May 27, 2013 05:28 PM

In Property Tax Debate, the Pros Outweigh the Cons


The country's real estate market is marked by high prices and ineffective macro control policies.

Three steps must be taken before the market gets back to normal: a mortgage policy with different levels reflecting credit of borrowers must be enacted; property tax must be introduced; and a nationwide, unified land market should be created.

The country is considering the second step and mulling a nationwide property tax, a process repeatedly delayed by local governments' heavy reliance on land income and the central government's worry about financial risks.

There is no doubt that revenue from land sales has been the backbone of local government coffers. The annul fees rose from 500 billion yuan in 2003 to 2.9 trillion yuan in 2010, and accounted for 72 percent of local government income in 2010.

The problems with this are obvious. There is a limit to the quantity of sellable land and violence in the expropriation process has been a frequent source of social unrest. In addition, local governments' fiscal decisions are often made on the assumption that land prices will continue to appreciate. When property prices do not go up anymore, the trading volume of land will drop and severely affect the spending ability of local governments. These problems are imminent, and solutions should not wait any longer.

In the United States, property tax income, based on a 1 percent to 3 percent rate, accounts for more than 70 percent of the revenue of local governments. China's total residential housing covered an area of about 14.8 billion square meters in 2012 and continues to grow. With a 1 percent tax rate, the total income in a year could be 800 billion yuan in 2012 and about 900 billion yuan in 2013.

In the absence of a total number of households to compute all kinds of tax exemptions, the calculation is rough. But the size of the income is definitely significant.

The introduction of a property tax would put downward pressure on the housing industry and reduce land sale income for local governments, but this can be offset. Let's assume the reduction is 20 percent. The money missing from local government coffers – including both land sale fees and 11 types of taxes related to property rights transactions – is as much as 890 billion yuan, still less than the 900 billion yuan projected property tax income.

One can question the reliability of a 20 percent reduction in market sales. The only shock to China's nascent real estate market occurred during the global financial crisis in 2008, when prices dropped by 13 percent. The 20 percent assumption has already left a wide margin for a deep market downturn.

Another legitimate question is: Does the government have the right to both collect land transfer fees and a property tax. The official explanation is that the Chinese government has a dual role as a provider of social services and the representative of public ownership. Land transfer fees are collected by the government, representing the owner, and the property tax would be collected by the government as society's representative in order to provide services. The validity of this explanation is worth further debate, but is not the focus of this article.

Who is most worried by a property tax? Among the forces against such a tax are corrupt officials who own multiple properties. There is hope that this problem can be solved by June 2014, the deadline set by the State Council to have a unified property registration system.

A slowing property market will bring fears to local governments and inhibit their ability to raise money. In the long run, less income will limit the investments made by local governments, and in the short term it could result in half-finished projects begging for funding. This is a scenario the central government wants to prevent. But the cause of this likely scenario is not a property tax, but the over-borrowing of local governments and the continuous spending spree on infrastructure.

Lou Jiwei, the new finance minister, has set in motion a survey on government debt. He plans to take action to stop the debts of local governments from further growing and divert them a to sustainable revenue channel. In addition, Lou might aim to reduce the work of local governments. He said in public speeches in 2011 and 2012 that central government agencies are understaffed and under-funded, leaving local governments to make decisions on policies that should be handled at the central level.

Everyone agrees that the funding of local governments is not enough for them to perform all of their responsibilities. A redesign of the tax split between central and local governments will happen, and it could move some of the responsibilities back to the central level, rather than giving more financial resources to the local level.

Collecting a property tax can curb local governments' urge to sell land. Coupled with a careful policy to de-leverage local government debt and a redesign of central-local tax income split, the move has the potential to set the government revenue on the right track and bring significant benefit to the country's economic growth as a whole.

The authors are macro-economy analysts at Haitong Securities

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