combined with a lack of reliable data on the sales values of properties that are exchanged).
A key issue in this regard is the relative merits of decentralized versus central valuation systems.36 Although there appears to be broad consensus that the legal framework for property taxation should be uniform and centrally determined, arguments both for and against making the actual valuation a central or local task can be made. A frequent argument emphasizes the usefulness of local knowledge about the nature of property markets and sales conditions, as well as the need to provide a strong incentive for local administrations to keep coverage and values up to date. In many countries (such as Vietnam), local councils are charged with keeping the valuation rolls. In several Latin American countries where the property tax is a local revenue source (Guatemala and Mexico, for instance) these administrative responsibilities have gradually shifted to local governments, and in Brazil responsibility for property tax administration rests solely with local governments (Bahl 2009). Conversely, a lack of qualified local assessors and the tendency of local valuation officers to be subject to political pressures to delay or minimize updates would favor a centralized valuation system based on a critical mass of technical expertise (such as those used in, for example, Denmark, Latvia, Lithuania, and Uruguay). In many countries local and central governments share the responsibility, and in others a payment system for valuation services across levels of government is used. Although there is no single “correct” way of organizing the valuation function, it would seem that the case for local responsibility is strongest where the property tax is an important local revenue source.
These valuation problems frequently lead to value assessments for tax purposes that are much lower than market values.37 Low assessment ratios (assessed tax base relative to actual market value) seem to be typical under any of the standard valuation methods presented in Box 11.4. Bahl (2009) reports dramatic underassessments in many developing countries, with assessment ratios in the range of 25–50 percent in selected Indian cities (rental value), and a wider range of 10–90 percent in selected Latin American cities (market value). Serbia provides another striking example: for taxpayers keeping business books, the tax base is the book value of the property, which generally is well below market value; an analysis conducted in one municipality shows that the book value for 83 percent of the properties was less than 50 percent of the market value (and for 31 percent of properties it was less than 10 percent of market value) (USAID 2010). Valuation problems are, however, not limited to developing and transition economies, but can also pose significant challenges in developed countries, such as Germany,38 although the valuation mechanisms in place in OECD countries generally are fairly advanced. Once a valuation system is in place, updating it on a regular basis is essential: if valuation updates fall behind, it may be hard politically to “catch up” as demonstrated by the German example.
The use of property transfer taxes may exacerbate other valuation problems, with adverse implications that go beyond their efficiency costs (see “Efficiency Considerations in Favor of Property Taxation”). Transfer taxes, often in the form of stamp duties, are popular in many (including developing) countries, for a variety of reasons.39 But significant transaction taxes on property may lead to serious tax evasion by providing a strong incentive for collusion between buyers and sellers to undervalue properties when they are sold, thereby also automatically undermining property transactions as a key source of information on up-to-date market values for the cadastre. In addition, by reducing the overall volume of property transactions, they reinforce valuation problems by thinning the market.40
High transaction costs may also adversely affect economic performance by discouraging labor mobility. Significant transaction taxes are found in a number of countries, such as the 15 percent real estate transaction taxes in Senegal, the 15 percent Droits d’Enregistrement in the Central African Republic, and the transfer duty rates of 8 percent for individuals with high-value property and 12 percent for companies in Namibia. A stamp duty has long been in place in the United Kingdom, now with a maximum rate of 7 percent. The drawbacks referred to above explain why some countries have considered reducing transaction taxes as an integral component of property tax reform. Transfer taxes could, alternatively, be replaced by capital gains taxes on property, the inherent self-checking mechanism of which (with opposite interests for buyers and sellers in declaring high sales values) could reduce or eliminate the incentive for underdeclaration.
Property Tax Enforcement
Enforcement of the property tax is frequently very weak resulting in modest collection ratios—(E) in equation (11.1). Dismal collection ratios (actual collections as a percentage of liability or invoices) are found in a multitude of countries (for example, 15 percent in FYR Macedonia, 50 percent in the Philippines, 60 percent in Kenya, and 70 percent in Croatia). In Latin America the collection ratios are generally 75 percent or above (Bahl 2009). Low collection ratios may result from the tax being collected by local authorities who may have a political interest in not pursuing effective collections, and from minimal expected penalties. Furthermore, if transfers from the center cover a large portion of local expenditures, adverse incentives for efficient local tax enforcement may be created.41
Addressing Administrative Complexities
These administrative complexities (C, V, and E) must be addressed in any property tax reform if the immovable property tax is to produce a higher yield.42 One underlying problem is that, in contrast to income taxes and the value-added tax, the property tax cannot—or can only with significant difficulty—be self-assessed, that is, property owners cannot place an assessed value on their own property (the city of Bogota provides an interesting exception; see Box 11.5).43 Thus, relatively high administrative (as opposed to compliance) costs are incurred because of demanding information and record-keeping requirements and the need for an efficient valuation system. As noted, a particular problem in virtually all developing countries is the shortage of qualified property assessors or valuators.
The administrative complexities, if not properly addressed, may also reinforce each other, resulting in a high cost-to-revenue ratio for property taxes. It is readily evident from equation (11.1) that a combination of low coverage, valuation, and enforcement ratios will exacerbate each other, thus reinforcing their adverse impact on yield.44 Also, upgrading the administrative infrastructure necessary for an effective property tax often requires a significant up-front investment for establishment of registration procedures and a cadastre, introduction of information technology systems, and training programs. The recent wave of reform initiatives (Box 11.1) seem, however, to indicate that these up-front costs are not a decisive obstacle to reform. Unfortunately, information on the cost of administering property taxes is generally extremely scarce.45
These administrative obstacles may appear daunting, but a rich arsenal of different ways to value and tax property is available, providing a flexible means of adapting the tax and its administration to widely differing country circumstances (Mikesell and Zorn 2008). Although an efficient and accurate cadastre is a sine qua non of property taxation, a variety of valuation techniques can be used to measure the tax base, ranging—as discussed above—from simple unit land taxes (Vietnam, Nigeria) and taxation of estimated rental value to full-fledged market-value based systems. Many developing countries apply different property taxes to urban and rural property (Brazil, Namibia), taxing land and buildings in urban areas and only land in rural areas, while other countries exempt (partly or fully) agricultural land (Nicaragua, Guinea, Tunisia). To mitigate the impact of property taxes on low-income households and to substantially simplify tax administration by excluding low-value property from the tax net, some countries only tax property over a certain threshold (measured in area or, as in Serbia, value).
Box 11.5The Self-Assessment Approach in Bogota City
Until the property tax reform of 1993, the property tax in Bogota city was levied only on the less than 50 percent of total property owners who were included in the cadastral base. Furthermore, the cadastral valuations were outdated, with property values about 20–30 percent of their market values. With the 1993 reform, the city (as the only municipality in the country) introduced a self-assessment scheme, forcing taxpayers to declare the properties they owned and their values, substantially improving the extent of information available about the city’s real estate properties. The statute established that declared land values could not be less than the highest of the following three benchmarks: (1) 50 percent of the commercial value; (2) the cadastral valuation; or (3) the previous year’s self-assessment, indexed to inflation. The 50 percent provision was repealed in 1994 on the grounds that it was impossible to assign a market value to every property in the city unless a transaction had occurred. To further enhance compliance, the self-assessed values were used as the basis for calculating capital gains on property under the income tax (applying, however, to only a minority of property owners). The existence of an autonomous cadastral organization in the city was considered instrumental in implementing the self-assessment reform in Bogota City.
The reform led to the inclusion of a large number of previously informal properties in the cadastral base, and resulted in a doubling of tax filings in one year. It also brought taxable values closer to market values, and property tax revenues in real terms grew by 77 percent in 1994. The new scheme also resulted in a sustained increase in the number of properties paying the tax throughout the following decade.
In the late 1990s, however, property values dropped significantly as a result of the economic recession, and in many cases the minimum legal value determined by self-assessment became higher than the market value. The national government responded with legislation in 2000 leading to the elimination of the self-assessment provision and the introduction of a price index (the Urban and Rural Property Valuation Index), intended to update cadastral values that are not adjusted by the Cadastre Office in field activities. The index is calculated as the average increase in property prices estimated by the same office. This caused a further increase in the number of taxpayers declaring the cadastral value, from 72 percent in 2000 to 85 percent in 2002.
Subsequent valuation improvements based on substantially increasing the coverage of cadastral updating processes led to a historical record in the number of updated properties, and produced a ratio between the cadastral valuation and commercial value of about 81 percent in 2004.
Reformers can also draw on the vast experience with the use of property taxes in many developed countries (or their regions)46 as well as in some developing countries, and software tools, such as computer-assisted mass appraisal systems (Box 11.6), are widely available and have the potential to be applied in developing countries (Eckert 2008). Similarly, multiple options are available for the allocation between central and local authorities of the range of different responsibilities in the administration of the property tax; Martinez-Vazquez and Rider (2008) map the actual allocation of these responsibilities in a number of developed, emerging market, and developing countries.
Political Economy Considerations
Political economy considerations have also played important roles for the working of the property tax in many countries. By virtue of being a very transparent tax on an immobile base—the very features that make it a good tax—it is also a very politically unpopular tax. Furthermore, the property tax may, when looked at in isolation, run counter to politically and socially motivated objectives of stimulating home ownership, realizing the beneficial externalities from owner occupation.47 Opposition to the property tax has in a number of countries led to capping of the year-to-year growth of individual property tax liabilities.48 A problem with capping is that, by driving a wedge between tax liability and the market value, the tax may be transformed to something other than a real property tax, with subsequent consequences for economic efficiency, revenue raising, and fairness.49
Box 11.6Computer-Assisted Mass Appraisal (CAMA) Systems
The basic idea behind CAMA systems is to estimate a price index for a class of real estate, such as residential properties or business properties, from a representative sample of sold properties in the entire population (also called a hedonic price index). This index relates sales prices to the physical and location features of the sold properties (for example, property use and quality plus zoning). The index is then applied to the register of properties to revalue the entire universe of unsold properties. In developing countries with limited data on real estate markets, CAMA methods can make use of scarce price data to value entire classes of properties much more efficiently than traditional appraisal methods can. Also, recent improvements in spatial analyses using geographic information systems and low-level satellite technology have reduced the amount of data that needs to be collected from on-site inspections, resulting in a significant cost reduction for setting up an accurate fiscal cadastre.
In CAMA systems, the taxable value is determined by using the capital (improved) market value of the property.1 More specifically, capital market value would typically be estimated through the use of statistical techniques that assume that average or typical price-setting patterns and relationships can be estimated using samples of recently sold properties. The estimated statistical relationships between values and property attributes can then be used to estimate the market value of all properties in the same property class. This method typically involves the following steps:
Step 1: Gather market sales data for properties that were sold recently and include in the analysis sales price and property attributes. Data need to be cleaned to make sure that only data from arm’s-length property transactions are captured and that transactions have no special conditions attached.
Step 2: Using this sample of recently sold properties, estimate the relationship between property attributes and the realized sales price using standard regression analysis methods.
Step 3: Collect attribute data for each land parcel, including land or site area, building area, and building quality.
Step 4: By using the established relationships (coefficients) from Step 2, calculate the estimated sales price of each property.
Step 5: Calculate the taxable value from the estimated market value if the two differ as the result of property tax policies (exemptions or thresholds and the like).
Step 6: Apply the approved tax rate to the taxable value to derive the tax liability.
Increased use of property taxes also raises complex issues of intergovernmental fiscal design, involving, among other components, transfer systems. Particularly in many transition economies, democratization underpinned by decentralization programs has made the property tax an increasingly important instrument of local government financing (Bahl 2009). The use of taxes on business property also raises particular issues that require attention, among them preventing costs from being increased disproportionately for businesses that use relatively more property as a factor input.
By virtue of not being directly proportional to income, property taxes are also frequently considered to be unfair. This issue has been addressed in different manners, for example, by taxing property whose value is only above a certain threshold, or by exempting sectors characterized by a high frequency of low-income earners, such as agriculture in developing countries.
A Strategy for Reform
The administrative and political economy challenges discussed above are not trivial, and require resolute action and careful planning. Foremost among these challenges, reforms require strong political will to introduce, enforce, and maintain a property tax—political will that must address the variety of policy and administrative challenges discussed in this chapter, and often in the face of strong popular opposition. These challenges cannot be resolved overnight but must be addressed through a medium- and long-term reform strategy that has to be carefully calibrated to fit the particular circumstances of individual countries.50 In particular, reform approaches cannot simply be copied from successful developed countries. It is also important to realize that successful reform of immovable property taxation, with its promising revenue potential, requires up-front investment in training and creation (or upgrading) of the necessary administrative infrastructure, most importantly in the form of a comprehensive and accurate cadastre or register for tax purposes. Common elements of a reform strategy would ideally involve the following:51
An in-depth diagnostic analysis that carefully maps present capabilities and identifies policy and administrative weaknesses, combined with policy decisions on the future role of property taxes, particularly as part of a broader decentralization strategy.
Development of specific tax policy design, with particular focus on the definition of the base, the rate structure, and exemption policy. The key objective should be simplicity with a minimum of exemptions and other relief, for ease of administration and maximum fairness. Regular costing of tax relief—revenue forgone—is essential.
Detailed planning of administrative reform, carefully adjusted to individual country circumstances, involving in particular (1) improved coverage of the cadastre or tax register; (2) better valuation, including procedures for regular updating; (3) improved record keeping based on close coordination between the agencies involved; (4) improved collection rates through strong enforcement and low compliance costs; and (5) clear decisions on the allocation of responsibilities between the central and local governments with regard to how these core administrative tasks are carried out.
Reduction or phasing out of property transfer taxes, to possibly be replaced by either the recurrent property tax under reform, or (where administratively feasible) a capital gains tax on property.
Finally, to prevent property tax systems from falling back into disrepair, development of a monitoring device based on quantitative performance indicators. These indicators would ideally include regular assessments of coverage of the tax register, valuation performance, and collection efficiency.
In summary, efficiency and equity considerations combine to provide a strong case for exploring ways to further strengthen the role of property taxes, and in particular recurrent taxes on immovable property. Although careful planning of necessary improvements to the basic administrative infrastructure is clearly required to carry out successful reforms in this area, there is clear scope for assigning a more prominent role to immovable property taxes in the medium to longer term. Data deficiencies preclude accurate estimates of their potential role, but it would not seem unrealistic to target a revenue raising potential of about 0.5–1 percent of GDP in the next 5–10 years for many developing and emerging economies, but with a much larger potential of about 2 percent of GDP or even higher for many developed countries that today rely only modestly on taxation of immovable property.
|Taxes on Property||Recurrent Taxes on Immovable Property|
|Country or||GDP per||% of||% of||% of||% of||% of Local||% of General|
|Economy||OECD||capita, US$||GDP||Taxes||GDP||Taxes||Taxes||Property Taxes|
|Hong Kong SAR||No||36,589||2.74||20.24||0.65||4.83||n.a.||n.a|
|Taxes on Property||Recurrent Taxes on Immovable Property|
|General Government||General Government||Local Government|
|Country or Economy||OECD||World Bank Income Group||GDP per capita, US$||% of GDP||% of Taxes||% of GDP||% of Taxes||% of Local Taxes||% of General Property Taxes|
|Taxes on Property||Recurrent Taxes on Immovable Property|
|General Government||General Government||Local Government|
|Country or Economy||OECD||World Bank Income Group||GDP per capita, US$||% of GDP||% of Taxes||% of GDP||% of Taxes||% of Local Taxes||% of General Property Taxes|
African Development Bank, Organisation for Economic Co-operation and Development, and United Nations Development Programme (AfDB, OECD, and UNDP).2010. African Economic Outlook 2010.Côte d’Ivoire: AfDB; Paris: OECD; New York: UNDP.
2009. “Property Tax Reform in Developing and Transition Countries.” Fiscal Reform and Economic Governance project, USAID, Washington.
2008. “The Determinants of Revenue Performance.” In Making the Property Tax Work, edited by RoyBahl, JorgeMartinez-Vasquez, and JoanYoungman. (ed)Cambridge, Massachusetts: Lincoln Institute of Land Policy
2008. Making the Property Tax Work.Cambridge, Massachusetts: Lincoln Institute of Land Policy.
2010. “Challenging the Conventional Wisdom on the Property Tax.” Lincoln Institute of Land Policy, Cambridge, Massachusetts.
2011. Implementing a Local Property Tax When There Is No Market: The Case of Commonly Owned Land in Rural South Africa.Cambridge, Massachusetts: Lincoln Institute of Public Policy.
2005. “Land and Property Taxation in 25 Countries: A Comparative Review.” DICE3(3): 34–42.
2012. “The Hated Property Tax: Salience, Tax Rates, and Tax Revolts.” NBER Working Paper No. 18514, National Bureau of Economic Research, Cambridge, Massachusetts.
2008. “Computer-Assisted Mass Appraisal Options for Transitional and Developing Countries.” In Making the Property Tax Work, edited by Roy Bahl, Jorge Martinez-Vasquez, and JoanYoungman. (ed)Cambridge, Massachusetts: Lincoln Institute of Land Policy.
2011. “Do Caps on Increases in Assessed Values Create a Lock-In Effect? Evidence from Florida’s Amendment One.” National Tax Journal64(1): 8–25.
International Monetary Fund (IMF). 2009. “Debt Bias and Other Distortions: Crisis-Related Issues in Tax Policy.” Fiscal Affairs Department, Washington.
2012. “Rethinking Property Tax Incentives for Business.” Policy Focus Report, Lincoln Institute of Land Policy, Cambridge, Massachusetts.
2008. “The Connection between House Price Appreciation and Property Tax Revenues.” Finance and Economics Discussion Series, Federal Reserve Board, Washington.
2010. “The Housing Crisis and State and Local Government Tax Revenue: Five Channels.” Federal Reserve Board, Washington.
2008. “The Assignment of the Property Tax: Should Developing Countries Follow the Conventional Wisdom?” Working Paper 08–21, International Studies Program, Georgia State University, Atlanta, Georgia.
1972. “The Property Tax: An Excise Tax or a Profits Tax?” Journal of Public Economics1(1): 73–96.
2008. “Data Challenges in Implementing a Market Value Property Tax: Market and Market-Informed Valuation in Russia, Ukraine, and the Baltic States.” In Making the Property Tax Work, edited by Roy Bahl, Jorge Martinez-Vasquez, and JoanYoungman. (ed)Cambridge, Massachusetts: Lincoln Institute of Land Policy.
Organisation for Economic Co-operation and Development (OECD).2008. “Tax and Economic Growth.” Economic Department Working Paper No. 620, OECD, Paris.
Organisation for Economic Co-operation and Development (OECD).2009. Revenue Statistics 1965–2008.Paris: OECD.
Organisation for Economic Co-operation and Development (OECD).2010. “Tax Policy Reform and Economic Growth.” OECD Tax Policy Studies No. 20, OECD, Paris.
Organisation for Economic Co-operation and Development (OECD).2014. Revenue Statistics 1965–2013.Paris: OECD.
2010. “Determining Countries’ Tax Effort.” Hacienda Publica Spanola, Instituto de Estudios Fiscales.
2014. Capital in the Twenty-First Century.Cambridge, Massachusetts: Harvard University Press.
2011. “How to Deal with Real Estate Booms: Lessons from Country Experiences.” IMF Working Paper No. 11/91, International Monetary Fund, Washington.
2008. “Incidence and Economic Impacts of Property Taxes in Developing and Transitional Countries.” In Making the Property Tax Work, edited by Roy Bahl, Jorge Martinez-Vasquez, and JoanYoungman. (ed)Cambridge, Massachusetts: Lincoln Institute of Land Policy.
Tax Notes International.2010. “Tax Court Calls for New Property Valuations,” Tax Analysts, Falls Church, Virginia, August 30.
UN-Habitat. 2011. Land and Property Tax—A Policy Guide.Nairobi, Kenya: United Nations Human Settlements Programme.
United States Agency for International Development (USAID). 2010. “Tax Policy in Serbia—Looking Forward.” USAID Sega Project, Belgrade.
2010. “Assessing the Tax Performance of Developing Countries.” Discussion Paper, Deutsches Institut für Entwicklungspolitik and German Development Institute.
2001. “A History of the Property Tax in America.” In Property Taxation and Local Government Finance, edited by WallaceOates, (ed)123–47. Cambridge, Massachusetts: Lincoln Institute of Land Policy.
The author is grateful to Michael Keen, Victoria Perry, Ruud de Mooij, Dora Benedek, Russell Krelove, Mario Mansour, Thornton Matheson, Martin Grote, Selcuk Caner, Peter Mullins, Victor Thuronyi, Riel Franzsen, and Lawrence Walters for constructive comments on an earlier draft. Tarun Narasimhan and Kelsey Moser contributed with highly competent research assistance, including the compilation of the underlying data set on property tax revenue and the regression analyses reported in Box 11.2.
Although a distinction should be made between taxation of business and residential properties in respect of both their economic effects and revenue potential, with potentially very different distributional effects and with business property in many countries being subject to (often much) higher tax levels than residential property.
Cabral and Hoxby (2012) suggest that the salience of the tax can explain differences in the level of property taxes across areas.
These measures include, for example, transfer pricing provisions, a multitude of exchange of information arrangements (such as the European Commission’s interest directive and the Global Forum), controlled foreign company legislation, and thin capitalization provisions.
The main ones being the IMF’s Government Finance Statistics and the OECD’s Revenue Statistics.
Capital transfer taxation is a buoyant tax handle in some countries (including in some non-OECD countries, such as South Africa), but is also generally acknowledged to generate potentially large efficiency costs, and may, furthermore, have negative spillover effects on the working of immovable property tax systems, as discussed later in this chapter.
Net wealth and inheritance and gift taxes may rest on a sound rationale in their importance for redistribution from the wealthy (particularly if exemption levels are high enough to exclude the life-cycle savings of all but the wealthy), and as a useful backup to personal income taxes. But they may also discourage savings by the people to whom they apply, and—because of the mobility of their bases—taxation may induce people to move wealth abroad. They also require fairly sophisticated tax administrations, and some countries have scaled back or eliminated net wealth taxes in recent years, while others have chosen not to introduce them in the first place (for example, Mexico, the United Kingdom, and the United States have no net wealth taxation).
This fairly recent decline in reliance on property taxes reflects in some cases a continuation of a much longer and stronger trend: for the United States, for example, Wallis (2001) reports that although the property tax in 1902 constituted 73 percent of all local government revenues, and 68 percent of combined local and state revenues, these shares had dropped to 40 percent and 18 percent, respectively, by 1992.
Albeit with large variations within both groups.
Annex Tables 11.1.1 and 11.1.2 also show that the yield of immovable property taxes, on average, represents 3½ percent of total taxes in high-income countries compared with about 1.4 percent in middle-income countries.
However, a large number of transition economies have implemented decentralization reforms, including devolution of political decision making—a key element of which has been the strengthening of property taxes, typically with some local autonomy to set tax rates (Bahl 2009).
The data deficiencies do not allow empirical estimations of tax capacity for property taxes, defined as potential tax collections in individual countries as determined by a variety of structural attributes (Pessino and Fenochietto 2010). Tax effort then measures actual collections relative to estimated tax capacity.
Although tax effort is not necessarily lower in middle-income than in high-income countries, the well-established positive relationship between a country’s ability to collect taxes and its development level (von Haldenwang and Ivanyna 2010) would support the hypothesis that tax capacity is generally higher in high-income countries. Combining this hypothesis with an assumption that countries—within each income group—with the highest property tax ratios also exhibit the highest tax effort provides the rationale for the simple calculations made here.
Bahl and Martinez-Vazquez (2008) conduct simulation experiments for developing countries based on improved collection and assessment ratios, and also arrive at significant potential for improved property tax collection.
However, present low levels of taxation, particularly in developing countries, render this distortion less of a concern (Bahl 2009).
If a property asset yields US$1,000 in untaxed return and the discount rate is 5 percent, its market price in a competitive market will be US$20,000. If a tax of 20 percent is introduced, the (net-of-tax) return will fall to US$800, and the market price to US$16,000 assuming an unchanged discount rate. The (net-of-tax) rate of return will thus remain unchanged at 5 percent for new buyers. This, in principle, also applies to business properties, although the effect may be more complex if other taxes are affected (for example, if the tax is deductible for corporate income tax purposes).
A “pure” benefit tax would, in principle, prevent tax competition among local governments. However, to avoid potentially harmful tax competition among local governments, particularly as the tax applies to business property, a number of countries often set narrow bands for allowable property tax rates.
Some countries apply the tax to counter speculation in land that lies idle or to induce land development.
Although the use of capital transfer taxes raises broader tax policy issues, such as whether a capital gains tax is in place, the issue of better balancing transfer taxes with recurrent taxes on property is pertinent in many countries, and therefore mentioned here as an important policy objective. The additional problems for valuation of property that may be induced by the use of property transfer taxes are discussed in the section titled “Issues of Policy Design and Implementation.”
Property transfer taxes could conceivably help dampen price volatility, but the effect is ambiguous and could be counterproductive when lower transaction volumes lead to higher volatility.
The use of tax and other policy measures in controlling house price boom-busts are discussed in Rabanal and others 2011, which provides insights into the pros and cons as well as the implementation challenges of various policy tools—tax and nontax—that can be used to contain the damage to the financial system and the economy from real estate boom-bust episodes.
There is, for example, renewed interest in strengthening property taxation in a number of countries in the Caribbean region as well as in the Baltic countries.
A brief account of historical property tax events in selected countries, including the United Kingdom and the United States, is provided by Youngman (2008), who refers to the property tax revolts in the United Kingdom in 1990 (introduction, and subsequent repeal, of the poll tax) and in the United States in 1978 (California’s Proposition 13), when unpopular value-based taxes were replaced with politically more palatable alternatives.
The incidence in developing and transition economies may be even less clear than in developed countries because capital markets are less developed and ownership rights are often ill defined.
The different incidence views are discussed by Sennoga, Sjoquist, and Wallace (2008), who also address the limitations to the new view and the benefit view when applied to developing and transition economies.
These deciles would include, for example, pensioners with low income but valuable property and the newly self-employed with low income. Some countries address these particular problems by allowing property tax deferrals until ownership of a property changes.
This is particularly important for local governments, which are less able to absorb revenue shocks than are central governments with more revenue sources at their disposal. However, it also suggests that the property tax may be less powerful as an automatic stabilizer than other taxes illustrated here.
Tax on agricultural land may in some cases be a substitute for agricultural income tax.
Bahl (2009, 5) refers, for example, to a study of Punjab province in Pakistan where bringing owner-occupied housing fully into the tax net would triple the level of provincial property tax revenues.
Kenyon, Langley, and Paquin (2012) provide a good account of the use of property tax incentives for business in the United States, with a critical assessment of their effectiveness in promoting economic development.
Bahl 2009 estimates the revenue costs of exempting government property as equivalent to about 12 percent of collections in India’s 36 largest cities. Many countries, such as Kenya and Canada, charge a payment in lieu of property taxes on government property and nonprofit uses of property (Bahl 2009).
In Windhoek, for example, the rates are 0.0734 percent of the site value, and 0.0379 percent of the house (improvement) value.
Particularly in developing countries, where the place of residence is often the same as the place of business, levying different rates can be administratively difficult.
Comprehensive and accurate registration of property, and thereby close to complete coverage of the property tax base, is a cornerstone of successful property tax reform, and is, in turn, crucially dependent on the sharing of data between key players (cadastral agency, property registry, courts, tax authorities, geodetic institutes, and others).
Often because of lack of appropriate training programs or a significant gap in compensation between the public and private sectors.
Or more generally, the system applied for the upkeep of the cadastre, including coverage, titling, and valuation.
Which in some countries is adjusted for through increases in tax rates—a second-best solution in view of the continuous changes in relative property values.
In a June 2010 judgment, Germany’s Federal Fiscal Court ruled that the continued failure to conduct a general revaluation of real property violated the equality principle of the German constitution, and that a reassessment of property values was necessary. The problem was that the German property valuation system had relied on assessments dating back to 1964 for states in the former West Germany and to 1935 for states in the former East Germany. It was up to the German municipalities to implement the decision (Tax Notes International 2010).
The transfer tax is an easy tax handle, with high compliance due to property buyers’ desire to acquire proper legal ownership documents; revenues collected can be very high with low administrative costs, in part because there are many fewer taxpayers than under a recurrent property tax; and the tax may be progressive.
Another means of avoiding a property transaction tax is to register property in closed corporations such that, in the case of transfers, the object of the sale may not be the property itself, but the shares in the company (or interest in a trust) that holds the property. This would also deprive the cadastre of important market price information.
Remedial measures—proposed or adopted—to strengthen enforcement include moving collection points to banks, rewarding improved enforcement with higher transfers, and linking property tax payments to the provision of utility services.
See Bahl and Martinez-Vasquez 2008 for a good discussion.
Although elements of self-assessment (or self-identification) are found in Hungary, Thailand, and the Philippines (Bird and Slack 2005).
A simple example may clarify this point: if both coverage and valuation ratios are at about 0.7 in a given country—not unrealistic assumptions in many developing countries—the total yield of the property tax could potentially double through an aggressive program to widen coverage and update values, and—importantly—these actions are within the existing legal and regulatory framework.
Estimates for Latvia indicate that administrative costs at the municipal level exceed 10 percent of revenues in about half of the local governments, and reach up to 36 percent (in addition to the costs incurred at the central government agency involved). However, these seemingly high ratios are affected not only by “high” administrative costs, but also by very low tax rates, and hence may not provide a generally applicable cost estimate.
Such as, for example, in Denmark, Sweden, Northern Ireland, Spain, and Canadian provinces.
See IMF 2009, which also illustrates the point that property taxation is only one element in determining effective tax rates on property, interest deductibility and (non)taxation of imputed rent and capital gains being others.
A well-known case in the United States was “Proposition 13,” an amendment to the Constitution of California enacted in 1978, which capped both property value increases (at 2 percent per year) and the tax rate (at 1 percent), but capping is now in force in most U.S. states (Lutz, Molloy, and Shan 2010). Capping is also in place in other cities and countries, such as Bogota, Buenos Aires, and Latvia.
Ihlanfeldt (2011) discusses the potentially adverse impact of capping on housing and labor market mobility, and tests for these effects in Florida.
A particular timing issue in this respect is that the government that endures the pain of initializing reform may not be the government that reaps the benefits of reform.
See Bahl 2009 for a discussion. These elements are broadly applicable to both developed and developing countries engaged in property tax reform.