Property Tax in BRICS Megacities : Local Government Financing and Financial Sustainability 978-3-319-62671-0, 331962671X, 978-3-319-62670-3

Table of contents :
Front Matter ....Pages i-xiii
Introduction (Marco Salm)....Pages 1-12
Theoretical Insight on the Property Tax (Marco Salm)....Pages 13-40
Property Taxes Within the BRICS States (Marco Salm)....Pages 41-185
Summary and Way Forward (Marco Salm)....Pages 187-207
Back Matter ....Pages 209-220

Citation preview

Contributions to Economics

Marco Salm

Property Tax in BRICS Megacities Local Government Financing and Financial Sustainability

Contributions to Economics

More information about this series at http://www.springer.com/series/1262

Marco Salm

Property Tax in BRICS Megacities Local Government Financing and Financial Sustainability

Marco Salm Bonn, Germany

Dissertation German University of Administrative Sciences Speyer, Germany ISSN 1431-1933 ISSN 2197-7178 (electronic) Contributions to Economics ISBN 978-3-319-62670-3 ISBN 978-3-319-62671-0 (eBook) DOI 10.1007/978-3-319-62671-0 Library of Congress Control Number: 2017949277 © Springer International Publishing AG 2017 This work is subject to copyright. All rights are reserved by the Publisher, whether the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfilms or in any other physical way, and transmission or information storage and retrieval, electronic adaptation, computer software, or by similar or dissimilar methodology now known or hereafter developed. The use of general descriptive names, registered names, trademarks, service marks, etc. in this publication does not imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use. The publisher, the authors and the editors are safe to assume that the advice and information in this book are believed to be true and accurate at the date of publication. Neither the publisher nor the authors or the editors give a warranty, express or implied, with respect to the material contained herein or for any errors or omissions that may have been made. The publisher remains neutral with regard to jurisdictional claims in published maps and institutional affiliations. Printed on acid-free paper This Springer imprint is published by Springer Nature The registered company is Springer International Publishing AG The registered company address is: Gewerbestrasse 11, 6330 Cham, Switzerland

Preface

‘Old’ taxes are not necessarily ‘good’ taxes—especially in a rapidly changing world. Both ‘old’ and ‘good’ might apply with regard to property taxation. Property tax is as ‘old’ as public administration and still exists as a tax levy today. Governments at various levels have assessed and taxed actual or perceived incomes arising from capital, labour and property, which determined various forms of taxation: income tax, capital gains tax, sales tax and property tax. Beyond that, property tax is a ‘good’ tax; the excess tax burden is minimised due to the immobile tax base— namely land and improvements thereto. The discussion on the German property tax reform reveals that old taxes are not necessarily good taxes. For 35 years, there have been various reform attempts. Year after year, inequality between taxpayers increases due to divergent trends in property values throughout German territory. Assessment values, however, have not developed since the last assessment in West Germany 1964 (or 1935 in eastern Germany). Therefore, the tax rates have increased hugely (up to 810% in Berlin) in order to keep tax revenue stable. The level of tax rates is symptomatic for the inherent problems involved in German property tax—especially with regard to equity. The German experiences illustrate that an old tax can be far from a good tax. The question therefore has arisen as to how other countries—especially emerging economies, such as Brazil, Russia, India, China, and South Africa (BRICS), are coping with the changing world. Within these countries, megacities have been most affected by change: vertically due to decentralisation of functions (less finances) and horizontally due to rural urban migration. Several tax systems of the BRICS have been revised in the past—especially since the end of the 1990s and the appearance of fiscal decentralisation, thrusting BRICS tax systems into the spotlight. However, underlying local tax systems—especially with regard to property tax—are still a neglected field in academic research and political action, as is the case in Germany. With regard to the BRICS, the focus should certainly be on the megacities as they are economically and administratively leading the way in their respective countries.

v

vi

Preface

This book systematically illuminates the inherent benefits of the property tax, its diverse designs to be found and its shortcomings by contrasting property tax in practice with normative public finance criteria. The book further stimulates the awareness that property taxation is the most viable local own-tax revenue source for local governments in general and for megacities in specific. Property tax should be utilised—equitably and efficiently. This book is based on several publications that have been revised and consolidated: The initial enthusiasm for property taxation was laid by the revision of the German property tax reform approaches and their impact on the equalisation scheme between the central and state governments (which explains the absence of local property tax reform in Germany, Fa¨rber et al. 2013). The normative public finance framework for assessing the property tax systems in the BRICS states followed (Salm 2014), which provides the basic structure of this book. Thereafter, a first assessment of the Chinese property tax system was published (Salm 2016), which has been the blueprint for the other property tax systems to follow in this publication. Finally, and most importantly, I would like to thank my academic supervisor Prof. Gisela Fa¨rber. Academically, we walked a long way down the road writing expertise for local, state and the federal Government at the German Research Institute for Public Administration. Here, I learned to write. Thereafter, under the lead of Prof. Fa¨rber I have been research assistant at the German University of Administrative Sciences, where I gained a deeper insight into local public finance, particularly by assisting the seminar on ‘Basics Foundations of Local Government Finance in Germany’. Overall, thanks to Prof. Fa¨rber, I had the opportunity to write this book and the possibility to undertake a research visit to China to gain a deeper insight into the Chinese property tax system. Beyond that, I would like to thank Prof. Gunnar Schwarting for devoting his expertise as second examiner. The German Research Institute for Public Administration has supported the book by awarding a doctoral scholarship (from April 2014 to March 2015). Bonn, Germany

Marco Salm

References Fa¨rber G, Salm M, Hengstwerth S (2013) Property tax reform in Germany – eternally unfinished or an instrument of a more equitable (local) tax system? In: The Copenhagen workshop 2013, Korea Institute of Public Finance and the Danish Ministry for Economic Affairs and the Interior, pp 167–202 Salm M (2014) Property taxes in BRICS – comparison and a first draft for performance measurement. Discussion paper 79, German Research Institute for Public Administration Salm M (2016) Property tax as a local government financing instrument for megacities in China. J Prop Tax Assess Adm 13(2):5–34

Contents

1

Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.1 Research Approach . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1.2 Range of Megacities Considered . . . . . . . . . . . . . . . . . . . . . . . . 1.3 Fundamental Terminology . . . . . . . . . . . . . . . . . . . . . . . . . . . . References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

. . . . .

1 5 7 9 11

2

Theoretical Insight on the Property Tax . . . . . . . . . . . . . . . . . . . . . 2.1 Theoretical Background . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.1.1 The Property Tax as Decentralized Tax . . . . . . . . . . . . . 2.1.2 Incidence of the Property Tax . . . . . . . . . . . . . . . . . . . . 2.1.3 Local Finance Criteria for a Rational Decentralized Tax . . 2.2 Stylized Facts of the Property Tax . . . . . . . . . . . . . . . . . . . . . . . 2.2.1 Property Tax Base . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.2.2 Exemptions and Exclusions . . . . . . . . . . . . . . . . . . . . . . 2.2.3 Property Tax Assessment . . . . . . . . . . . . . . . . . . . . . . . . 2.2.4 Tax Rates . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.2.5 Identification, Assessment, Billing, Collection, Enforcement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2.2.6 Property Tax Performance Ratios . . . . . . . . . . . . . . . . . . 2.2.7 Revenue Mobilizing Model . . . . . . . . . . . . . . . . . . . . . . References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

. . . . . . . . . .

13 13 13 18 23 25 26 26 27 30

. . . .

32 36 36 38

Property Taxes Within the BRICS States . . . . . . . . . . . . . . . . . . . . 3.1 Country Profiles . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.1.1 Brazil . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.1.2 Russia . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.1.3 India . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.1.4 China . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.1.5 South Africa . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

. . . . . . .

41 41 43 45 46 48 50

3

vii

viii

Contents

3.2

4

Case Studies: Megacities in Brazil, India, and China . . . . . . . . . 3.2.1 Brazil . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.2.2 India . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.2.3 China . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.3 Comparative View on Stylized Facts of the Property Tax in BRICS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.3.1 Tax Policy Decisions . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.3.2 Administrative Practices . . . . . . . . . . . . . . . . . . . . . . . . 3.4 Future Significance of Property Tax in a Transitional Setting . . . References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

. 51 . 51 . 96 . 141 . . . . .

164 164 170 173 182

Summary and Way Forward . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.1 Similar Megacities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.2 Different Tax Designs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.2.1 Policy Decisions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.2.2 Administrative Practices . . . . . . . . . . . . . . . . . . . . . . . . 4.3 Way Forward . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . References . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

. . . . . . .

187 188 190 194 199 202 206

. . . . . .

209 209 211 212 214 217

Annex . A.1 A.2 A.3 A.4 A.5 A.6

................................................. Taxes on Property in Brazil . . . . . . . . . . . . . . . . . . . . . . . . . . . Taxes on Property in Russia . . . . . . . . . . . . . . . . . . . . . . . . . . . Taxes on Property in India . . . . . . . . . . . . . . . . . . . . . . . . . . . . Taxes on Property in China . . . . . . . . . . . . . . . . . . . . . . . . . . . Taxes on Property in South Africa . . . . . . . . . . . . . . . . . . . . . . Local and Central Revenue and Expenditure Assignments in China . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A.7 Development of Local Tax Revenues in Sample Cities, 1999–2013 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

. 219 . 220

List of Figures

Fig. 1.1

Research approach. Source: Author . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

6

Fig. 2.1

Institutional symmetry. Source: Author; Blankart (2003: 27f) . . . .

17

Fig. 3.1

Example for penalties levied by Prefeitura Rio de Janeiro, 2016. Source: Prefeitura Rio de Janeiro . .. . . . .. . . . . .. . . . .. . . . . .. . . . .. . . . .. . . 67 Estimated market value (PGV) relatively to market price, 1995–2014. Asterisk—Complemented by estimation for 2014, according to FN35. Source: Author; Prefeitura de S~ao Paulo, Secretariat de Receita Municipal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 71 Sensitivity of ISS and IPTU, S~ao Paulo. Source: Author; Prefeitura de S~ao Paulo; IGBE .. . . .. . . . .. . . .. . . .. . . .. . . .. . . .. . . .. . . .. . . .. . . .. . . .. . 86 Organizational chart of China’s tax administration. Source: Author; State Administration of Taxation . . . . . . . . . . . . . . . . . . . . . . . . . . . 150 Level of urbanization within the BRICS states 2015–2050. Source: Author; United Nations (2014) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 176

Fig. 3.2

Fig. 3.3 Fig. 3.4 Fig. 3.5 Fig. 4.1

Limitations on property tax (PT)—policy and compliance gap. Source: Author, IMF (2014) ............................................. 194

ix

List of Tables

Table 1.1

Megacities (resp. urban agglomerations) within BRICS States, 1980–2030 . . . .. . . . .. . . . . .. . . . .. . . . .. . . . .. . . . . .. . . . .. . . . .. . . . .. . . . . .. .

8

Table 2.1 Table 2.2 Table 2.3 Table 2.4 Table 2.5

Detailed composition of land value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Normative criteria for a local tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Applying rational local tax criteria to assessment base . . . . . . . . . Relationship between tax base and tax rate . . . . . . . . . . . . . . . . . . . . . . Relationship between nominal and effective tax rate . . . . . . . . . . .

19 23 28 31 32

Table 3.1 Table 3.2 Table 3.3

Key characteristics BRICS states . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Institutional structure of the BRICS states . . . . . . . . . . . . . . . . . . . . . . . Local taxes on property and administrative assignments in Brazil . . .. .. . .. .. . .. .. . .. .. . .. .. . .. .. . .. .. . .. .. . .. .. . .. .. . .. .. . .. .. . Local taxes on property and administrative assignments in Russia . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Local taxes on property and administrative assignments in India .. . . .. . . .. . . .. . .. . . .. . . .. . .. . . .. . . .. . .. . . .. . . .. . . .. . .. . . .. . . .. . Local taxes on property and administrative assignments in China . . . . .. . . .. . . . .. . . .. . . . .. . . .. . . . .. . . . .. . . .. . . . .. . . .. . . . .. . . .. . . Local taxes on property and administrative assignments in South Africa . . .. . . . . . . .. . . . . . . .. . . . . . . .. . . . . . . .. . . . . . . .. . . . . . . .. . . Total revenue, expenditure and net-transfers according to/among levels of government, 2013 . . . . . . . . . . . . . . . . . . . . . . . . . . . . Tax revenues in Brazil according to governmental level, 2013 . . . .. . . . . .. . . . . . .. . . . . .. . . . . . .. . . . . .. . . . . . .. . . . . .. . . . . .. . . . Revenues Rio de Janeiro and S~ao Paulo, 2012 . . . . . . . . . . . . . . . . . . Rio de Janeiro and S~ao Paulo and IPTU . . . . . . . . . . . . . . . . . . . . . . . . . Factor age (A) . . . .. . . . .. . . . . .. . . . .. . . . .. . . . . .. . . . .. . . . . .. . . . .. . . . . .. . Factor position (P) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Factor type residential (TR) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Calculation of market value in S~ao Paulo . . . . . . . . . . . . . . . . . . . . . . . .

42 43

Table 3.4 Table 3.5 Table 3.6 Table 3.7 Table 3.8 Table 3.9 Table 3.10 Table 3.11 Table 3.12 Table 3.13 Table 3.14 Table 3.15

44 46 47 48 50 53 55 57 58 62 62 62 63 xi

xii

Table 3.16 Table 3.17 Table 3.18 Table 3.19 Table 3.20 Table 3.21 Table 3.22 Table 3.23 Table 3.24 Table 3.25 Table 3.26 Table 3.27 Table 3.28 Table 3.29 Table 3.30 Table 3.31 Table 3.32 Table 3.33 Table 3.34 Table 3.35 Table 3.36 Table 3.37 Table 3.38 Table 3.39 Table 3.40 Table 3.41 Table 3.42 Table 3.43 Table 3.44 Table 3.45 Table 3.46 Table 3.47 Table 3.48 Table 3.49 Table 3.50 Table 3.51 Table 3.52 Table 3.53

List of Tables

Rebate on property tax according to tax amount, 2016 . . . . . . . . . Tax calendre Rio de Janeiro, 2016 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . S~ao Paulo property tax relief mechanisms, 2012 . . . . . . . . . . . . . . . . Correction factors assigned to value of land . . . . . . . . . . . . . . . . . . . . . Statistical value per m2 of a building according to type and standard . . . . . .. . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . Correction factors assigned to value of building . . . . . . . . . . . . . . . . Calculation of market value in S~ao Paulo . . . . . . . . . . . . . . . . . . . . . . . . Tax rate for residential properties, 2015 . . .. . . . .. . . . .. . . . .. . . . . .. . Classification of properties—Rio de Janeiro . . . . . . . . . . . . . . . . . . . . . Classification of properties—S~ao Paulo . . . . . . . . . . . . . . . . . . . . . . . . . . Recorded properties (City Administration), surveyed properties (National Census Data) and coverage ratios . . . . . . . . . . . . . . . . . . . . . Assessment ratio, S~ao Paulo (Carvalho) . . . . . . . . . . . . . . . . . . . . . . . . . . Assessment ratio (Lincoln Institute) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Tax collection ratio S~ao Paulo, 2011—Carvalho . . . . . . . . . . . . . . . . Tax collection (spontaneous payments)—Lincoln Institute . . . . Administrative performance indicators, 2010 . . . . . . . . . . . . . . . . . . . . Potential tax revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Administrative performance indicators, 2011 . . . . . . . . . . . . . . . . . . . . Long-term revenue elasticity of ISS and IPTU, S~ao Paulo, 2004–2013 . . . .. . . . .. . . . . .. . . . .. . . . .. . . . .. . . . . .. . . . .. . . . .. . . . .. . . . . .. . Estimated population 2014 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Tax sharing system in India (not including local taxes) . . . . . . . . Municipal revenue in India, 2007–2008 . . . . . . . . . . . . . . . . . . . . . . . . . . Municipal finance in Mumbai, in billion Rs . . . . . . . . . . . . . . . . . . . . . Revenue and expenditure according to budget and actuals, BBMP . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Property tax according to budget and actuals, BBMP, in billion Rs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Determination of unit area value (per sq. ft/per month) . . . . . . . . Depreciation table . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Calculation of property tax, greater Bangalore . . . . . . . . . . . . . . . . . . Revenue department—organization chart . . . . . . . . . . . . . . . . . . . . . . . . Weighting factors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Calculation of property tax, Greater Mumbai . . . . . . . . . . . . . . . . . . . . Department for assessment and collection—Organisation chart . . . .. . . . . . . . .. . . . . . . . . .. . . . . . . . .. . . . . . . . . .. . . . . . . . .. . . . . . . . . .. . . . . Ward set-up assessment and collection section . . . . . . . . . . . . . . . . . . Features of early bird incentive . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Classification of properties—Greater Bangalore . . . . . . . . . . . . . . . . Coverage ratio of Greater Bangalore . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Property tax receipts and administrative cost—Greater Bangalore . . . . . .. . . . . . . .. . . . . . . .. . . . . . . . .. . . . . . . .. . . . . . . .. . . . . . . . .. . . . Collection ratio (excluding arrears)—Greater Bangalore . . . . . . .

64 66 70 72 72 73 73 74 77 77 78 79 80 80 81 82 83 83 87 94 99 102 103 104 104 110 111 111 113 118 118 119 120 121 123 124 125 126

List of Tables

Table 3.54 Table 3.55 Table 3.56 Table 3.57 Table 3.58 Table 3.59 Table 3.60 Table 3.61 Table 3.62 Table 3.63 Table 3.64 Table 3.65 Table 3.66 Table 3.67

xiii

Enforcement ratio—Greater Bangalore . .. . . . . . .. . . . . . .. . . . . . . .. . . Potential tax revenue, Greater Bangalore . . . . . . . . . . . . . . . . . . . . . . . . Status of ownership and median house price-to-income ratio in urban Bangalore and Greater Mumbai . . . .. . . . .. . . . .. . . .. . . . .. . Local taxes within the tax sharing system in China . . . . . . . . . . . . . Local tax revenues of sample cities, billion yuan . . . . . . . . . . . . . . . Land Transfer Fee (LTF), billion yuan . . . . . . . . . . . . . . . . . . . . . . . . . . . Property Tax—Urban and Township Land Use Tax and House Property Tax, billion yuan . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Property tax in national context, 100 million yuan . . . . . . . . . . . . . . GDP and Urban income per capita (pc) . . . . . . . . . . . . . . . . . . . . . . . . . . Floor price (yuan/m2) and house price to income ratio (P/I) . . . Long-term revenue elasticity of Chinese local tax system, 2004–2013 . . . .. . . . .. . . . . .. . . . .. . . . .. . . . .. . . . . .. . . . .. . . . .. . . . .. . . . . .. . Facts on property tax of pilot programs . . . . . . . . . . . . . . . . . . . . . . . . . . Number of agglomerations according to size class . . . . . . . . . . . . . . Population size and density of BRICS urban agglomerations . . . .

126 127 130 144 145 145 146 147 153 153 154 156 177 177

Chapter 1

Introduction

This book applies to the BRICS states’ megacities.1 BRIC is the acronym for four major emerging economies: Brazil, Russia, India, and China. The term goes back to economist Jim O’Neill, who predicted in 2001 that these states would see strong economic growth—which in turn was, and is, mainly based on their urban centres. The same has qualified South Africa a BRIC member since 2010; thus the term is now BRICS. Since then, these states have gained significant influence on regional and global affairs, as they are all members of the G20. Due to their political and economic role within their regions, the BRICS states are named as anchor states in German development cooperation. These emerging economies—and especially the megacities within these states—have a positive impact on their geographic region. The megacities in particular lead the way within their countries by currently coping with the problems soon to face many (mega)cities. “The world had entered an urban millennium”.2 The process of urbanization is exclusively occurring in developing countries. Urban growth results not only from demographic growth (increasing birth- and/or decreasing death rates), but also from rural exodus; about 25% of urbanization accounts to rural-urban migration (UN-HABITAT 2010). Each week, the ranks of urban residents within the BRICS states will increase by more than half a million in the upcoming 15 years (2015–2030). In the same period, the level of urbanization in BRICS states will increase from 63% to 70% (UN 2014). This inflow into urban areas is best illustrated by reviewing the number of megacities, those having more than 10 million inhabitants. In the period 1950–2030 there is an exponential increase in numbers observable. In the 15 years to come, the total number of megacities will increase from 29 in 2015 to 41 in 2030. Of these, approximately half are within the 1

Reference for the definition of megacity is Urban Agglomeration from UN-HABITAT. This definition includes the actual city and its surrounding suburbs, making them a megacity (or urban agglomeration). 2 Kofi Annan, UN Secretary-General, at Opening Meeting of HABITAT Twenty-fifth Special Session, 6 June 2001. © Springer International Publishing AG 2017 M. Salm, Property Tax in BRICS Megacities, Contributions to Economics, DOI 10.1007/978-3-319-62671-0_1

1

2

1 Introduction

BRICS’ (13, respectively 18). These megacities exemplify only the tip of the urbanization iceberg as there will be an additional 50 cities within BRICS to have between one and 10 million residents. Megacities are engines of national economic growth: Beijing and Shanghai generate 3.1% and 13.6% of the GDP in China, Mumbai accounts for 5% of GDP in India, and Johannesburg yields 15% of GDP in South Africa (UN-HABITAT 2008: 19). They have the potential to make countries rich because they provide economies of scale and proximity that generate enhanced productivity. Because of that, urbanization is positively correlated with prosperity, since income increases with the rising productivity in urban centres. Jane Jacobs (1984: 32) put this concisely, noting, “Cities, not countries, are the constituent elements of a developing economy and have been so from the dawn of civilization.” Therefore, megacities play a decisive role in economic growth and, likewise, fighting urban poverty levels. Cities hold the bulk of public resources, therefore play an important role in the choice of the type and level of supply of public goods and thus can exert considerable influence on the scope of poverty. Literature on fiscal decentralization shows that local public goods, inter alia, infrastructure, education, and medical care, have a high correlation to the poverty level (Bird and Rodriguez 1999). However, the increasing number and complexity of (mega)cities places financial burdens on both municipalities and central governments, whereby most local governments carry the weight of the responsibility, in part, due to the decentralisation concept. All BRICS states have faced or are facing a period of fiscal decentralization. Decentralised government structures are closer to the citizens, thus can better meet the local needs and increase the possibilities of political participation. Decentralization contributes to an improvement of public services, an efficient administration and a strengthened democracy. This rationale is well grounded in theory and it is gaining momentum in many developing countries. However, despite these theoretical advantages, political decentralization is often not accompanied by fiscal decentralization in practice, i.e. compulsory tasks are delegated to municipalities without allocating additional finances. In most cases, fiscal decentralization is shaped by unclear institutional arrangements, duplication, and confusion in the areas of shared responsibility. Further, municipalities are often de facto, but not de jure, responsible for local public service provision. Therefore, while literature has identified suitable concepts for expenditure and revenue sources for local governments, there is often a vertical imbalance in functions and finances. In the urban context, the imbalance is becoming even more pronounced due to the inability to tap the increasing tax base, such as increasing numbers of residents (income tax), economic growth (corporate income tax, business tax) and—in the focus of this book—increasing land values (property tax). Although the magnitude of the outlined effects may differ among the BRICS states, the results are comparable: Urbanization and decentralization lead to major investment needs, rising poverty, and increasing congestion and pollution levels in the context of limited financial resources. Therefore, the focus herein is on the

1 Introduction

3

megacities. This trend in the urban centres raises the question for a suitable decentralized funding source. Property taxation has historically been the backbone of local taxation. Several reasons for the local property tax appear (e.g. Henry George 1882; Tiebout 1956; Oates 1969, 1972; Mieszkowski 1972; Fischel 1985, 2001; Zodrow and Mieszkowski 1986): First, the property tax can be seen as a benefit tax, where local citizens experience the cost and benefits of local public services rendered. Generally, taxes are levies without specific service in return. The property tax, however, could be seen as a tax on collective benefits (or public good benefits) received by local citizens. Second, one can argue that the property tax can be seen as a tax on unearned economic rents. Urban property owners in particular those that are passive beneficiaries in terms of rising property values due to external factors, such as urbanization, natural population increase, transformation of rural to urban land, and/or speculation. Increasing demand against land supply constraints results in rising property values and the respective property owners become effortlessly rich(er). Finally, the property tax can be seen as a local wealth tax. Property taxes are typically defined as an ad valorem (based on value) tax. Property is a primary finance asset of wealth accumulation, it is highly visible, is immobile in nature, and highly concentrated. In this context, the property tax could be levied according the taxpayer’s ability to pay. However, from a public finance point of view, the benefit tax character should be the centre of attention, because local tax money is reinvested in local infrastructure and public services for the benefit of the respective taxpayers: In this case, the property tax is a tax in lieu of charges. Nowadays, property tax systems are too often described as having “significant potential” or “significant untapped potential” (Franzen and McCluskey 2013: 6). This is especially the case in developing countries. Hernando de Soto (2001: 223f) even distinguishes developed from undeveloped countries according to formalization of land and property rights. According to Hernando de Soto informal property is dead capital that cannot be taxed, capitalized or protected by rule of law. Yet, property taxation as local revenue source and the formalization of property becomes more and more important—especially with respect to the steady increasing urbanization process in transition countries. Property tax revenue (recurrent tax on immovable property) as percentage of GDP constitutes merely 0.5% in Brazil, 1.1% in Russia, 0.3% in India, 0.0% in China, and 1.0% in South Africa compared to 2.85% in Canada, 2.48% in France, 2.53% in United Kingdom, and 2.91% in the United States.3 Therefore, it is obvious that the property tax within BRICS does not play out its local revenue potential. Notwithstanding the theoretical concept favoured within financial theory, property taxes are perceived as being an appropriate financing instrument for cities in general and for megacities in particular. Property tax is seen as the means of choice

3

Prakashm Prashant (2013: 25). The amount for China is not specified, as there are controversies about the property tax/taxes on property in China. Herein, the taxes on urban property (Urban and Township Land Use Tax and House Property Tax) are seen as a property tax, see Chap. 3.

4

1 Introduction

for putting megacities’ financing on a sound basis. It is a major source to raise revenues. Furthermore, property tax reflects the city’s economic activities if they are based on market values. Financial theory suggests a ‘golden way’—a welladministered tax based on market values with a high degree of local autonomy—for a rational local tax; however, each BRICS state has its own institutional framework, tax-specific legislation, and political, fiscal, and administrative environment, resulting in a variance in property tax designs and performances. Within the megacities in transition countries, the property tax revenues can be expected to be above national average, constituting a large share of national property tax revenue (in relative and absolute terms), because megacities play a leading role within their countries with regard to tax administration. Property taxes are very resource-intensive from an administrative perspective. By making use of economies of scale and highly educated professionals, they can more easily achieve results on core functions of property taxation, such as coverage, assessment, and collection. Thereby, megacities’ tax administrations should better cope and tap into an expanding tax base. Therefore, large inter-city differentials in property tax revenues (in relative and absolute terms) should be observable in transition countries. Megacities should be at the cutting-edge of administering property taxes within their respective states. This assumption is of importance as megacities should basically be financially self-sufficient. Urbanization expands the tax base and increases the property values: Larger cities generally have a larger per capita property tax base due to economic growth, enhanced urban public services, speculation and/or rural land converted into urban. Furthermore, such cities can impose higher taxes without losing their tax base to more competitive localities. Overall, the very dynamic megacities in emerging BRICS states are or should be—in contrast to other cities in their respective states—at the forefront of national economic growth, having an above average tax base and an excellent administration. Nonetheless, they face low yields of property tax revenues, though the property tax—if well designed—is the best way to put megacities in BRICS on a sound financial basis. The key questions can be formulated for this purpose with referring to case studies on the BRICS megacities: Do megacities have the ‘right’ functions assigned and taxing powers devolved to address the urban (dis)advantages? What is the normative state-of-the-art property tax design that ‘fits’ the megacities and their outlined challenges ahead and what are the current shortfalls in terms of property tax performance (e.g. policy decisions and administrative practices)? In this context, this book will assess the status and the integral elements of the property tax regimes in the BRICS states and their megacities. The focus therein is on residential real property taxes (recurrent taxes on immovable property within municipal areas). In order to make this possible, an analytical public finance framework will be developed, which enables a case-by-case assessment of the megacities selected, and at the same time, establishes the basis for a comparative assessment of the property tax systems. The property tax performance is of main interest since maximizing revenues should be seen as a key goal if municipal governments’ are to have the means to address the problems they are facing.

1.1 Research Approach

5

By doing so, the way towards a modern equitable, efficient, and benefit-related property tax is established. Based on the findings, reform strategies for optimizing the property tax design can and will be developed throughout this book.

1.1

Research Approach

The book reviews the BRICS megacities property tax designs by making use of two distinct approaches. Firstly, each property tax system will be reviewed separately by contrasting property tax in practice with normative public finance criteria; secondly, the property tax systems of the BRICS states will be discussed with each other by referring to relevant comparison parameters. By doing so, commonalities and differences will appear and, therewith, explain the property tax performance amongst BRICS megacities (Fig. 1.1).4 (1) A structured case-by-case assessment based on the current literature on public finance with tax-assignment principles and further specified local tax criteria is carried out. The property tax will be assessed under the aspects of an equitable and efficient tax design and will refer to local finance criteria for a rational decentralized tax; it will be revised according to property tax-design features with regard to political decisions and administrative practice; and it will be tested on its administrative performance (ratio study), which defines the property tax potential. Within the structured case-by-case analysis, several questions need to be raised and answered: • • • • •

Is the overall tax system equitable and efficient? Which taxes on property currently exist and what are their characteristics? What are the operational features of property tax? What is the administrative performance of the property tax? Is it a rational local tax?

Within this step the property tax in BRICS state megacities is assessed against the backdrop of normative public finance principles and criteria elaborated from the large and vibrant literature on public finance. By following this analysis matrix, the book systematically illuminates the diverse property tax designs to be found and their shortcomings by reflecting property tax in practice with normative public finance theory. A detailed descriptive portrait of each BRICS state is

4

This book is based on several publications that have been revised and consolidated. The normative public finance framework for assessing the property tax systems in the BRICS states ¨ V (Salm, 2014), available at: http://www. was published as a Working Paper in 2014 by the FO foev-speyer.de/files/de/fbpdf/DP-079.pdf. It provides the basic structure of this book. Thereafter, a first assessment of the Chinese property tax system was published by the Journal of Property Tax Assessment and Administration (Salm 2016), which has been the blueprint for the other property tax systems to follow in this publication.

6

1 Introduction

Case-study Brazil

Case-study Russia

Case-study India

Case-study China

Case-study South Africa

Most Similar Case Design Independent variable Endogenous: Policy decisions (tax base and rate) and administrative practices (coverage, assessment, collection, enforcement) Exogenous: Economic city growth, urbanization, decentralization, other revenue sources, real estate governance, speculation

Dependent variable Property tax performance

Fig. 1.1 Research approach. Source: Author

compiled in order to identify the different property tax designs within the sample-megacities. (2) The Most Similar Case Design (MSCD) is applied for a comparative view on the property tax regimes. ‘Similar’ megacities making use of property taxes with ‘different’ property tax performance constitutes a fruitful basis for comparison. The megacities in the sample face a similar context with regard to population sizes, economic status, decentralization of functions, urbanization, etc.; yet have different property tax performances. Hence, the property tax performance (dependent variable) displays the needed variance, while the explanatory or independent variables indicate a comparably low level of variance; thus, they satisfy the basic idea of MSCD. MSCD is to identify and explain the differences in the dependent variable, which is the variance of the property tax performances. The independent variables (e.g. policy choices and administrative practices) should be allowed to vary and should not be identical if they are to provide insight into the driving reasons for the variance of the dependent variable. However, whereas the independent variable should exhibit a low level of variance, the dependent variable should preferably feature a high level of variance. This holds in regard to the megacities of the BRICS states in this comparative approach, which matches similar cases as much as possible with the assumption that independent variables are capable of explaining the value of the dependent variable. To define the dependent variable—the property tax performance—it was first necessary herein to identify the independent variables that follow from political decisions and administrative practices and explain the present performance. Moreover, the independent variable could be further specified into those that

1.2 Range of Megacities Considered

7

were endogenous and those that were exogenous. Endogenous variables are those linked to the tax design or structure (i.e. tax base, tax assessment, tax rates, etc.). Exogenous variables are economic city growth, urbanization, decentralization, etc. all of which may have an effect on property values and therefore on property tax revenues. Thus while endogenous variables have a direct impact on property values, the latter may have an indirect impact via property values. In other words, within this study, the property tax performance is defined as the dependent variable and (independent) variables are identified that explain the variance in performance within the BRICS states’ megacities. Although it is not possible to totally disregard the notion that other national or megacity-specific contextual factors may influence the property tax design, the common context of the megacity cases is sufficient to account for the major possible exogenous drivers and thus justify the selection.

1.2

Range of Megacities Considered

While the BRICS states are the focus of this book, three countries and their megacities are examined in more detail, viz. the Federative Republic of Brazil, Republic of India, and People’s Republic of China.5 The Russian Federation and the Republic of South Africa will be reviewed, but not in the form of a case-by-case study.6 They will be assessed within the comparative (MSCD)section of this book. The limitation on Brazil, India, and China, as case studies, has several motives. First and foremost, they serve research-pragmatic purposes, secondly, they cover more than 90% of all megacities within the BRICS states (12 out of 13, Table 1.1); and thirdly, they are a great sample to illustrate the evolution of property taxation. The BRICS states and their megacities illustrate in detail the evolution of property tax and property tax design. While Russia could be classified as terra incognita with regard to property tax and research thereof, there are, at present, discussions in China to introduce property taxation with first pilot programs conducted in two megacities (see Man 2011; Nikitin et al. 2012; Brys et al. 2013; Hong 2013; World Bank 2013; Cho and Choi 2014; Hou et al. 2015). The Chinese government is debating if the tax should be a tax on windfall gains or a local wealth tax (Salm 2016). Therefore, the Chinese example illustrates the overall debate on property tax purpose and involved incidence. Indian megacities have already implemented a property tax. However, the assessment base in place is the principal reason why the tax does not play out its potential (see Mohanty et al. 2007; Bandyopadhyay 2013, 2014a, b; Rao 2013; Chary and Prasad 2014). The discussion therefore is on the right assessment base (capital, rental or area-based assessment)

5 6

Hereafter referred to as Brazil, India, and China. Hereafter called Russia and South Africa.

8

1 Introduction

Table 1.1 Megacities (resp. urban agglomerations) within BRICS States, 1980–2030 (Megacity  10 million inhabitants) Country City Brazil Rio de Janeiro Brazil S~ao Paulo Russia Moscow India Ahmadabad India Bangalore India Chennai India Delhi India Hyderabad India Kolkata India Mumbai China Beijing China Chengdu China Chongqing China Guangzhou, Guangdong China Shanghai China Shenzhen China Tianjin South Africa Johannesburg Number of megacities BRICS World

Population (in thousands) 1980 1990 2000 8784 9697 11,307 12,089 14,776 17,014 8136 8987 10,005 2484 3255 4427 2812 4036 5567 4203 5338 6353 5558 9726 15,732 2487 4193 5445 9030 10,890 13,058 8658 12,436 16,367 5336 6788 10,162 2150 2955 4222 2961 4011 7863 1870 3072 7330 5966 7823 13,959 58 875 6550 3750 4558 6670 3202 3709 5605

2015 12,902 21,066 12,166 7343 10,087 9890 25,703 8944 14,865 21,043 20,384 7556 13,332 12,458 12,741 10,749 11,210 9399

2030 14,174 23,444 12,200 10,527 14,762 13,921 36,060 12,774 19,092 27,797 27,706 10,104 17,380 17,574 30,751 12,673 14,655 11,573

1 5

13 29

18 41

3 10

8 17

Source: Author; United Nations (2014)

with its inherent (dis)advantages. Furthermore, the case of Indian megacities nicely illustrates that exogenous factors (Rent Control, FSI/FAR, Octroi) heavily influence the property tax performance. Brazil could be seen as supposed best practice with the tax design fully devolved to the local bodies and capital value assessment in place (see Annez 2010; Afonso et al. 2012; Rodrigues et al. 2012; Carvalho 2013, 2014; Wetzel 2013). However, the tax administration is not capable of uniformly assessing the very heterogeneous properties leading to similar values for different properties or different values for similar properties. Furthermore, the horizontal variance with regard to the local own-tax revenue mobilization is not reflected in the transfer scheme. Therefore, the applied system does not provide any incentive to appropriately identify, assess, collect, and enforce the tax. In contrast, South Africa has the most profound property tax system, in terms of administration and tax yield (see Slack 2004; Bhana et al. 2011; Franzsen et al. 2013). Beyond that, the megacities considered reflect the impact of different types of government (federal and unitary) on the property tax. The megacities included are located in both federal (Brazil, Russia, India, South Africa) and unitary countries (China). Different degrees of decentralization are reflected, which are expected to have an impact on the property tax design and yield. While in China all aspects of

1.3 Fundamental Terminology

9

property taxation are centrally determined, Indian municipalities are assigned to their respective states, which define the overall tax design, and the local bodies in Brazil are among the most (fiscally and politically) decentralized countries in the world. Therefore, the sample illustrates to a great extent the impacts of assigning the property tax to different levels of government, though it is in all cases a localown tax revenue source. The selected eight megacities within Brazil, India, and China have been chosen in order to substantiate and verify the aspects outlined—importance of property tax, impact of higher level government on the tax design, impact of context variables on property tax and yield, and local (political/administrative) self-responsibility for property tax—on megacities level (Table 1.1). In Brazil, the two megacities chosen are S~ao Paulo and Rio de Janeiro. In the case of China four megacities are reviewed—Beijing, Chongqing, Shanghai, and Tianjin. They are directly under the administration of central government in China and have provincial status. Due to their status, local finance data is available, which is not the case for the remaining Chinese megacities. The megacity selection in India orientates on financial data availability and the type of property tax reform. Herewith, Greater Bangalore and Greater Mumbai are in the focus.

1.3

Fundamental Terminology

In the case of property taxation, the same word or term may have different meanings in different states or even within a single country. This depends, for instance, on economic or juridical terminology used. Furthermore, different words or terms may be used within the BRICS states reviewed describing what is, in essence, the same.7 Therefore, defining a consistent terminology that is used throughout the book is necessary: Property The term refers to (i) immovable property or real property/real estate usually including land and buildings and (ii) to movable or personal property, which includes e.g. vehicles and machinery. Further, in the case of megacities holding a large share of slum settlements with no formally adjudicated property rights, the term property could be distinguished between secured and unsecured property, with unsecured property referring to tenure rights not formally adjudicated while secured property refers to clear tenure rights where the (property tax) debt is against real property. Tax A tax is generally seen as a compulsory, recurrent or once-off monetary levy imposed by public authority on all taxpayers and is not payment for specific

7

The terminology used is based mainly on Bird/Slack 2003 and on an online seminar “Designing and Implementing Property Tax Systems in Africa“ held by Rie¨l C. D. Franzsen, Lincoln Institute of Land Policy (attendance, April 2014).

10

1 Introduction

services rendered. The main objective of a tax is usually (but not necessarily) for revenue raising purposes.8 Typically, the main function of taxes is to generate revenues (revenue function). Additionally, property taxes can seek to re-distribute wealth from the rich to poor (distributional function), e.g. via a progressive tax rate structure, or they can be used to encourage a specific behaviour by the taxpayer (steering function), e.g. by setting higher taxes on vacant land to stimulate urban land development. Property (related) Tax The Property Tax itself is a tax imposed by local government on the ownership or occupation of property. In some countries taxes paid by occupiers are referred to as rates (from the Latin taxo, ‘rate’), especially those with a British colonial heritage, or council tax; in other cases it is referred to as user tax in order to demarcate occupier from ownership-related taxes (Hong 2013: 255). The Real Property Tax is distinct from the Land Tax (also called Site-Value Tax or Tax on Unimproved Land), which refers to the land value only, excluding any buildings or improvements on the land. Generally, property (related) taxes are levied on (i) possession (ownership), (ii) use (occupation), (iii) profits, (iv) donation, and (v) transfer of real property. While the first two levies are linked with recurrent public benefits received, the latter three are not. In the case of possession and use of property, local governments have an incentive to recoup the costs for specific public-benefit-related expenditures or services that are continuously provided or maintained at local level. Possession of property and the right of property use may involve profits or gains that cannot be traced back to the owner’s action; if the profits/gains are due to public investments they may be subject to Property Tax, Capital Gains Tax, Land-Value Increment Tax and/or Tax Increment Financing. The donation and transfer of property in case of acquisition or elimination of a property may be a base for Value Added Tax (VAT), Real Property Transfer Tax, Succession Tax, Donations Tax, Gift Tax, Stamp Duty, Estate Duty and/or Death Duty. Throughout this book, the property tax is considered as an annual tax on the ownership and/or occupation of residential immovable (un)secured real property only. Herewith, the primary function of the property tax is to mobilize tax revenues.9 While recurrent taxes on immovable property are the key focus, the broader concept of property taxation is also discussed in order to gain a comprehensive picture of property (related) taxation in megacities of BRICS’ states.

8 More specifically, a tax could be defined as (i) cash payment (ii) without specific public specific services in return (iii) levied by sovereign government authorities only. (iv) The tax revenues must accrue to the public community—e.g. local governments. However, (v) generating revenues is not necessarily the main objective for levying the tax; generating revenues may also be seen as secondary aim (Homburg 2007: 1). 9 Redistribution, for instance, is better achieved on the expenditure side, e.g. by providing public housing.

References

11

References Afonso JRR, Araujo EA, da No´brega MAR (2012) The urban property tax (IPTU) in Brazil: an analysis of the use of the property tax as a revenue source by Brazilian municipalities. Working Paper, Lincoln Institute of Land Policy Annez PC (2010) Financing Indian cities – opportunities and constraints in an Nth best world. Policy Research Working Paper 5474, World Bank Bandyopadhyay S (2013) Property tax reforms in India: a comparison of Delhi and Bangalore. Working Paper 13–21, Georgia State University, Andrew Young School, International Centre for Public Policy Bandyopadhyay S (2014a) Issues in municipal finance: a summary for India. Am Int J Soc Sci 3 (4):134–146 Bandyopadhyay S (2014b) Impact of area based valuations in property taxation: a tale of two Indian cities. J Prop Tax Assess Adm 11(4):35–51 Bhana K, Hendricks M, Tonkin A (2011) Land and property taxation in post-apartheid South Africa. In: Innovative land and property taxation. UN HABITAT, Nairobi Bird RM, Rodriguez ER (1999) Decentralization and poverty alleviation. International experience and the case of the Philippines. Public Adm Dev 19(3):299–319 Brys B, Matthews S, Herd R, Wang X (2013) Tax policy and tax reform in the People’s Republic of China. OECD Taxation Working Papers, No. 18. OECD, Paris Carvalho PHB (2013) Property tax performance in Rio de Janeiro. J Prop Tax Assess Adm 10 (4):19–37 Carvalho PHB (2014) Property tax performance in S~ao Paulo. J Prop Tax Assess Adm 11(2):63–89 Chary VS, Prasad DR (2014) Municipal finance and service delivery in India. Administrative Staff College of India (ASCI), Hyderabad Cho SC, Choi PPS (2014) Introducing property tax in China as an alternative financing source. Land Use Policy 38:580–586 De Soto H (2001) The mystery of capital. Why capitalism triumphs in the west and fails everywhere else. Black Swan, London Fischel WA (1985) The economics of zoning laws: a property rights approach to American land use controls. Johns Hopkins University Press, Baltimore, MD Fischel WA (2001) Municipal corporations, homeowners and the benefit view of the property tax. In: Property taxation and local government. Lincoln Institute of Land Policy, Cambridge, MA, pp 33–78 Franzen R, McCluskey WJ (2013) Value-based approaches to property taxation. In: A primer on property tax – administration and policy. Wiley-Blackwell, West Sussex, pp 41–68 Franzsen RC, Kamarudin N, McCluskey WJ, Zulkarnain D (2013) Property tax in Malaysia and South Africa: a question of assessment capacity and quality assurance. J Prop Tax Assess Adm 10(4):5–18 George H (1882) Progress and poverty. Appleton, New York Homburg S (2007) Allgemeine Steuerlehre, 5th Erweiterte Auflage edn. Franz Vahlen, München Hong Y (ed) (2013) An introduction to China‘s taxation. Enrich Professional Publishing, Hong Kong Hou Y, Ren Q, Zhang P (2015) The property tax in China: history, pilots, and prospects. Springer, Cham Jacobs J (1984) Cities and the wealth of nations: principles of economic life. Random House, New York Man JY (2011) Local public finance in China: an overview. In: China’s local public finance in transition. Lincoln Institute of Land Policy, Cambridge, MA, pp 3–17 Mieszkowski P (1972) The property tax: an excise tax or a profits tax? J Public Econ 1:73–96 Mohanty PK, Misra BM, Goyal R, Jeromi PD (2007) Municipal finance in India: an assessment. Development Research Group Study No. 26, Department of Economic Analysis and Policy, Reserve Bank of India

12

1 Introduction

Nikitin D, Shen C, Wang Q, Zou H (2012) Land taxation in China: assessment of prospects for politically and economically sustainable reform. Ann Econ Financ 13(2):489–528 Oates WE (1969) The effects of property taxes and local public spending on property values: an empirical study of tax capitalization and the Tiebout hypothesis. J Polit Econ 77:957–971 Oates WE (1972) Fiscal federalism. Harcourt Brace Jovanovich, New York Prakash P (2013) Property taxes across G20 states: Can India get it right? Center for Budget and Governance Accountability, Oxfam India Working Paper Series, Jan 2013 Rao MG (2013) Property tax system in India: problems and prospects of reform, Working Paper No. 2013-114. National Institute of Public Finance and Policy, New Delhi Rodrigues JR, Aroujo EA, No´brega MA (2012) The urban property tax (IPTU) in Brazil: an analysis of the use of the property tax as a revenue source by Brazilian municipalities, Working Paper. Lincoln Institute of Land Policy, Cambridge, MA Salm M (2014) Property taxes in BRICS – comparison and a first draft for performance measurement. German Research Institute for Public Administration, Speyer Salm M (2016) Property tax as a local government financing instrument for megacities in China. J Prop Tax Assess Adm 13(2):5–34 Slack E (2004) Property taxation in South Africa. In: International handbook of land and property taxation. Edward Elgar, Northampton, MA, pp 199–204 Tiebout CM (1956) A pure theory of local expenditures. Polit Econ 64:416–424 UN (2014) World urbanization prospects: The 2014 revision. United Nations, Department of Economic and Social Affairs UN-HABITAT (2008) State of the world’s cities 2010/2011 – bridging the urban divide UN-HABITAT (2010) State of the world’s cities 2010/2011 – bridging the urban divide. United Nations Human Settlements Programme, London Wetzel DL (2013) Metropolitan governance and fiscal finance in S~ao Paulo. In: Financing metropolitan governments in developing countries. Lincoln Institute of Land Policy, Cambridge, MA, pp 309–338 World Bank and the Development Research Centre of the State Council, P. R. China (2013) China 2030: building a modern, harmonious, and creative society. World Bank, Washington, DC Zodrow GR, Mieszkowski P (1986) The new view of the property tax: a reformulation. Reg Sci Urban Econ 16(3):309–327

Chapter 2

Theoretical Insight on the Property Tax

The large and vibrant literature on local public finance constitutes the basis for a normative framework on property tax, which is outlined in Sect. 2.1. Beyond that, the question of the property tax incidence, i.e. who pays the property tax, is illustrated in Sect. 2.2. Finally, based on the public finance literature, criteria for a rational local property tax are derived and reviewed in Sect. 2.1.3. The property tax is more complex than it seems at first sight. Disaggregating the design of the property tax into its basic elements, the stylized facts of a property tax (e.g. tax base, exemptions, assessment, tax rates, etc.), is of importance to gain an insight on how the tax burden is allocated to the taxpayer(s), see Sects. 2.2.1, 2.2.2, 2.2.3 and 2.2.4. Based on this, the administrative aspects of property taxation, which typically constitute the main weakness of any property tax system, are outline in Sect. 2.2.5. Rounding off, the chapter closes with performance indicators (Sect. 2.2.6), in order to evaluate the administrative aspects of property tax systems. They will express the administrative shortcomings in monetary figures by applying the revenue mobilizing model (Sect. 2.2.7).

2.1 2.1.1

Theoretical Background The Property Tax as Decentralized Tax

The concept of decentralization is broad and the component parts are many: the World Bank distinguishes between different types of decentralization, such as political, administrative, fiscal, and market decentralization. In our case here, fiscal and administrative decentralization are of most importance. Guidelines for an efficient and effective tax system are based on the concept of fiscal decentralization. In order to shape the tax (and transfer) system, Musgrave (1939, 1959) categorized the division of governmental economic activities into © Springer International Publishing AG 2017 M. Salm, Property Tax in BRICS Megacities, Contributions to Economics, DOI 10.1007/978-3-319-62671-0_2

13

14

2 Theoretical Insight on the Property Tax

three governmental branches: the allocation of resources with related questions of efficiency, the distribution of income with an integrated tax and transfer system, and the stabilization of the overall economy. Referring to the standard Musgrave model of the public sector, the responsibility for stabilization, distribution and allocation should be assigned to different levels of government: while stabilization and distribution is mainly a central government task, the efficient allocation of public goods should be assigned to local governments.1 The above demarcation is by and large true although there may be considerable overlapping and intergovernmental coordination required with regard to all these functions. Musgrave and Musgrave (1976: 19) conclude that the allocation function, the provision of public goods, “calls for a decentralized system”. The decentralization theorem (Oates 1972: 55) states that “each public service should be provided by the jurisdiction having control over the minimum geographical area that would internalize benefits and costs of such provision”.2 The fiscal instruments in such a setting focus on an overall equitable and efficient tax system (Oates 1999: 1228): – central governments should collect non-benefit taxes and taxes that have an unequally distributed tax base; – progressive tax rates should be levied at the central government level (the central government could be a tax collector for lower-level governments within a revenue sharing system);3 – lower-level governments should avoid mobile tax bases; – benefit taxes and user fees4 not competing seriously with central tax bases can be decentralized.5 However, the efficient allocation of public goods in practice was challenging public finance economists due to the free-rider problem. Musgrave and Samuelson stated that there is no “market-type” solution to determine the level of expenditures on public goods. People would never disclose their true preferences for public goods provision because they cannot be excluded from public goods consumption

1

Depending on the spatial benefit incidence, the allocation function could also be assigned to the central government. However, decentralizing political, financial, and administrative authority is generally more efficient as the focused attention is on local preferences. 2 The decentralization theorem presumes that there is no perfect information given and, therefore, the central government provides a uniform provision of public services across all jurisdictions. 3 Dillinger (1991: 3) states that intergovernmental transfers (mainly revenue sharing) and local indirect taxes may play a role in stabilization and distributional policies but that they cannot be seen as prices (as is the case of benefit taxes). 4 All public services with ‘private good’ character user fees are appropriate because spillovers are unlikely to exist. In the case of collective or ‘public good’ benefit, where specific beneficiaries cannot be identified, a local benefit tax is best. The property tax, for instance, covers the cost of providing services that provide collective benefits to the local community (Mohanty et al. 2007: 33; Kitchen 2013: 3). 5 The revenue assignment is, however, not that easy. The vertical tax assignment structure is therefore described in literature as ‘tax-assignment problem’ (McLure 1983).

2.1 Theoretical Background

15

(free-riding problem)6. There is no conditional link between expenditures and taxes. Tiebout (1956) found a solution for municipalities. Tiebout was responding to Musgrave and Samuelson’s (1954) analysis with his article “A Pure Theory of Public Expenditures”. On the municipal level, public goods provision is geographically limited to municipalities with municipal managers offering a “menu” of alternative bundles of local public services and local taxes accordingly. Each individual household selects the “prix fixe menu” that best fits their preferences (Fischel 2001: 34). This decision-making process—often called voting with feet— provides a market-like solution on the local level by preventing the free-riding problem. Residents choose not only the bundle of public goods and services but also the corresponding tax rate.7 In such a setting, taxes charged turn into market-like prices as homeowners reveal their preferences by choosing to reside in the jurisdiction that mirrors their individual preferences best. Households are therefore effectively purchasing their preferred level of public services. As a result, there is a match between those who receive the benefits of the public goods provision and those who pay for it within a unique border of a governmental institution. According to Olson (1969), this match is called fiscal equivalence.8 Tiebout neither published an empirical test of his hypothesis nor mentioned the property tax as a financing instrument for public goods provision. Wallace Oates (1969) added property taxes to the Tiebout model. Moreover, he empirically showed that inter-municipal differences in local government spending and taxes do determine housing prices (capitalization effect).9 The Tiebout hypothesis received little attention until Oates’ article. Therefore, it has to be called the Tiebout-Oates hypothesis (Fischel 2001: 38). Bruce Hamilton (1975) added to the Tiebout model zoning, responding to the criticism of Buchanan and Goetz (1972)— among others—that the ‘poor would chase the rich’ within the Tiebout model. By 6 Musgrave first clearly articulated the free-riding problem in his 1939 article “The Voluntary Exchange Theory of Public Economy“. In his book, “The Theory of Public Finances” he emphasized that public and private goods provision differs in the free-riding problem. 7 Tiebout (1956: 422): “Just as the consumer may be visualized as walking to a private market place to buy his goods, the prices of which are set, we place him in the position of walking to a community where the prices (taxes) of community services are set. Both trips take the consumer to market”. 8 Fiscal equivalence does not necessarily imply that taxes paid reflect someone’s individual consumption of public goods. Fiscal equivalence fits best when thinking about (relatively) various municipalities consisting of homogenous Tiebout-like groups, where public goods generate (about) the same utility for each individual within one (out of many) respective Tiebout-like group. Services would be provided at the lowest point on the average cost curve, where the ones who pay for service provision are the ones who benefit. This is also called group-related local equivalence (Haller 1981: 40; Zimmermann 2009: 142). 9 The capitalization effect could be defined as the manifestation of local taxes and expenditures into property values. Oates (1969: 968) econometric evidence of the capitalization effect was based on a 1960-dataset of northern New Jersey municipalities. Oates concluded “if a community increases its tax rates and employs the receipts to improve its school system, the coefficients indicate that the increased benefits from the expenditure side of the budget will roughly offset (or perhaps even more than offset) the depressive effect of the higher tax rates on local property values.”

16

2 Theoretical Insight on the Property Tax

zoning, exclusion of households that are fiscally undesirable is possible; it also guarantees that new development will pay its own way. Zoning and the possibility of exclusion correspond with the theory of clubs (“An Economic Theory of Clubs”) by Buchanan (1965), though herein no reference is made to Tiebout. Thereafter, Fischel (1985, 1992)10 proved that Hamilton’s model of zoning is realistic and added politics (2001) to the Tiebout model. Fischel (2001) argues that Tiebout wanted to avoid politics, as an efficient allocation of local public goods could be provided without the influence of politics. Fischel shifts away from the emphasis on ‘voting with feet’ by emphasizing the more realistic control of the political decision-making process. As homeowners do not have a realistic exit option due to immobility of homeownership (reduced mobilization due to capitalization effect, transaction costs), homeowners have to rely on ‘vote’ rather than ‘exit’. Therefore, according to Fischel (2001: 40), “rational political actors are the key”. Home-voters need to have the ability to adjust local institutions to their demands (by electing public officials and their policy agenda). Home-voters are committed to influencing politics because local decisions are capitalized into property values. The Tiebout-Oates-Hamilton-Fischel world fits perfectly into the decentralization concept, as people get what they want and thus enhance overall public welfare (Bahl 2013: 86).11 This public finance setting, also known as subsidiarity, is based on the assumption that efficient allocation of public resources to match public preferences for services is best achieved by the lowest governmental level possible. Here, the needs and preferences of the citizens, i.e. the beneficiaries, are best met. This holds true especially for states with different languages, ethnic background, climate and terrain, or sub-national governmental units that are too big to control from the centre—such as megacities. Derived from the outlined fiscal decentralization concept there are public finance principles that nicely illustrate an equitable and efficient tax system for the local level (Fig. 2.1). The institutional symmetry is given when congruence exists between beneficiaries of public goods, policy-makers, and taxpayers.12 The principle of congruence requires that local governments render public goods and services self-dependently that are within their local boundary (spatial identity between decision-maker and user). Furthermore, the benefit principle demands that beneficiaries of the public goods and service provision bear the costs

10 According to Fischel (2001: 56) “capitalization is everywhere”. Fischel (1992: 171) argues that there is a wide range of zoning tools (e.g. minimum lot sizes, height restrictions, requirements for off-street parking etc.) that could be used by local governments to control their capital stock (zoning is imposing strict limits on housing consumption). 11 In the context of private goods, the ultimate form of decentralization would be delivered by the market, with a consumer buying a tailored good from a choice of suppliers. As this in not the case with public goods, decentralization may approximate the market allocation. 12 The idea of the institutional symmetry goes back to Knut Wicksell’s (1896) “Finanztheoretische Untersuchungen”. His ideas were revived by Richard A. Musgrave’s (1939) publication “The Voluntary Exchange Theory of Public Economy” (Blankart 2003: 27f.).

2.1 Theoretical Background

17

DecisionMaker Congruence principle

Connexity principle

User

Payer

Benefit principle

Fig. 2.1 Institutional symmetry. Source: Author; Blankart (2003: 27f)

accordingly (spatial identity between users/beneficiaries and payer). Finally, the principle of connexity constitutes that those who make spending-decisions (directly or indirectly) should pay for it (spatial identity between decision-maker and payer). In an ideal Tiebout-Oates-Hamilton-Fischel world institutional symmetry is given, because there is spatial symmetry of decision-maker, user, and payer of public goods and services as homogenous preferences in reality. In such a world, the three circles of Fig. 2.1 would not only have an intersection, but would be one above the other. In this context, all principles are group-related. However, leaving such ideal world, facing free riding and spillover or external effects, a lower intersection, respectively, a reduced dimension of institutional symmetry is realized. The same symmetry holds for homeowners that are typically competing for economic rents by deciding on realization of public investments in their neighbourhood, which, in turn, are capitalized into their property values. Therefore, homeowners have an incentive to engage themselves in politics (i.e. decisionmaking) in order to promote only those local programs or public services where benefits (‘user’ of services or capitalization of public spending into property values) are equivalent or even exceed the costs (‘payer’ of property taxes). Nonetheless, if public programs have the equal development of the local government in focus, property taxation could be seen as a means to achieve institutional symmetry (at least to some extent). Herewith, in both situations, the decision-making, either individual or group-specific, is cost-based and benefit-oriented. Next to the fiscal decentralization, the administrative decentralization is of main concern—especially with regard to property taxation. Herein, decentralization can be disaggregated according to the degree of responsibilities for and discretion in decision-making that is transferred to local governments. Herewith, the classification is according to control over functions (Rondinelli et al. 1983: 13–28): – Deconcentration can be classified as the most centralized form of decentralization, as decision-making authority and financial and management responsibilities are merely shifted from central ministries and agencies to regional and local offices of central line ministries—which imply a ‘geographic’ shift of functions within a central bureaucracy. It is mainly found in unitary states.

18

2 Theoretical Insight on the Property Tax

– Delegation: Centrally controlled responsibilities for decision-making (functions and duties) are transferred to organizations outside the regular bureaucratic structure, e.g. semi-autonomous organizations or quasi-public cooperatives or institutions (e.g. state-owned enterprises), not fully controlled by the central government level but accountable to it. Ultimate responsibility is with the sovereign authority. – Devolution implies transfer of authority for decision-making, finance and management, to autonomous units of local government (local self-governance). Functions and the authority for decision-making are moved from the central government to a subnational government, e.g. state, provincial or local government, with independent political accountability and legally recognized geographical boundary. – Privatization refers to the transfer of responsibility for functions to voluntary organizations (e.g. religious organizations, political parties or cooperatives) or private enterprises that have formerly been provided or regulated by the government. Both, fiscal and administrative decentralization are a subset of decentralization. Speaking in administrative decentralization terms, fiscal decentralization can be defined as the devolution of taxing and spending decisions to lower-level governments by the central government where decision-making powers reside with the residents via their elected public officials (Hong and Ingram 2008: 3; Mohanty et al. 2007: 26).13 Therefore, devolution is meant when decentralization is referred to. Among scholars, there is no common understanding of whether decentralization of power to local governments increases or decreases the effective provision of public goods and rising of taxes. Critics are concerned that small local units of government may lack local administrative capacities and are subject to potential corruption (i.e. decentralized corruption) and the risk of “elite capture” (McLure 1995). (De)centralization should not be seen as an either/or condition, rather a balance of both is to be found in many states, which often takes the shape of decentralized responsibilities with centralized supervision.

2.1.2

Incidence of the Property Tax

The fundamental question regarding the incidence of the property tax is on who pays the property tax. The tax burden can be shifted to other economic agents (e.g. from the owner to the tenant) or to other less taxed activities in order to avoid taxation (Kitchen 2013: 26). In the next step, the focus herein is on the question of how property taxation and its burden is related to personal income. If a higher tax burden is allocated to higher income individuals than to lower income individuals 13

There is a grey area with subnational governments having budgetary discretion and political leadership responding to local preferences, but they are not elected by local population as is the case in China.

2.1 Theoretical Background

19

Table 2.1 Detailed composition of land value Unearned economic rent due to demographics (natural population growth, rural-urban migration), economic growth, speculation, reclassification of rural to urban land, and change in land use regulation Increase in land value due to governmental intervention, such as public investment in infrastructure Increase in land value due to landowner’s investments Intrinsic land value

Land value increment should be skimmed by the government on behalf of the general public

Local government or public service providers should skim the economic rent to cover their expenditures Economic rent should be skimmed by the land owner Is perceived by the land owner on transaction stage by selling property right (and the involved right to make use) of land

Source: Author; Yu-Hung Hong et al. (2015: 3); Yu-Hung Hong and Brubaker (2011: 168)

then the tax rate is progressive. In the reverse case, the tax is regressive. A neutral or proportional tax would, irrespective of income, allocate the same tax burden in proportion to the amount subject to taxation onto the taxpayer. The so-called Georgist view refers to a tax on land only (Henry George 1882).14 The tax cannot be shifted. It is perfectly incentive-neutral since it does not distort an otherwise desirable allocation of resources.15 Therefore, heavy taxes on land values might be advocated on the grounds of equity and neutrality. This holds especially since external effects—such as natural population increase, rural-urban migration, speculation, and reclassification of rural to urban land—are capitalized into land values and therefore play a vital role in the case of property taxation (Table 2.1). The landowner is a passive beneficiary. These gains derived from increases in land values—especially as seen in metropolitan areas—are sometimes considered as unjust enrichment, as argued by Henry George (1882). Landowners receive an ‘unearned’ economic rent, as the increased value cannot be traced back to the initiative or effort of the landowner. This impact could be called the ‘getting rich (er) while sleeping effect’.16 Municipalities should aim at skimming the increased land value resulting from these external effects. Following the assumptions of the Georgist view, there is no economic inefficiency implied by taxing immobile land. The traditional (or old) view extends the view on structures and assumes that a property tax is a tax on structures (capital)

14

Besides, land taxation roots can be found in earlier works of Adam Smith, David Ricardo, and John Stuart Mill (Gu and Trefzger 2000: 149). 15 The property tax on unimproved land (land value only) cannot be shifted, as the tax will not cause any change in the behaviour of the landowner. This holds if the market value is the assessment base. The particular use is then independent of the tax. “Whatever use would be most profitable in the absence of such a tax will remain so when the tax is levied” (Heilbrun 1983: 58). 16 Lowell C. Harris is speaking about “getting richer while sleeping” in the context of urban landownership (Harriss and Oates 2001: 15).

20

2 Theoretical Insight on the Property Tax

with perfect elastic supply and a tax on immobile land with a perfect inelastic supply (Aaron 1975). In this case the tax is regressive as (especially business) owners have the option to shift the burden of the capital part fully onto consumers, workers, and renters with an average lower income than property owners. Within the Tiebout-Oates-Hamilton-Fischel world (see Sect. 2.1.1), there is a homogenous group of residents due to the fact that people move to the individually preferred jurisdiction that provides the public goods and services at marginal cost equalling the property tax. Within such a Tiebout-municipality, all residents are subject to the same group-specific preferences, tax liabilities, and benefits received from public goods and services. Households thus pay for the benefits they receive, i.e. tax liabilities and public services are balanced, which is known within literature as benefit view.17 Within a perfect Tiebout world, the benefit view results in a lumpsum property tax within each jurisdiction, and a proportional tax across all jurisdictions according to the combinations of taxes paid and public services rendered. Because of the fact that such a perfect Tiebout-like world does not exist18, the lump-sum tax could be a regressive tax. Because the lump sum paid is independent from a person’s income, lower income households spend a larger fraction of their income on property taxes (as income rises, there is a tendency towards a declining proportion being paid in property taxes). All economists do not, however, share this benefit view. Peter Mieszkowski (1972) brought up a competing approach—further developed by Mieszkowski and Zodrow (1986)—called the new view. Mieszkowski and Zodrow see the property tax as a levy on capital (including buildings) resulting in both distortions in the housing market and in local fiscal decisions. If the tax base includes structures, the tax discourages buildings. As a consequence, the capital-land-ratio (the amount of capital used per unit of land) will be less than the economically efficient level. According to the new view capital is in fixed supply and perfectly mobile across sectors and geography. The average rate of the property tax across all jurisdictions is a tax on all capital. If municipalities are taxing buildings (capital) then the average rate of the property tax becomes a national tax on capital: Capital in high-tax jurisdictions will migrate (if there is no corresponding local public service level provided) to low-tax jurisdictions or other uses in non-housing sectors, depressing the rate of return on all forms of capital.19 Therefore, within the profit tax component, the property tax is shifted

17

Therefore, the benefit tax could be seen as a non-distortionary user charge. “The match between incidence of the property tax and the benefits of the service it finances is clearly far from perfect: the statutory burden of the property tax is distributed according to value of property; the benefits of the service it finances are not (Dillinger 1991: 3).” 19 “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” (Norregaard 2013: 17). 18

2.1 Theoretical Background

21

to capital owners, making the property tax a progressive tax, because higherincome households possess a higher share of capital and/or land. With the only immobile factor being land and assuming full mobility of households and other factors, the property tax differentials20 will be capitalized into land values. In the case of land there is a “benefit view within the new view” resulting in a regressive tax effect (Nechyba 2001: 115). Thus, it is progressive from a national perspective and regressive from a local perspective. Further, there is a view of property tax as a local wealth tax on fixed assets used to help financing local government provision of public services. Property taxes are often defined as an ‘ad valorem’ tax (according to the market value, in opposition to unit taxes) against an object (opposed to a personal tax). In the context of property taxes, Musgrave and Musgrave (1976: 343) point out that there are some arguments for wealth taxation—especially in respect to the ability-to-pay principle.21 In this regard, Musgrave and Musgrave see wealth as representing taxpaying ability. A primary finance asset for wealth accumulation is real estate—especially in developing countries given their weak capital markets and high inflation. Land and real estate are therefore a major way to concentrate wealth. These investments are highly visible, immobile and concentrated. If property wealth is to be taxed on ability-to-pay grounds, it should be a personal tax on the net worth of the property (like the income tax) with a progressive tax rate. The various incidence views outlined are discussed in Sennoga et al. (2008: 66) against the backdrop of developing and transitional countries in order to address the limitations of the various views on property tax incidence. The discussion becomes even more complicated as underlying aspects of the incidence theory, such as capital markets, access to information, and defined property rights do not or only partially exist in developing and transitional countries. The incidence theory of the property tax is based on studies of developed countries; whether the theory holds for developing and transitional countries as well has not been proven. Therefore, they reviewed the incidence theory and the applicability to developing and transitional countries and summarized some contradictions:

20

The property tax differential is defined as the difference between the present value of the benefits of local public services received and property taxes paid. 21 In order to make the benefit principle work in general, property taxation has to be applied so that all real property benefits from local public services equal the property tax yields, which would be the Tiebout equilibrium (Musgrave and Musgrave 1976: 344); “A general tax on real property, therefore, is a poor instrument for charging for services rendered.” Musgrave and Musgrave conclude, that income and value added tax might be a better proxy for benefits for individuals and firms. Yet, in the case of different service levels among municipalities, the benefit principle fits. Given a community A with higher public service levels than community B, the difference will be capitalized in property values in A. Therefore, the argument for benefit taxation holds only for the differential. This establishes a tenuous link between ownership and service level.

22

2 Theoretical Insight on the Property Tax

Assumption Capital is mobile among jurisdictions

View Traditional and new view

Households are mobile and able to vote with their feet

Benefit view

Jurisdictions are allowed to impose different tax rates

New view and benefit view All views

Non-monopoly markets for land and capital

Reality This may be true in theory, but a lack of available capital or an unwillingness to invest in many areas of the country may effectively negate the value of this assumption. In some states, regulations prevent the legal movement of capital outside the country In many developing countries, individuals are mobile but not necessarily able to vote in local elections. In some transitional countries, such as Russia or China, individuals are not legally allowed to migrate freely, which may prevent voting if they migrate illegally Not true in all states, but might be true if tax administration varies In some transitional countries (e.g. China), state ownership of land may have confounding effects on incidence

Source: Sennoga et al. (2008: 66)

To summarize, the implications of the property tax with regard to incidence, therewith its fairness, is a long-standing and contentious issue, which becomes an even more complicated topic with regard to developing and transitional countries. After more than 40 years of debate, there is no common agreement on one single view. All views have strong assumptions on the tax distribution impact on taxpayers that are even more unrealistic for transitional countries. Although there is no evidence supporting the different views, there is a common understanding of the views outlined that we must look at the property tax with regard to the property tax incidence: – A tax on residential real property is regressive because housing constitutes a relatively larger share of consumption for low-income households. – A tax on capital is progressive because income from capital constitutes a relatively higher share of income for high-income households. – A tax on land value only paid out of the unearned economic rent is neutral (and equitable) because external factors (public service provision, re-classification of land, urbanization) determine the value. – A tax on benefits received (benefit tax) does not raise the question of incidence because it could be seen as a tax in lieu of charges. However, no matter what view applies, at least a part of local decisions are capitalized into land values; therefore this part of the tax is in accordance with the benefit principle, as it can be seen as a voluntary payment for access to the public services and facilities rendered (Netzer 2001: 328). This part of the tax has a usercharge character (being neither regressive nor progressive).

2.1 Theoretical Background

2.1.3

23

Local Finance Criteria for a Rational Decentralized Tax

Features of a rational local tax system are based on the decentralization theorem. In order to meet the objectives of fiscal decentralization and to establish an equal and efficient tax system, there are well-elaborated and well-defined criteria that are generally applied to all kinds of taxes, while there are also further criteria—derived from the benefit principle—specifically applied for taxes on local level (Table 2.2).22 Considering these criteria allows us to examine local taxes and make a general determination as to whether the examined local tax is a good local tax or not. The general requirements for a tax system are related to aspects such as efficiency, equity, and transparency. Fiscal efficiency requires that both the tax be non-distortionary for other economic allocations and that the taxes paid and benefits received match (allocative efficiency/benefit principle). Equitability has two components: horizontal equity (individuals with the same ability-to-pay should pay the same tax amount) and vertical equity (individuals with higher ability-to-pay should pay a larger part of the tax burden as a proportion of their income). As redistribution is a central government task, there should be more concern with horizontal than vertical equity on the local level. Taxes perceived as equitable lead to taxpayer acceptance. In this context, each taxpayer should be able to track his or her annual tax liability. Therefore, the calculation method should be designed to be simple and transparent. Ease and cost of administration implies that the fiscal productivity, i.e. tax revenue less administrative and taxpaying costs, is as high as possible. Therefore, the administrative part of local taxes is sometimes in the hands of the central tax Table 2.2 Normative criteria for a local tax

General requirements • Fiscal efficiency • Ease and cost of administration • Harmonization of fiscal policy objectives (stabilization, distribution, allocation)

Local/municipal specific requirements Horizontal Vertical justification justification • Visibility • Fiscal autonomy/ • Source of own rev- flexibility enues • Evenly distributed • Balance of interest tax base • Minor level of • Avoidance of inefcyclical sensitivity ficient migration • Proportional growth sensitivity

Source: Author; Zimmermann (2009: 139–149)

22 For discussions on local tax criteria, see Oates (2001: 23–24); Mohanty (2003: 7); Bird and Slack (2004: 40–41); Smoke (2008: 40); Zimmermann (2009: 139–149); Brys et al. (2013: 13–18).

24

2 Theoretical Insight on the Property Tax

authority. The local tax should be easy to assess and administer. However, if the assessment method is too simplistic then inequities in the tax assessment may occur among different properties within a municipality. A simple assessment method should be in place, building on objective features that can be determined in a mass appraisal procedure. Ease and cost of administration and equity are typically working in opposite directions: It is thus a question of balance between simplicity and equity. In the case of municipal specific requirements, the local tax base should not compete seriously with central government tax bases; this constitutes the vertical dimension that justifies a local tax. Herewith, the tax base should be physically immovable (relatively inelastic) and, thereby, less distorting. In addition, an inelastic tax base is important for local governments since other factors, such as labour and capital, are highly mobile on the local level. A local tax should form a visible connection between taxes paid and local public services rendered. A property tax is a highly visible tax in various senses and this should be seen a virtue, not a shortcoming. Property taxation features at least two advantages with regard to visibility: First, property is physically visible, i.e. can be verified physically, and is therefore difficult to hide and to avoid legally. Second, public services rendered at the local level are highly visible, such as local parks, garbage collection, etc. This kind of visibility enhances accountability from an economic (hard budget constraints) and from a political (democratic) perspective. In both ways, accountability is very much linked to homeowners, which are on the one hand paying property taxes, therefore, being a major source of local own revenues and, on the other hand, beneficiaries of public spending. Property owners derive their benefit in different ways, directly by making use of public services rendered or by an increase of property values due to public spending, i.e. capitalization effect. Therefore, according to the balance of interest criterion, which refers to the different user groups of local public services, property owners should be—next to other (possible) local revenue sources such as residents (income tax) and businesses (corporate income tax, business tax)—part of the local tax base. Residents, as well as businesses and land-/homeowners have to be taxed by the municipality, as they receive different services based on different needs. Each local interest group (property owners, residents, and businesses) should respectively contribute by paying related local taxes to the extent that public services are provided. This goes along with the benefit principle, where the beneficiaries of a community are the ones that collectively pay. Furthermore, local taxes are classified rational if they feature a certain degree of sensitivity. Property tax yields should grow with the economic cycle, because with increasing GDP expenditures for public service provision increase. The property tax yields feature proportional growth sensitivity, assuming the revenue elasticity equals one. In the case of an ad valorem assessment base, property tax yields might expand as fast as expenditures; hence, they are sensitive to GDP growth if frequently re-assessed. Beyond that, property taxes are less sensitive to the economic cycle, in contrast to corporate taxes or income taxes. The tax yields are relatively stable and therefore predictable local revenue, because of the inelastic tax base (land and buildings) with

2.2 Stylized Facts of the Property Tax

25

elastic assessment base (market value).23 Therefore, revenues from property tax are the most stable revenues in times of economic ups and downs (cyclical sensitivity) and they are automatically increasing with GDP. Second, there is a horizontal dimension putting local governments in relation to each other, which defines additional local tax criteria. In order to adopt local public service levels and to achieve an efficient allocation, local governments should have (at least some) degree of fiscal autonomy (flexibility) to cover their expenditures. Flexibility can only be achieved by owning (partial) tax competence, i.e. autonomy to set rates, on local level and results in variation in the tax rates between municipalities, reflecting at the same time different public service levels. By doing so, taxpayers are aware of the costs of local public programs and they can weigh the benefits. In this context, if the public service level is about to increase because of residents’ vote, the tax rate has to increase, which leads to the outlined visibility inherent to property tax. Furthermore, a local tax should avoid inefficient migration. Migration is common in dynamic economies and it is efficient as it allows scarce resources to be used in the most efficient way. Migration occurs if another municipality accounts better residents preferences, has lower production cost, or a higher contribution to growth. This (partially) explains in-migration into the urban centres, such as megacities. Overall, the local tax system should not distort the location of businesses or the choice of residence as taxes paid should be reflected in public services rendered. Herewith, the tax burden could be different among the municipalities in such a way as it reflects the differences in local public services. Besides, an evenly distributed tax base across local governments is of advantage to avoid strong disparities and fiscal equalization systems. Based on these normative criteria, the property tax is—derived from the benefit principle—the most nearly ideal or rational tax to be levied on local level.

2.2

Stylized Facts of the Property Tax

Integral elements of property taxation are tax base, tax valuation/assessment, tax rate(s), tax relief (e.g. exemptions), billing, collection and enforcement. The basic nature of these elements must be reviewed to give a general understanding of the political and administrative complexity of property taxes.24 Each of the property tax elements has an influence on the property tax design and its performance (Sects. 2.2.1, 2.2.2, 2.2.3, 2.2.4, and 2.2.5). In order to identify the variance in the property

23

“The relative greater stability of market values is of little consequence, if market values are not accurately reflected in assessed property values (Bahl and Martinez-Vazques 2007: 6).” 24 The online seminar lecture “Designing and Implementing Property Tax Systems in Africa“, provided by the Lincoln Institute of Land Policy, gives a well-structured overview on administrative and political aspects of the property tax design (attendance, April 2014).

26

2 Theoretical Insight on the Property Tax

tax performance, an analytical ratio study is necessary. Therefore, Sect. 2.2.6 will draw up tax performance indicators that constitute the basis for testing the elements and their impact on the tax performance. Based on this, the revenue mobilization model defined by Kelly (2003) is used to show the direct impact of the single elements on the property tax revenue (Sect. 2.2.7).

2.2.1

Property Tax Base

The tax base adopted of the property depends on the objectives of the tax, such as generating municipal revenues or incentivizing land development, and in part on the level of development of the respective property market and the property tax administration (Kitchen 2013: 3f; Franzen and McCluskey 2013: 44). The tax can be levied upon all types of properties including residential, commercial, industrial and agricultural properties. These categories of property are further specified concerning nature and extent of the tax base. Regarding the nature of the tax base, it has to be decided whether to make use of land only, land and buildings, or buildings only.25 The decision upon the extent of the tax coverage relates to whether to include urban and/or rural land and whether to take a broad or narrow tax base (exclusion versus exemption, Sect. 2.2.2).

2.2.2

Exemptions and Exclusions

Exemptions and/or exclusions are mainly based on ownership (e.g. governments), use (e.g. bona-fide farming), ownership and use (e.g. religious groups) or value (e.g. properties below a threshold value).26 From an economic perspective it is important to distinguish between exemptions, where the property belongs to the tax base and is exempt from the property tax after assessment, and exclusion, where (parts of) the property is not considered in the tax base. In case of exemptions, the revenue cost or opportunity cost of the property taxes has to be paid by the

25

While taxing land only leads to an unbiased development of residential properties, taxing buildings is not incentive-neutral (see Sect. 2.1.2). Nonetheless, there are countries taxing buildings only, this is usually the case where the land is nationalized or land is perceived as national asset belonging to the people collectively. Herewith, taxing buildings only is not considered as it is very costly to maintain the fiscal cadastre (see Sect. 2.2.5) and it would stifle land development. From an economic and administrative context, taxing buildings only is ‘nonsense’. 26 Exemption and exclusions constitute only one part of tax relief. Tax relief, however, can be granted on a number of stages besides exempting or excluding property from the tax base, such as differentiating the tax rates among the taxpayers or by not valuing/billing/collecting all properties, respectively, by not enforcing all property liabilities. Property tax relief programmes are outlined by Kitchen (2013: 29ff).

2.2 Stylized Facts of the Property Tax

27

remaining taxpayers (if the level of public services remains constant).27 Only if the full cost of land use is taken into account is the decision about resource allocation efficient. In the case of exclusions, it would therefore be more adequate if instead of exclusions the government made transfer payments to balance the expenditure adequately. Generally, exemptions and exclusions are implicit subsidies, raise complexity and cause a loss of transparency and equity (Kelly 2013: 10; Kitchen 2013: 10). Furthermore, the level of government deciding upon the granting of exemptions is important with regard to accountability: If a higher level of government is allowed to grant exemptions, they might ‘buy’ popularity but there would be fewer distortions among the different municipalities. If the local level has discretionary power on granting exemptions, political pressure by similar and equally deserving taxpayer groups might increase or local elites might influence the political decision-making process. Furthermore, if the local administrative level has discretion there might be issues of decentralized corruption.

2.2.3

Property Tax Assessment

The tax base for assessment—unit, sizes or value—distributes the tax burden across taxpayers according to the number of units, their sizes (e.g. carpet area, floor area), or according to their property value (e.g. market value, rental value). Therefore, the assessment method applied is very important as it allocates the total property tax burden to the taxpayers. If taxing a unit as the assessment base, then each property, regardless size or location, would pay an equal amount of the tax burden. In the case of size as the assessment base, each property regardless of location would pay an equal per square meter rate. Lastly, the value as the assessment base implies that each property would pay the tax based on their relative property value.28 In contrast to an area-based assessment (square meters only), the property tax typically reflects value, i.e. at least some value of the property is assessed (land and/or building). For instance, many developing countries tax the size of the land linked to the location (and other factors, such as use, age and quality of the

27

The revenue cost could be estimated if the average tax liability per property and the number of exempt properties is known. However, it has to be kept in mind that most exempt properties are well-located governmental properties; therefore, the revenue cost is a gross underestimation, see Mathur et al. (2009: 34): RCEX¼(NEX) [TD AP ]; RCEX¼Estimated revenue cost of exemption NEX¼Number of exempt property TD¼Property tax demand for taxable properties AP¼Number of taxable properties assessed. 28 Within the assessment, it is not required to determine an absolute value in market terms, but the relative value of properties at a common point in time (Dillinger 1991: 16).

28

2 Theoretical Insight on the Property Tax

Table 2.3 Applying rational local tax criteria to assessment base Efficiency Ease and cost of administration

Equity

Visibility

Elasticity

Area-based assessmenta – Property size badly reflects benefits received – Less data required, easily obtained; especially in less-developed property markets/property records – Cheaper to administer: municipalities could be responsible for tax assessment and collection – Easier to maintain – Disconnection between property values and tax levies results in inequities of the tax burden across properties (even with adjustment coefficients such as age, location, use etc.) – Regressive tax: high-/and low-income properties are taxed the same – Rising property values (e.g. reclassification of rural to urban land) lead to inequities – Physical aspects of property are visible (easy to self-assess or to verify official tax bill) – Less volatile – Predictable tax revenues

Value-based assessmentb – Value is a better indicator for benefits received – Synergy effect: assessment base could be used for other taxes (e.g. inheritance tax) – Usually requires well-trained assessment staff, computer assisted mass appraisal systems – Costly to implement and to maintain – Good proxy for ability-to-pay – More equitable because it more accurately differentiates properties according to age, use, quality, location etc. – Rising property values (e.g. reclassification of rural to urban land) are captured

– Visibility may be lacking (because regression analysis is not transparent), self-assessment is difficult – Revenue increases to the extent that the property values are frequently reassessed

Source: Author It applies to area-based assessment not including any adjustment factors b Here, perfect property market and optimal utilization is assumed, so differences between rental and market value disappear. However, underutilization is more realistic, resulting in adverse incentives, such as holding land for speculation purposes or high rates of vacation homes a

building), which reflects some value of the property. Therefore, the assessment methods can generally be separated into area-based assessment or value-based assessment (Table 2.3). The non-value area-based assessment is often applied if there is no wellfunctioning property market, which is important in order to achieve a fair value measurement approach.29 In the case of less efficient, less developed property markets (e.g. command-based economies), an area-based property assessment might be more appropriate. However, if an efficient property market (largely depending on the availability of information for buyers and sellers) exists, a

29

A well-functioning property market implies that properties can be sold and bought on an open and competitive market. In this case, the property value reflects the highest and best use of the property and market price would equal the capital/market value (RICS 2012: 32f).

2.2 Stylized Facts of the Property Tax

29

value-based assessment might be applied. The value-based assessment is sub-divided into the rental and capital value approaches. The capital value is based on the highest and best use and is seen as the most equitable assessment base (although it may not reflect the current use and therefore can penalize taxpayers). In contrast, the rental value is commonly based on the current use of the property and therefore does not necessarily reflect the highest and best use.30 The right choice herewith depends on the predominant market type: a highly developed capital market with predominantly owner-occupation versus a highly developed rental market with predominantly rental-occupation.31 The decision about the allocation of the tax burden to the taxpayer with regard to the assessment base has direct implications for equity and efficiency32: – Area-based assessment Area based assessment is directly related to physical land and/or building characteristics (square meters of land area and/or of buildings). These characteristics may be regarded as a proxy for the intensity of public infrastructure usage and the resulting public costs. – Area-value-based system Besides the ‘pure’ area-based assessment, which is based on physical aspects only, there are hybrids to proxy market value.33 They include adjustment factors, sometimes also referred to as weightage factors, with regard to location, age of buildings, type of construction, type of use (i.e. residential, commercial, etc.), and/or other factors that determine market value. – Rental value assessment The assessment base in this approach is the rental value or net rent. The logic of using the rental value is that taxes are paid from income (flow) instead of wealth (stock). To the extent that property is used for its best and highest use, the rental value approximates the market value. However, this is often not the case, as usually the current use is assessed. A property that is under-utilized (as in the case of vacant land) in its current use results in lower assessment rental-values than market-values.

30

The distribution of the tax burden differs between rental value and capital value. The capital value will place a higher proportion of the tax burden on underdeveloped property such as, for instance, vacant land. 31 Some counties make use of hybrid approaches, capital value for residential properties (owner occupied) and rental value for commercial property (rental occupation). 32 The overview is based on Franzen and McCluskey (2013: 46–54); McCluskey (1999: 12–17); Norregaard (2013: 24); Bird and Slack (2003: 47–52); Bird and Slack (2004: 26–30); Bell et al. (2009: 1), Gosh and Kundu (2011: 97), and on proposals for a property tax reform in Germany. 33 Market value is determined by demand and supply factors and specific location factors that include the quantity and/or quality of public services. According to RICS (2014a, b: 9) “market value” is defined as: “... the estimated amount for which a asset or liability should exchange on the date of valuation date between a willing buyer and a willing seller in an arm’s length transaction after proper marketing and where the parties had each acted knowledgeably, prudently and without compulsion.”

30

2 Theoretical Insight on the Property Tax

– Capital market value assessment The capital value is further sub-divided into unimproved value (land value only) and improved value (land and structures). The market value can be ascertained by examining real estate transactions. If the number of transactions is not representative then there are three different methodologies that can be used to estimate market values: (1) Comparable sales approach: looks at valid transactions of similar property assessments, (2) Depreciated cost approach: the land value is estimated separately from the replacement costs of the building; both components reflect the market value, (3) Income approach: the potential gross rental income is estimated and operating expenditures deducted; the resulting net rent is converted to a capital value by making use of a capitalization rate.

2.2.4

Tax Rates

The tax rate converts the assessed value into a tax bill. As tax revenue is mainly based on the tax base and the tax rate, the tax rate depends primarily on the revenue requirements of the specific municipality. There are different approaches to setting a specific tax rate and thereby determining the revenue size (Zorn 2013: 133). One approach, the so-called residual approach, applies to the expenditure needs of the respective municipality and follows the question “How much do we have to mobilize?” Further, tax rates could be set in order to maximize property tax revenues. The revenue maximizing approach follows therefore the question on “How much could we mobilize?” Finally, there could be an official determination approach, which refers more to official decision making instead of revenue mobilization. In the first case, the residual approach, the property tax rates are most likely determined on the local level. The locally elected municipal council would determine the expenditure needs, subtracting available non-property tax revenues (e.g. charges, fees, intergovernmental transfers etc.) and then setting the tax rate accordingly.34 The broader/narrower the tax base, the lower/higher the nominal tax rate, so there is a close relationship between the tax base and tax rate (Table 2.4). In the case of revenue maximizing, a higher-level government may set the tax rate, where the link between taxes levied and public services rendered is lost, as is accountability for tax decisions broadly. If a higher government level does not set the tax rate it may still, nonetheless, set statutory limits (statutory or legal rates) that limit local discretion power to a tax corridor, which might be the case in order to avoid distortions.35 In the case of official determination of tax rates, the budget

Tax rate ¼ (expenditures needs  non-property revenues)/(total assessed value). Whereas a minimum tax rate may avoid distorting tax competition (property tax decisions play a role in intra-regional location decisions, hence there could be a race-to-the-button), a maximum tax rate avoids distorting tax-exporting (which happens especially when setting higher rates on commercial properties) (Kitchen 2013: 17). 34 35

2.2 Stylized Facts of the Property Tax

31

Table 2.4 Relationship between tax base and tax rate Examplea: A property consisting of land (200,000 EUR) and building (800,000 EUR), alternatively the property could be rented for 100,000 EUR/year. The municipal tax yield is a constant 10,000 EUR Tax base ¼ Land and building value 1,000,000 EUR Tax rate ¼ 1% 10,000 EUR Tax base ¼ Land value 200,000 EUR Tax rate ¼ 5% 10,000 EUR Tax base ¼ Rental value 100,000 EUR Tax rate ¼ 10% 10,000 EUR a

Example is based on lecture of Rie¨l C. D. Franzsen: “Designing and Implementing Property Tax Systems in Africa”, Lincoln Institute of Land Policy, MA: Cambridge (April, 2014)

expenditures and the revenues expected from other tax sources are not taken into account in the decision-making process. This approach is often found in developing and transition countries with central government determine the tax rate. The design of tax rates can be further specified by deciding upon uniform versus differential tax rates and by deciding upon the tax rate structure (progressive, regressive, proportional):

2.2.4.1

Uniform Versus Differential Tax Rates

A uniform rate applies equally to all property categories while differential rates are designed to set different rates on different property classes (residential, commercial, etc.), persons or objects (land and building, land only, etc.) in order to reflect different costs of public servicing. Motivation for differential tax rates may be based on efficiency, equitability or political grounds (McCluskey 1999: 26f; Kitchen 2013: 18; Zorn 2013: 131). However, the differential tax rates are only fair if the rates reflect the different benefits received from public service provision.36

2.2.4.2

Progressive, Regressive or Proportional Tax Rate Structure37

The different tax rate structures imply different impacts on taxpayers. A progressive rate is favoured from an economic and equity perspective, as it reflects the abilityto-pay of the taxpayer. Further, it might promote efficient land use because the tax rate increases as the taxable amount (wealth) increases. A regressive tax rate could be a political decision made with land-rich owners who are well connected to

36

The same benefit-rule applies as between municipalities where different levels of public service provision are reflected in different tax rates. They are an indicator for public service differences if Tiebout-like municipalities are given. 37 Proportional rate: As the value of property rises the tax liability rises by the same percentage; Progressive rate: As value/size increases, the tax takes an increasing percentage of value/m2; Regressive rate: As value/size increases, taxes take a smaller percentage of value/m2.

32

2 Theoretical Insight on the Property Tax

Table 2.5 Relationship between nominal and effective tax rate

Examplea: A property values 100,000 EUR Value reductions 15,000 EUR Assessment ratio 0.8b Nominal tax rate 1.5% Rebate 10% Tax amount 918 EUR Effective tax rate 0.92% (¼918/100,000) a Example is based on lecture of Rie¨l C. D. Franzsen: “Designing and Implementing Property Tax Systems in Africa”, Lincoln Institute of Land Policy, MA: Cambridge b Only 80% of the assessed value is taken into account

politics, as this tax rate decreases with increasing taxable amount. Proportional tax rates imply a proportional tax incidence, regardless of ability-to-pay. In practice, the tax rate structures might generally be split according to the assessment base (Norregaard 2013: 26): In the case of capital value as assessment base, a flat or progressive rate is often applied (progressivity might be achieved by deductions). Under rental value, a flat rate is applied. Area-based assessments often go along with a specific flat rate. Both, progressive and regressive tax structures imply higher complexity for the administration (tax billing and collection) in contrast to proportional rates that are simple, transparent, and generating more predictable revenues. Progressive tax rates are susceptible to issues of corruption. Finally, the difference between the nominal and effective tax rate has to be considered. The effective tax rate adjusts the nominal tax rate by considering exemptions, value reductions, assessment ratio and rebates and is therefore lower than the nominal rate (Table 2.5). Overall, the comparison of different municipal tax rates must be done very carefully, as there might be differences in municipal revenue requirements, expenditure needs, the tax base used, age/quality of (re)assessments and effective tax versus nominal tax rates.

2.2.5

Identification, Assessment, Billing, Collection, Enforcement

Property tax administration is one of the most important aspects of property taxation; without billing, collecting, and enforcing all political decisions made are obsolete. According to Dillinger (1991) and Bahl et al. (2008), the fundamental weakness of the property tax is its administration, which is resource intensive.38 The tax administration is responsible for recurrent key tasks of administration, such

38

Dillinger (1991: 4) states that the poor performance of the property tax is partly technical. If the tax administration in developing countries would increase the coverage and collection efficiency, the revenue would increase substantially.

2.2 Stylized Facts of the Property Tax

33

as property discovery (identification of taxable properties), assessment (calculating the relative value), valuation (calculating the amount of tax), billing (informing taxpayers of liability), collection (collecting tax payment) and enforcement, and taxpayer services and dispute resolution (Dillinger 1991: 11–28; Bandyopadhyay 2013: 6; Kitchen 2013: 6–12). These administrative aspects of property taxation have to be discussed in more detail:

2.2.5.1

Discovery and Identification

There are two basic approaches: self-declaration, where taxpayers provide the information to the taxing authority, or government inventory, where the taxing authority collects information in the field. Besides, the information could be obtained by outsourcing the collection of data to an agency. In order to have a viable tax administration, all data necessary has to be collected in a property tax cadastre with an efficient method in place in order to keep them up to date (Norregaard 2013: 27). This constitutes one of the main problems to be found in developing countries (Bahl and Slack 2004). Each property should be assigned an unique identification number in order to link the property with taxpayer. To ensure efficient and accurate tax administration there is a need for a well-functioning property cadastre system, which could be differentiated into a legal cadastre and fiscal cadastre. While a legal cadastre is unnecessary for property taxation purpose, a financial cadastre is a conditio sine qua non. A legal cadastre could be defined as a cadastre holding all necessary property data that would suffice in a court of law. A fiscal cadastre, however, is a more complex and data-orientated system. It has to provide specific data for property and taxpayer identification (address of the property, owner, building and lot size, the age of the building, and information on improvements/renovations) to ensure proper property tax assessment and treatment of administrative aspects such as billing and collection (Kitchen 2013: 6).39 Crossreferencing among administrative bodies is important in order to ensure up-to-date data (fiscal cadastre, deeds registry, sales records, official building permits and bills on basic public services rendered such as water/electricity provision and garbage collection). Further, the maintenance of the fiscal cadastre data is twofold: first, physical changes to the characteristics of the property (subdivision of property parcels, re-classification from rural to urban land, improvements etc.) have to be incorporated as they occur; second, changes of ownership have to be captured.

2.2.5.2

Assessment

Again, there are two distinct approaches: area-based and value-based assessment, of which the latter is further subdivided to the rental and capital value approaches.

39

Properties and taxpayers are usually identified by making use of a geographic reference system such as parcel maps or (as in United Kingdom) street maps with a street address system.

34

2 Theoretical Insight on the Property Tax

From the administrative perspective, it is important to achieve uniform assessments within each jurisdiction in order to meet the criteria of horizontal equity, i.e. that similar income groups are treated in an equal way by the tax regime (Kitchen 2013: 7; Brys et al. 2013: 18).40 In order to achieve uniformity, assessments have to be reassessed every 4–6 years.41 In the case of value-based assessments in booming cities, where market values might change quite quickly, the assessment should be more often. This is only manageable with computerized mass appraisal techniques (CAMA), which make use of multiple regression analysis taking physical property aspects (such as building and lot size, location, age of building, existence of a swimming pool and/or garage, number of bathrooms) and selling price into account in order to determine the market value.42 In order to keep prices at least adjusted to inflation; the administration could index the assessment value. This approach does not achieve the same uniformity as reassessments, but it absorbs to some extent the larger changes in assessment values and, respectively, tax burdens. Another key issue in this context is decentralized versus centralized assessment. There is general agreement on the need for a legal framework that is centrally determined and uniform property tax assessment; there are pros and cons for (de)centralized assessments: A local assessment emphasizes better knowledge with regard to the assessment base (e.g. land and buildings) and the local property market, while centralized assessment is associated with better-skilled assessors, (more) uniform assessments, and scale-effects. Furthermore, assessors do not face (the same) political interference with regard to delaying or minimizing assessments/updates (as it might be on local level).43 In the case of self-assessment, there should be significant and effective penalties in order to prevent underassessment (Bird and Slack 2004: 31f). In any case, it is essential to have an assessment manual containing all practices and procedures in order to achieve uniform assessments. Besides the self-assessment, there should be training standards in order to become an official assessor.

40

Assessing and taxing wealth is quite complex from the administrative perspective, which would be based on the ability-to-pay principle. Therefore, it is more appropriate to tax income from property/wealth instead of wealth only. 41 The frequency of re-assessment recommended by the International Association of Assessing Officers (IAAO) is four to six years for physical reviews and property re-inspection (IAAO 2013: 12). 42 Assessors are still necessary within this approach as they have to test assessments according to their accuracy, equity, and uniformity by the application of standard statistical measures (e.g. ratio studies, coefficient of dispersion, and coefficient of variation) (McCluskey 1999: 29). Further, they have to identify property features that explain selling prices. Thereby, they further improve the mass-appraisal system. 43 Dillinger (1991: 30) got to the heart of deciding upon central or decentral tax administration by stating: “The choice between central and local administration can be characterized [. . .] as tradeoff between indifference and incompetence.”

2.2 Stylized Facts of the Property Tax

2.2.5.3

35

Billing, Collection and Enforcement

The general aspect in this context is to establish a climate that makes taxpayers pay their liabilities by setting the right incentives, sanctions, and penalties (or a combination): A high rate of tax compliance means fewer costs of tax administration, as well as insuring a more equitable tax system (McCluskey 1999: 21f). In the case of billing, the definition of ownership may be necessary, as the owner (or occupier) is liable for the property tax.44 Collection penalties are generally essential, as they set a financial incentive that makes taxpayers pay and that makes them pay on time. An ad rem remedy against longstanding delinquents could be withholding (public) services (e.g. water, electricity), selling personal possessions of the taxpayer, pursuing the taxpayers through the court system or selling/auctioning the property.45 Another measure of enforcement would be a quid pro quo approach, e.g. only when taxes are paid and a clearance certificate received is a legal change in ownership allowed. Overall, these functions are usually done by the taxing jurisdiction, but there is no need for that: while local governments have more incentive to effectively collect taxes, central government could make use of scale effects. In order to effectively bill, collect, and enforce property taxes, a wellfunctioning fiscal cadastre is essential. In case the local government level is responsible for these functions, but not for the assessment, administrative crossreferencing might be needed.

2.2.5.4

Appeal Mechanism

Taxpayers have to have the option to appeal against the assessment, respectively, their tax bill, in order to correct occurring problems of inequities. This could be in case of re-assessment of the properties or within the regular updating process of the cadastre system and respectively the assessment (e.g. extension or reconstruction of improvements). In both cases, a period of time has to be granted in order to lodge appeals. In order to prevent frivolous appeals, a lump sum in advance could be in place, which is refunded if the appeal was successful (McCluskey 1999: 28). Overall, all outlined administrative aspects might have substantial effect on uniformity and horizontal equity within a jurisdiction. Presuming the assessment results are true and accurate to the best of the administration’s and assessor’s knowledge, properties that are assessed and billed for a tax must see that tax is collected and enforced. Failure on the collection and enforcement level results in horizontal inequities between the honest and willing taxpayers and non-tax payers, so-called free riders. 44

Defining ownership is a difficult matter, as much of the urban periphery land in Africa has never been formally adjudicated. The same holds for Latin America, where some formally adjudicated land has been illegally occupied (Dillinger 1991: 25). 45 The penalties imposed have high political and administrative costs. In the case of the administration, they may not pay off directly but perhaps indirectly by increasing the overall tax compliance/collection performance.

36

2 Theoretical Insight on the Property Tax

2.2.6

Property Tax Performance Ratios

Ratio studies are conducted in order to evaluate performance. In this context, the policy choice about the tax base and tax rate influences the complexity of the property tax administration by setting the overall framework for property taxation. However, the tax administration is itself the key factor for the property tax performance, as it is responsible for the efficiency and accuracy of coverage, assessment and collection. The property tax is very resource-intensive from an administrative perspective. Therefore, the administration is the focus of the ratio study. The main determinants of administrative performance are (Linn 1980; Bird and Slack 2004; Mathur et al. 2009): • • • • •

Coverage and enumeration of properties within the fiscal cadastre Collection rate Assessment/valuation rate Extent of exemptions Level of the tax rate

An analysis of these determinants is important in order to identify the weaknesses of a given property tax system in order to, in turn, mobilize tax revenues. The ratios illustrate the administrative performance and the potential for further improvement. The ‘potential’ represents a gap between the present property tax revenues collected and the taxes that could be collected under ideal conditions. A comparative view of key administrative features such as coverage, assessment and collection is especially useful for discovering similarities and differences in individual tax performances and for drawing lessons for further improvement. Examples for a property tax ratio study are: Coverage • Assessed properties/Total properties  100 (coverage ratio) • Tax-paying properties/Assessed properties  100 (real coverage) • Tax-paying properties/Total properties  100 (effective coverage) Assessment • Assessed property values/Market property value  100 (valuation ratio) Collection • Tax collection/Tax demanded or assessed  100 (collection ratio) Enforcement • Arrears collected or enforced/Arrears demanded  100 (enforcement ratio) Source: Linn (1980), Kelly (2003, 2013), Bird and Slack (2004), Mathur et al. (2009)

2.2.7

Revenue Mobilizing Model

Keeping the results of the property tax ratio study in mind, the impact of each ratio on tax revenues could be tested by making use of the revenue mobilization model

2.2 Stylized Facts of the Property Tax

37

established by Kelly (2003: 14, 2013: 143–146). Kelly defines revenue as a set of policy and administrative variables. Revenue is defined by policy choices (tax base, tax rate) and administrative actions (Coverage Ratio (CVR), Valuation Ratio (VR), Collection Ratio (CLR), and Enforcement Ratio (EFR)):46 2

3

2

3

 VR  CLR  EFR 5 Taxrevenue ¼ 4Tax Base  Tax Rate 5  4CVR |fflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflffl{zfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflffl} |fflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflffl{zfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflffl} ðPolicy-related variablesÞ ðAdministrative-related variablesÞ From a political decision-making perspective, property taxation involves critical elements, such as the decision about the tax base (land only, land and buildings, etc.) as well as possible decisions about the scope of tax relief (e.g. exemptions). Furthermore, politics has to decide upon the allocation of the tax burden by deciding upon the tax base (urban and/or rural; land only, land and buildings, buildings only) and assessment base (size, unit, value) as well as setting the specific assessment rate (adjustment factors) in case of area-based assessment. The administration, in turn, is responsible for the efficiency and accuracy of coverage, assessment and collection. The administration has to identify all taxable real properties and capture these in the fiscal cadastres: therefore, the coverage ratio (CVR) is defined as taxable properties listed in the fiscal cadastre in relation to all properties legally defined. It measures the completeness and accuracy of the fiscal cadastre. Beyond that, the administration has to assess the properties. Its accuracy is measured by the valuation ratio (VR), which is defined as the ratio of assessed to actual value. Finally, the administration is responsible for tax collection, which is measured by the collection ratio (CLR) that relates the actual tax revenue collected as a share of current liabilities invoiced. Outstanding tax liability is captured with the enforcement ratio (EFR). Typically, the latter two aspects, current tax liability and outstanding tax liability, are considered cumulative in a single ratio, referred to as collection ratio. The revenue-mobilizing model matches the defined main function of the property tax: generating local tax revenues. In an ideal world the administrative-related part of the revenue model would sum up to one (with each ratio taking on the value of one), leaving the political-related part as tax revenue. However, as the administration’s performance barley achieves 100% accuracy and efficiency, the tax revenues are less to the same extent that the overall administration does not perform as it could, at least theoretically.47 Therefore, the property tax has to be seen as a system and not merely as a set of independent activities. According to Bagchi

46

The method used here is based on a simple model of ratios (see also Linn 1980; Bahl and Linn 1992; Lewis 2003). Bahl and Martinez-Vazquez (2007: 11) formulate a similar equation putting the property tax revenue to GDP, which makes the formula a benchmark for cross-referencing administrative performance among different countries. 47 A combination of administrative failure on coverage, valuation, and collection/enforcement even reinforces the negative impact in a multiplicative manner on the tax revenue.

38

2 Theoretical Insight on the Property Tax

(1993: 5) “there is no doubt a lot of merit in approaching property tax administration as a system with four interrelated dimensions [identification, record keeping, assessment, and collection], calling for concerted attention.” In order to improve the tax system, collecting and analysing data on the political and administrative variables should be seen as sine qua non for every property tax assessment.

References Aaron HJ (1975) Who pays the property tax. Studies of government finance. The Brookings Institution, Washington, DC Bagchi A (1993) Financing urban local governments – issues and approaches. National Institute of Public Finance & Policy, New Delhi Bahl RW (2013) Decentralization of governance in metropolitan areas. In: Property taxation and local government. Lincoln Institute of Land Policy, Cambridge, MA, pp 85–105 Bahl RW, Linn JF (1992) Urban public finance in developing countries (1. print.). A World Bank book. Oxford University Press, Oxford Bahl R, Martinez-Vazquez J (2007) The property tax in developing countries: current practice and prospects, Working Paper, Lincoln Institute of Land Policy Bahl RW, Martinez-Vazquez J, Youngman J (2008) The property tax in practice. In: Making the property tax work: experiences in developing and transitional countries. Lincoln Institute of Land Policy, Cambridge, MA, pp 3–16 Bandyopadhyay S (2013) Property tax reforms in India: a comparison of Delhi and Bangalore. Working Paper 13–21, Georgia State University, Andrew Young School, International Centre for Public Policy Bell ME, Bing Y, Katrina C (2009) A compendium of states with an area-based tax. Lincoln Institute of Land Policy, Cambridge, MA Bird RM, Slack E (2003) Land and property taxation around the world: a review. J Prop Tax Assess Adm 7(3):31–80 Bird RM, Slack E (2004) Land and property taxation in 25 states: a comparative review. In: International handbook of land and property taxation. Edward Elgar, Northampton, MA, pp 19–56 ¨ ffentliche Finanzen in der Demokratie. Verlag Vahlen, München, 5. Auflage Blankart C (2003) O Brys B, Matthews S, Herd R, Wang X (2013) Tax policy and tax reform in the People’s Republic of China. OECD Taxation Working Papers, No. 18. OECD, Paris Buchanan JM (1965) An economic theory of clubs. Economica 32:1–14 Buchanan JM, Goetz CJ (1972) Efficiency limits of fiscal mobility: an assessment of the Tiebout model. J Public Econ 1:25–43 Dillinger W (1991) Urban property tax reform: guidelines and recommendations. Urban Management and Municipal Finance, World Bank, Washington, DC Fischel WA (1992) Property taxation and the tiebout model: evidence for the benefit view from zoning and voting. J Econ Lit 30(1):171–177 Fischel WA (1985) The economics of zoning laws: a property rights approach to American land use controls. Johns Hopkins University Press, Baltimore, MD Fischel WA (2001) Municipal corporations, homeowners and the benefit view of the property tax. In: Property taxation and local government. Lincoln Institute of Land Policy, Cambridge, MA, pp 33–78 Franzen R, McCluskey WJ (2013) Value-based approaches to property taxation. In: A primer on property tax – administration and policy. Wiley-Blackwell, West Sussex, pp 41–68

References

39

George H (1882) Progress and poverty. Appleton, New York Gosh D, Kundu D (2011) Innovations in property taxation systems in India. In: Innovative and property taxation. UN HABITAT, Nairobi Gu AY, Trefzger JW (2000) Make it simple and light: some thoughts on real estate related taxation in China. Int Real Estate Rev 3:142–161 Haller H (1981) S. 40 ff.: Die Steuern, 3. Aufl., Tübingen Hamilton BW (1975) Zoning and property taxation in a system of local governments. Urban Stud 12:205–211 Harriss CL, Oates WE (2001) Property taxation and local government finance: essays in honor of C. Lowell Harriss. Lincoln Institute of Land Policy, Cambridge, MA Heilbrun J (1983) Who bears the burden of the property tax. In: Lowell Harriss C (ed) The property tax and local finance. The Academy of Political Science, New York, pp 57–71 Hong Y-H, Ingram GK (2008) Fiscal decentralization and land policies. Lincoln Institute of Land Policy, Cambridge, MA, pp 3–16 IAAO (2013) Standard on ratio studies. International Association of Assessing Officers (IAAO), Kansas City Kelly R (2003) Property taxation in Indonesia: challenges from decentralization. Lincoln Institute of Land Policy, Cambridge, MA Kelly R (2013) Making the property tax work. Working Paper 13-1, International Centre for Public Policy, Andrew Young School, Georgia State University Kitchen H (2013) Property tax: a situation analysis and overview. In: A primer on property tax. Administration and policy. Wiley-Blackwell, West Sussex, pp 1-40 Lewis BD (2003) Property tax in Indonesia: measuring and explaining administrative (under-) performance. Public Adm Dev. doi:10.1002/pad.268, 227-239 Linn JF (1980) Property taxation in Bogota, Colombia: an analysis of poor revenue performance. Public Finance Q 8(4):457–476 Mathur OP, Rajadhyaksha N, Thakur D (2009) Urban property tax potential in India. National Institute of Public Finance and Policy, New Delhi McCluskey W (ed) (1999) Property tax: an international comparative review. Ashgate, England McLure CE Jr (ed) (1983) Tax assignment in federal states. Australian National University, Canberra McLure CE Jr (1995) Comment on “the dangers of decentralization” by R. Prud’homme. World Bank Res Obs 10:221–226 Mieszkowski P (1972) The property tax: an excise tax or a profits tax? J Public Econ 1:73–96 Mieszkowski P, Zodrow GR (1986) The new view of the property tax: a reformulation. Reg Sci Urban Econ 16(3):309–327 Mohanty PK (2003) Reforming property tax: the approach of municipal corporation of Hyderabad. Working Paper, Centre for Good Governance, Hyderabad Mohanty PK, Misra BM, Goyal R, Jeromi PD (2007) Municipal finance in India: an assessment. Development Research Group Study No. 26, Department of Economic Analysis and Policy, Reserve Bank of India Musgrave RA (1939) The voluntary exchange theory of public economy. Q J Econ 53:213–237 Musgrave RA (1959) The theory of public finance: a study in public economy. McGraw-Hill, New York Musgrave RA, Musgrave PB (1976) Public finance in theory and practice, Second edn. McGrawHill, New York Nechyba TJ (2001) The benefit view and the new view. Where do we stand, twenty-five years into the debate? In: Property taxation and local government finance. Lincoln Institute of Land Policy, Cambridge, MA, pp 113–122 Netzer D (2001) Local property taxation in theory and practice – some reflections. In: Property taxation and local government finance. Lincoln Institute of Land Policy, Cambridge, MA, pp 321–338 Norregaard J (2013) Taxing immovable property. Revenue potential and implementation challenges. IMF Working Paper, WP13/129

40

2 Theoretical Insight on the Property Tax

Oates WE (1969) The effects of property taxes and local public spending on property values: an empirical study of tax capitalization and the Tiebout hypothesis. J Polit Econ 77:957–971 Oates WE (1972) Fiscal federalism. Harcourt Brace Jovanovich, New York Oates WE (1999) An essay on fiscal federalism. J Econ Lit 37:1120–1149 Olson M (1969) The principle of “fiscal equivalence”: the division of responsibilities among different levels of government. Am Econ Rev 59(2):479–487 Oates WE (2001) Property taxation and local government finance. Lincoln Institute of Land Policy, Cambridge, MA RICS (2012) RICS valuation – Professional standards. Royal Institution of Chartered Surveyors (RICS), Mar 2012 RICS (2014a) The role of international and local valuation standards in influencing valuation practice in emerging and established markets. Royal Institute of Chartered Surveyors (RICS), London RICS (2014b) Global affordable housing report: BRICS plus mortar. Royal Institute of Chartered Surveyors (RICS), London Rondinelli D, Nellis JR, Cheema GS (1983) Decentralisation in developing countries: a review of recent experience, World Bank Samuelson PA (1954) The pure theory of public expenditures. Rev Econ Stat 36:387–389 Sennoga EB, Sjoquist DL, Wallace S (2008) Incidence and economic impacts of property taxes in developing and transitional countries. In: Making the property tax work, experiences in developing and transitional countries. Lincoln Institute of Land Policy, Cambridge, MA, pp 63–102 Slack E (2004) Property taxation in South Africa. In: International handbook of land and property taxation. Edward Elgar, Northampton, MA, pp 199–204 Smoke P (2008) Local revenues under fiscal decentralization in developing countries: linking policy reform, governance, and capacity. In: Fiscal decentralization and land politics. Lincoln Institute of Land Policy, Cambridge, MA, pp 38–68 Tiebout CM (1956) A pure theory of local expenditures. Polit Econ 64:416–424 Yu-Hung H, Brubaker D (2011) Integrating the proposed property tax with the public leasehold system. In: Chinas local public finance in transition. Lincoln Institute of Land Policy, Cambridge, MA, pp 168–187 Yu-Hung H, Murakami J, Suzuki H, Tamayose B (2015) Financing transit-oriented development with land values, adapting land value capture in developing countries. The World Bank, Washington, DC Zimmermann H (2009) Eine Einführung in die finanzwissenschaftliche Analyse der kommunalen Finanzwirtschaft, Berlin Zorn K (2013) Establishing a tax rate. In: McCluskey WJ, Cornia GC, Walters LC (eds) A primer on property tax: administration and policy. Wiley-Blackwell, Oxford

Chapter 3

Property Taxes Within the BRICS States

In this chapter brief BRICS states profiles are provided (Sect. 3.1) before expanding on the case studies (Sect. 3.2). All integral elements of the property tax designs of the Brazil, India, and China will be reviewed in this chapter, including those relating both to political decisions (tax base, tax assessment, tax rate) and to administrative practices (tax assessment, billing, collection, and enforcement). Furthermore, exogenous factors are essential, such as the role of urbanization and housing markets. Those factors over which the megacities have only limited control will be reviewed and discussed with focus on property taxation. Rounding of, the chapter closes with a comparative view of both the political decisions and administrative practices within all BRICS states (Sect. 3.3) and outlines the future significance of property taxation in urban BRICS states (Sect. 3.4).

3.1

Country Profiles

The BRICS countries have three aspects in common, which underlie the relevance of these countries: their economies are of an outstanding size, they have strong growth rates resulting in increasing significance in the global economy, and they are demanding a stronger position within the international governance structure (EU Parliament 2012: 7). The role of South Africa among these nations is different, as it does not perfectly fit within the characteristics of the BRICS states. With South Africa in an exceptional position on the one side, China and Russia would be the exceptions on the other side; China in regard to its economic dominance and Russia being a former superpower. Despite a considerable number of similarities, the sample of countries is very heterogeneous at a closer look, as Table 3.1 illustrates. The variance among the countries in terms of GDP per capita and central government revenues (% of GDP) is significant. Beyond that, the (urban) population varies significantly—also with regard to area and resulting therefrom population densities. © Springer International Publishing AG 2017 M. Salm, Property Tax in BRICS Megacities, Contributions to Economics, DOI 10.1007/978-3-319-62671-0_3

41

HDI Rank 2010 75 71 134 92 129

Estimated population 2010 (millions) 195.2 143.6 1205.6 1359.8 51.5

Urban population (% total) 84.3 73.7 30.9 49.2 61.5

Slum population as percentage of urban 2009 (%) 26.9 – 29.4 29.1 23.0 Area (1000 km2) 8459 17,098 3287 9597 1219

Population density 2010 (population per km2) 23 8 367 142 42

GDP per capita (PPP 2005 US$) 10,079 14,182 3122 6819 9516

Central government current revenues, 2010 (% of GDP) 26.2 26.1 12.9 11.5 28.8

Type of government Federal Federal Federal Unitary Federal

Sources: Author; United Nations, World population prospects; Central Intelligence Agency, The world factbook; World development indicators, World Bank; IMF

B R I C S

GDP in PPP Rank in world 2010 8 6 4 2 26

Table 3.1 Key characteristics BRICS states

42 3 Property Taxes Within the BRICS States

3.1 Country Profiles

43

Table 3.2 Institutional structure of the BRICS states

B R I

Central government Central government Central government Central government

C

Central government

S

Central government

State governments 27 states and the federal district

Local government 5508 municipal governments

State governments

Local government units

28 state governments and 2 union territories with separate legislature Not applicable

Local governments

9 provinces

31 provinces (excluding Taiwan, Hong Kong, Macao; including Beijing, Shanghai, Chongqing, Tianjin); 333 sub-provincial administrative regions; 2487 counties; 656 cities; 44,067 townships; 678,589 villages 46 district municipalities, 231 local municipalities and 6 metropolitan municipalities

Source: IMF (2004, 2008), Government finance statistics yearbook: institutional tables

The distribution of the governmental bodies—central, state, and local—also demonstrates great variance (Table 3.2). Nonetheless, with regard to the megacities, the variance is not as pronounced as it appears at the national level. The megacities have population sizes of above 10 million, they are centres of urbanization and they are hubs of national economic growth. A more detailed review of each of the BRICS states with special regard for the embedment of municipalities within the national financial framework and taxing powers will be given in separate country profiles below and more detailed case-bycase analysis. Thereafter, the property tax designs will be reviewed from a comparative perspective.

3.1.1

Brazil

In Brazil, all levels of government have been equal partners (cooperative federalism) since the 1988 Constitution came into force; i.e. the municipalities are autonomous and have an equal status as higher levels of government. Expenditure assignments follow the subsidiarity principle. In terms of fiscal decentralization, municipalities have devolved functions, functionaries, and revenue and expenditure powers. However, according to Rezende (2007: 77), an overhaul of Brazilian fiscal federalism is needed, as equity, autonomy, efficiency, and growth objectives have collided.

44

3 Property Taxes Within the BRICS States

Table 3.3 Local taxes on property and administrative assignments in Brazil L ¼ Local, F ¼ Federal Urban land and territorial tax (IPTU) Tax on real estate ownership transfer (ITBI) Tax on services (ISS) Income tax withheld at the source (IRRF) Betterment contributions

Determination of. . . Base Rate Tax collection and administration F L L F L L F F/L L F F L F L L

Source: Rezende (2007: 81)

Municipalities are in charge of basic urban and social services such as urban roads, water supply and sewage, public transportation, streetlights, primary education, basic health, and providing assistance to low income families in the area of housing (De Cesare and Ruddock 1999: 270). For the provision of public services on the local level, the municipalities receive financial assistance from the federal and state governments. In addition to these (formula based) general purpose transfers via the Municipal Participation Fund, which constitute approximately 40% of municipal revenue, municipalities are entitled to impose user charges and to collect municipal-own taxes, such as Taxes on Sales of Services (ISS),1 Urban Property Taxes (IPTU), and Real Estate Transfer Tax (ITBI) (Table 3.3). The federal government covers 60% of health care costs, which are provided on a cost-free basis to every Brazilian citizen; municipalities and state governments split the remaining costs. The health care transfer constitutes a larger source of revenue for metropolitan cities than the shared taxes from the federal government. Furthermore, the metropolitan cities are penalized with regard to federal shared taxes, which are biased towards smaller municipalities: “The state capitals generate one-third of GDP and house one-fourth of the population but get only 10 percent of this pie” (Rezende 2007: 81). However, the 12 most important cities (out of 5536) in Brazil raise more than 50% of the overall local property tax revenue (Carvalho 2013: 19). The reason for this concentration (in total and per capita) is simple; as intergovernmental transfers favour small municipalities, the importance of own-revenues is increased in metropolitan cities. The Urban Property Tax (IPTU) constitutes an important revenue source for municipalities. Generally, the property tax takes second place in the composition of municipal own revenues—after the tax on services (ISS). The property tax constitutes approximately 0.5% of GDP. The legal taxpayer of the IPTU is the occupant or possessor of the real property located within an urban area; in practice the tax is levied upon the owner of the property. The tax base constitutes land and buildings; the assessment base is the fair market value (Afonso et al. 2012: 10), which is determined by the tax authority.

1

Taxes that are levied on businesses and self-employed individuals for providing services to third parties. They are based on the price of the service rendered. Taxes on services, such as transportation (inter-state and inter-municipal) and communication, are assigned to the states.

3.1 Country Profiles

45

They estimate the value of the land according to market conditions and using the attributes of the property as recorded within the cadastre. The tax bill is calculated by applying the appropriate tax rate to the assessed value of the property. With regard to the administration of IPTU several problems have been reported (De Cesare and Ruddock 1999: 276; Afonso et al. 2012: 7–9). There is a high incidence of illegal and/or informal properties not included in the cadastre, the cadastre itself is incomplete and outdated, properties are very heterogeneous in terms of property characteristics leading to errors in assessment (lack of assessment uniformity: similar values for different properties, different values for similar properties) and valuation cycles are infrequent.

3.1.2

Russia

The Russian form of federalism is shaped according to the layer cake approach (versus coordinated-authority approach); i.e. there is a distinct hierarchical (unitary) relationship among the different tiers of government (Shah 2007: 5). Local governments have no power according to the 1993 Constitution; they have to be seen as extensions of the state governments. A reform of federal relations and local governments in the 2000–2004 period sought to demarcate expenditure obligations and revenue assignments. The reforms have been revised several times since then. The national government can exercise influence over the local governments either in a direct way or via the state governments. The local level has formally designated revenue sources and spending obligations. However, they have no fiscal autonomy as in practice the upper levels of government control all the revenue and expenditure arrangements (Deryugin and Kurlyandskaya 2007: 238). Local government expenditure obligations are determined by federal laws (obligatory tasks) but can be expanded if own revenues are generated (voluntary tasks). While the standards of public goods provision are determined on the central government level, the actual provision is assigned to the different levels of government. Therefore, most functions are shared among the governmental levels, exemplified by culture and housing services (federal, provincial, local). Often local governments are not de jure responsible but de facto, as in the case of secondary education (de jure: federal, provincial) or the civilian registry (de jure: federal) (Deryugin and Kurlyandskaya 2007: 239). The subsidiarity principle is—at least de facto—applicable to housing, communal services, education, cultural institutions and health care. Regional governments provide some typical local services such as fire protection and public transport. The local level receives transfers from the federal level that constitute a high share of local revenues. Aside from these transfers, the municipalities depend almost completely on the regional taxes levied through the Enterprise Profit Tax (EPT) and the Business Property Tax (BPT). Furthermore, income tax (paid by employers) is part of the local budget. Therefore, municipalities depend heavily on the businesses located (headquartered) within their municipal boundaries. The

46

3 Property Taxes Within the BRICS States

Table 3.4 Local taxes on property and administrative assignments in Russia

L ¼ Local, F ¼ Federal Individual Property Tax (e.g. residences, apartments) Land Tax

Determination of. . . Tax collection and Base Rate administration F F/L F F

F/L

F

Source: Deryugin and Kurlyandskaya (2007: 248); Federal Tax Service of Russia, available at: http://eng.nalog.ru/taxation_in_russia/nifl/ [Accessed: 4 February 2015]

property tax generates a minor part of the overall local revenues; mostly because of underdeveloped personal property markets (Deryugin and Kurlyandskaya 2007: 254). At present, the real property tax is split into land (Land Tax) and buildings/ improvements (Individual Property Tax) (Table 3.4). Both taxes are asset-related and levied against the owner. The Land Tax is assessed according to the market value of the land (“cadastre value”). Tax rates are set by local legislative acts but may not exceed 0.3% of cadastre value. The Individual Property Tax (a tax on residencies, buildings) is assessed on data provided by the cadastral and registry federal authority, which maintains technical building records. The tax rates are set within a range determined by the municipal government. The Individual Property Tax in Russia is seen as problematic, as in the case of residential development the tax is based on inventory cost/original cost, which in practice constitutes construction costs (not adjusted for inflation). The tax is therefore much higher for newer buildings than older ones even though they might be quite similar (Anderson et al. 2009: 122/123). Concerning the administration, all taxes are administered and collected by the Federal Tax Service. Due to the lack of incentives, the collection of subnational taxes is under-collected. Furthermore, the administration of taxes is complicated due to the large number of entities that obtain exemptions from states and municipalities.

3.1.3

India

Since 1992 India is a three tier federation with urban and local bodies having constitutional status. The structure of Indian federalism is often called “quasi federal” due to its “centripetal bias” (Rao 2007: 152). With regard to fiscal decentralization within the restructuring process, states devolved functions to the municipalities at their own discretion. However, herein certain problems arose as some states have “devolved functions, functionaries, and finances, but the functions have been encapsulated in terms of schemes, and local bodies do not have flexibility or autonomy in expenditure implementation” (Rao 2007: 168).

3.1 Country Profiles

47

The functions assigned to the three levels of government follow the subsidiarity principle, with municipalities being in charge of street lighting, construction and maintenance of public roads, bridges, and underground drainage, solid waste management, education, health care, economic and social planning, and housing for the poor as well as slum development (Bangalore Municipal Corporation Act 1976). Furthermore, they are responsible for all residual matters that are not provided by the Union or the respective State (Rao 2007: 156). The local revenues are determined by transfers recommended by the Central Finance Commission and grants recommended by the State Finance Commission, central and state government grants and funds for implementing centrally sponsored schemes, the Property Tax and, lastly and conditionally, some urban local bodies are allowed to levy the Octroi2 (a tax on the import of goods into the urban area for consumption, use or sale). The Property Tax in India is based on land and buildings (Table 3.5). The assessment base differs among the municipalities. Some municipalities make use of value-based assessment, referring to the annual rateable value (ARV), which either uses rent as the basis (hypothetical rent) or instead is based on weightage factors, such as location, type of construction, age of building, and nature of use in order to come up with an estimated market value. Other municipalities make use of the area assessment, referring to the carpet area. Overall, there are large inter-municipal variations in regard to property taxes; the spread is from Rs. 1334 in Mumbai Municipal Corporation to Rs. 40 in Patna Municipal Corporation. The tax base in India is narrow and constricted, only 50–55% of the 715 million urban properties pay property taxes (Mathur et al. 2009: 1). The Property Tax, therefore, plays a minor role on the municipal level and constitutes only 0.15–0.23% of the Indian GDP (estimated, as data on property tax revenue is not available, see Mathur et al. 2009: 49). With regard to the property tax administration there are several drawbacks that can be identified (Naresh 2004; Mathur et al. 2009; Rao 2013). There is a major lack in the coverage of properties within the fiscal property cadastre and a lack of clarity in regard to ownership and tenure rights. Assessments that are based on rental values are characterized as inequitable due to the freezing of rents under the Rent Control Act. Furthermore, the definition of reasonable rents is based on arbitrary interpretations. Table 3.5 Local taxes on property and administrative assignments in India L ¼ Local, S ¼ State Property Tax

Determination of. . . Base Rate S S/L

Tax collection and administration S

Source: Rao (2007: 161)

2 Dillinger (1991: 3) states in regard to the Octroi that “local indirect taxes are bad local prices (in turn to benefit taxes), the tax falls on business rather on all residents. Local residents could therefore vote themselves a subsidy in the short term, which will result in the long term in cut-back of production, shift of tax to consumers etc., by taxpaying businesses.”

48

3.1.4

3 Property Taxes Within the BRICS States

China

China is a unitary state with a highly decentralized fiscal structure (Rao 2003: 27). Following the fiscal reform of 1994, taxes were reassigned between the central and local governments. Local governments have received tax assignments with significant revenue potential—e.g. the Urban and Township Land Use Tax, a House Property Tax, a City Maintenance and Construction Tax (Table 3.6). However, the revenue assignments and intergovernmental transfers do not provide adequate revenue to pay for all the public services assigned to the local governments (Wu 2011: 42): local governments account for nearly 80% of total government expenditures, but receive only 47% of total government revenues (Man 2011). The main expenditure assignments of subnational governments are cultural, educational, scientific, public health, social security and urban maintenance and construction. Martinez–Vazquez and Qiao (Martinez-Vazquez and Qiao 2011: 21) stated that the decentralization process was not guided by an explicit strategy for formal expenditure assignments based on the subsidiarity principle. This is why pensions and unemployment insurances are assigned to the local level. As a result, there is a mismatch between expenditure responsibilities and revenue sources at the lowest levels of governments. The fiscal imbalance means that many local governments rely on selling landuse rights to make up the shortfall.3 This windfall-type of revenue is unstable and unpredictable. Nonetheless, it constitutes the main revenue source for local governments in China. In addition, local government officials make use of the “backdoor approach”, i.e. informal (often illegal) taxes are levied and kept in off-budget accounts (Bahl 2007: 23). Table 3.6 Local taxes on property and administrative assignments in China L ¼ Local, C ¼ Central Government City Maintenance and Construction Tax Urban and Township Land Use Tax Land Appreciation Tax House Property Tax Tax on the Use of Arable Land Deed Tax

Determination of. . . Base Rate Tax collection and administration C C C/L C C/L C/L C C C/L C C C/L C C C/L C C C/L

Source: Author, State Administration of Taxation of the People’s Republic of China

3 Public leasehold is a common land tenure system found in post-communist/transformation states where the state owns a majority of the land. The land is assigned for development and use rights given to private entities through long-term land leasing. Mostly land is not sold at comparative market prices; in Shenzhen for instance around 98% are allocated by negotiation instead of auctions. Furthermore, the property market could be classified as an “emerging market” because the definition and enforcement of property rights are limited, see Anderson (2011: 146).

3.1 Country Profiles

49

Local governments are assigned both local tax revenues and shared tax revenues (VAT, Business Tax, Individual and Corporate Income Tax). The Chinese taxes on property (land and buildings) are manifold; however, they generate a limited amount of tax revenue. The Urban and Township Land Use Tax is imposed on land plots located in urban areas; the House Property Tax is levied on houses located within urban areas; the Farmland Occupation Tax4 applies to all state owned and collectively owned farmland; the Tax on the Use of Arable Land is levied for making use of arable land for non-agricultural purposes (e.g. the construction of residential houses); the Land Appreciation Tax is levied on the transfer of state-owned land use rights, and the Deed Tax is levied on the transfer of land and houses. These many different forms of taxes exist due to a land system divided between state ownership in urban and collective ownership in rural areas (Man 2011: 8). The Chinese property tax structure still faces substantial problems: The current tax structure on land and property has barely changed over the centuries; the House Property Tax and the Urban and Township Land Use Tax go back to the late 1980s; all taxes and land-usage fees have to be paid at the transaction stage, leading to higher housing prices (Anderson 2011: 146); and indeed most taxes place the tax burden on the transaction stage and not on the possession stage, making them unstable and unpredictable revenue sources. Furthermore, local governments have no discretionary power in setting tax rates according to local priorities, economic structure and fiscal status, as tax rate bands are centrally determined. The People’s Republic of China is currently engaged in a process of property tax reform, mostly to slow-rising property/housing market prices.5 The intent of the proposed property tax system is to amalgamate the diverse property taxes that exist into a single ad valorem tax on land and buildings. With regard to the administration,6 local revenues are administered and collected on the local level. In 1994, the State Administration of Taxation (SAT), the state tax bureau system and the local tax bureau system were established. The tax bureaus on the various local levels are always under the supervision of higher level authorities: On the provincial level—for instance—the tax bureaus are mainly under the leadership of local governments and under leadership and supervision of SAT.

4 50% of the farmland occupation tax shall be allocated to the local governments to establish an agricultural development fund for reclamation and consolidation of land and improvement of existing arable land. 5 The central government permitted (on January 28, 2011) Shanghai and Chongqing to collect property taxes on new up-market homes. Shanghai started to collect taxes on newly purchased second homes of residents and first homes of non-residents based on transaction value. The city of Chongqing targets existing single-family residences and newly purchased luxury apartments of residents or newly purchased second homes of non-residents. 6 State Administration of Taxation, available at: http://www.chinatax.gov.cn/n6669073/n6669133/ 6886063.html [Accessed: 4 February 2015].

50

3.1.5

3 Property Taxes Within the BRICS States

South Africa

South Africa has practiced a cooperative federalism with independent spheres ever since the Constitution of 1996 came into force; i.e. while the federal government determines policy, the state and local governments are the implementation agents (Shah 2007: 5). In this setting, states/provinces have an influence on federal policy making through a second chamber (in the upper house of parliament). In regard to fiscal decentralization, there are expenditure assignments that are still unresolved, opening up the possibility of unfunded mandates. Within the range of municipal services provided, there are several services which the national and provincial level have (de jure) shared in responsibility, but which are delivered de facto at the local level only. For instance ambulance service, air pollution, childcare facilities, firefighting services, municipal airports, municipal health services, etc. Furthermore, the local level is also in charge of electricity and gas infrastructure, street lighting, solid waste disposal etc. (Khumalo and Mokate 2007: 270). Municipalities—especially larger ones—have a high degree of revenue raising powers. On average, municipalities finance 90% of their local expenditures by own revenues, though there is wide variation around this mean; some metropolitan areas finance up to 98% of their expenditures by own-revenues while some small rural municipalities are highly dependent on transfers and grants (Khumalo and Mokate 2007: 266). The most important local revenue sources (2009/2010 est.) for South African municipalities are service charges on the provision of (especially) electricity, water, sanitation, and refuse removal (43%); property tax (19%); grants (22%); and other revenues (16%) (Franzen et al. 2013: 9). Furthermore, they receive a formula-based transfer that utilizes population, poverty and household income to determine the capita share for each municipality. The Property Rates are based on land and buildings and the assessment is defined as ‘improved value of property’, i.e. levying a rate on the market value (Table 3.7). Market value, in turn, is defined as “the amount the property would have realised if sold on the date of the valuation in the open market by a willing seller to a willing buyer” (Bhana et al. 2011: 139). Before the property tax reform of 2004, municipalities could even choose the tax base based on provincial laws (Franzsen et al. 2013: 7). Property Rates constitute 1% of GDP.

Table 3.7 Local taxes on property and administrative assignments in South Africa L ¼ Local, N ¼ National Property rates

Determination of. . . Base Rate N L

Tax collection and administration L

Source: Author, according to Khumalo and Mokate (2007: 274f)

3.2 Case Studies: Megacities in Brazil, India, and China

51

With regard to the property tax administration, the responsibility lies with the municipalities. Comprehensive property tax coverage is basically attainable as a national tax base has been defined since 2004. However, this is unlikely to happen given shortcomings in terms of the skills and capacity of local tax administration (Franzsen et al. 2013: 10).

3.2 3.2.1

Case Studies: Megacities in Brazil, India, and China Brazil

Brazil is a three-tier federation, with each tier having the same constitutional powers. This type of federalism could be called symmetrical federalism (Souza 2004: 2) or cooperative federalism. The Brazilian federal system has unique features with regard to its political and administration system and the extent to which the federal system decentralizes authority and independence to states, metropolitan regions, and municipalities. The level of autonomy and decentralization afforded to municipalities was expanded by the Constitution of 1988. Decentralization is the dominant characteristic of the system adopted in 1988 not only for tax assignments and intergovernmental transfers, but also in the case of expenditures. This makes Brazil one of the most decentralized countries in the developing world. Municipalities have according to the Constitution of 1988 the power—among others—to “legislate upon matters of local interest”, “institute and collect taxes within their jurisdiction”, and “organize and render, [. . .], the public services of local interest” (Art. 30). The fiscal constitution (Title VI) of Brazil allocates the tax on urban buildings and land property, so-called Imposto sobre a Propriedade Predial e Territorial Urbana (IPTU), to the municipalities and states that the tax shall, whenever possible, be graded according to the economic capacity of the taxpayer (Art. 145), i.e. they should follow the ability-to-pay principle. This approach is justified by the inherent “social function” of urban property (Art. 182). The progressivity in time stimulates the efficient use and further improvement of urban land. Next to the urban property tax, there is a rural land property tax (Imposto sobre a propriedade Territorial Rural, ITR) levied by the Union, which is therefore not in the focus of this case-study. The property tax in Brazil has been a local tax since 1967, and since then, has had little effect on overall revenues for many—especially smaller—municipalities. At the time of the constitutional reform of 1988, Giffoni and Villela (1987)7 showed how limited the importance of the property tax was. They noticed “a lack of

7 Quoted in Afonso et al. (2012: 8); Giffoni, Francisco de Paula and Luiz Villela. 1987. Tributac¸~ao da Renda e do Patrimoˆnio. Texto para Discuss~ao n. 105. Brası´lia: IPEA, March.

52

3 Property Taxes Within the BRICS States

technical and human resources at municipal level to assemble a fairly complex administrative structure required to maximize the potential of the property tax as a revenue source” (Afonso et al. 2012: 8). The administrative complexity in Brazil is determined by the large heterogeneity of land tenure and property characteristics within the municipalities and the occurrence of illegal/informal properties, which are a major administrative obstacle in order to identify and record these properties in the fiscal cadastre (Villela 2001).8 These are some explanations for the low property tax performance. However, it is also politics which has to take responsibility for the low performance. Villela (2001) testifies a lack of political commitment, because of the property tax being a direct tax with a large number of statutory taxpayers, respectively, voters. According to de Cesare and Smolka (2010) the urban and the rural property tax revenues represented together 0.58% of GDP. Herewith, there are large intramunicipal differences. Afonso et al. (2012) found out that the average IPTU revenue per capita was about US$ 46.50 in 2007. Out of 5248 municipalities,9 43% collected less than 2.50 US$ per capita, while larger cities (over 100,000 inhabitants) and state capitals collected on average of more than 20 US$ per capita. The size of municipalities seems to determine the revenue performance, since larger cities appear to have an above average tax base and a better administration to tap the revenue potential. Furthermore, large cities have a more transparent real estate market, which seems to positively influence property tax revenue. According to the Jones Lang La Salle Global Real Estate Transparency Index (2014), the firsttier cities in Brazil, Rio de Janeiro and S~ao Paulo, are the only Latin American representatives in the transparent market category and are comfortably ahead of other BRICS countries.10 Herewith, the two (mega)cities Rio de Janeiro and S~ao Paulo are in the focus. As every city constitutes its own tax jurisdiction in Brazil, the focus is on the case cities themselves and not the urban agglomerations (the metropolitan areas of Rio de Janeiro and S~ao Paulo consist of 19 and 39 municipalities, each one being its own tax jurisdiction).11 Rio de Janeiro and S~ao Paulo are the largest cities of Brazil accounting for more than 17% of national GDP (5.9 and 11.4%) and for more than

8 Quoted in Afonso et al. (2012: 8); Villela, Luiz. 2001. A Tributac¸~ao Subnacional, o Imposto Predial e os Desafios para Moderniza´-Lo. Porto Alegre (Paper presented at the Semina´rio Internacional sobre Tributac¸~ao Imobilia´ria in March 2001). 9 There are 5570 municipalities as of 2014. The number changes, because there is neither a restriction on the number of municipalities per state nor a restriction on the size (Afonso et al. 2012: 29). 10 The index classifies 102 countries real estate markets into five categories; highly transparent, transparent, semi-transparent, low transparency, and opaque. The first-tier cities of Brazil rank 28th, while South Africa is on rank 20. Both real estate markets are classified “transparent”. The first-tier cities of China, India, and Russia are classified “semi-transparent” ranking 35th, 40th, and 37th. Available at: http://www.jll.com/greti/Pages/Rankings.aspx [Accessed: 4 February 2016]. 11 Available at: http://www.observatoriodasmetropoles.ufrj.br/metrodata/ibrm/index.html [Accessed: 5 February 2016].

3.2 Case Studies: Megacities in Brazil, India, and China

53

9% of the total population (3.5 and 5.9%) in 2012.12 Furthermore, they are main venues of international events, such as 2014 FIFA World Cup and the 2016 Olympic Games. Additionally, since 2007 both cities have been facing high rates of economic city growth resulting in a real estate boom (Carvalho 2013: 19). So far, S~ao Paulo should be better off than Rio de Janeiro with regard to property tax revenues, because S~ao Paulo reformed the property tax system and up-dated the cadastre in 2009 (came into effect 2010) while Rio de Janeiro’s properties are still based on 1997 values. For that reason, the two megacities constitute a fruitful basis for a closer look on the property tax as a financing instrument of megacities.

3.2.1.1

Is the Tax System Equitable and Efficient?

The Brazilian Federation features vertical imbalance with regard to revenue and expenditures assignments. Table 3.8 illustrates the de facto shares of different levels of government in revenue collection and expenditures, i.e. the vertical imbalance before transfers, and the net-transfers among the levels of government. Due to transfers assigned to municipalities, the revenues disposable to the municipalities increases against the revenue share of the Federal Government, while the States’ revenues remain relatively static: In 2013, the share of total revenue of the Union decreased due to transfers by 10.4%, while the revenue share of the municipalities increased almost by the same amount, 12.7%, i.e. only 2.3% were transferred by the states. The municipalities clearly receive the greatest share of transfers, which also illustrates the vertical imbalance among the levels of government. Afonso et al. (2012: 25) criticize the general transfer system’s failure to relate to fiscal needs and its discouragement of efforts to raise own-tax revenues.

Table 3.8 Total revenue, expenditure and net-transfers according to/among levels of government, 2013

Federal States Municipalities General government

Revenues (million R$) 1,325,325 515,365 174,798 2,015,488

% 65.8 25.6 8.7 100.0

Expenditures (million R$) 1,248,113 492,164 402,525 2,142,802

% 58.2 23.0 18.8 100.0

Net-transfers % of national revenue 10.4 2.3 +12.7 0.0

Source: Author, Tesuro National, Estatı´sticas de Financ¸as Pu´blicas e Conta Intermedia´ria de Governo

12

IGBE. 2014. Produto Interno Bruto dos Municı´pios 2012, Instituto Brasileiro de Geografia e Estatı´stica, 23. Available at: http://servicodados.ibge.gov.br/Download/Download.ashx?u¼ftp. ibge.gov.br/Pib_Municipios/2012/pibmunic2012.pdf [Accessed: 4 February 2016].

54

3 Property Taxes Within the BRICS States

Therefore, incentivizing the transfer system could increase local-own tax revenues and help foster local self-governance. The national tax system is based on the Constitution, which allows the Union, the States, the Federal District and the Municipalities to collect taxes. The fiscal constitution (Title VI) establishes the general principles of taxation, the limitations on the power to tax, tax competence across levels of government, and tax revenue sharing provisions. More precisely, the administrative-political autonomy confers to each level of government the possibility of instituting taxes, fees, and improvement charges. According to the Brazilian Constitution, the tax competence of taxing powers is as follows: Tax competence Union

States

Municipalities

Taxes on. . . Foreign trade on imports (II) and exports (IE) of goods and services; Income and earnings (IR); Industrialized products (IPI), a value added tax on manufactured goods; Financial operations (IOF); Rural land property (ITR) Inheritance and gifts (ITCD); Circulation of goods and transportation and communication services (ICMS), a value added tax levied on goods in general and some services; Motor vehicles (IPVA) Urban land property (IPTU); Transfer of real estate (ITBI); Services (ISS), except those subject to ICMS

Source: Ministry of Finance Brazil (2002: 4)

The institutional assignment of taxing and revenue powers within the constitution is quite unique in the developing countries. The tax sharing system in Brazil before the constitutional transfers is shown in Table 3.9. Thus, the Union collects 69% of overall taxes, the States 25%, and the Municipalities about 6%. The taxes assigned to the municipal level are far below the expenditures. The municipal fiscal imbalance is corrected by transfers in the context of an elaborated tax sharing system. To emphasize the administrative-political and fiscal autonomy of the three tiers of government in Brazil the Constitution defines a number of unconditional transfers between the Union, States and Municipalities. Transfers in Brazil are always designed from higher to lower levels of government. The Financial Constitution also allocates a share of federal and state taxes to the municipalities (Ministry of Finance Brazil 2002: 5–6; Art. 153, 158): • 100% of income tax withheld at source on own civil servants’ salaries (IRRF), • 50% of the federal tax on rural property levied on real estate within their territory (ITR), • 50% of the Motor Vehicle Tax (IPVA), attributed as property tax, registered in the territories levied by the respective state,

3.2 Case Studies: Megacities in Brazil, India, and China

55

Table 3.9 Tax revenues in Brazil according to governmental level, 2013 (Accrual basis, before constitutional transfers) Union Income Tax (IR) Tax on Industrialized Products (IPI) Tax on Financial Operations (IOF) Tax on Foreign Trade Tax on Rural Land Property (ITR) Federal taxes Others Social Security Budgeta Othersb States Value-Added Taxes (ICMS) Motor Vehicle Tax (PVA) Inheritance and Gift Tax (ITCD) State Social Security Others Municipalities Taxes on General Services (ISS) Urban Tax on Immovable Property (IPTU) Property Transaction Tax (ITBI) Municipal Social Security Other taxes Total

R$ million 1200,168 298,881 42,923 29,417 36,974 764 4981 5538 642,705 137,985 438,927 363,190 29,232 4142 16,499 25,864 101,324 48,301 24,389 9983 7774 10,878 1,740,419

% Total 69.0 17.2 2.5 1.7 2.1 0.0 0.3 0.3 36.9 7.9 25.2 20.9 1.7 0.2 0.9 1.5 5.8 2.8 1.4 0.6 0.4 0.6 100.0

% U, S, M 100.0 24.9 3.6 2.5 3.1 0.1 0.4 0.5 53.6 11.5 100.0 82.7 6.7 0.9 3.8 5.9 100.0 47.7 24.1 9.9 7.7 10.7

% GDP 22.57 5.62 0.81 0.55 0.70 0.01 0.09 0.10 12.09 2.60 8.26 6.83 0.55 0.08 0.31 0.49 1.91 0.91 0.46 0.19 0.15 0.20 32.74

Source: Author; Banco Central do Brazil Confins, CSSL, PIS/Pasep, CPSS, other social contributions; b FGTS, CIDE, Education allowance, System “S”, other a

• 25% of the state Value Added Tax (ICMS; 75% of this amount is distributed by origin based on economic activity and 25% according to the state law, e.g. to benefit the poor), • 22.5% of the federal Value Added Tax (IPI) and Income Tax (IR), which form the Municipal Participation Fund (FPM). This fund is divided into two parts: 10% for municipalities that are capitals of states and 90% for other cities, • 100% of profit taxes paid on city enterprises or foundations, • 70% of IOF tax collection—Gold (as a financial asset). Table 3.9 indicates the high relevance of the ISS own-tax revenues on a municipal level (about 48%), which is a tax levied on businesses or self-employed individuals providing services to third parties.13 The urban tax on land and buildings, so-called Imposto sobre a Propriedade Predial e Territorial Urbana (IPTU) 13

Exceptions are on transportation and communication, which fall within the responsibility of the states (Afonso et al. 2012: 10).

56

3 Property Taxes Within the BRICS States

comes second with regard to local own-taxes and constitutes half of ISS tax revenues. The other (tax) sources account for smaller shares of the total.14 The significance of ISS and IPTU shifts with size and geographical region of the municipalities. The larger the population, the higher is the share of IPTU in own-tax revenues (Afonso et al. 2012: 33). This is the case because larger municipalities receive fewer transfers, making own-tax revenues more important.15 Taking the case-studies S~ao Paulo and Rio de Janeiro into account, the most important own-tax revenues on a municipal level, in percent to recurrent revenues, are ISS (local service tax) and IPTU (local urban property tax). Large transfers from Central and State government complement the revenues raised by the cities, among others ICMS (state Value Added Tax), SUS (health transfers), and Fundeb (education transfers). They make up 37% of current revenues, of which SUS and Fundeb ´ nico de Sau´de) is a federal transfer linked to are most important. SUS (Sistema U municipal health expenses and Fundeb (fundo de manutenc¸~ao e desenvolvimento da educac¸~ao ba´sica) is a shared federal and state fund linked to municipal elementary education expenses (Carvalho 2013: 66). With regard to own-tax revenues, S~ao Paulo and Rio de Janeiro show similar shares with regard to ISS and IPTU. ISS is twice as high as IPTU in own-tax revenues. In absolute and relative terms, the IPTU in S~ao Paulo is much higher than in Rio de Janeiro. Looking more closely on IPTU, it is noticeable that national IPTU revenue in relation to overall GDP is 0.46% in Brazil (Table 3.7). In Rio de Janeiro and S~ao Paulo the share against municipal GDP (MGDP) is about double: Rio de Janeiro achieves 0.74% and S~ao Paulo 1.01% (Table 3.10). This reveals that both cities not only achieve a GDP IPTU tax-ratio above national average, but above developing countries ratio as well, which is about 0.6% (Bahl and Wallace 2008: 42). Both cities collect jointly 30.8% of national urban property tax, which illustrates their significance and indicates their collection efficiency on IPTU (Table 3.11). Their impressive role on IPTU is also expressed in per capita revenue terms. While the national average is R$ 111, Rio de Janeiro collects R$ 254 and S~ao Paulo R$ 442.

3.2.1.2

Taxes on Property in Brazil: An Overview

In Brazil, there are several taxes related to property that have to be reviewed in order to obtain a full picture on property taxation (more details, see Annex A.1):

14

Besides the taxes stated, municipalities are allowed to impose fees, such as garbage collection fee (TCL) and a street lighting fee (COSIP), and betterment levies (CM). 15 According to Afonso et al. (2012: 13) the main revenue source for many municipalities constitutes the federal and state governments taxes transferred. Especially for smaller municipalities the Municipal Participation Fund (FPM) is the most important revenue source: “The FPM is a federal redistribution fund that is allocated irrespectively of the municipal ability to generate its own-revenues; the funds are distributed according to the size of the municipal population. Smaller municipalities are expected to have less capacity to collect taxes and thus receive higher transfers from the FPM.”

0.38 0.36 6.44 1.98 0.23 0.23 0.00 1.24 0.28 2.76 1.99 0.54 0.23 1.69 1.69 17.01 19.69

Billion R$ 7.17 4.28 1.62 0.75 0.51 2.2 2.1 37.9 11.6 1.3 1.3 0.0 7.3 1.6 16.2 11.7 3.1 1.4 9.9 9.9 100.0

% Current revenues 42.1 25.2 9.6 4.4 3.0

Source: Author; Secretaria do Tesouro Nacional; FINBRA; IGBE

Accrual basis Own Tax Revenues Tax on Services (ISS) Urban Property Tax (IPTU) Property Transfer Tax (lTBI) Income Tax withheld at Source (IRRF) Municipal Social Security Fees Governmental Transfers Union Federal Rural Property Tax (ITR) Municipalities’ Fund (FPM) IOF (Gold) Unified Health Fund (SUS) Other States State VAT (Cota ICMS) State Vehicle Tax (Cota IPVA) Other Multigovernmental Transfers Education Funds (Fundeb) Current Revenues Total Revenues

Rio de Janeiro

Table 3.10 Revenues Rio de Janeiro and S~ao Paulo, 2012 % Own tax 100.0 59.8 22.7 10.5 7.1 0.17 0.16 2.91 0.89 0.10 0.10 0.00 0.56 0.13 1.25 0.90 0.24 0.11 0.76 0.76 7.70 8.91

% City GDP 3.24 1.94 0.74 0.34 0.23 0.83 0.22 12.84 1.85 0.17 0.17 0.00 1.19 0.32 8.21 6.15 1.98 0.07 2.64 2.64 34.85 37.29

Billion R$ 17.32 9.94 5.03 1.20 1.15

S~ao Paulo

2.4 0.6 36.8 5.3 0.5 0.5 0.0 3.4 0.9 23.5 17.7 5.7 0.2 7.6 7.6 100.0

% Current revenues 49.7 28.5 14.4 3.4 3.3

% Own tax 100.0 57.4 29.0 6.9 6.7

0.17 0.04 2.57 0.37 0.03 0.03 0.00 0.24 0.06 1.64 1.23 0.40 0.01 0.53 0.53 6.98 7.47

% City GDP 3.47 1.99 1.01 0.24 0.23

3.2 Case Studies: Megacities in Brazil, India, and China 57

58

3 Property Taxes Within the BRICS States

Table 3.11 Rio de Janeiro and S~ao Paulo and IPTU

2012 Brazil Rio de Janeiro S~ao Paulo

GDP (million R$) % 4,805,913.0 100.0 220,924.6 4.6 499,375.4

10.4

IPTU (million R$) 21,538.4 1624.9

% 100.0 7.5

5027.4

23.3

IPTU/ MGDP (%) 0.74 1.01

Population (million) 193.95 6.39 11.38

% 100.0 3.3 5.9

IPTU/ Capita (R$) 111.1 254.3 441.9

Source: Author; Banco Central do Brazil, based on Federal Revenue Secretariat of Brazil; Secretaria do Tesouro Nacional; FINBRA

• IPTU (Imposto sobre a propriedade predial e territorial urbana) is a recurrent annual tax on urban property in Brazil. The tax competence is granted to the municipal level according to the Constitution (Art. 156). Beyond that, Art. 156 states that the tax may be “progressive according to the value of the property” and “have different rates according to the location and utilization of the property”.16 The fundamental principles of the urban property tax, such as tax base (urban land and buildings), assessment base (market value), and tax payer (property owner) are defined in the National Fiscal Code (CTN) (Art. 32–34). Any further specification (e.g. exemptions, tax rate) is defined on a municipal level. Therefore, the tax base and the tax rates vary considerably across municipalities. • ITBI (Imposto sobre Transmiss~ao de Bens Imo´veis) is a transaction-related tax on the transfer of immovable property and rights relating thereto. It is a municipal tax assigned by the Constitution (Art. 156). The following exemptions are generally granted: property belonging to the government, churches, political parties, education, social welfare and non-profit institutions. The tax varies from city to city and is calculated on the market value of the property. Generally speaking, the tax does not exceed 3% of the property’s value. ITBI liability may be offset if the money is reinvested within 180 days for other real estate assets. • ITR (Imposto sobre a propriedade Territorial Rural) is recurrent rural land property tax constitutionally assigned to the Union: “the Union shall have the power to institute taxes on. . . (vi) rural property (Art. 153).” The taxpayer can either be the actual owner or a holding company and the basis for calculating the tax is the land value (CTN, Art. 30, 31). Exemptions are granted according to small rural plots (up to 100 ha). • IRPF (Imposto de Renda das Pessoas Fı´sicas) is a recurrent tax on income in case of renting or leasing property. The IRPF is a Federal tax according to the Constitution (Art. 153): “The Federal Government shall have the power to institute taxes on . . . (iii) income and earnings of any nature”. The recipient of

16

Brazil. 2010. Constitution of the Federative Republic of Brazil, 3rd Edition (Constitutional text of October 5, 1988, with the alterations).

3.2 Case Studies: Megacities in Brazil, India, and China

59

such income has the legal obligation to report all receipts on yearly basis (in April). • ITCMD (Imposto de Transmiss~ao Causa Mortis e Doac¸~ao) is a transactionrelated inheritance/gift tax levied by the states. The tax is due upon any person or entity that receives goods or rights as inheritance (due to the death of former owner) or as a donation. Each state may have its own specific tax rate up to the maximum limit of 8%; the State of S~ao Paulo levies the inheritance tax at 4%. The taxes on property in Brazil are designed as in most industrialized economies, such as Germany and are linked to possession (ownership) or use (occupation), to profits generated, to donation, and to transfer of real property. All tax powers assigned are declared in the Constitution. The rural property tax is assigned and collected by the Union (thereof 50% of ITR is assigned to the municipalities) and urban property tax by the municipalities. In the following chapters only the municipal urban property tax on land and buildings (IPTU) is reviewed.

3.2.1.3

What Are the Operational Facts of the Property Tax?

Every municipality is its own tax jurisdiction with regard to IPTU in Brazil. Therefore the following chapter refers to the two case studies Rio de Janeiro and S~ao Paulo only, not taking into account the large metropolitan areas they are embedded into (consisting of 19 municipalities in Rio de Janeiro and 39 municipalities in S~ao Paulo). Both municipalities are capital cities in their respective states (state of Rio de Janeiro and state of S~ao Paulo).

Rio de Janeiro Rio de Janeiro is the second largest municipality with regard to population size and economic power in Brazil. A population of 3.3% produces a GDP of 4.6% (Table 3.11). Rio de Janeiro also shows the highest urbanization rate of 97.3% against the national average of 85.1% in 2014.17 In the last 5 years Rio de Janeiro has experienced substantial transformation due to the 2014 FIFA World Cup and the 2016 Olympic Games. There have been substantial infrastructure investments, not only within the city’s sports venues, transportation, housing, sanitation, health care, etc., but also for precarious and informal settlements in hazardous areas. Since 2008 prices have almost quadrupled in Rio de Janeiro.18 Even some favelas show booming property prices, because they are now controlled by police forces (Unidade de Polı´cia Pacificadora, UPP) due to military interventions in preparation 17

S~ao Paulo has an urbanization rate of 96.6%, see: IGBE. 2015. Sı´ntese de Indicadores Sociais— Uma Ana´lise das Condic¸ões de Vida da Populac¸~ao Brasileira 2015. 18 Available at: http://riotimesonline.com/brazil-news/rio-real-estate/brazil-housing-market-coolsbut-not-crashing-yet/ [Accessed: 18 February 2016].

60

3 Property Taxes Within the BRICS States

of the 2014 World Cup. In order to finance these investments, Rio de Janeiro has been trying to increase own-tax revenues by 15.5% between 2012 and 2016 by improving equity of the tax burden—so far 20% of taxpayers account for 80% of the municipal tax collection—and by combatting tax evasion.19 Notwithstanding, Rio de Janeiro illustrates the benefits of local public investments and the capitalization effect on homeowners’ property values. In practice, capitalization of public investments on property values does not necessarily lead to higher property tax yields as will be shown in the case of Rio de Janeiro. Effects on the property tax, i.e. its assessment and property tax yields, will therefore be examined in more detail. Political Decisions All political decisions concerning IPTU are written in municipal tax law.20 The law must clarify how a property with certain characteristics will be assessed in monetary terms. While the City Councillors have to approve changes in the property taxation, there is the strict legal requirement that these assessment criteria must be approved by law before the tax base can be updated. This rule was introduced by Brazil’s Superior Court in 1996. Thereafter, “discussions of legislative revisions of the IPTU always result in heated debates and intense political response, in many cases causing mayors and other officials to avoid embarking on the process (Domingos 2011: 2)”. This might explain the fact that 1997 is the year of the last tax reform in Rio de Janeiro. The tax base constitutes the ownership, the useful domain (i.e. the rights to use and rent the property), or the tenure of the property by simple right or physical accession on urban land and buildings. The tax distinguishes between residential and non-residential build-up properties, and vacant land. For the purpose of the tax, urban is defined as any area with at least two public services provided and maintained by the municipality, such as pavement with water drainage, water supply, sewage system, public lighting system, and primary school or health centre to a maximum of three kilometre distance (Art. 52). Restrictions on the tax base, i.e. exemptions, are in the hands of politics as the municipalities have wide autonomy to establish the criteria and the level of exemptions and property tax rebates. Besides constitutional immunities for government agencies, temples of any denomination, educational and social welfare institutions, unions and political parties, there are exemptions granted at the discretion of the municipality also provided by the municipal tax code, such as diplomatic missions and consulates, forest reserve, property used for sports facilities, theatres, museums, film industry, ex-combatants properties, historical/cultural/ecological preserved

19

Rio de Janeiro. 2013. Plano Estrate´gico do Prefeitura do Rio de Janeiro 2013–2016, 78. The municipal tax law referred to is Lei 691 De 24 De Dezembro De 1984 in its most current version, see Consolidation of Tax Laws in Force in Rio de Janeiro. Available at: http://www2.rio. rj.gov.br/smf/fcet/legislacao.asp [Accessed: 17 February 2016]. 20

3.2 Case Studies: Megacities in Brazil, India, and China

61

properties, retiree or pensioners over 60 years, and handicapped (Art. 61). Taxpayers who receive tax bills not exceeding R$ 90 are exempt from property tax payment. Vacant land is exempt from property taxation if the value is below R$ 29,338 in 2016.21 In addition, a rebate is granted on “unidades autonomas populares”, i.e. residential properties with less than 100 m2 and a market value up to R$ 60,054. They receive a 40% discount on the market value and the waste collection rate (Lei no 2.955/99 de 29/12/1999).22 Taking exemptions and discounts together, 65% of residential properties and 90% of vacant land registered in the municipality are exempt in Rio de Janeiro (Carvalho 2013: 22, b: 175). The (re)assessment is the most important policy decision, because it determines how the tax burden is allocated to the remaining property owners/taxpayers (i.e. tax incidence). According to the tax code, the assessment base is the market value, i.e. the value that would be reached between a willing buyer and seller according to market conditions (Art. 63). The assessment process distinguishes between built-up area and vacant land (includes excess land, i.e. surrounding land to the built-up area). The market value for built-up land takes into account the land and building combined per unit (m2). There is also a market value for vacant land only. For builtup land, the Generic Value Plan (Planta Gene´ricas de Valores, PGV) of Rio de Janeiro determines the value in square meters for new residential or non-residential buildings and land jointly. Most Brazilian municipalities make use of a separate assessment of land (value of the location) and buildings (reproduction cost), but not so in Rio de Janeiro. The market value of the land and housing unit will be determined according to the location, characteristics of the construction, current prices of real estate sales in the housing market, urban facilities provided within the same street, taxpayers statement, and other data [Art. 63 (2)]. In determining the PGV market value, the value of movable assets held in property, although on a permanent basis, is not considered. In order to calculate the market value of a built-up area, the area of the property is multiplied by the residential unit value (VR)—or non-residential unit value (CV) or vacant land value (V0), which is the square meter value for a specific street provided in PGV. The values are published on the homepage of the Prefeitura de Rio de Janeiro.23 In order to determine more precisely the market value of the values given in the PGV, correction factors are applied according to their age (Factor A), position (Factor P), and type of residential property (Factor TR). The correction factors are indexes, which are provided in municipal tax code. The depreciation amount arising from the application of the correction factors is not applied to the market value of the buildings only, but to the total value of the property, i.e. correction factors are applied on both: the value of the land (which does not detract) as well as the value of the building. The correction Factor A

21

See Prefeitura de Rio de Janeiro. 2016. Informativo Valor Venal—IPTU 2016. Ibid. 23 VR and VC according to the street names of Rio de Janeiro. Available at: http://www2.rio.rj.gov. br/smf/siam/logradouro.asp [Accessed: 17 February 2016]. 22

62

3 Property Taxes Within the BRICS States

reduces the overall PGV market value by 1% for each additional year of the building’s age, up to a limit of 50% for buildings older than 50 years (Table 3.12). Therefore, the value of the land shrinks along with the number of years of the building. The correction Factor P applies to the situation of the building in relation to the street nearby (Table 3.13). It differentiates if the building is directly facing the street (de frente), in the backyard (de funos), at a road that is not officially in PGV (de vila), or if it is landlocked, i.e. if another property has to be passed (encravado). The correction Factor TR depends either on the apartment size (m2) or the tax region where it is located (region A, B, or C) (Table 3.14). The property tax is updated annually by the Consumer Price Index (IPCA-E), released by the Brazilian Institute of Geography and Statistics (IBGE). For property taxes in 2016 the update rate is 10.71%. The last reassessment of these values was in 1997 (Carvalho 2013: 22). With the real estate boom taking place, the assessment values are now severely outdated. As outlined, the assessed market value is the product of land value per square metre and building value (gross built-up area and adjustment factors) (Table 3.15). Table 3.12 Factor age (A)

Age in years Factor 1 1.00 For each additional year the factor shrinks by 0.01 +1 0.01 More than 50 0.50 Source: Art. 64, Table I

Table 3.13 Factor position (P)

Position De frente De fundos De vila Encravado

Factor 1.00 0.90 0.70 0.50

Source: Art. 64, Table II

Table 3.14 Factor type residential (TR)

Position Apartment with an area  100 m2 Apartment with an area > 100  300 m2 Apartment with an area > 300  500 m2 Apartment with an area > 500 m2 House (Region A) House (Region B) House (Region C) Other houses Source: Art. 64, Table III-A

Factor 0.90 1.00 1.15 1.35 0.60 0.70 0.90 1.00

3.2 Case Studies: Megacities in Brazil, India, and China

63

Table 3.15 Calculation of market value in S~ao Paulo Market value of built-up area ¼ Ar  VR  Ag  P  TR Ar ¼ Built-up area; VR ¼ Residential unit value per m2 according to PGV; Ag ¼ Age factor; P ¼ Position factor; TR ¼ Factor type residential Market value of vacant/excess landa ¼ Tf  Vo  S  L  A  D Tf ¼ Tested dummy, different formulas for vacant and excess land; Vo ¼ Standard unit value per m2 according to PGV; S ¼ Situation, depending on tax region (A, B, C); L ¼ Legal restriction, applicable to land on which legal restrictions are imposed; A ¼ Topography, applicable to lands that have topographical characteristics that hinder full utilization; D ¼ Drainage factor applicable to flood and flooded land, ranging from one-tenth to nine tenths Source: Author; Prefeitura de Rio de Janeiro, Informativo Valor Venal—IPTU 2016 Art. 65, Table VI–IX

a

Example: Calculation of taxable value in Rio de Janeiro, 2010 Correction factor/R$ per m2 R$ 657 per m2

Location S~ao Clemente Street Size 60 m2 Year of construction A: 1958 (52 years old) 0.5 Position P: Facing into backyard 0.9 Built-up area TR: Apartment  100 m2 0.9 Inflation index Inflation since 1998 210% Market Value: 60  R$ 657  0.5  0.9  0.9  2.1 ¼ R$ 33,527 Because the property is less than 100 m2 and below the threshold market value of R$ 60,054 a discount of 40% (R$ 13,411) is granted on the market value. The final assessed market value is R $ 20,116 Source: Author; Carvalho (2013: 32)

The tax rate constitutes the remaining political decision that has to be decided on. The tax rate transfers the assessment value into the final tax liability. Rio de Janeiro applies a single tax rate on residential and non-residential properties and on vacant or excess land. Rio de Janeiro had a progressive tax rate system before 1997; however, it was changed because it was declared unconstitutional by the Brazilian Federal Constitutional Court in 1997 (Carvalho 2013: 22). Since the last property tax reform of 1997, there have not been any changes on PGV or tax rates. The tax rate applicable is 1.2 for residential, 2.8 for non-residential, and 3.5 for vacant/ excess land (Art. 67). If both apply, e.g. a residential house with garden, then each part is taxed accordingly.24 The same article of the tax legislation provides a

24

The single tax rate for built-up and vacant land jointly is calculated as follows: a ¼ (ap  Ap + at  At)/(Ap + At), where “a” is the tax rate, and “A” the area. The subscribed “p” stands for built-up and “t” for the vacant land (Art. 67).

64

3 Property Taxes Within the BRICS States

Table 3.16 Rebate on property tax according to tax amount, 2016

Residential units Non-residential units Vacant land

Tax amount (R$) up to. . . 7807

Discount (R$) 390

9008

1546

18,016

4504

Example taxable value R$ 20,116 R$ 20,116  0.028 ¼ R$ 563 R$ 563  R$ 390 ¼ R$ 173

Source: Author; Art. 67 [calculation: 1 UNIF ¼ R$ 3 (Assessed values are expressed in Fiscal Monetary Units (UNIF). Due to high-inflation periods the monetary units are adjusted according to the inflation rate, which is adopted to update values for taxation purposes)]

monetary rebate if the tax amount is below a specific threshold (Table 3.16). The higher tax on vacant land is understood as an incentive for land development, which is consistent with the social function assigned to urban land according to the constitution. However, a higher rate on vacant land does not necessarily indicate a higher tax burden, since the exemptions granted and market value assessed differs between built-up area and vacant land. Over and above all exemptions and rebates granted, there is a 7% discount on the tax amount payable if the tax is paid in one single instalment. The impact of the tax rates on the property tax is negligible compared to the outdated assessment of 1997 and the exemptions and discounts granted. Administrative Practices The market value of each property in the city of Rio de Janeiro is calculated using a mass appraisal process, which is based on the technical and legal parameters set by policy. Real estate appraisal is one of the most important factors in the performance of the administration as there are linkages to property identification, the property register (fiscal cadastre), and property tax collection and enforcement. The Municipal Department of Finance of Rio de Janeiro (RJ-SMF) is responsible for the tax administration, e.g. it is responsible to levy IPTU, ISS, and ITBI, for inspections, as well as to assess, bill, and collect these taxes. Different subunits apply with regard to property taxation. The administrative structure with regard to the property tax cadastre is such that there are independent management units, such as General Management (F/CIP) and specialized management units (F/CIP-1 to F/CIP-5)25: • F/CIP is responsible for ensuring the integrity and reliability of the property tax registration; it coordinates property inspections and the annual tax billing. The proper names are Coordenadoria do IPTU (F/CIP), Gereˆncia de Fiscalizac¸a~o e Revis~ ao de Lanc¸amento (F/CIP-1), Gereˆncia de Atendimento e Controle Processual (F/CIP-2), Gereˆncia de Cobranc¸a e Acompanhamento da Arrecadac¸a~o (F/CIP-3), Gereˆncia de Controle Cadastral e Inclus~ ao Predia (F/CIP-4); Gereˆncia de Recadastramento e Atualizac¸a~o Cadastral (FCIP-5). 25

3.2 Case Studies: Megacities in Brazil, India, and China

65

• F/CIP-1 is responsible for inspection management. The unit is responsible for all procedures relating to exemptions, immunity, and tax rate rebates. They also review and resituate payments from error due to cadastral changes. • F/CIP-2 is responsible for services and control procedures. All requests for information, guidance and access to other property tax issues must be entrusted to F/CIP-2. It is responsible for all contacts with the taxpayer (formulations required, delivery notes, receipt of funds, etc.). • F/CIP-3 is the collection management unit. It certificates the registration number, promotes the settlement of payments, and provides market value guide. • F/CIP-4 is responsible for the fiscal cadastre. It maintains and updates the property tax cadastre. The management unit is responsible for carrying out surveys and procedures for the inclusion and updating of data. • AF/CIP-5 is responsible for inspection of the property in order to verify the data contained in the property tax cadastre. Generally, property tax should reflect, in theory and practice, the market value of the property. In order to properly mass appraise market values, property identification and registration within the fiscal cadastre is of most importance. In 2009 the Ministry of Cities established a national directive for the Multipurpose Cadastre (CTM: Cadastro Te´cnico Multifinalita´rio), which is in place in Rio de Janeiro. The cadastre withholds—among others—all data necessary to assess the market value of a property, such as, specific property registration number, legal status, total builtup area, age, location, use, typology, construction details, and spatial analysis of property surroundings. The cadastre makes use of geo-reference cadastre information and aerial photographs. All properties are enrolled in the cadastre—even those being exempt (Art. 72). A change in any of these data may lead to changes in market value, subsequently adding or reducing the property tax. Therefore, any change has to be declared by the property taxpayer, which leads to a reassessment in the year in which the change has occurred in the property tax registration. In 2016, the cadastre system will be updated through aerial photographs and field surveys in order to check for new constructions or alteration of other cadastre information without proper notification to the Municipal Finance Department. The taxpayers may receive a letter in which the need for technical inspection of the property is explained.26 After inspection, each taxpayer receives a receipt of a statement of the cadastre update. If the taxpayer disagrees with the information it can be challenged within 15 days of notification. Such revision seems to be necessary as about one out of three residential properties are not recorded on the cadastre; while less than 40% of these properties are slums, the remaining properties are located in well-serviced areas occupied by high-income families (De Cesare and Ruddock 1999: 273).

26

Due to safety reasons, the assessors have special vests of the City Hall; in addition they send a specific password by email, which needs to be confirmed to the property owner. Available at: http://www.rio.rj.gov.br/web/smf/o-que-e1 [Accessed: 17 February 2016].

66

3 Property Taxes Within the BRICS States

The application of a cadastre system facilitates identification, assessment, collection and enforcement of local taxes. Beyond that, it enables the development of feasibility studies and therefore supports planning activities and political decision making. The property tax assessment should be fair and transparent. Therefore, it is necessary that the assessed value is close to the market value. However, the assessment of the market value of a property is a complex process, especially in the case of mass appraisal. A fair and accurate assessment is the main administrative challenge with regard to property taxation. Only if this is achieved is the property tax equitable, e.g. properties of equal value bear the same tax amount. In the case of Rio de Janeiro, tax assessments are undertaken by qualified tax assessors, some having a degree in architecture or engineering.27 To assess the market values, the sales comparison approach and the cost approach are applied as assessment methods but also other mass appraisal techniques, such as multiple regression analysis are used.28 The overall assessment process underlies general standards issued by the Brazilian Association of Technical Standards (ABNT). Beyond that, the Ministry of Cities issued Administrative Rule 511/09, which recommends minimum parameters for assessment level and uniformity, as well as maximum assessment cycles. The recommendations, however, are not compulsory.29 In Rio de Janeiro, tax bills are sent to taxpayers on an annual basis at the beginning of the year (throughout the month of January). The tax bill discloses the tax amount to be paid, either as single tax quota with an early bird incentive of 7% on the total tax bill. Otherwise, payments can be made in ten equal instalments according to the tax calendar published in the Official Gazette (Table 3.17). The property owner is primarily responsible for paying property tax. An occupier or user, even without legal authorization to use the property, can be requested to pay the tax. The tax bill includes the different tax calendar, which varies according to

Table 3.17 Tax calendre Rio de Janeiro, 2016 Final registration digit 0–5 6–9

Early bird rebate (7%) 03/02 04/02

1st instalment 2nd 3rd 4th 5th 6th 7th 8th 9th 10th 03/02 10/03 11/4 10/5 10/6 11/7 10/8 12/9 10/10 10/11 04/02 11/03 12/4 11/5 13/6 12/7 11/8 13/9 11/10 11/11

Source: Prefeitura Rio de Janeiro

27

See Lincoln Institute for Land Policy; they provide comparative results on various cities in Latin America with regard to various aspects of property taxation. Available at: http://www.lincolninst. edu/resources-tools/property-tax-in-latin-america-comparative-analysis/access-to-data [Accessed: 13 February 2016]. 28 Ibid. 29 Ibid.

3.2 Case Studies: Megacities in Brazil, India, and China

67

Fig. 3.1 Example for penalties levied by Prefeitura Rio de Janeiro, 2016. Source: Prefeitura Rio de Janeiro

the final number of the property real estate registration. Those with final digit of the property registration number 0–5 must pay the single instalment or the first instalment of the property tax by 03/02. All others, with final digit 6–9 have to make the same payments on 04/02. The tax bill can be paid at any bank branch (e.g. Caixa Econoˆmica Federal, Banco Santander, Bradesco, Itau´, Mercantil do Brail, HSB Bank Brasil, Citibank, etc.), lottery, and the internet. In the case of non-payment the enforcement measure are penalties and fines, which become automatically due. In each of the ten due dates of the respective instalments there appear three deadlines for payment with increasing fine rate from 4%, 8%, and 12% on the basic tax amount due (Fig. 3.1). If no payment is made within the three deadlines set, the taxpayer faces extra monthly arrears of 1.0%. To calculate the due amount the following formula applies: Vd ¼ Vm12 + (n  0.010  V), where Vd ¼ Due amount Vm12 ¼ Due amount including arrears of 12% n ¼ Number of months from payment deadline of 12% for late payment V ¼ Original tax amount billed Furthermore, due amounts from the previous year, e.g. 2015–2016, are multiplied by the inflation index (Consumer Price Index), which would be a multiplying factor of 1.1071. However, if the tax is not paid at all, the debt is subject to the court and may result in the sale of the property by public auction in order to pay the debt. According to Carvalho (2014: 74) Rio de Janeiro is the only known case in Brazil that has effectively applied this method.

68

3 Property Taxes Within the BRICS States

In each step of administrative property assessment, there is the possibility to appeal, for instance, if. . . • There are false statements in the property registration data (location, age, type, etc.). In this case the taxpayer has to approach the Cadastral Data Review or Re-registration unit; • The property is entitled to exemption or immunity,30 which was not considered. • The taxpayer considers that the value taken as a basis for tax calculation is incorrect. The taxpayer challenges the process of market value assessment of the property; in this case a Technical Report is demanded. For each type of process there is a specific deadline provided, minimal documentation is required, and a body responsible for deciding about that particular issue is entitled. S~ao Paulo S~ao Paulo is the most populous city in Latin America and the economic powerhouse in Brazil: with a total population share of merely 5.9% an astounding 10.4% of national GDP is produced (Table 3.10). All this wealth notwithstanding, S~ao Paulo has the largest slum population in Latin America (UN-HABITAT 2010: 74, 114): there are 1599 official favelas housing approximately 1.6 million people, a further 1.7 million live in illegal settlements in the periphery, and 38,000 live in cortic¸os in the city centre. In total, about 20% of overall population belong to the favela population. Beyond that, an estimated 70% of the urban land (approximately 1500 km2) is covered with substandard housing. The city’s situation emphasizes the inequality, spatial separation, social exclusion, and illustrates what is meant by a divided city. The large scale of irregular, illegal, and unofficial housing has—of course—its effects on public goods and service provision and on property taxation: while expenditures increase heavily (for infrastructure, housing, etc.), the revenues may well stay behind as people cannot afford to, or simply do not, pay property tax. For instance, a large number of residents in the S~ao Paulo area own their homes; however, they are neither registered as being the owner of the land nor have a regularized title (UN-HABITAT 2010: 111). Therefore, they don’t pay property tax. The city of S~ao Paulo illustrates the benefits and costs of exponential economic growth, rapid urbanization, and urgent need to increase own-tax revenues in order to push local self-governance. In this context, the property tax in S~ao Paulo is subjected to a more detailed examination.

30

The difference between exemption and immunity is that exemption occurs at the time of real estate property transaction, e.g. a rentier buys the property, and it has to be applied for. Immunity occurs immediately, e.g. reciprocal immunity given in the Federal Constitution (Art. 150), whereby the Union, States and Municipalities may not impose property taxes on each other’s properties.

3.2 Case Studies: Megacities in Brazil, India, and China

69

Political Decisions IPTU in S~ao Paulo underlies constant change, always with a focus on increasing collection efficiency, and thereby, revenues. All decisions are transposed into municipal tax legislation.31 According to the municipal tax law, the tax base of the property tax is immovable property and the rights assigned thereto are located in the urban area of the municipality (Art. 1).32 However, the tax has only to be paid if at least two municipal services are provided, amongst which are pavement with rainwater drainage, water supply, sewage system, public lighting system, and primary school or health centre within 3 km of the property (Art. 2). This clearly relates to the benefit principle. While the Constitution exempts federal, state, and municipal properties and foreign consulates, and properties of religious entities, political parties, labour unions, cultural entities (social assistance and education), the municipality may grant further exemptions. According to municipal law (Art. 19–21) all properties that are in the domain of sports associations, religious organizations, foreign consulates, cultural entities (education, social assistance), political parties or unions, housing projects of the Companhia Metropolitana de Habitac¸~ao de S~ao Paulo, historical heritage buildings, and buildings constructed for veterans/widows of veterans who fought in the second world war are exempt from the tax. Exemptions are also granted to residential properties are with a market value less than R$ 90,000 and residential properties (type 1 and 2) with lower standard (A–C) are exempt up to R$ 160,000 according to Art 16. Beyond that, discounts are granted on residential property also based on specific threshold market values (Art. 7 and 17).33 Major discounts are also received by retirees or pensioners whose incomes are between three and five times the minimum wages, historical or restored properties (50%), and for land with native vegetation or near water sources (50%). Both, exemptions and discounts, are only granted once to a single property. As shown by Carvalho (2014: 74) about one-third of all recorded properties are exempt from IPTU and one-fifth received a deduction on the tax payment, with the result of 55% of properties having granted some tax relief (Table 3.18). Any reassessment of the property values will therefore address only half of the property owners. (Re)assessment is based on market values (valor venal), established on an annual basis. Assessed values are estimated and published in generic value maps, 31

All changes on IPTU are published in chronical order on the official homepage of the Prefeitura de S~ao Paulo. Available at: http://www.prefeitura.sp.gov.br/cidade/secretarias/financas/legislacao/ index.php?p¼3165 [Accessed: 9 February 2016]. 32 In the following it is referred to DECRETO Nº 56.235, from 3rd of July, 2015. Available at: http://ww2.prefeitura.sp.gov.br//arquivos/secretarias/financas/legislacao/Decreto-56235-2015CLT.pdf [Accessed: 9 February 2016]. 33 Discounts are granted according to value bands. For residential buildings that are exclusively or predominantly used as a residence with a market value higher than R$ 160,000 and less than or equal to R$ 320,000, a discount on the market value corresponding to the difference between R$ 320,000 and its market value is granted.

70

3 Property Taxes Within the BRICS States

Table 3.18 S~ao Paulo property tax relief mechanisms, 2012 Exemption Assessed value threshold R$ (nominal values) For all types of properties (except garages) For residences with low or medium quality of construction Granted properties (%) Rebate on the assessment Assessed value threshold R$ (nominal values) For residences with low or medium quality of construction Rebate value in R$ (nominal values) Granted properties Properties with some relief (%) Taxable assessed values (%)

2012 73,850 97,587 34.1

195,175 39,035 21.3 55.4 78.4

Source: Carvalho (2014: 72)

so-called Planta Gene´ricas de Valores (PGV), which provide average market values (R$) per square meter for land (5800 land zones) and buildings (30 types) separately for zones (on the level of street names) with homogenous characteristics across the city, taking into account (Art. 48) current prices of real estate transactions and real estate market offers, reproduction cost, current rental rates, regional characteristics of the property’s location, and other data. Not taken into account is the value of movable assets, such as furniture and equipment, whether on temporary or permanent basis, used for occupation, exploration, beauty or comfort of the property (Art. 49). The reassessment frequency was 2001, 2009, and 2013. The latest reassessment of property values (update of PGV) was approved by municipal tax law Nº 15,044 in 2009 and was conducted in 2013 for the year 2014. Furthermore, the law provides that the frequency of the reassessment changes thereafter from every 4 years to every 2 years, with upcoming reassessment in 2015 for tax-year 2016.34 Tax caps are applied to limit the increase in property tax. For property taxes in 2015 a maximum increase of 20% for residential property is applied on top of the property tax of 2013, which already includes inflation adjustment of 2014 (i.e. a residential taxpayer paid R$ 100 property tax in 2013, with inflation adjustment the taxpayer paid R$ 105.6 in 2014, and in 2015 will pay a maximum of R$ 120). The increase in market values for 2016 is limited to 10% against 2015 for residential properties with an area less than 500 m2. According to the Prefeitura de S~ao Paulo, the estimated market values represented on average 30% (2013) of the market prices; with the adjustment of the assessment values in 2014 the assessment

34

Law 15,044, 2009, Art. 10: “From the year 2013, the Executive Branch is required to forward by 15 October of the year in respect of first and third year of its mandate, the legislature, the bill with proposed upgrade of unit values of square meter of construction and land contemplated by Law No. 10.235, of December 16, 1986.”

3.2 Case Studies: Megacities in Brazil, India, and China

71

Market Value (IPTU) / Market Price

0.7 0.59

0.6 0.54

0.59

0.55 0.52

0.53

0.5

0.51

0.59*

0.57

0.56 0.53 0.58 0.57 0.51 0.48 0.45

0.42 0.4

0.36 0.34 0.3

0.3

0.2

Fig. 3.2 Estimated market value (PGV) relatively to market price, 1995–2014. Asterisk— Complemented by estimation for 2014, according to FN35. Source: Author; Prefeitura de S~ao Paulo, Secretariat de Receita Municipal

(market) values will represent 59% of the market price.35 Figure 3.2 illustrates the effect of outdated assessment values. Due to rising market prices, especially precarious in booming phases of the real estate sector, and constant assessment values (PGV) in between reassessments, the ratio of PGV against market price declines. In order to slow down the decline of the ratio the assessment values are adjusted by an inflation index. However, tax caps are applied for assessment, which limits the ratio to a maximum growth of 30% for residential property and 45% otherwise (Art. 71) in relation to the tax issued in the previous year. The market values of land and buildings are considered separately, in both cases there are correction factors taken into account. The assessed market value of land per square meter is primarily based on the physical and location attributes of the property (Art. 51). However, if the property has several entrances the most valuable street is taken into account, and if values are not available in the fiscal cadastre they will be fixed by the Municipal Bureau of Finance and Economic Development.36 The market value of the land results from the multiplication of its total area by the corresponding square meter unit value of land and correction factors provided (Table 3.19). For the category residential horizontal (multi-storey buildings) the market value per square meter is limited to R$ 9300, i.e. values above will not be taken into account (Art. 69).

35 36

Available at: http://www.capital.sp.gov.br/portal/noticia/537 [Accessed: 12 February 2015]. Secretaria Municipal de Financ¸as e Desenvolvimento Econoˆmico.

72

3 Property Taxes Within the BRICS States

Table 3.19 Correction factors assigned to value of land Basis Slope of urban land Number of corners

Other assessment corrections for residential horizontal buildings only Maximum square metre market value

Explanation Slope inclination of urban ground (hills, flat area etc.) Depending on the number of corners, from 1 to 4, maximum area of 900, 1800, 2700, or 3600 m2 is taken into account • No public road nearby • Public road within 4 m • Not listed in the value map • Area of owner-occupied flats Only for residential horizontal

Correction factors 1.0–0.4472 (according to inclination and location) 1.3: 1st urban subdivision 1.2: 2nd urban subdivision 1.1: other urban subdivision 1.0 residential horizontal • 0.5 • 0.6 • 0.7 • 1.6 R$ 9300

Source: DECRETO N 56.235, Art. 52–54, Table I–III

Table 3.20 Statistical value per m2 of a building according to type and standard

Construction type Standard A Standard B Standard C Standard D Standard E Standard F

Residential horizontal (multi-storey house) Subdivision of urban zone 1st 2nd Other 920.00 700.00 480.00 1120.00 840.00 560.00 1420.00 1070.00 710.00 1920.00 1370.00 960.00 2210.00 1580.00 1180.00 2550.00 1820.00 1440.00

Residential vertical (apartment buildings) Subdivision of urban zone 1st 2nd Other 1020.00 790.00 570.00 1320.00 1040.00 750.00 1730.00 1300.00 990.00 2020.00 1500.00 1200.00 2500.00 1790.00 1430.00 2910.00 2150.00 1750.00

Source: DECRETO N 56.235, Art. 57, Table V, VI

The assessed market value of the building is calculated by multiplying generic unit cost for predefined building typologies—residential, commercial, industry, and other, such as Theatre, Airport, Museum, Zoological Park, etc.—and construction and equipment standards—categories are from A to F for residential buildings, based on structure of the building, number of bedrooms, standard of electric installation, availability of bathroom—set out in municipal law with the gross built-up area. Further, the unit value of construction is associated with the subdivision of the urban zones to which it belongs (Table 3.20) and the obsolescence factor (Table 3.21). As outlined, the assessed market value is the sum of the value of the land and the value attributed to buildings (Table 3.22).

3.2 Case Studies: Megacities in Brazil, India, and China

73

Table 3.21 Correction factors assigned to value of building Basis Obsolescence

Explanation Age of building; residential buildings are divided according to standard A–B and C–F

Correction factors A–B (C–F): Buildings younger than 1 year a factor of 1.0 is applied, thereafter the factor is slightly decreasing with the age of the building. From age of 40 (60) a factor of 0.2 is applied

Source: DECRETO N 56.235, Art. 62, Table IV

Table 3.22 Calculation of market value in S~ao Paulo Market value (MV) ¼ Market value land (MVL) + Market value building (MVB) Correction factors MVL ¼ AL Vm2T MVB ¼ AB Vm2C Obsolescence Defined by law: Fiscal Cadastre: PGV: Correction factors, AL: Area land (m2) Vm2L: Market value land AB: Gross build-up area Vm2B: Market value building Obsolescence (Age) building (m2) Source: Author; Prefeitura de S~ao Paulo Example: Calculation taxable value in S~ao Paulo, 2012 Weightage factor/R$ per m2 2

Built-up area 70 m Land value 2010 Avenida Morumbi R$ 1200 Building value Apartment with high quality of R$ 770 2010 construction Year of 1980 (22 years old) 0.81 construction Inflation index 2010–2012 13.4% Taxable value land (MVL): R$ 770  1134  0.81  70 ¼ R$ 49,509 Taxable value built-up area (MVB): R$ 1200  1134  70 ¼ R$ 95,256 Source: Carvalho (2014: 75)

Once the market value is assessed, in the case of residential buildings, a tax rate of 1% is applied. To the tax rate, discounts or surcharges are applied depending on the assessed market value. The tax rate results in a gradually increasing tax rate, i.e. progressive taxation. The rate is set by the property value, reflecting the abilityto-pay principle (Table 3.23). The tax is calculated by the sum of the assessed market value corresponding to each class of value multiplied by its respective rate (sliding scale of rates): The lower the value, the lower the rate. The progressive tax rate is not to be confused with the progressivity over time, which is a punitive sanction instrument to achieve compliance with the social function of the land (Art. 95). Herewith, the tax rate increases over time forcing the land owner to develop vacant land or to rent vacant buildings, which might be held for speculation.

74

3 Property Taxes Within the BRICS States

Table 3.23 Tax rate for residential properties, 2015 Market value band Up to R$ 150,000 Above R$ 150,000 to R$ 300,000 Above R$ 300,000 to R$ 600,000 Above R$ 600,000to R$ 1200,000 Above R$ 1,200,000

Discount/ surcharge (%) 0.3

Resulting tax rate residential (vacant land) 0.7 (1.1)

0.1

0.9 (1.3)

+0.1

1.1 (1.5)

+0.3

1.3 (1.7)

+0.5

1.5 (1.9)

Example: taxable value R$ 310,000a 150,000  0.007 ¼ R$ 1050 149,999  0.009 ¼ R$ 1350 10,001  0.011 ¼ R$ 110 Total tax levied: R$ 2510

Source: Author; Prefeitura de S~ao Paulo, Decreto N 56.235, Art. 8, Art. 9 a Rebate FN33 already deducted

In the case of one-off payment of the property tax another discount of 5% is granted. The tax burden on each individual taxpayer is defined by decisions on policy made, such as tax base, exemptions, assessment method, and tax rate. However, the overall tax burden is also determined by administrative practices, which will be reviewed in the upcoming chapter. Administrative Practices All administrative competences regarding the property taxation are within the municipal administration of S~ao Paulo, more precisely, the Municipal Bureau of Finance and Economic Development (SF).37 That is, in turn, structurally divided into three distinct departments: • Department of Tax Collection (Decar); Decar is responsible for the revenue collection and related administrative aspects, such as billing of the tax, controlling due payment (of instalments), controlling tax debts, coordinating the preparation of up-dates of the fiscal cadastre and land value maps. Beyond that, they propose accreditation of financial institutions for municipal tax collecting. • Department of Supervision (Defis); Defis is responsible for supervision, control, and evaluation of all surveillance activities with regard to the taxes administered by the Municipal Bureau of Finance, as well as the management of activities related to electronic invoice and tax statements. Further, the Department is responsible for preventing crimes against the tax system (i.e. tax evasion), promoting studies on these issues, and suggesting legislative changes. • Department of Assessment and Judgment (Dejug); Dejug is responsible for the evaluation of initial trial activities. Among other duties, they record and administer proceedings of applications for recognition of tax immunity (exemptions),

37

Secretaria Municipal de Financ¸as e Desenvolvimento Econoˆmico (SF).

3.2 Case Studies: Megacities in Brazil, India, and China

75

requests for special payment schemes, applications for granting of tax incentives, etc. The Department has the responsibility for judgments related to administrative and judicial tax proceedings, i.e. they analyse and decide on appeal in respect to taxes, fees and contributions administered by SF and the fines and arrears due. Property identification is within the hands of the taxpayer. Nonetheless, in 2006, a complete and comprehensive property re-inspection was undertaken, and afterwards the property information could be updated by the taxpayer via the Internet (Carvalho 2014: 68). Information declared by the taxpayer relates to land and building characteristics, changes in property rights, type of tenure, changes in use, etc.38 The fiscal cadastre in S~ao Paulo is a computer-based system that withholds physical attributes of the building, the location, and the taxpayer details. Collecting all property tax-related data and constantly updating the cadastre is important to mass assess the market values. Especially in large cities as S~ao Paulo the availability of specialized technical equipment and modern technology contributes significantly to improving the ability of local government to track the constant changes in real estate properties. An example of such improved technology is the use of aerial photographs and georeferenced mapping of properties using GIS (geographic information systems).39 An update of the georeferenced mapping got underway in 2014 (Carvalho 2014: 68). Furthermore, S~ao Paulo makes use of several records, such as sales prices, changes in property rights, changes in use, etc. in order to keep the cadastre up-to-date.40 The main property assessment standard in Brazil is ABNT (Associacao Brasileira de Normas Te´cnicas), which addresses all property assessed for fiscal purposes (RICS 2014a: 22). ABNT defines market value as “the most likely amount payable for a good when consciously and voluntarily negotiated at a specific reference date within current market conditions” (ABNT Section 3.44, Part 1). According to RICS this is in accordance with the key terms of “willing buyer”, “willing seller” and “arm’s length transaction” that are commonly used to define market value. Based on this definition, the municipal law itself clarifies how a property with certain characteristics is assessed in monetary terms. The tax administration achieves such an assessment by applying sales comparison approach, descriptive statistics, and multiple regression analysis. The tax assessment is

38

See Lincoln Institute for Land Policy; they provide comparative results on various cities in Latin America with regard to various aspects of property taxation. Available at: http://www.lincolninst. edu/resources-tools/property-tax-in-latin-america-comparative-analysis/access-to-data[Accessed: 18 February 2016]. 39 Ibid. 40 Ibid.

76

3 Property Taxes Within the BRICS States

undertaken by qualified staff who have degrees in architecture or engineering.41 They receive performance incentives, i.e. they receive a bonus payment, depending on their productivity.42 In S~ao Paulo, the tax bills are sent out on an annual basis at the beginning of the year. The tax bill indicates the amount to be paid, the basic characteristics, the assessed market value and the tax rate. The tax bill is sent by mail or to the address chosen by the taxpayer according to a tax calendar issued.43 The calendar specifies the maturity dates of the first instalment or, alternatively, payment in cash. The property owner is primarily responsible for paying property tax. However, an occupier or user, even without legal authorization to use the property, can be requested to pay the tax. The tax collection of property tax begins on February 1st. Payment can be made in up to ten equal instalments (with max. of R$ 20.00, Art. 81). The tax can be paid through all the banking networks (Itau´ Unibanco, Bradesco, HSBC, Nossa Caixa, Safra, ABN Amro Real, Brazil Bank Federal Savings Bank, Santander), via internet, or in the lottery. In the case of non-payment, enforcement measures available are interest and fines (Art 82). The unpaid debts that are due include a fine equivalent to 0.33% per day (with a limit of 20% of the tax due) and default interest of 1% per month. If debt is outstanding, attorneys’ fees and costs and legal fees of tax enforcement have to be paid. Further instruments to achieve higher rates of compliance, such as prohibiting the transfer of sale or auctioning of the property in order to pay the due tax amount are not used, thus, the only instrument in the case of non-payment is the lawsuit (Carvalho 2014: 74).44 Appeal procedures in the case of a false assessment or disputes over tax bills, are available to taxpayers who wish to apply for a revision. Proposals for reassessing any individual property are accepted within 90 days from the date the first instalment becomes due. The request must be made by the person concerned through the appropriate form (Tax Complaint). The taxpayer is informed by the Finance Department about its decisions. Any negative decision can be further objected to a Municipal Councillor who revises the decision undertaken, or by a formal appeal to the Court of State and, finally, to the Supreme Court of the Nation.

41

Ibid. Ibid. 43 Tax calendar available at: http://www.prefeitura.sp.gov.br/cidade/upload/Edital-do-IPTU2016_1452003466.pdf [Accessed: 7 February 2016]. 44 In order to enforce the tax, S~ao Paulo also makes use of a municipal register of delinquents named Cadastro Informativo Municipal (CADIN) that registers the names of individuals and companies that have disputes with the organs and entities of the Municipal Public Administration. However, the blacklist is mostly focused on commercial properties only, such as a prohibition on signing contracts with the S~ao Paulo municipal government and on receiving tax incentives (Carvalho 2014: 74). 42

3.2 Case Studies: Megacities in Brazil, India, and China

3.2.1.4

77

What Is the Administrative Performance?

The administrative performance has substantial impact on the property tax revenues. After policy decisions are made, it is up to the tax administration to efficiently identify, record, and assess properties and to effectively collect and enforce the due tax payments. In order to gain an insight into the administrative tax performance of Rio de Janeiro and S~ao Paulo, a ratio study with a focus on coverage, assessment, and collection is undertaken. By applying this method of analysis, the potential property tax yields that could have been levied under ideal circumstances will be calculated. The data is drawn from two distinct sources: on the one hand there is a study provided on each city’s tax performance by Carvalho (2013, 2014). On the other hand there is a data set provided by the Lincoln Institute for Land Policy, which is a unique and comprehensive survey on property tax in Latin American cities based on legislative review, web-based research and, primarily, information provided by tax administrators.45 Based on the two sources a performance analysis on Rio de Janeiro and S~ao Paulo will be conducted. The management of property tax-related information, i.e. the fiscal cadastre, is among the most important aspects of tax administration. Only when all property tax-relevant aspects are withheld in a cadastre is an accurate and efficient tax assessment possible. Tables 3.24 and 3.25 show the classification of properties within the respective megacities. In both cases, the share of residential properties is about 80%, non-residential approximately 10%. However, the share of vacant land

Table 3.24 Classification of properties—Rio de Janeiro Residential Non-residential Vacant land Total

2000a 1,268,792 190,844 170,589 1,630,225

% 77.8 11.7 10.5 100.0

2006b 1,357,142 206,567 167,781 1,731,490

% 78.4 11.9 9.7 100.0

2011a 1,422,381 213,293 170,144 1,805,818

% 78.8 11.8 9.4 100.0

Source: Author; Carvalho (2013)a; Lincoln Institute for Land Policy, Survey Datab Table 3.25 Classification of properties—S~ao Paulo

Residential Non-residential Vacant land Total

2005a 2,272,162 359,170 131,511 2,762,843

% 82.2 13.0 4.8 100.0

2012b million 2.6 0.4 0.1 3.1

% 83.9 12.9 3.2 100.0

Source: Author; Lincoln Institute for Land Policy, Survey Dataa; Carvalho (2014)b

45

See Lincoln Institute for Land Policy, available at: http://www.lincolninst.edu/resources-tools/ property-tax-in-latin-america-comparative-analysis [Accessed: 3 February 2016].

78

3 Property Taxes Within the BRICS States

in S~ao Paulo is half the size of Rio de Janeiro. These figures, however, do not express the size of coverage against all properties within the respective cities. Carvalho (2013, 2014) makes, therefore, use of the National Census data to proxy the total number of properties in both cities in order to estimate the coverage ratio. The coverage ratio is defined as the number of properties recorded in the cadastre against all properties in the jurisdiction where the property tax is collected and expressed in percent. The coverage ratio might be subdivided according to property-use class, such as residential, non-residential, and vacant land. Carvalho (2013, 2014) focuses on households with a sewer system for calculating coverage ratio as they receive a municipal service, which goes along with the benefit-tax concept, and the properties are of certain market value, which indicates the feasibility of property taxation. Therefore, a good proxy for residential property coverage constitutes the properties that receive such service in relation to properties registered. Table 3.26 shows the overall coverage ratio for residential properties in both cases being about 59%. However, these figures take into account informal settlements, where no public goods or services are provided; therefore, they should not be considered as taxable property. Residential properties with a sewerage system provided and maintained by the municipality are a good proxy for formal settlements, amounting to 73.5% of total residential properties in Rio de Janeiro in 2010. In S~ao Paulo, about 69.3% are registered in the cadastre; however, the rate was as high as 81.3% in 2000. The case of S~ao Paulo illustrates that the number of properties with sewerage system increased faster than properties registered; therefore, the overall coverage decreased. Public investments in poorer areas seem to have little effect on property tax registration (Carvalho 2014: 69). The assessment ratio is defined as the assessed value in the fiscal cadastre divided by the (estimated) market value for each property. The median of the Table 3.26 Recorded properties (City Administration), surveyed properties (National Census Data) and coverage ratios r ¼ residential; c ¼ commercial Registered properties (r + c) Registered properties (r) Surveyed properties (r + c) Surveyed properties (r) Surveyed properties (r, sewer) Surveyed properties (r + c, sewer) Surveyed properties (c, sewer) Registered/surveyed properties (r) Registered/surveyed properties (r, sewer) Registered/surveyed properties (r + c) Registered/surveyed properties (r + c, sewer) Source: Author; Carvalho (2013, 2014)

Rio de Janeiro 2010 1,635,674 1,432,822 2,609,667 2,406,815 1,949,962 2,152,814 202,852 59.5% 73.5% 62.7% 76.0%

S~ao Paulo 2000 2,466,522 2,117,494 3,721,194 3,372,166 2,604,766 2,953,794 349,028 62.8% 81.3% 66.3% 83.5%

2010 2,851,192 2,274,002 4,480,998 3,903,808 3,283,314 3,860,504 577,190 58.3% 69.3% 63.6% 73.9%

3.2 Case Studies: Megacities in Brazil, India, and China

79

Table 3.27 Assessment ratio, S~ao Paulo (Carvalho) Street Av. Indiano´polis Av. Rouxinol R. Oscar Freire Av. Horacio Lafer Av. Morumbi R. Melo Freire R. Mario de Andrade R. Dr. Romeo Ferro Av. lpiranga R. Emilia Marengo Av. Cupece Av. Elisio Teixeira Leite R. Marcio Beck Machade Median (n ¼ 22)

Zone Indiano´polis Moema Cerqueira Cesar Itaim Bibi Morumbi Tatuape´ Santa Cecı´lia Butant~a Centro Ana´lia Franco Jabaquara ´ Freguesia do O Cidade Tiradentes

HDI 0.961 0.961 0.957 0.953 0.938 0.936 0.930 0.928 0.901 0.884 0.858 0.850 0.766

Assessment ratio (%) 2009 2010 51.4 44.9 42.9 46.0 50.0 88.9 40.0 49.1 40.7 48.4 34.4 44.7 33.3 47.1 34.6 37.5 115.0 115.4 26.7 37.0 50.0 44.2 34.8 31.0 36.7 35.0 40.4 44.8

2012 34.2 32.5 65.3 34.9 36.7 36.5 32.1 28.9 87.5 29.7 32.5 22.2 34.1 32.5

Source: Carvalho (2014)

assessment ratios is the average assessment level. Carvalho (2014: 72) illustrates such an approach on a sample of 22 selected streets in S~ao Paulo (Tables 3.27). He refers to building values for apartments “with medium quality of construction that were 20 years old” and land values for the respective street. The market value was retrieved from Fipe/ZAP database, which is compiled from property announcements in newspapers. According to Carvalho, the assessment ratio varies between 22.2–87.5% in S~ao Paulo with an average assessment level of 32.5% in 2012. Based on a sample of 2511 residential properties, Carvalho (2013: 28, 29) estimates the assessment ratio in Rio de Janeiro to be 35% in 2009 (ranging from 25 to 40%), which decreased to about 25% in 2011. For non-residential properties the assessment ratio is usually higher, for instance, in Rio de Janeiro an assessment ratio of approximately 50% is estimated (Carvalho 2013: 28, 2014: 71), because assessed non-residential values are above residential ones. The Lincoln Institute has obtained assessment ratios from tax administrators, which estimate the assessed values against the market values to be 54% in Rio de Janeiro and 70% in S~ao Paulo (Tables 3.28). Notably, the ratio in Rio de Janeiro ranges from 47% for vacant sites, and 50% for residential property, up to 85% for non-residential property. The difference between the results of Carvalho and the survey data provided by the Lincoln Institute might have several reasons: For one thing, it depends on the assessed values; therefore, inflation adjustments and general updates of assessed values (that happens to be the case only every couple of years) have an influence on the assessment ratio. Furthermore, soaring market prices have a huge impact on assessment values. The combined result typically shrinks assessment ratios over time until re-assessment, as illustrated in Fig. 3.2, because market values grow stronger than assessment values.

80

3 Property Taxes Within the BRICS States

Table 3.28 Assessment ratio (Lincoln Institute)

Rio de Janeiro S~ao Paulo

Fiscal year 2006

Total assessed value (millions in local currency) 100,622,970.87

Average assessment level (%) 54

2008

278,413,490.00

70

Observations 47% for vacant site/unbuilt lots; 50% for residential property; 85% for non-residential property –

Source: Lincoln Institute for Land Policy, Survey Data Table 3.29 Tax collection ratio S~ao Paulo, 2011—Carvalho

Residential Non-residential Vacant land Total

Rio de Janeiro Tax Tax levied collected (billion (million R$a) R$a) 743 n.a. 1178 n.a. 160 n.a. 2080 1706

Collection ratio (%) n.a. n.a. n.a. 82

S~ao Paulo Tax levied (million R$a) 2.64 3.00 0.21 5.86

Tax collected (billion R$a) 2.38 2.62 0.16 5.28

Collection ratio (%) 90.0 87.3 78.3 88.2

Source: Author, Carvalho (2014) Values adjusted to March 2074 R$ by IPCA inflation index (IBGE 2074) On March 3, 2014, R$1 ¼ US$ 0.4233

a

The collection ratio is defined as collection of both, current liability and tax arrears, against total tax amount assessed/billed. The collection ratio is provided by Carvalho (2013: 28), which is 80% in Rio de Janeiro and 88% in S~ao Paulo (as an example see Table 3.29). The collection ratio in S~ao Paulo can be considered a national benchmark (Carvalho 2014: 77). Another, less precise administrative performance indicator concerning collection would be the collection rate, defined as properties paying the property tax against all registered properties. This information is provided by the survey data of the Lincoln Institute for S~ao Paulo, where 55.6% of the taxed properties paid their due tax (Table 3.30). Furthermore, some insights are provided into the obstacles of efficient property tax collection: While S~ao Paulo names only the problem of non-payment and out of date cadastre, Rio de Janeiro is also facing problems of tax evasion, tax fraud, corruption, and legal obstacles. The impact of these obstacles, however, needs further study. The Lincoln Institute provides in addition data on effectiveness of collection. Rio de Janeiro’s tax administration costs 8.12% of the tax revenue expected (under the assumption of no tax evasion) in 2006. The administrative cost increases to 10.76% if the administrative cost is divided by revenue effectively collected. Overall, both megacities revised are among the administrative top-performers in Brazil, in some aspects even the benchmark. Carvalho (2013: 77) reviewed ten large municipalities in Brazil with regard to coverage ratio, assessment ratio, and

2,971,400

2008

1,652,000

Properties paying tax in the period (amount) 1,272,885,954

Source: Lincoln Institute for Land Policy, Survey Data

Rio de Janeiro S~ao Paulo

Properties recorded in the cadastre (amount) –

Fiscal year 2009

Table 3.30 Tax collection (spontaneous payments)—Lincoln Institute

55.6%

Collection rate – X

X

–

Tax performance problems Out of Nondate Tax payment cadastre evasion X X X

–

Tax fraud X

–

Corruption X

–

Legal obstacles X

3.2 Case Studies: Megacities in Brazil, India, and China 81

82

3 Property Taxes Within the BRICS States

Table 3.31 Administrative performance indicators, 2010 S~ao Paulo Rio de Janeiro Belo Horizonte Porto Alegre Brası´lia Salvador Fortaleza Manaus

Coverage ratio (%) 64 64 60 77 77 60 54 50

Assessment ratio (%) 36 35 60 55 25 55 25 5

Collection ratio (%) 90 80 80 80 60 30 60 60

Source: Carvalho (2014)

collection ratio (Table 3.31). Herewith, Porto Alegre and Brası´lia achieve a higher coverage ratio; however, they are not facing as much informal settlement as the case studies. With regard to assessment, Belo Horizonte achieves higher results, but in the case of collection the benchmark is set by S~ao Paulo. Finally, taking all administrative performance indicators together, the potential property tax could be calculated. Herewith, it is assumed that the collection ratios achieve an administrative feasibility performance level of 85% and a level of 100%, which is—of course—not attainable. It marks the upper limit of potential property tax revenues only achievable in an ideal administrative world with complete taxpayer compliance. The calculation is based on Carvalho (2013, 2014) as the ratios refer to the same year, 2010. However, revenues and municipal GDP refer to 2011 (IGBE 2011). Furthermore, because of limited data availability on use-classes and their respective ratios, the potential property tax will be calculated as a whole (residential, non-residential, vacant land). However, the calculation distinguishes between single measures of the tax administration in order to improve coverage, assessment, or collection, respectively, improving only one of the three ratios, and a combined package of measures on all three administrative performance ratios. The latter has a multiplicative effect on the revenue outcome, because increasing coverage constitutes the new basis for assessment, which, in turn, constitutes the new basis for collection. Table 3.32 indicates that the tax revenues generated could be increased threefold to the tax revenues collected in the respective financial year within the moderate 85% aim. They could even increase up to fourfold in an ideal administrative world. In both situations the property tax per GDP would increase dramatically: Rio de Janeiro could increase the property tax per GDP from formerly 0.8 to 2.2% in the case of tax ratios that are levied to a level of 85% and 3.5% to GDP if the administrative performance would be 100%; S~ao Paulo would raise their property revenues from 1.1 to 3.1% and 5.1% respectively (Table 3.33). The calculation also shows that measures on the assessment level have the biggest effect on potential tax revenues, because they are on the lowest levels of

3.2 Case Studies: Megacities in Brazil, India, and China

83

Table 3.32 Potential tax revenue

Tax collection (billion R$) Rio de 1.71 Janeiro S~ao 5.28 Paulo

CVRa AR CLR (%) (%) (%) 76 35 88

Potential tax revenue (85 and 100%) Single administrative measure and Administrative result measures combined, CVR CLRb multiplicative 85/100 AR 85/100 85/100 result 85/100 1.9 2.2 4.1 4.9 1.6 1.9 4.6 7.3

74

6.1

36

82

7.1

12.5

14.7

5.5

6.4

14.8

24.2

Source: Author Ratios: CVR ¼ Coverage; AR ¼ Assessment; CLR ¼ Collection a Properties with sewer-system; b 88% in the case of S~ao Paulo

Table 3.33 Administrative performance indicators, 2011

Rio de Janeiro S~ao Paulo

Municipal GDP (billion R$) 209.4

Tax collection (billion R$) 1.71

% municipal GDP 0.8

% municipal GDP (85%) 2.2

% municipal GDP (100%) 3.5

477.0

5.28

1.1

3.1

5.1

Source: Author

only 35 and 36%. A single administrative measure to increase the assessment level to 85% would—for instance—more than double tax revenues in both megacities. The calculations do not take into account increasing administrative costs that go along with the improvement measure(s). These administrative costs are likely to increase exponentially with number and complexity of property files. Their impact on overall potential tax revenue has to be taken into account and the additional revenues have to be high enough to compensate respective costs induced.

3.2.1.5

Is It a Rational Local Tax?

The requirements on a rational local tax are specified by horizontal criteria, such as visibility, source of local own revenues, balance of interest, sensitivity, and vertical criteria, such as fiscal autonomy, and inefficient migration. The set illustrates that there are many aspects linked to real estate and taxation thereof. A comprehensive analysis is therefore difficult to achieve, but following the set of criteria a deeper understanding of the interlinkages will be gained. First, we will review the vertical criteria that apply to a rational local tax.

84

3 Property Taxes Within the BRICS States

Visibility is one of the most important criteria with regard to property taxation. It refers to the property tax paid and the public goods and services provided/received. Both are visible, in form of direct taxation, or in the form of parks, hospitals, kindergartens, public transport, etc. This benefit-tax link is given in several respects with regard to the case studies. First, in order to impose a property tax, the urban area nearby needs to have at least two public services provided and maintained by the municipality. They comprise rainwater drainage, water supply, sewage system, public lightning system, and a primary school or a health centre to a maximum distance of 3 km. Second, the assessment process takes into account public infrastructure and other public goods that are available in the street that influence the real estate market. Third, even though there is generally no direct link between taxes paid and public services rendered, Brazil is unique in that the Federal Constitution prescribes that each municipality should spend at least 25% of municipal tax revenues on education and 15% on health, which includes revenues from IPTU.46 Visibility is, however, heavily undermined by policy decisions and administrative weaknesses. On the one hand, because of the large number of exemptions and rebates granted—about one third of all residential properties in S~ao Paulo do not pay IPTU. On the other hand, due to administrative weaknesses—one out of three residential properties is not recorded on the cadastre in Rio de Janeiro, therefore, not paying IPTU. According to the Family Budget Survey (2008–2009), only 33% of Brazilian households pay property taxes (Carvalho 2013: 27). This figure represents the aggregate of exemptions and rebates policies, incomplete tax cadastre, and the delinquency of payments. Overall, one might come to the same conclusion as De Cesare and Ruddock (1999: 267): “Taxpayers are used to paying insignificant property tax bills.” The property tax is constitutionally assigned to municipalities; therefore, it constitutes a source of local own revenues, as high as 22.7% of local own-tax revenues in Rio de Janeiro and 29.0% in S~ao Paulo. Though more important than IPTU is the municipal tax on services, ISS, which constitutes approximately 50% of municipal own-taxes. The importance of ISS is of no surprise, because the tax collection of ISS is less expensive than IPTU collections—from financial and political perspectives. The real estate markets are often characterized by informal, illegal, irregular, or clandestine land use not conforming to urban standards and regulations, which have an impact on the identification of properties and the maintenance of the property tax cadastre. Beyond that, the property characteristics across the municipalities are very heterogeneous, which impedes assessment equity within the megacities. The results are “assessment errors such as very different values for similar properties or similar values for clearly different properties”, according to Afonso et al. (2012: 8). Larger municipalities concentrate their

46

See Lincoln Institute for Land Policy; they provide comparative results on various cities in Latin America with regard to various aspects of property taxation. Available at: http://www. lincolninst.edu/resources-tools/property-tax-in-latin-america-comparative-analysis/access-to-data [Accessed: 13 February 2016].

3.2 Case Studies: Megacities in Brazil, India, and China

85

collection effort on ISS, which is levied on transaction stage and implies less advances assessment techniques. The property tax is, therefore, beneficial to megacities that have enough resources (qualified assessors, advanced assessment techniques, critical mass of assessment cases) to levy recurrent property tax. IPTU is imposed on residential and non-residential properties; therefore, the criterion balance of interest is fulfilled—at least at first sight. The criterion states that each local interest group (property owners, residents, and businesses) should respectively contribute by paying related local taxes to the extent that public services are provided. The large number of exemptions on residential properties might have an effect on the balance of interest, with higher tax burdens on remaining residential properties or non-residential properties. In order to meet the criterion and in order to keep the tax burden as small as possible, each property owner should pay the tax. In Brazil, as in the case samples reviewed, only about every third residential household pays IPTU—even though they live in public serviced areas. Among all exemptions granted—which are not to be reviewed in more detail— the greatest problem with regard to the balance of interest criterion is to be found in Rio de Janeiro. There, a substantial depreciation is applied to the overall assessment value (land and buildings), because of the age of the buildings. The depreciation on the overall assessment value is up to 50% if the building is older than 50 years. While a square meter of real estate cost R$ 3851 on average in Rio de Janeiro in 2008, it was R$ 8636 in 2013.47 The dramatic increase was not taxed to its full potential, especially in richer neighbourhoods with older buildings, as up to 50% were tax-relieved. This fact benefits greatly the highest-valued properties, where the land value in relation to the construction cost is very high. According to Carvalho (2013: 183), for instance, many high-value properties located on Copacabana are exempt due to older age. As the depreciation is not balanced out with progressive tax rates as set in S~ao Paulo, therefore the overall property tax is likely to be regressive in Rio de Janeiro. The assessment values of high-value properties show greater discrepancy to the market values than lower-value properties, which makes the richer households pay less property tax (per m2) than poorer ones. Therefore, the balance of interest within the residential sector is distorted. S~ao Paulo has an assessment element that can make the tax regressive as well. S~ao Paulo limits the assessed land value for residential buildings (multi-storey buildings) to R$ 9300 per m2. Assessment values above will not be taxed. However, S~ao Paulo’s housing price per m2 ranges between R$ 2600 and R$ 14,600 in 2013, with an average price of R$ 6865; therefore, only a small number will benefit from the assessment cap.48 Furthermore, all residential 47

Ben Travener. 2013. Wages Outpaced by Property Prices in Rio. The Rio Times. Available at: http://riotimesonline.com/brazil-news/rio-business/wages-outpaced-by-property-prices-in-rio/ [Accessed: 24 February 2016]. 48 Alexander Wasastjerna. 2014. Property prices in Brazil: Statistics about average Brazilian house prices per m2. Available at: http://www.propertybrazil.com/articles/property-prices-in-brazil-sta tistics-about-average-brazilian-house-prices-per-m2 [Accessed: 24 February 2016].

86

3 Property Taxes Within the BRICS States

12

600

10

500

08

400

06

300

04

200

02

100

00

0

ISS

IPTU

Municipal GDP in Bn R$

ISS & IPTU in Bn R$

properties up to the assessment value of R$ 90,000 are exempt in S~ao Paulo. And considering the progressive tax rates applied in S~ao Paulo, the IPTU is most likely progressive as a whole. In Rio de Janeiro, on the contrary, the range in housing price per square metre is R$ 1900 up to R$ 20,300. Herewith, the average selling-price for new properties (R$ 5800) is higher than for old properties (R$ 8625), which is quite a unique feature for real estate markets. With the knowledge that the Basic Unit Cost (CUB) for high standard buildings is between R$ 2000 per m2 and R$ 2500 per m2 in 2012,49 it shows that the land value is the major price component, and it clearly indicates that the property tax is regressive in Rio de Janeiro. Thus, the assessment disparities in Rio de Janeiro are unfounded—especially with regard to the balance of interest criterion. Even though exemptions and rebates have substantial impact on the revenue yields, the application of inflation index on IPTU guarantees nominal growth of the IPTU-revenues. However, inflation-adjusted real growth is of importance and in the long term consideration, the property tax should be linked to economic municipal growth with a revenue elasticity of one, i.e. the revenues of IPTU should increase to the same extent, so-called proportional growth sensitivity. Figure 3.3 illustrates that revenue from ISS has been rising at a faster pace than IPTU in S~ao Paulo. Reviewing a 10-year period (2004–2013), we see that the revenue elasticity of ISS is 1.9 against 1.0 in the case of IPTU (Table 3.34). Both are elastic (ɛ > 1), i.e. they are increasing at least at the same pace as municipal GDP. Beyond that, the property tax should be relatively stable with the economic cycle, so-called economic cycle sensitivity, to shelter municipalities from cyclical effects, which is definitely the case for S~ao Paulo.

Municipal GDP

Fig. 3.3 Sensitivity of ISS and IPTU, S~ao Paulo. Source: Author; Prefeitura de S~ao Paulo; IGBE

49

Carvalho (2013: 169).

3.2 Case Studies: Megacities in Brazil, India, and China Table 3.34 Long-term revenue elasticity of ISS and IPTU, S~ao Paulo, 2004–2013

S~ao Paulo Rio de Janeiro

87 ISS 1.9 n.a.

IPTU 1.0 n.a.

Source: Author; provided by Prefeitura de S~ao Paulo; IGBE

Second, we review the horizontal criteria that apply to a rational local tax. Fiscal autonomy is one of the most important criteria for a rational local tax. The municipalities have great liberties in this regard: each municipality is responsible for establishing its own tax base (especially by setting exemptions), its own market value assessment system, and its own tax rates. The devolved property tax in Brazil follows taxpayer’s priorities, the fiscal need of the municipality, and the administrative capacity of the tax administration as all decision-making is in the hand of the local political representatives. The criterion inefficient migration is very difficult to determine, as too many aspects play into the decision of migrating from one city to another. However, due to the fact that each municipality has its own property tax system, taxation might be one variable to explain migration in Brazil, especially within metropolitan areas. As already outlined, the S~ao Paulo metropolitan area consists of 39 municipalities and Rio de Janeiro of 16 municipalities, each of them having the right to establish different property tax systems. Even within the sample megacities property taxation falls apart, which might have effects on migration: higher-valued residential properties are less taxed in Rio de Janeiro; lower-valued properties are tax-favoured in S~ao Paulo. As outlined, the assessment process provides substantial tax reliefs for old-aged mostly high-valued properties in Rio de Janeiro, However, Rio de Janeiro only rebates properties up to the value of R$ 60,054 while S~ao Paulo leaves residential properties tax free up to R$ 90,000. Though the old assessment values and the less elaborated property tax cadastre of Rio de Janeiro will most likely benefit the poor as well as the higher income groups. More important than the tax system is that S~ao Paulo is the economic powerhouse of Brazil and attracts many people looking to find their fortune. According to UN HABITAT (2010: 2) “the poor vote with their feet” resulting in a substantial housing shortage in the metropolitan region of S~ao Paulo. The region is short in supply of approximately 500,000 units for low-income households (incomes of up to three minimum salaries, UN HABITAT 2010: 116). At the same time there were 619,915 vacant units in S~ao Paulo metropolitan region in 2007. The social function to urban property, which is constitutionally assigned and further specified in municipal law, allows the property tax to be increased progressively over time (on the land value) if the property is permanently vacant. Beyond that, the urban land can even be reclaimed by the municipality. Although the instrument is incorporated in many municipal laws, none of the instruments available for enforcing the social function of urban land appears to be in use currently. They are rarely regulated in such a way that would make them immediately applicable, i.e. the notion is often left open to interpretation. The only municipality making use

88

3 Property Taxes Within the BRICS States

of punitive property tax rates to underutilized urban land is S~ao Paulo (Ondetti 2015: 11). Finally there is a criterion which refers to an evenly distributed tax base. In the context of taxation, the criterion is important as it avoids strong disparities among the municipalities and, therefore, relieves horizontal equalization or vertical transfer systems.

3.2.1.6

What Are Current Reform Initiatives?

There have been several larger Brazilian cities reforming their property tax systems, such as Belo Horizonte (2010), S~ao Paulo (2010), Fortaleza (2011), and Manaus (2012). Others, such as Rio de Janeiro have studied possible reforms (Carvalho 2014: 64). Rio de Janeiro is currently combatting tax evasion by renegotiating tax burdens of IPTU and ISS.50 About 375,000 taxpayers have the ability to renegotiate their debts with the city in the amount of R$ 30 billion—most of the outstanding tax is property tax. The city of S~ao Paulo is contacting the owners of about 150 properties that are empty or underutilized within the centre of S~ao Paulo.51 The measure aims at ensuring the social use of private urban property. If the buildings are vacant or under-constructed, the owner has to provide a development plan, which has to be implemented within 5 years. Otherwise, the city starts the collection of progressive property tax over time. The city might even expropriate the property concerned. The measure is to curb speculation as land and buildings are held in order to maximize profits.

3.2.1.7

Critical Summary

The guiding principle of Brazil’s three-tier federation is marked by the decentralization concept. With the 1988 Constitution, municipalities have gained new expenditure and revenue responsibilities. With regard to the latter, they have been empowered to levy local taxes, such as the urban property tax (IPTU). The reviewed megacities illustrate the political, fiscal and administrative decentralization concept, which was implemented due to the very large heterogeneity given across the states. Therefore, the symmetrical federalism concept is due to the socio-economic asymmetries to be found in the federation. The megacities

50

Maria Luisa Barros, tributario, 14/08/2015. Available at: http://tributario.com.br/a/cidade-dorio-de-janeiro-prefeitura-renegocia-dividas-de-iptu-e-iss/ [Accessed: 4 March 2014]. 51 Gisele Brito and Diego Sartorato, 10/24/2014. Available at: http://outraspalavras.net/ outrasmidias/destaque-outras-midias/sao-paulo-comeca-a-aplicar-iptu-anti-especulacaoimobiliaria/ [Accessed: 4 March 2014].

3.2 Case Studies: Megacities in Brazil, India, and China

89

reviewed—Rio de Janeiro and S~ao Paulo—illustrate the disparities not only across the states, but also within the municipal boundaries. Rio de Janeiro and S~ao Paulo are the most populous and economically strongest municipalities in Brazil. Combined, they host 9.2% of total population and they comprise 15.0% of national GDP. At the same time, they attract many poor that vote with their feet and live in informality. At least 20% of S~ao Paulo’s population lives in favelas. The population growth and the economic dominance in Brazil—especially with regard to S~ao Paulo—have substantial impact on the property values. Furthermore, Rio de Janeiro hosted the 2014 World Cup and the 2016 Olympic Games, with huge infrastructure investments also having an impact on the property values. Nonetheless, it is surprising that 30.8% of national property tax is collected within the two cities only (out of 5570 municipalities): Hereof, 7.5% is account for by Rio de Janeiro and 23.3% by S~ao Paulo. Of course, other aspects as well have to come into play in order to achieve this outstanding amount of property tax revenues. At the same one might raise the question why S~ao Paulo is doing so much better than Rio de Janeiro. The reasons are to be found—as in any tax system—in the political design of property taxes (and its tax environment) and the performance of the tax administration. The political decision on tax base is not an easy task, especially with regard to the very heterogeneous properties and different taxpayer’s ability-to-pay. To address the peculiar needs of the taxpayers (owner, occupier, etc.) or the peculiar categories of properties (residential, non-residential, etc.) some form of tax relief is required. In the case of Rio de Janeiro and S~ao Paulo tax reliefs are granted at various stages of residential property taxation: First, at the stage of defining the tax base, where properties are exempt from paying the tax as a whole; second, at the stage of assessment, where properties with a certain assessment value (per square meter or overall assessment value) are exempt or entitled to a rebate. Beyond that, Rio de Janeiro and S~ao Paulo have indirect tax reliefs, such as depreciation based on the age of the building, which, in turn, is applied to the overall assessment value in Rio de Janeiro or the tax capping to smooth tax burdens in the event of reassessments in S~ao Paulo. The depreciation in Rio de Janeiro is clearly in favour of the property of the rich as most properties with older age are located in wellsituated areas with very high land values. Third, property taxes are lowered at the collection stage, where taxpayers receive an early bird rebate if the due tax is paid in one single instalment. The number of policy-interventions is based on various stages and are generally high, therefore, eroding the tax base. The relief measure in place makes it difficult to determine if and how intended relief effects are currently met. According to Carvalho, about 65% of properties and 90% of vacant land are exempt in Rio de Janeiro, and about one third of all recorded properties are exempt in S~ao Paulo—rebates not included. Interestingly, Rio de Janeiro quotes that 20% of its taxpayers account for 80% of the municipal tax collection, which evokes Pareto’s Law, also known as 80–20 rule, where 80% of the tax revenues come from 20% of taxpayers. It is—of course— important that the easiest properties with regard to assessment are taxed first as well as all those properties where the tax assessed is highest; however, either the focus needs to broaden up or the reliefs have to be reduced in order to divide the tax

90

3 Property Taxes Within the BRICS States

burden more equally across the beneficiaries of public goods and services within municipal boundaries. Even though tax reliefs might be advantageous to prevent financial hardship, to cushion shocks of reassessments, to enhance simplicity by excluding low property values in certain areas, etc.,52 they should be reasonable and transparent on the outcome-side. The tax assessment is the most problematic aspect with regard to political decisions made—especially in Rio de Janeiro. Political interventions in the property tax design, such as tax capping, depreciation applied, threshold values in place, etc., impact the assessment values. With a booming real estate market, the assessment values move further away from market values. From a public finance perspective it would be preferable to accurately assess market values—even though they might drastically increase because of booming real estate markets—and to adopt the tax rate thereafter. This would have the advantage that the tax burden is divided relatively and, therefore, equitably to the existing properties according to their market values. At the same time, the relative tax burden would better reflect the public benefits received as public goods and services are capitalized in the property values. The difference between the tax rate(s) applied in Rio de Janeiro and S~ao Paulo is that the tax assessed is transferred differently onto the tax payers. While Rio de Janeiro applies a single tax rate on residential properties, S~ao Paulo applies a progressive tax rate. Therefore, the tax assessed is transferred distinctively to each single property tax burden; while the tax burden increases proportionally with the value in Rio de Janeiro, it increases progressively in S~ao Paulo. Herewith, S~ao Paulo refers more to the ability-to-pay principle (i.e. local wealth tax), while Rio de Janeiro has a proportional tax incidence regardless of ability-to-pay. The imposition of progressive rates in S~ao Paulo illustrates the property tax being used as urban policy instrument. Due to high inflation rates, and unstable economic period cycles, real estate is a major way to concentrate wealth. Progressive tax rates encouraged investment in productive activities and deters to some extent speculation (De Cesare and Ruddock 1999: 280). Overall, the tax designs compared in both municipalities are different in nature: While the tax is most likely regressive in Rio de Janeiro, thereby favouring highincome property owners, it is progressive in S~ao Paulo, thereby subjecting highincome property owners to higher property taxation. The tax administration seems to be compatible with the tax policy in the case studies, which is of utmost importance. The tax administration in both cities is capable of running all administrative aspects needed to efficiently and effectively tax property according to the political decisions made. Of course, the best tax administration is not identified by looking on the tax revenues collected only. At the same time, it is important that the tax administration achieves uniformity in the

52

For this see Rie¨l Franzsen’s lecture on the topic “Tax Relief” in the context of the online-course “Designing and Implementing Property Tax System in Africa” at the Lincoln Institute for Land Policy.

3.2 Case Studies: Megacities in Brazil, India, and China

91

assessment process to guarantee horizontal equity, i.e. that all property owners with similar locations and public service provision within the same municipality pay similar property tax amounts. Because the tax amount paid is the reference to identify horizontal equity, other administrative aspects, such as identifying property, assessing property values, billing, and enforcing the tax are also of importance. The property tax administration within both cities seems to follow the standards with regard to coverage, billing, collection, and enforcement of the property tax.53 The management of the property tax is divided among several separate departments with separate duties in order to prevent aspects of corruption. Herewith, the management elements, such as data-gathering and property identification, assessment of property value, billing, and enforcing are assigned to different departments. Beyond that, each single administrative aspect, which forms a management cycle, seems to be implemented according to lessons learned on property tax administration (Bird and Casanegra de Jantscher 1992; De Cesare and Ruddock 1999): Property Discovery, Data Auditing and Maintenance Both cities make use of fiscal cadastre, which provides all legal formats (e.g. civic address, site and building areas and attributes) in order to assess and collect the property tax. They make use of improved technology, such as aerial photographs and georeferenced mapping of properties using GIS (geographic information systems) in order to determine if changes have occurred in properties registered or identify missing properties in the tax net. The property characteristics are controlled by field visits. In addition, all data collected can be looked at by the taxpayer (public access is provided on the homepages, which can be entered by a unique property number assigned to each property). However, the rhythm of updating and controlling the cadastre entries could be improved. Furthermore, both cities are increasingly closing in on advancing unsecure property taxes, i.e. illegal and informal occupiers of urban land. Herewith, the focus is on properties with a threshold value and on public services provided within the area. Overall, the assessment ratio (the amount of properties recorded against all properties) is about 59% in both municipalities and increases to about 70% considering properties with sewerage system. In this context, the case of S~ao Paulo illustrates that the number of properties with sewerage system increased faster than properties registered; therefore, the overall coverage decreased. Assessment and Modelling Both megacities make use of contemporary mass appraisal systems in order to assess the market values, i.e. they do not rely on individual property assessment and, therefore, face lower administrative costs. This approach is also of advantage with regard to predictability, stability, defensibility, and uniformity.54 The assessments are predictable as the data gathered (e.g. sales 53

For this see Dian Johnstone’s lecture on the topic “Tax Administration” in the context of the online-course “Designing and Implementing Property Tax System in Africa” at the Lincoln Institute for Land Policy. 54 See William McCluskey’s lecture on the topic “Automated Valuation” in the context of the online-course “Designing and Implementing Property Tax System in Africa” at the Lincoln Institute for Land Policy.

92

3 Property Taxes Within the BRICS States

cost data) allows for prediction of the value of each property in the municipality. It is stable in the sense that re-assessment cycles occur at more frequent intervals, as illustrated by S~ao Paulo, which runs a two-year reassessment cycle. Furthermore, they provide objective results, banishing the inherent subjectivity of assessments by municipal assessors. Due to the objectivity provided, there are often fewer appeals against the assessment results. However, these results are typically based on multiple regression analysis, which is less transparent for the taxpayers, thereby typically leading to more appeals. This is not the case in the reviewed cities, because they provide less-advanced formula-driven systems that are rather comprehensible. Problematic in this regard, especially in the case of Rio de Janeiro, is that the patterns (which determine the value of a property) of residential properties are crude, land and buildings assessments are combined, and the depreciation factors are too extensive for old aged buildings, therefore resulting in very low assessment values. These factors, however, are politically driven. Both municipalities show very low assessment ratios (assessed values against market values) being less than 40%. This shows that property values assessed and market values differ widely. Here, a significant improvement of the ratio is of urgent need. The closer the properties are assessed according to their market values the fairer the tax with regard to horizontal equity. Tax Billing, Collection, and Enforcement The overall collection process is based on a tax calendar, which is crucial for timely administration. All dates with regard to billing, objection, collection, and enforcement are delivered by statutory deadlines. The tax bill is sent out in January, providing all information necessary (e.g. property database identifier, name of taxpayer, assessed value, tax rate, date on which the payment is due, etc.) for the taxpayer in order to pay the tax on time. If the tax is not paid, due taxes with interest and penalty are billed. The tax bill as well as the outstanding tax amounts due are also accessible online (with unique property number assigned). The tax can be paid in various ways, such as online, by the banking system, or at the lottery. Even though both municipalities have high collection ratios (collection of current tax liability and tax arrears against total tax amount assessed), 80% Rio de Janeiro to 90% S~ao Paulo, there is room for improvement—as the renegotiation of outstanding taxes in Rio de Janeiro illustrates. The collection and enforcement lie solely within the responsibility of the tax administration, which is of high importance in order to achieve a fair tax. All properties assessed have to pay the tax; otherwise, some taxpayers will freeride at the expense of all other taxpayers (residential and non-residential). Even though most delinquents are listed in a blacklist, there seems to be a certain number still not paying the tax. The measure of last administrative resort—which has not been implemented so far—could be the forfeiture of the property. The property tax in Brazil is embedded into a tax assignment and tax sharing system, which features no incentive for the municipalities to tap the potential of their immobile tax base. In the German context, the tax base and the assessment are the same across the German territory; the only exception is the tax rate, which is in the hands of the municipal authorities (Fa¨rber et al. 2013: 180). Within the local

3.2 Case Studies: Megacities in Brazil, India, and China

93

equalization scheme, i.e. municipal transfers from the states to their respective municipalities, the fiscal capacity and the fiscal needs of the municipalities are decisive. In order to calculate the fiscal capacity the average tax rate of all municipalities within the respective state is applied, i.e. those revenues from tax rates above the average will not be taken into account for the equalization but remain with the municipality. Conversely, those municipalities applying tax rates below the average will lose revenues within the equalization system, because the revenues collected are below the revenues taken into account; therefore, the municipality will receive less revenue in transfers. This has the advantage that municipalities have an incentive to raise above-average property tax revenues and therefore have an incentive to tap the potential tax base. Furthermore, the municipalities are part of the states; therefore the transfers are from sub-national to sub-national. As the municipalities in Brazil have the same constitutional status as the Federal Government and the States, the large transfers from Federal to municipal level seem to be rational from a public finance perspective, but exceptional. Summarizing, both municipalities are the top IPTU revenue generators in Brazil, of which S~ao Paulo is to emphasize as best practice example. However, both have potential to further improve their tax revenues: The potential increase of Rio de Janeiro’s property tax to municipal GDP ranges in between the current 0.8% up to 3.5%. S~ao Paulo’s tax potential is between 1.1% up to 5.1%. The potential increase is heavily dependent on a more comprehensive assessment of property in order to estimate market values more accurately. A fair and accurate assessment is the main administrative challenge with regard to property taxation in the case studies. However, as long as the tax administrative capacities are less advanced, a simplified assessment is to be preferred.

3.2.1.8

Reform Options

The matrix to evaluate property taxes applied has clearly identified the weaknesses and vice versa solutions of the respective cities reviewed: While Rio de Janeiro’s property tax system faces several shortcomings (e.g. it’s regressively), S~ao Paulo could be seen as role model for property tax reforms in Brazil. Because of that, reform chapter dedicates onto distinct aspects that are of relevance with regard to property taxation.

Metropolitan Governance Structure In Brazil, each municipality constitutes its own tax jurisdiction. The two megacities are embedded into large metropolitan areas consisting of 19 municipalities in the Rio de Janeiro metropolitan area and 39 municipalities in the S~ao Paulo metropolitan area. The population size of both municipalities almost doubles by taking into account the nearby municipalities, which together account for about 16% of the

94

3 Property Taxes Within the BRICS States

Table 3.35 Estimated population 2014

Rio de Janeiro S~ao Paulo

Municipal population 6,453,682

% of national population 3.18

Population metropolitan area 12,116,616

% of national population 5.98

11,895,893

5.87

20,935,204

10.32

Source: Author; IGBE

national population (Table 3.35). Article 25, Paragraph 3 of the Brazilian Constitution gives the states the right to create metropolitan regions “in order to integrate to integrate the organization, the planning and the operation of public functions of interest”. Because the municipalities hold the same constitutional status as the states, they are not subordinates of the states or subordinates of metropolitan areas created by the states. According to Wetzel (2013: 316) this is of importance: “While the states have created metropolitan authorities or agencies, there are no formal mechanisms for funding or specific tools to implement metropolitan policy:” As a consequence, any decision within the metropolitan must be agreed to by all municipalities involved. This top-down approach, with states being able to implement such metropolitan areas, does not fit into the general decentralization setting. Funding and decision-making is, however, important in order to develop metropolitan areas as a whole.

Informality The rapid urbanization occurred between 1980–2000 resulted in a national profile with staggeringly high levels of urban poor: since then, about 78% of the nation’s poor live in urban areas (UN HABITAT 2010: 5). Within the metropolitan area of S~ao Paulo there are about 6.4 million people living in poverty (Ibid.). Most urban poor live in the peripheral areas of the metropolitan region “where the lack of urban services and public transport supply are at their worst (Ibid.)”. Therefore, metropolitan action and funding are necessary in order to improve the overall living conditions within the metropolitan area.55 The property tax could play a role by financing the public amenities and infrastructure, thereby increasing the mobility to job centres, which, in turn, legitimizes imposing property taxes. According to De Cesare and Smolka (2010: 13) low income families are willing to pay property taxes more often than actually assumed in return for needed public investments. In the context of property taxation, Gaffney (1999)56 supports land value taxation; because it has redistributive effect and opens up more land to the poor. The property tax imposed leads to a lower revenue stream expected from the

55

Of course, this carries the risk that urbanization into the metropolitan areas is further accelerated, which leads to further investment needs, etc. 56 Cited by De Cesare and Smolka (2010: 13).

3.2 Case Studies: Megacities in Brazil, India, and China

95

property as it is negatively priced into the current property value (capitalization effect), and leads therefore to more affordable land for the poor. This should lead to a levelling effect across income classes. Less theoretical and more to the practiceoriented are policy and administrative measures suggested by De Cesare and Smolka (2010: 14–15): • “Extending tax liability to alternative forms of secure tenure.” The limitation on secure properties has substantial impact on the tax base—especially in countries characterized by widespread informal housing, as is the case in Brazil. Secured property has the advantage that the property tax liability is secured by the property itself. However, In the case of unsecured property, other forms of secure tenure need to be sought in order to potentially enforce the tax. • “Adjusting the tax burden on the poor.” Throughout the case studies, low-valued properties are exempt from property taxation, which does not necessarily have to be the case. Informal property owners are typically willing to pay with the expectation that public investments improve their living conditions. Because of the public welfare character, typically the case for social goods or public infrastructure, such investments need to be publically funded. Psychologically it is important that such measures are not for free. This increases the visibility from a democratic and public finance perspective. At least symbolic tax payments should be levied. • “Updating urban cadastres.” Informality is a huge tax administrative challenge that begins with property identification and integrating into the cadastre system. In this context, the administrative costs are significant, with regard to human resources and technology. However, well-maintained property cadastre provides the possibility to tax according to public amenities rendered and offers valuable information for urban planning, which is necessary to further improve the living conditions. • “Assessing informal property.” The case studies have shown the problems involved in assessing urban properties at market value in Brazil, i.e. inaccuracy in the assessment, e.g. due to inappropriate adjustment factors, resulting in horizontal disparities, or infrequent reassessment cycles leading to low assessment values, etc. Assessing informal property is—of course—even more challenging. However, informal properties are also bought and sold and very often a vibrant informal property market can be observed. Therefore, informal real estate has a price tag that can be determined. Further, self-assessment could be applied in order to ease the administrative workload. • “Minimizing tax evasion.” Differently than expected, poor people are willing to have their properties included in the fiscal cadastre. By doing so, they can expect public investments, because they appear on the city’s map, which constitutes the bases for urban planning. More often than the poor, it is the owners of high-value properties not paying the tax. • “Establishing a fiscal culture.” Both, formal and informal property markets and taxation thereon need a raised awareness for taxing. The justification might be based on ability to pay or benefits received. Further, the rights (for public

96

3 Property Taxes Within the BRICS States

services) and duties (paying property taxes) have to be explained. In both cases, explanation and tax education lead to higher tax compliance. In this case, higher administrative costs for taxing low-value properties are offset by achieving a better fiscal culture. The challenges ahead and measures summarized could be seen as improvement measures on a municipal level, but also for joint action on a metropolitan level. Improving both, property tax and living conditions of the poor, is imperative and interrelated by the benefit principle of property taxation.

3.2.2

India

India’s local level looks back on more than 20 years of decentralization with elected governments on the local level and adjunct devolution of administrative and fiscal functions. Since the 74th Constitutional Amendment Act (1992), municipalities constitute a third-tier of government and therefore units of local self-governance. They are responsible for maintaining and improving public services and finding suitable local finance instruments. Even though the 74th Constitutional Amendment Act was introduced to constitutionally recognize and to further decentralize decision-making to municipalities, Bagchi (2003) remarked that urban infrastructure and services have not improved substantially, because finances do not follow functions in India. In such a federative setting, there is a strong link provided for unfunded mandates. So far, functions are assigned by the constitution, finances by the States. Due to State responsibility, with regard to finances there are large interstate differences across the municipal sector, which is, in turn, reflected in a bouquet of property tax designs. From a federative perspective, a main challenge presented between the States and their respective municipalities is a missing statistical database on municipal finance. The fiscal situation of the urban local bodies (ULBs)57 is largely unknown. Due to a lack of reliable, comprehensive and consistent data on the local level, there are special surveys and case studies commissioned, which could be seen as a reference frame; still, they cannot replace consistent municipal finance statistics for informed decision-making. The statistical database becomes even more vital in future with regard to municipal finance in India, which has been characterized so far by increasing expenditures and decreasing revenues: On the one hand, local own-tax revenues have been abolished in some States, such as Octroi (an import tax into the city) or even the property tax, while municipal expenditures are significantly increasing due to urbanization, decentralization of tasks, etc., on the other hand. Both developments intensify the inadequate financial situation on the 57

Urban local bodies are split into municipal corporations, municipalities (second-tier urban local bodies) and the nagar panchayats (third-tier local bodies) (Fourteenth Finance Commission, 2014: 113).

3.2 Case Studies: Megacities in Brazil, India, and China

97

local level, and, at the same time, provide clear and strong signals for a comprehensive municipal database, which discloses the basic financial need of the municipality’s year-by-year. Against this background, the Fourteenth Finance Commission (FC XIV) realized that governing cities is constantly becoming more of a challenge. The municipalities in India are characterized by “inadequate finances, weak institutional framework and lack of capacity for service delivery” (FC XIV 2014: 106). Furthermore, the FC XIV attests that the local bodies need to be encouraged to generate own revenues and to improve the quality of basic services they deliver, particularly with regard to the urbanizing future of India. The urban population in India is set to double from 2010 to 2030 and “[u]rban India is, [. . .], unprepared for this growth” (Reserve Bank of India 2015: 42). As part of the solution, the FC XIV (2014: 106) calls for a Constitutional assignment of municipal revenues (“municipal revenue list”), which would include—among others—the property tax and the vacant land tax. Both are and should be seen as proper financing instruments of municipalities in India—a fortiori with regard to urbanization. Property tax revenues grow with the demand for land in urban India. The increasing property values are mostly related to external factors, such as urbanization, in-situ population growth and public investments. This increment in property values could lead to an increment in property taxes. Especially in times of ever more mobility of other production factors, such as the case of the corporation tax. Property is a perfect local tax due to its immobility and, therefore, neutrality of taxation. Therefore, property taxes are indispensable for Indian municipalities and they are already the most important local own-revenue source next to Octroi, which is already abolished in most States (Bagchi 2003: 4482). However, the property tax in India is characterized by various administrative problems, such as property identification, assessment, collection and enforcement, downsizing the potential property tax revenues. Therefore, several municipal corporations—Ahmedabad, Bangalore, Delhi, Patna, Hyderabad, and Pune (Bagchi 2003: 4482; Karnik et al. 2004: 3820; Gosh and Kundu 2011: 95)—have approached property tax reforms since the 74th Constitutional Amendment. In the focus have been administrative and taxpayers aspects addressing the weaknesses of the current systems. Beyond that, the case of India illustrates that context variables play an important role in mobilizing property tax revenues. Policy decisions, such as high transaction taxes, rent control and restrictions on density (Floor Area Ratio), regulate the real estate market and erode the tax base in such a way that property tax revenues are limited in static and dynamic terms. Therefore, Annez (2010: 26) classifies the Indian urban real estate sector as “the most repressed among the fast-growing developing countries”. In India—as in other countries—the megacities have a significant tax base. According to Mathur et al. (2011: 74) bigger municipalities are advantageously placed in India in terms of revenue generation “whatever may be the explanatory factors”. The question is if they are able to tap the revenue potential in order to finance public services assigned in an appropriate manner in the upcoming urbanizing decades. The agglomeration benefits should be captured by property tax,

98

3 Property Taxes Within the BRICS States

which would imply major reforms on this type of tax. Being subject to their respective states with regard to property tax reforms, Indian municipalities face major constraints on increasing the their own-tax revenues and abolishing the policies that repress real estate values. Therefore, the question arises on the role the property tax can play within this field of tensions the municipalities are exposed to and to what extent property tax can help to increase the local own-tax revenues in order to cope with the challenges ahead. In order to gain a better understanding of the property tax in India the chapter draws on two municipal corporations that are at the same time the capital cities of their respective States, namely Greater Bangalore in the State of Karnataka and Greater Mumbai in the State of Maharashtra.58 Furthermore, they are megacities as they house more than 10 million inhabitants.

3.2.2.1

Is the Tax System Equitable and Efficient?

India is a three-tier federation with urban and local bodies having constitutional status since the 74th Constitutional Amendment Act (CAA) in 1992. Functions, finances, and powers of the Union (central government) and State Governments are laid out in the Constitution of India, which is known as the Union List, State List, and Concurrent List. Herewith, the Central Government levies Income Tax, Customs Duties, Central Excise (taxes on manufacturing) and Service Tax, and the State Governments levy Value Added Tax, Stamp Duties, Land Revenue, and State Excise (Table 3.36). The municipalities are also recognized as a tier of government within the constitution; however, their functions and finances are subject to the respective State Governments.59 Nonetheless, due to the 74th Constitutional Amendment Act, ULBs are recognized in a de jure sense as a third tier entrusted with a list of functions (in Schedule 12 of the CAA).60 The local functions assigned 58

Municipalities with more than 300,000 residents are classified as municipal corporations. Urban Local Bodies (ULBs) are subdivided along the demarcation line of 300,000 inhabitants with those towns/cities having less being called municipalities and those surpassing the 300,000 being called municipal corporations. In this chapter, municipalities and ULBs are used synonymously. 60 Functions that have to be accomplished by ULBs: (1) urban planning including town planning; (2) regulation of land-use and construction of buildings; (3) planning for economic and social development; (4) roads and bridges; (5) water supply for domestic, industrial and commercial purposes; (6) public health, sanitation conservancy and solid waste management; (7) fire services; (8) urban forestry, protection of the environment and promotion of ecological aspects; (9) safeguarding the interests of weaker sections of society, including the handicapped and mentally retarded; (10) slum improvement and upgradation; (11) urban poverty alleviation; (12) provision of urban amenities and facilities such as parks, gardens, playgrounds; (13) promotion of cultural, educational and aesthetic aspects; (14) burials and burial grounds; cremations, cremation grounds and electric crematoriums; (15) cattle pounds; prevention of cruelty to animals; (16) vital statistics including registration of births and deaths; (17) public amenities including street lighting, parking lots, bus stops and public conveniences; (18) regulation of slaughter houses and tanneries. 59

3.2 Case Studies: Megacities in Brazil, India, and China

99

Table 3.36 Tax sharing system in India (not including local taxes) 2011–2012 Central taxes Interest tax Gift tax Expenditure tax Estate duty “Shared” taxesa Union excise duty Customs Service tax Income tax Corporation tax Wealth tax Othersb State taxes Agricultural tax Tax on purchase of sugarcane (including cess) Entertainment tax Tax on goods and passengers Tax on duty and electricity Land revenue Stamp and registration fees State excise duty Sales tax Taxes on vehicles Hotel receipts tax All taxes

Tax revenues (Rs. in billion) 0.03 0.01 0.21 0.00

Sharing ratea C S

Tax revenue as % of all taxes

Tax revenue as % of GDP

100.0 100.0 100.0 100.0

0.0 0.0 0.0 0.0

0.0 0.0 0.0 0.0

0.0 0.0 0.0 0.0

80.2 70.3 69.2 68.9 68.8 50.6 40.3

19.8 29.7 30.8 31.1 31.2 49.4 59.7

22.0 11.2 0.1 9.9 6.6 10.2 1.1

3.6 1.8 0.0 1.6 1.1 1.7 0.2

1.52 2.69

0.0 0.0

100.0 100.0

5.1 24.6

0.8 4.0

19.20 116.81

0.0 0.1

100.0 99.9

0.8 1.2

0.1 0.2

173.00

0.1

99.9

0.0

0.0

70.81 668.26

0.1 0.2

99.9 99.8

0.0 0.5

0.0 0.1

0.5 0.5 0.5 5.3 43.1

99.5 99.5 99.5 94.7 56.9

0.0 0.1 4.6 2.0 100.0

0.0 0.0 0.7 0.3 16.4

1449.01 1493.28 975.09 1645.25 3228.16 7.87 162.56

751.25 3613.32 299.88 0.70 14,678.90

Source: Author; Indian public finance statistics 2013–2014, Ministry of Finance The “shared” taxes are assigned to the Central Government; however, the revenues are effectively shared with the State Governments b The tax share of the Union includes Foreign Travel Tax, Entertainment Tax, Betting Tax, etc. The tax share of the States includes taxes on professions, trades, callings and employment and non-urban immovable properties, inter-state transit duties, Advertisement Tax, Education Cess, Tax on Raw Jute, Betting Tax, etc. Source: http://mof.gov.in/reports/IPFStat201314.pdf a

follow the subsidiarity principle with municipalities being in charge of street lighting, municipal roads, solid waste collection and disposal, water supply, sewerage and drainage, health and sanitation, roads and bridges. Further, they provide all residual matters not provided by the Union or the States. The revenues allocated by the respective States are—apart from own revenues, such as property tax and in

100

3 Property Taxes Within the BRICS States

some cases the levy of Octroi61—determined by grants from the Centre and the respective State Governments, which are tied and/or untied, and formulated in form of transfers from the Central Finance Commission (FC) and the State Finance Commissions (SFCs).62 The Finance Commission expresses the equitability of the Indian system at this level, because—for instance—all stakeholders’ views are considered in the FC report: the State Government, the Union Government, representatives of local bodies, Commissions and Committees, the State Finance Commission and the Central Finance Commission. However, concerning fiscal decentralization, State governments devolve functions and finances to the municipalities at their own discretion. Herewith, certain problems arise as some States have “devolved functions, functionaries, and finances, but the functions have been encapsulated in terms of schemes, and local bodies do not have flexibility or autonomy in expenditure implementation” (Rao 2007: 168). Even more concerning in this context is the lack of reliable financial data on the local level: India as a three-tier federation draws back on two-tier financial data; therefore, Table 3.36 does not comprise the local government level. The constitution of the Finance Commission illustrates the only suitable (political compromise) approach due to the lack of objective financial data. This situation makes it difficult to assign appropriately resources to the local level in order to carry out core functions of local governments. Consequently, decentralization is still far from satisfactory. Urban local bodies lack empowerment in a de facto sense (Pethe 2013: 244). As the lower levels are highly dependent on the devolution of finances, the Indian federalism is referred to as “quasi federal” with “centripetal bias” (Rao 2007: 152; Pethe 2013: 244). In order to address these issues, the 14th Finance Commission (FC) recommended a comprehensive reform by moving towards a cooperative federalism (FC XIV 2014: 157). This shift will also have an influence on the local level, because the FC attests the local government level “considerable scope to improve revenues from own sources” (FC XIV 2014: 115). In general, the main revenue source of local governments constitutes the property tax, which has several drawbacks (Naresh 2004; Mathur et al. 2009; Rao 2013;

61

Octroi is an import tax of goods into urban area for consumption, use or sale. To coordinate the vertical and horizontal fiscal balance between the three tiers of government there are constitutional Bodies, the Central Finance Commission (FC) and the State Finance Commissions (SFC), that have to confer every five years to review the finances and to provide suggestions to improve further the fiscal environment among the respective levels of government. The SFC makes recommendations on (i) taxes, levies, and duties that are assigned to municipalities, (ii) taxes, duties, and levies shared between the states and municipalities, (iii) grants-in-aid, and (iv) further measures that augment the municipal finances (Mathur et al. 2011: 27). Thereafter, the Central Finance Commission is expected to assign supplement resources to the States based on the State Finance Commission’s recommendations in order to augment the Consolidated Fund of the States, which is further passed to the respective municipalities (and panchayats) via a distribution formula. Beyond that, the FC consolidates recommendations of the SFC and sponsors various studies on Union, State and municipal finances in order to retain reliable data on the finances and to enable the FC to make informed decisions. 62

3.2 Case Studies: Megacities in Brazil, India, and China

101

FC XIV 2014): Some States have not empowered their municipalities to levy property taxes as legislation is not passed or remains under consideration. Those municipalities empowered have a narrow and constricted tax base; only 50–55% of the 715 million urban properties pay property taxes. Furthermore, the property tax administration shows shortcomings in the coverage of properties and of clarity in ownership and tenure rights. Assessments that are based on rental values are characterized as inequitable due to the freezing of rents under the Rent Control Act. Furthermore, the definition of ‘reasonable rents’ or ‘hypothetic rents’ is based on arbitrary interpretations. Therefore, the property tax plays a minor role on the municipal level and is estimated to be 0.15–0.23% of the Indian GDP only (Mathur et al. 2009: 49). Nonetheless, Property Tax is the single biggest revenue source available to ULBs. In order to make the ULBs efficient bodies of self-governance, the outlined shortcomings of the property tax as source of own revenues were addressed in 2005: The Jawaharlal Nehru National Urban Renewal Mission (JNNURM) was put in place by the Indian Government aiming at supporting urban development and goes along with mandatory reforms of the property tax system. Herewith, the focus was on improved methods of property tax assessment and further improvement of property tax administration. The guidelines emphasize the need for a proper mapping by using geographic information system (GIS) in order to bring all properties on the tax roll, making the system work with self-assessment, and improving the collection of property taxes. In order to achieve an administrative “reasonable” tax system, benchmarks were established with regard to coverage of properties and collection of property taxes: within the JNNURM scheme, 85% of total properties should be subject to taxation and 85% of the tax should be assessed and collected (Mathur et al. 2011: 36). However, the results have been far short of expectations (Bandyopadhyay 2013: 78). In order to gain an insight into the Indian property tax system, the Finance Commission sponsored two studies with the following results: The FC XIII (2009) financed the first comprehensive studies on municipal finance in India to gain an insight on the urban property tax potential. The first study was based on 36 municipal corporations, out of 5161 cities and towns (Mathur et al. 2009). The study estimated that the property tax revenues range between 0.15 and 0.23% of GDP. Furthermore, there was a follow-up study to assess the municipal finance in more detail also based on FC data specially collected relating to 21 States (out of 28, Mathur et al. 2011). The latter study provides the most comprehensive overview on municipal finance so far with aggregated municipal revenue amounting to Rs. 444.29 billion against Rs. 470.26 billion in municipal expenditures (Table 3.37). The municipal revenue consists of own revenues (53%), and the balance was accounted for by assignment, devolution, and grants in aid from the States (33.4%),63 central government grants (5.3%), and 63

Some state revenues from Table 1.1 are shared with the respective municipalities. Revenue shares are often assigned to the ULBs with regard to Entertainment Tax, Profession Tax, and Surcharge on Stamp Duty.

102

3 Property Taxes Within the BRICS States

Table 3.37 Municipal revenue in India, 2007–2008

Own tax revenuec Own non-tax revenue Total own revenue Assignments and devolution Grants-in-aid Others Transfers from Central Government Finance commission transfers Total revenue Total expenditure

2007–2008 Rs. in billionb 152.78 82.44 235.21 91.71 56.76 28.18 23.73

Per capita Rs. 492 265 757 295 183 91 76

% of total revenue 34.4 18.6

8.69 444.29 470.26

28 1430 1513

2.0 100.0

20.6 12.8 6.3 5.3

% of GDPa 0.35 0.19 0.54 0.21 0.13 0.07 0.05 0.02 0.66 1.09

Source: Author; Mathur et al. (2011: 36) Factor cost, current prices b Originally assigned in Cr. The conversion is as follows: 10 lakh ¼ 1 million; 1 crore ¼ 100 lakh ¼ 10 million; 100 crore ¼ 1 billion ¼ 1000 million; 1lakh crore ¼ 1 trillion ¼ 1000 billion c Local taxes depend on the devolution of taxing powers by the respective States; among others the own taxes comprise Property Tax, Profession Tax, Vacant Land Tax, Octroi, Elementary Education Tax, Advertisement Tax, Water Tax, Sewerage Tax, Vehicle Tax, Lighting Tax, Fire Tax, Timber Tax, Company Tax, Tax on Carriage and Animals a

grants from the FC (2%). Taking both studies together, the property tax makes up between 42.9 and 65.7% of own tax revenues. However, despite the vital importance of the property tax to local governments the property tax revenues ranging between 0.15 and 0.23% of GDP are far below average within the developing countries—being 0.6% of GDP (Bahl et al. 2008). The FC statistics also demonstrate large inter-municipal variations with regard to property tax per capita reaching from Rs. 1334 in Mumbai Municipal Corporation to Rs. 25 in Patna Municipal Corporation. The shortcomings are assigned to administrative aspects such as lack of appropriate assessment and collection, and on political aspects, such as granting too many exemptions and low tax rates. The FC study revealed that there is tremendous scope for increasing property tax revenues even without increasing rates or any structural change of the tax base, but merely by increasing coverage, assessment and collection. The FC XIV (2014) commissioned one more study on municipal finances and service delivery (Chary and Prasad 2014). The FC recommends that the States ensure property tax reforms in order to tap the revenue potential of the property tax. This includes objective determination of the tax base, minimization of exemptions, regular revisions (in a four-to-five year term), strengthening assessment mechanisms, levy and collection, and improving the efficiency of billing and collection. With regard to the financial situation of local bodies, the sample draws on 478 ULBs. In attempting to deliver adequate services, local bodies are facing a financial gap that varies dramatically across the local level in India. The FC

3.2 Case Studies: Megacities in Brazil, India, and China

103

Table 3.38 Municipal finance in Mumbai, in billion Rs

A-1 1 2 3 4 5 6 7 A-2 1 2 3 A-3 A-4 A-5 A

Mumbai Taxes—Own sources Octroi (Net) Property Taxes Water Tax Water Benefit Tax Sewerage Tax Sewerage Benefit Tax Other Taxes Non-tax revenues—Own sources Fees, charges and others Water charges Sewerage charges Assigned revenues Other income Grants/Transfers from state Total—Revenue income

Revised estimates 2008–2009 67.16 43.00 13.52 1.08 4.59 2.21 2.75 0.01 32.46

Budget estimates 2009–2010 67.63 43.25 14.20 0.97 4.73 1.66 2.82 0.01 35.89

Budget estimates 2010–2011 72.84 46.50 15.40 0.97 5.20 1.66 3.10 0.00 39.97

% 2010–2011 58.6 37.4 12.4 0.8 4.2 1.3 2.5 0.0 32.2

24.70 5.19 2.57

28.25 5.02 2.62

32.33 5.02 2.62

26.0 4.0 2.1

7.66 2.36 109.63

6.52 3.16 113.20

7.04 4.47 124.32

5.7 3.6 100.0

Source: PWC (2010: 56)

recommends the introduction of a “municipal finance list” in the Constitution, which comprises all taxes already contained within the domain of the local bodies, viz. property tax, vacant land tax, service charge on Central and State properties, trade licensing, building permission fee, impact fee, and development fee. Beyond that, the list could include motor vehicle tax, surcharge on stamp duty, professional tax, entertainment tax, and VAT. According to the report, such a list is essential for the SFCs to work out detailed financial allocations to local bodies. The reviewed city sample—Greater Bangalore and Greater Mumbai—illustrates the financial situation of municipal corporations in more detail: The revenue source of Mumbai can be split into own revenues and grants (Table 3.38). The own revenues make up to 90.8% of the total revenue income, which demonstrates the negligible dependence on State Government grants (3.6%). From a public finance perspective, Mumbai shows that self-dependency is possible on the local level. However, Mumbai is a class by itself, which could be classified as ‘goose that lays the golden egg’. With regard to tax revenues, some 70% of State tax revenues and more than 11% of national tax revenues can be attributed to the Corporation (Pethe 2013: 244).64 The main own-tax source constitutes the import

64

According to Pethe (2013: 246), the per capita income of Mumbai metropolitan region is double the average of the respective State Maharashtra and about three times the national average.

104

3 Property Taxes Within the BRICS States

Table 3.39 Revenue and expenditure according to budget and actuals, BBMP 2010–2011 Receipts in billion Rs Budget 84.47 Actuals/RE 33.20 Expenditure in billion Rs Budget 88.61 Actuals/RE 36.26

2011–2012

2012–2013

2013–2014

2014–2015

94.01 40.03

99.41 38.30

85.21 30.93

60.26 28.94

94.01 38.39

99.41 43.58

85.21 33.43

60.26 29.27

Source: Author; BBMP (2015: 167–168) Table 3.40 Property tax according to budget and actuals, BBMP, in billion Rs Budget Actuals/RE

2009–2010 11.00 6.57

2010–2011 16.50 8.23

2011–2012 15.00 7.93

2012–2013 20.00 10.85

2013–2014 32.00 7.27

2014–2015 21.35 7.83

Source: Author; BBMP (2015: 182)

tax into urban areas, so-called Octroi (37.4%),65 followed by the property tax (12.4%), which is seen as a benefit tax. Further benefit related fees and charges make up to 26.0% of total revenue income. Overall, about 50% of total revenues (including taxes, charges, and fees) are linked to benefits received. The financial resources of Bangalore are Property Tax, Advertisement Tax and Licence Fees, Grants from State and Central Government. The prominent source of revenue is the Property Tax. BBMP shows a large discrepancy between the budget plan and revised estimates, which are the result of violation of basic principles of public financial management (BBMP 2015: 164f). The overstatements are in excess of 100% in most years (Table 3.39), which also applies to the property tax revenues (Table 3.40). The low financial management level with high budgets against revised estimates (RE) or even missing data are serious areas of concern in India. The review shows that India looks back on a three-tier (administrative) tax structure with functions and finances assigned to Union Government, the State Governments and to some extent—functions only—to the ULBs. However, it is highly questionable whether it is possible from public finance perspective to effectively manage three-tier federalism with two-tier financial statistics. The main problem that arises is vertical and horizontal asymmetric information among the governmental entities—especially in the context of vertical transfers and horizontal equalization schemes: Neither the fiscal power nor the expenditure needs are known in order to achieve vertical and horizontal equitability; unfunded mandates are habitually the outcome.

65

Greater Mumbai is the capital city of Maharashtra, one of the only States where Octroi is still levied. However, only municipal corporations are allowed to levy Octroi within the State.

3.2 Case Studies: Megacities in Brazil, India, and China

3.2.2.2

105

Taxes on Property in India: An Overview

The tax assignments for the Union Government and the State Governments have constitutional status enumerated within the Union List, State List, and Concurrent List. Furthermore, property tax is mostly assigned to the ULBs. Property is generally affected by different taxes from different levels of government: • Income Tax (1961) in the case of individuals, incomes generated from house property, business and profession, capital gain and other sources are subject to the tax.66 Women and senior citizens are extended certain privileges. With the purpose of simplification, earnings below 200,000 Rs. annually (the overwhelming majority of the country) are exempt from paying any income tax. In total, only 2.9% of the population (about 36 million people) filed income taxes.67 Those making between 200,000 and 500,000 Rs. are subject to 10%; those earning between 500,000 and 1 million Rs. pay 20% tax; and those above 1 million face a 30% tax rate. An education cess of 3% is levied on the total tax liability. Furthermore, since 2013, Tax Deduction at Source (TDS) is applied at the transaction stage by deducting 1% of the property value, if the property sold exceeds Rs. 5 million. TDS was introduced because the property values are usually undervalued and underreported; furthermore, half of the transactions are without a PNA card (Permanent Account Number), a number assigned by the income Tax Department.68 • Capital Gains Tax is levied on the profit (capital gain) that arises if property is transferred in the event of selling or exchanging the property. The capital gain is derived from the sale price deducting expenses for acquisition and improvements. If the property was held for less than 3 years the Income Tax Slab Rates apply; in the case of more than 3 years of holding the property, 20% applies. • Service Tax on Sale of Property (1994) is applicable if the property to be sold is under construction. The effective rate of the Service Tax on property is 3.625% or 4.35% depending on the size and the transaction value of the property. • Wealth Tax (1957) is levied at 1% on a taxpayer’s net asset in excess of Rs. 3 million.69 The tax base is the market value of urban land, guesthouses, residential house, commercial buildings, motorcar, jewellery etc. As most moveable items (jewellery etc.) are stashed from accounting, the tax might be abolished from the fiscal year 2015–2016.70

66

More details on property related taxes that are subject to income tax see Annex A.3. Palash Gosh. 2013. How many People in India Pay Income Tax? International Business Times. Available at: http://www.ibtimes.com/how-many-people-india-pay-income-tax-hardly-anyone1294887 [Accessed: 10 December 2015]. 68 Available at: http://www.charteredclub.com/tds-on-property/ [Accessed: 10 December 2015]. 69 Available at: http://www.incometaxindia.gov.in/tutorials/house-property.pdf [Accessed: 10 December 2015]. 70 Instead, there might be a surcharge on taxable high income (Arun Jaitley. 2015. 2015–2016 budget speech, 28 February 2015). 67

106

3 Property Taxes Within the BRICS States

• Estate Duty (Inheritance Tax) was abolished in 1985. With the government citing excessive administrative costs against realized tax yields, the tax was taken off the statute book. • Stamp Duty on Property (1899) is a transaction tax collected by the States. The stamp duty rates vary among the States. Stamp duty is payable for transfer of title of property and registration with the Government. Some States give concessions in case the new owner is female. • Property Tax and Vacant Land Tax: There is no comprehensive system of property taxation. The recurrent property tax not only differs among the State Governments (due to the discretionary power of the States); it also varies among the municipalities within the States due to property tax reforms conducted within several municipal corporations. Most cities in India are based on Area Rental Value assessment, which is mostly defined as “gross annual rent of land and buildings at which they might reasonably be expected to let from year to year” (Bagchi 2003: 4482). The term ‘reasonably’ involves a great deal of room for interpretation. Due to missing information on the rental values of properties, it has become an “assessors and valuers paradise” (Bagchi 2003: 4482). Rental values are estimated by inspectors based on a set of internal guidelines and a visual inspection of each property. Furthermore, Rent Control Laws are implemented, referring to ‘fair rent’ or ‘standard rent’, which have set limits on a ‘reasonable’ rent. Rent Control locked the rental value over time to unrealistic low values. Both, Rent Control and discretionary powers of authorised officers had important implications on the overall tax revenue generation and the tax burden among the taxpayers. Therefore, several cities reformed their property tax systems by moving toward the Capital Value System. Generally, Rental Value (income) and Capital Value (wealth) are the same, i.e. if property is put to best possible use; in this case, the net stream of rental payments discounted to the present value approximates the current capital value of the property. The property tax of Greater Mumbai is based on the capital value system, which constitutes at the same time the tax base for several other taxes. According to the Mumbai Municipal Corporation Act, the property tax is divided up into the General Tax (including fire tax), Water Tax, Water Benefit Tax, Sewerage Tax, Sewerage Benefit Tax, Education Cess, and Street Tax (Section 139). The property tax payable in Greater Bangalore is based on Unit Area Value (which features assessment under the capital value system according to Gosh and Kundu 2011: 109; and is referred to as quasi-capita system by Lall and Deichmann 2006: 5) with 20% tax rate applied. Beyond that, on the tax payable, another 15% Health Cess, 6% Library Cess, and 3% Beggary Cess are applied constituting the gross property tax payable. In summary, the taxes related to property are mostly assigned to the Union Government, with the exception of Stamp Duty being assigned to the State Governments. Beyond that, the local governments levy the property tax. Most taxes outlined are paid on the transaction stage. The recurrent property tax constitutes a tax base for other levies added on top. However, only the ‘net’ property tax is within the focus of further scrutiny.

3.2 Case Studies: Megacities in Brazil, India, and China

3.2.2.3

107

What Are the Operational Facts of the Property Tax?

In order to provide a solid basis for the performance of the property tax within the respective case studies, a discussion on the political and administrative aspects of the property tax in India is necessary. The tax power is vested with the States and delegated by law to the local bodies. The States decide upon the tax base, exemptions, the tax rates (minimum and maximum) and their revision, ceiling and floors, method of assessment, and the procedure of collection. Therefore, the overall property tax design lies in the hand of politics. Within the administration’s hands lie the tasks for identifying and assessing the properties and taxing, collecting and enforcing the property tax. Both, political and administrative aspects will be discussed by referring to the sample cities.

Greater Bangalore Municipal Corporation The property tax of Bruhat Bangalore Mahanagara Palike (BBMP), which is translated as the Greater Bangalore Municipal Corporation, is defined within the Karnataka Municipal Corporation Act 1976 (KMC Act 1976).71 Bangalore has already faced two property tax reforms; the first was undertaken in 2000 within Bangalore City Corporation, and the second reform was combined with the formation of the BBMP by the State Government in 2007.72 However, the 2007 amalgamation has not yielded the expected gains; therefore a new governance structure is expected.73 At the time of the 2007-merger, there was Annual Rental Value under the optional self-assessment system and the Capital Value System in place within the former BBMP area. Therefore, it was necessary to find a coherent property tax approach. In 2008, the Unit Area Value System was put in place by inserting a new section 108A into the Karnataka Municipal Corporation Act 1976. Since then, a uniform property tax is applied to the entire BBMP. The Annual Rateable Value (ARV) system was predominantly used before the formation of the BBMP. It shows some similarities to the Unit Area Value (UAV) system. The ARV system was based on the expected rent from the property; therefore, it would have reflected the location, quality of construction, usage, and age of the building without Rent Control. All the physical and usage features are typically reflected in the Annual Rental Value calculated per sq. ft. per month. The

71

Bangalore is the capital of the State of Karnataka. The BBMP was formed out of seven City Municipal Councils, one Town Municipal Council, and one hundred and eleven villages in the Bruhat Bangalore Mahanagara Palike. While the urban area tripled by the amalgamation (from 226 to 756 sq. km) the population increased from 4.5 to 5.6 million (TSFC Karnataka 2008: 166). 73 An Expert Committee consisting of 1000 stakeholders worked out a holistic approach for restructuring BBMP. The Committee reviewed best practices, heard citizen suggestions, etc., and set up recommendations for spatial planning, public finance, HR, governance and administration, etc., see BBMP (2015). 72

108

3 Property Taxes Within the BRICS States

Unit Area Value system is based on the expected returns from the property depending on the location and usage of the property, and the age of the building. The new assessment method is called Unit Area Value, because it is based on the Unit measured per square foot per month, whereas the Area of the unit is reflected by a particular location (street name), which, in turn, determines the assessment Value by applying a property rate (value) to the unit based on the location. The Unit Area Values, so-called rates, are based on zones (area and street names), which were retained from the Rental Value system after the amalgamation to BBMP in order to incrementally change the property tax system. With the latest tax reform, self-assessment was introduced in order to bring all un-assessed properties into the tax net. In this context, turning away from the tax authority toward taxpayer with regard to tax assessment has the huge advantage of switching the responsibility for property assessment. Self-assessment is mandatory, which includes so far unlawful properties, which now have to file the returns (physical and valuation-related information) to pay property tax. The new measures help to raise local own revenues, they improve horizontal equity among the taxpayers, and they increase the confidence that all taxpayers pay their due tax, which, in turn, results in higher tax compliance. Overall, the reforms in Bangalore are attributed by Bandyopadhyay (2013: 8) as “success story”. Political Decisions The tax base constitutes “buildings or vacant lands or both” situated within the corporation (108 KMC Act 1976). Exempt from property tax payment are several types of property according to section 110 KMC Act 1976. Generally, exemptions are granted to the following buildings and lands: agricultural land, places of public worship, properties used for charitable purposes (e.g. choultries; shelters for the destitute), ancient monuments, charitable hospitals and dispensaries, burial and cremation grounds, Government lands set apart for free recreational purposes, building or lands exclusively used for student hostels or educational purposes, offices of registered Labour Associations. Beyond that, buildings or lands belonging to the Central Government or any State Government, or the Bangalore Development Authority, or the Karnataka Housing Board. Furthermore, the Corporation exempts 50% of the property tax to self-occupied buildings used for residential purposes (108 KMC Act 1976) and properties of any ex-serviceman or family of a deceased ex-serviceman. However, all properties that are fully exempt have to pay a service charge instead. In order to exempt properties from tax payment the claimant has to apply to the Commissioner by filling out Form VI under the selfassessment scheme. The assessment base is defined as Unit Area Value, which is based on the “means an average rate of expected returns from the property per sq. ft. per month determined by the Commissioner, Bruhath Bangalore Mahanagara Palike on the basis of the average market rate determined through mass appraisal method or real estate market information or any other reliable source or combination of these sources that he may consider as sufficient and reasonable having regard to the

3.2 Case Studies: Megacities in Brazil, India, and China

109

location, type of construction of the building, nature of use to which the vacant land or building is put, area of the vacant land, built-up area of the building, age of the building, parking area of vehicles in non-residential buildings where there is a charge and such other criteria as may be prescribed (108 KMC Act 1976).” In order to determine an average rate of expected returns, the corporation area is divided into six zones (Table 3.41, Column 3). The zones are not a contiguous area; while zone A represents the highest value with regard to residential area, zone F represents the lowest. The zones are further clustered by different construction types of buildings (Column 1) and depend on the residential user status (Column 2). Within this matrix, different rates (values) per square foot per month are assigned accordingly. The rates are based on the ‘stamp values’ or ‘guidance values’ published by the Department of Stamps and Registration. They do not reflect capital values, as they do not refer to transaction data. However, due to a missing active and reliable real estate market, the published guidance values of the Department of Stamps and Registration are the only objective tool available for making a reasonable classification of zones. Other methods of classification are subjective and run the risk of official discretion. The guidance value published by the Department of Stamps and Registration is a reasonable basis for property tax assessment. The rates were the assessment base in the old ARV system as they are in the new UAV assessment. The assessment only refers to the first three building categories that are zone specific, while categories IV and V are special cases with a lump sum provided (Table 3.41). The value zones (areas, street names) are published and therefore transparent to the taxpayers. The KMC Act, 1976, has provision for a general revision of the rates once in 5 years. However, it was in 2000 that the first revision after 1972 took place (Bagchi 2003: 4486). The last revision of zonal rates was in the second phase of tax reform (after 2007 BBMP merger). Here, properties in more than 10,000 localities moved into the next higher zone (Bandyopadhyay 2013: 19). In order to keep the rates increase incremental, a cap has been provided, which limits a shift to the next higher zone only (even though the shift would have been two zones higher). In order to calculate the property tax, the built-up area has to be determined, which is the total area covered by buildings above the plinth area; beyond that, the basement, the garage, and balconies are taken into the built-up area calculation.74 The built-up area constitutes the main operand in order to calculate the property tax.

74

“Built-up area” means total area covered by building or high-rise buildings above the plinth level, and including all covered area like basement, mezzanine flooring, balcony whether covered or not; garage area, constructed boundary of swimming pool, fuel storage tanks constructed underground or above the ground, storage of merchandise in open space like timber, granite, bricks etc., stilts meant for parking and telecommunication and other towers and hoardings erected on the surface or top or any other open space of land or building but does not include—(a) court yard at the ground level, garden, rocky area, well and well structures, plant, nursery platform around a tree, overhead water tank, fountain, bench with open top and the like; (b) drainage, culvert, conduit, catch-pit, gully pit, chamber gutter and the like; (c) compound or boundary wall, chejja, uncovered staircase, watchman booth/pump house not exceeding 3 sq. m and sump tank.

110

3 Property Taxes Within the BRICS States

Table 3.41 Determination of unit area value (per sq. ft/per month) Column 1 Description of the property (including apartments) with sub category I RCC or Madras terrace buildings and where the flooring is partly cement/ red oxide and partly mosaic/tile/marble etc. II RCC or Madras terrace and where the flooring of the entire house is either cement or red oxide flooring III Tiled/sheet of all kinds IV

V

All hutments, house built/ allotted for the poor by the government under any scheme, all houses declared as slum by the Karnataka Slum Clearance Board of the Commissioner BBMP having a built-up area less than 300 sq. ft. and selfoccupied Special category:

Column 2 Status

Column 3 Zone Zone A B

Zone C

Zone D

Zone E

Zone F

Tenanted Owner

5.00 2.50

4.00 2.00

3.60 1.80

3.20 1.60

2.40 1.20

2.00 1.00

Tenanted Owner

4.00 2.00

3.50 1.75

3.00 1.50

2.50 1.25

1.60 0.80

1.40 0.70

Tenanted Owner Tenanted

3.00 2.50 2.00 1.60 1.00 1.50 1.25 1.00 0.80 0.50 Annual composite tax (Lump sum) of Rs. 80.00 + Cess Annual Composite tax (Lump sum) of Rs.160.00 + Cess

0.80 0.40

Owner

Annual Composite tax (lump sum tax) for properties falling under the 110 villages added to BBMP subject to following conditions: Owner-occupied ordinary village houses. See conditions (iv) Extent: Houses with built-up area including covered car park Lump sum rate area Less than 300 sq. ft Rs. 100.00 + Cess More than 301 sq. ft but less than 500 sq. ft Rs. 250.00 + Cess More than 501 sq. ft but less than 1000 sq. ft Rs. 500.00 + Cess More than 1001 but less than 1500 sq. ft Rs. 750.00 + Cess More than 1501 sq. ft Rs. 1000.00 + Cess If the property is tenanted then twice the lump sum tax + Cess is applicable Source: BBMP, Property Tax Handbook (2009)

The built-up area multiplied by the Unit Area Value in column 3 (Table 3.41), which, in turn, depends on the status of occupation (self-occupied or tenanted as in column 2), makes up the Monthly Unit Area Value (MUAV). The MUAV multiplied by 10 makes up the Taxable Annual Value (TAV). A two-month deduction is

3.2 Case Studies: Megacities in Brazil, India, and China

111

given in lieu of granting allowances for maintenance of the building. Depending on the age of the building, a second deduction is granted on the TAV (Table 3.42). As outlined, the assessed market value is the sum of the built-up area multiplied by the Unit Area Value (Table 3.43). Table 3.42 Depreciation table 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21

Age of the building >3 years 3 years >6 years 6 years >9 years 9 years >12 years 12 years >15 years 15 years >18 years 18 years >21 years 21 years >24 years 24 years >27 years 27 years >30 years 30 years >33 years 33 years >36 years 36 years >39 years 39 years >42 years 42 years >45 years 45 years >48 years 48 years >51 years 51 years >54 years 54 years >57 years 57 years >60 years 60 years

Depreciation rate in percentage on taxable annual value 3 6 9 12 15 18 21 24 27 30 33 36 39 42 45 48 51 54 57 60 70

Source: BBMP, Property Tax Handbook (2009)

Table 3.43 Calculation of property tax, greater Bangalore • Tax on Built-up Area: ▪ Built-up area  Unit area value  10 months ¼ Total 1 (T1) ▪ T1  Applicable depreciation ¼ Taxable annual value (TAV, T2) ▪ TAV  20% ¼ Property tax (T3)a ▪ Property tax  5% ¼ Rebate for early payment (T4) ▪ T3  T4 ¼ Net property tax payable • Tax on Excess Vacant Land (if the land exceeds three times the plinth area of the building): ▪ Total area—Plinth area of building ¼ Open area ▪ Open area—(3  Plinth area building) ¼ Excess vacant land ▪ Excess of vacant land  Unit area value  10 ¼ Taxable annual value Source: BBMP, Property Tax Handbook (2009) Bangalore levies a health cess (15%), a library cess (6%), and a beggary cess (3%) along with the property tax amount. The cess is used for specific services related to the cess paid; therefore, the benefit principle applies. However, the effective tax rate on property increases

a

112

3 Property Taxes Within the BRICS States

Example: Weightage factor Plinth area 800 sq. ft Built-up area 1750 sq. ft Total area 5000 sq. ft Status Owner-occupied Unit area value Zone C Year of construction 1985 Taxable value of built-up area: 1750  1.80  10 ¼ 31,500 31,500  0.33 ¼ 10,395 31,500 – 10,395 ¼ 21,105 Taxable value of excess vacant land: 5000  800 ¼ 4200 sq. ft 3  800 ¼ 2400 sq. ft 4200  2400 ¼ 1800 sq. ft 1800  10  1.80 ¼ 3240

1.80 33%

The Taxable Annual Value is the basis on which the tax rate is applied. Herewith, the Property Tax has to range between 20 and 25% for residential property of the taxable annual value of a building, vacant land or both (108A KMC Act 1976). The tax rate applied in 2015 is 20%. Administrative Practices The Greater Bangalore Municipal Corporation is subdivided into eight zones that are further subdivided into 198 administrative Wards. In charge of all administrative aspects of the property tax is the Revenue Department (Table 3.44), not the Wards. In more detail, duties and responsibilities with regard to property taxation are prescribed according to the job descriptions provided by the Corporation75: • Up to a site area of 4000 sq. ft. the Revenue Officer is responsible for the property assessment, for recovery and exempting property tax, for Katha Registration76 (property tax register), and for any appeal pertaining to property taxation. • The Assistant Revenue Officer is in charge of three to four Wards and the assessment (up to site area of 1200 sq. ft.) and collection of property tax within the assigned Wards. • The Assessor is responsible for the identification of under-assessed and/or unassessed properties and gives proposals—for instance with regard to fixation

75

Available at: http://bbmp.gov.in/documents/10180/532690/Duties+and+Responsibality+Eng. pdf/ab61aca3-ce7b-417f-b5b5-70c4714aff2f [Accessed: 15 December 2015]. 76 Katha registration of a property applies to the recording of property in the property register, which is maintained by a Municipality or Corporation. When a property is registered with the Municipality or Corporation, it is assessed to tax, assigned a municipal number. The person primarily responsible for paying the property tax is also recorded.

3.2 Case Studies: Megacities in Brazil, India, and China

113

Table 3.44 Revenue department—organization chart Commissioner of BBMP Special/Additional Commissioner (Finance and Welfare) Zonal Level Zonal Additional/Joint Commissioner Zonal Deputy Commissioner Revenue Officer Assistant Revenue Officer Executive Staff (Assessor, Manager, Revenue Inspector/Tax Inspector, Tax Collector)

Head Office Deputy Commissioner (Revenue)

Source: Author; BBMP

and revision—that rely on property tax assessment. Furthermore, the Assessor is responsible for arrear tax collection. • Within the administrative hierarchy, the Manager is responsible for maintenance of overall property tax data (i.e. files and registers). • The Revenue Inspector supervises the Tax Inspectors; both verify the Hand Book and the Receipt Book; prepare the defaulters list; identify unassessed properties and bring them into the property tax net; propose a unique municipal number for new properties in the respective street after verification of the assessment register and the location of the property; identify new constructions and alterations of existing structures; identify changes in usage status, and list all BBMP properties and maintain details of properties. • The Tax Collector maintains the Hand Book by listing all the properties streetwise and ward-wise. He sends notice to all tax payers for payment of tax, prepares the defaulters list, sends notice to defaulters, and in case of non-payment he collects the property tax by visiting house-to-house. Tax receipts are issued only by computer. In the first place, property identification is done by the property owners themselves, as the self-assessment scheme is in place. The property owners have to fill out a specified ‘Return’ that applies to residential use of property.77 The return form provides the necessary data needed in order to calculate the property tax. Due to the shift toward the self-assessment scheme, many properties formerly outside the tax net have been identified. Furthermore, the BBMP has introduced the Geographical Information System (GIS) in order to bring all properties in the tax net by assigning a unique property identification number (PID) to each property. So far, there are 70% of all properties identified and allotted a PID number under GIS.78 This has 77

There are several Return forms applied: Formula I is for properties already having a PID number (mostly in erstwhile BMP area), Form II is for all properties still having Katha Number (properties in CMC, TMC and the 110 villages that have been added to BBM), and Form III is for the properties that have neither PID nor Katha number (unlawful/unauthorised properties). Beyond that, there is Form VI for properties that are exempt; however, they have to give all property tax details in order to calculate the service charge. 78 BBMP Budget Speech, 2014–2015: 35.

114

3 Property Taxes Within the BRICS States

resulted in a more accurate data base of all properties in BBMP. In order to achieve compliance within the self-assessment scheme, there is a need for strict validation of property tax data (new constructions, alterations, new status of occupancy etc.). The property tax register holds all relevant data regarding the property (Katha or GIS based) and owner or occupier. The GIS-based property tax system was launched in 2012 assigning to each single property a unique PID that is a combination of Ward number, street number, and plot number. In this context, a unique street number has been assigned to each street. The property register is open to the respective owners or occupiers in order to inspect the entries and receive an authorised certificate containing all details of buildings or lands or both in the register (112B KMC Act 1976). The established property tax register is used with high-speed connectivity with information available at any point in time; therefore the accuracy of the output on collection and defaulters has increased. After receiving the self-assessment Return (I–III or VI), the administration calculates the property tax. In order to self-assess the tax, there are property tax calculators provided on the homepage of the BBMP. The assessment process is objectivised by the Property Tax Board (IX-A KMC Act 1976) that assists the BBMP with regard to the determination of the zonal rates applied.79 Beyond that, the Board recommends ways of further improving the assessment system and recommends modalities and basis for periodic revision. Revisions of the zonal rates—in order to stabilize property tax revenue—might be carried out once in 3 years by 15–30%. The increase might be partially absorbed by the municipal council, which determines the property tax rate. Along with the submission of the Return, each property owner or occupier has to pay the amount indicated by the self-assessment Return, which constitutes the tax bill, at a bank and then hand over the filled self-assessment Return and a receipt for payment to the local ward office. After the final assessment is made by the respective officers and the submitted Return is deemed correct and complete, the final property tax is assessed and the copy of the final assessment is sent to the owner or occupier. The property tax bill can be paid in various ways; it might be paid as online property tax payment, or at various city service centres (where other public services are also provided), help centres, and at various banks. After payment and revision of the self-assessment by the tax authorities, a tax receipt is issued containing the name of the person to whom it is granted, the property identification number, the date of payment, the way of payment, the period for which the payment has been made, and the amount being paid. The property tax can be paid in two equal instalments—one before 30th May and the other by 29th November. If the full amount is paid in one instalment before 30 April a 5% tax rebate is granted on the property tax bill. If—within the procedure—the property owner or occupier fails to submit (a correct and complete) Return, or fails to pay the property tax in advance, the

79

The 13th Finance Commission of India recommended the establishment of Property Tax Boards on State level. They assist urban local bodies in determining and collection of property tax.

3.2 Case Studies: Megacities in Brazil, India, and China

115

respective administrative authority might take further steps in order to enforce the property tax. In the case of unpaid tax, the respective authority sends a notice of demand, which has to be paid within 30 days, otherwise the Commissioner is allowed to sell (at public auction) the movable property of the defaulter (27 KMC Act).80 In the case, of an incorrect or incomplete Return, the respective authority has the right to inspect the identified land and/or building in order to assess the tax payable. In the case of tax evasion due to incorrect self-assessments, a penalty is applicable. If the re-assessed tax deviates more than 5% of the tax paid along with the Return, the evaded tax is payable together with a penalty being not less than twice the tax evaded plus interest on the withheld tax amount calculated at 2% per month (108A (13)b KMC Act). Objections against the assessment and the penalty may be turned in to the Commissioner or the authorized officer within a period of 30 days from the date of receipt of a copy of the final assessment. The Commissioner or the authorized officer considers the objections and either confirms or revises the assessment within a period of 60 days from the date of filing objections. The decision is final; a tribunal or competent court is not taken into account for decision-making with regard to the assessment or reassessment. A copy of the order is sent to the owner or occupier concerned.

Municipal Corporation of Greater Mumbai The property tax of Brihanmumbai Municipal Corporation (BMC), which is translated as the Municipal Corporation of Greater Mumbai, is defined within the Mumbai Municipal Corporation Act 1899 (MMC Act 1899).81 BMC had a property tax reform in 2010. Mumbai Municipal Corporation implemented the capital value system in order to solve the problems that came along with the Annual Rental Value (ARV).82 From a conceptual approach, the ARV and CV systems are identical whenever the property is put to its highest and best use. In this case, the net stream of rental payments discounted to the present value approximates the current capital value of 80

In order to do so, the Commissioner or any officer charged with the execution might even “break upon any outer or inner door or window of a building in order to make the distress, if he has reasonable ground for believing that such building contains property which is liable to seizure” (28 KMC Act). 81 Mumbai is the capital of the State of Maharashtra. 82 ARV generally lacks transparency with regard to residential letting rates that were not published and the difficulties to calculate and assess the tax liabilities. In contrast, CV is based on a formula; therefore, self-assessment is more transparent. The ARV system for residential properties in Mumbai was based on 187.5% or 83.5% of ARV depending on the existence, respectively, non-existence of water meters within each household. The ARV system depended on the gross annual rent that the property might bring minus an allowance of 10% for maintenance. Data on the number of properties, their classification (commercial, residential, etc.) were not available at that time.

116

3 Property Taxes Within the BRICS States

the property (Karnik et al. 2004: 3821). However, this is seldom the case due to speculation or—as often the case in India—due to Rent Control. According to Karnik et al. (2004: 3819), the main problem involved with the ARC system was the freezing of rents, which resulted in inherent inequalities and unfairness. For instance, suburban residents in Greater Mumbai were facing disproportionately higher tax burdens than those living in the city centre; this was because newer buildings (mostly owned by lower and middle income classes) were outside Rent Control while older buildings in the city centre (mostly owned by the richer income groups) were facing rent freeze. Beyond that, the rent controller was in charge of fixing the rent for properties under the Rent Control Act, which formed the basis of assessment. Properties where Rent Control was not applied were facing other forms of discretion in the assessment process, because ‘reasonable’ rental value was not defined and guidelines for a fair and objective assessment were not provided. Revenue Officers had the possibility to agree on informal assessments with the taxpayers. These problems involved with the ARC system are diminishing by moving from ARV toward CV system. The new CV system came into force from 26th August 2010 as the Third Amendment to the Mumbai Municipal Corporation Act 1899. Thereafter, expert groups laid down the rules and classifications of the lands and buildings; building values, for instance, are classified by referring to the age of building, type of construction, user category, etc. A consultant recommended tax rates that were applied to the capital value. From December 2012, properties were firstly billed according to the capital value in Mumbai Corporation. In order to prevent sharp increases in property tax burdens the increase was limited to a maximum three times of the existing tax for residential houses having a carpet area of more than 500 sq. ft (46.5 m2); those residential houses being below 500 sq. ft. were exempt from paying property tax between 2010 and 2015. From 2015 onwards, all properties will be in the property tax net. Artificially low rents and the inherent inequalities that accompanied ARV will diminish. Political Decisions The tax base in Mumbai constitutes—according to section 143(1) MMC-Act—land (i.e. land appurtenant to the building and open land) and buildings (i.e. duplex flat, garage, penthouse, row house) that are classified according to user categories (i.e. residential, commercial, and industrial). The same section also names the exemptions granted within Greater Mumbai. Exemptions are provided by municipal law and are granted to certain property classes, such as religious and charitable institutions. Further, governmental properties used for public purposes and ‘Diplomatic or Consular Missions of a foreign State as Government’ are exempt. However, Central Government and State Government make payments in lieu of the property tax that are reasonable and fair (Section 144, MCC-Act). Whenever there is a profit purpose on these properties (e.g. trade and business) or a rent is derived from these properties, a property tax (according to the residential user category) is to be levied.

3.2 Case Studies: Megacities in Brazil, India, and China

117

A concession is granted to small tenements below a certain threshold value (Section 144 MCC-Act). They have to pay eight-tenths of the assessed property tax amount. As slum properties are so far outside the tax net, BMC plans to tax slum properties from the fiscal year 2015–2016 onwards. However, those settlements are not taxed according to the market value; instead, they have to pay a lump sum amount charged annually.83 According to the civic body’s plan, slum owners will have to pay between Rs. 2400 and Rs. 18,000 as property tax annually, depending on the size and type of huts.84 The lump sum paid does not result in regularization of those properties, but is levied for the civic amenities provided. (Re)assessment85 The determined assessment practice in Mumbai is the Capital Value system. The assessment base is the capital value. It indirectly depends on the stamp duty ready reckoner rates (values), which are governmentally approved persquare-meter rates (values) used as reference or base price for different user categories: vacant land, residential, commercial (office/shop), and industrial. The rates provided by the ready reckoner are differentiated according to wards, zones, and sub-zones of the municipal corporation. This means that for each sub-zone a fixed rate is given for vacant land, residential, commercial, and industrial properties per sq. ft. The zonal rates for vacant land or built-up area constitute the basis of the relative base value (rates multiplied by m2) in order to calculate the capital value. The rates (values per sq. ft. per month) are hereby revised each 5 years; they are allowed to increase up to 40% against the previous year of such revision. In order to fix the capital value, there are additional weightage factors applied to the relative base value in order to determine more precisely the value within the respective sub-zone. The weighting factors applied to built-up area reflects construction, usage, and age of the buildings (Table 3.45). The capital value of vacant land is fixed by the weighting factor of one. However, the weighting factors are not linked to actual property values (by regression analysis) or based on any public finance rationale. The revision of the rates might bring in subjective elements of property tax assessment.86 As outlined, the assessed market value is the sum of the built-up area multiplied value attributes (Table 3.46).

83

IPTI President’s Message—February 2016. Ibid. 85 All municipal laws provide the timeframe for re-assessment, which is de jure between four and five years. De facto, however, the period between re-assessment is about 20–30 years (Gosh and Kundu 2011: 98). 86 There is no continuance with regard to the weightage factors since the introduction in 2010; e.g. older buildings are more privileged from 2015 onwards as the weighting factor for buildings older than 50 years shifted from 0.7 to 0.5. 84

118

3 Property Taxes Within the BRICS States

Table 3.45 Weighting factors Municipal Corporation of Greater Mumbai Weightage Weightage according to according to residential nature and buildings, among type of Weightage according others. . . building to age of the building 1.0 5 years 1.00 Residential 0.50 RCCa user Waiting 0.50 Puccab 0.7 >5  10 years 0.95 room Swimming 0.50 Kachac 0.5 >10  15 years 0.90 pool Service 0.125 >15  20 years 0.85 floor Dry 0.125 >20  25 years 0.80 balcony Garage 0.125 >25  30 years 0.75 >30  35 years 0.70 >35  40 years 0.65 >40  45 years 0.60 >45  49 years 0.55 >49 0.50

Weightage according to floor factor for RCCa building with lift Basement used for 0.70 car-parking Basement used not for 1.00 car-parking Lower ground floor 1.00 Upper ground floor

1.00

Ground floor

1.00

1st–4th floor 5th–10th floor 11th–20th floor 21st–30th floor 31st–50th floor 51st–75th floor 76th–100th floor Above 100th floor

1.00 1.05 1.10 1.15 1.20 1.25 1.30 1.35

Source: Author; Mumbai (2015: 8–18) Reinforced concrete b Solid building c Temporary structure a

Table 3.46 Calculation of property tax, Greater Mumbai • Capital value (CV) of vacant land: CV ¼ BV  UC  FSI  AL BV ¼ Base value UC ¼ User category FSI ¼ Floor space index AL ¼ Area of land

• Capital value (CV) of a built-up area: CV ¼ BV  UC  NTB  AF  FF  CA BV ¼ Base value UC ¼ User category NTB ¼ Nature of building AF ¼ Age of Building FF ¼ Floor factor CA ¼ Carpet areaa

Source: Author; Mumbai (2015: 6) a (1) The total carpet area of a flat shall be reckoned by including the area of the following items, namely: (i) terrace in exclusive possession, (ii) mezzanine floor, (iii) loft (excluding loft in residential flat) or attic, (iv) dry balcony and (v) niches; and (2) The total carpet area of a building shall be reckoned by including the areas of the following items, namely—(i) total area of the flats in the building computed in accordance with sub rule (1), (ii) basement, (iii) stilt, (iv) porch, (v) podium, (vi) service floor, (vii) refuge area, (viii) entrance lobby, (ix) lounge, (x) air-conditioning plant room, (xi) air handling room, (xii) the structure for an effluent treatment plant room and (xiii) watchman cabin (xix)sewerage treatment plant room (xv) water treatment plant room (Mumbai 2015: 4)

3.2 Case Studies: Megacities in Brazil, India, and China

119

Example: Residential flat in 12th floor in building with lift

Relative rate of base value Rs. 80,600 User category Residential Nature and type of RCC building other than luxurious RCC building building Age of building 6 years Floor number 12 Built-up area 80 sq. ft CV ¼ 80,600  1.00  1.00  0.97  1.10  80 ¼ Rs. 6,880,016

Weightage factor N.A. 1.00 1.00 0.97 1.10 N.A.

Source: Author; Mumbai (2012: 16)

The Capital Value will be revised only after every 5 years, although the ready reckoner (per m2) rates are revised every year. The increase in taxes cannot be greater than 40% of the tax payable against the 5-year period before such revision. However, the Standing Committee decides the tax rates applied on the Capital Value so that the increase in tax burden could be kept to a minimum. The tax rate in Greater Mumbai is set within a corridor provided by the respective State and depends on the use of the property. Residential properties are taxed at a rate of 0.316%.

Administrative Practices For administrative purposes, Greater Mumbai is divided into seven zones that are subdivided into 24 administrative Wards and 7 individual Sections (among others: Vigilance Branch, Computer Cell, and Appeal Section). In charge of all administrative aspects of the property tax is the Department for Assessment and Collection (Table 3.47).

Table 3.47 Department for assessment and collection— Organisation chart

Municipal Commissioner Additional/Deputy Commissioner Assessor and Collector Assessment Joint Assessor and Collector Deputy A&C (City) Assistant Assessor and Collector Superintendent Deputy Superintendent Assistant Superintendent Ward Inspector Source: Author; Greater Mumbai (2014)

Deputy A&C (Western Suburbs)

120 Table 3.48 Ward set-up assessment and collection section

3 Property Taxes Within the BRICS States Assistant Assessor and Collector Indoor: Head Clerks Clerks

Outdoor: Superintendent Deputy Superintendent Assistant Superintendent Ward inspector Cash Receiving Clerk Clerks

Source: Author; Greater Mumbai (2014)

At the administrative Ward level there are two sections in each administrative Ward, namely Indoor and Outdoor (Table 3.48). Beyond that, there are Ward Sections that are split into groups. The individual Vigilance Branch performs surprise, random checking of the property and reports changes that need to be revised. Another individual branch is the Computer Cell that monitors the issuing of bills, bill books (Indoor and Outdoor), and penalties of property tax. The Appeal Section coordinates the Legal Department and the Ward for court cases, and attends the courts in all matters with regard to appeals and suits against the Capital Value etc. The property identification instructions are provided by law, which calls “upon the owner of every [. . .] taxable premise to furnish to the Assessing Authority a return containing all the particulars of the property within 2 months from the appointed day [. . .], to enable the Assessing Authority to prepare and publish a list of taxable premises” (Mumbai 2014). In the case of false statements provided, imprisonment (up to 6 months), a fine (up to 1000 Rs.), or both is possible. Beyond that, identification is also in the hand of the local assessing authority (Mumbai 2014). Ward Inspectors are allowed—after due notice—to perform their duties for surprise, random checking of the properties between sunrise and sunset. They are allowed to enter the taxable premises to record all changes in the property with regard to new constructions, additions, extensions, alterations, renovations, demolition, changes in user status, or amalgamations of properties. The Inspector reports to the Ward Superintendent for confirmation of revision, modification, amendment in Capital Value, for insertion/deletion of the name of the property holder, and for the person primarily liable for payment of property tax.87 All changes are recorded in the Inspection Book. The assessment process is very much linked to the “Assessment Book” (Section 158 MMC-Act) in the hand of the Commissioner, which also exists on the Ward level (“Ward Assessment Book”). It comprises property tax-related information such as account number, Ward number, street number, locality, description of the property, name of assessee, Capital Value of the property, and first date of assessment of the property. When the Assessment Book is complete, 87

For more details on identification process and the responsibilities of the respective persons in charge (according to Table 2.5) see Mumbai (2014).

3.2 Case Studies: Megacities in Brazil, India, and China

121

Table 3.49 Features of early bird incentive Payment date Up to 30.06.2014 Up to 31.07.2014

Property tax payment If bill of First half of 2014–2015 paid with arrears If bill of Second half of 2014–2015 paid with arrears If bill of First half of 2014–2015 paid with arrears If bill of Second half of 2014–2015 paid with arrears

Incentive due (%) 2 4 1 3

Source: Greater Mumbai (2014)

i.e. all data is collected, the public is informed (on 20th November) that the Assessment Book is displayed at the Ward Office in order to inspect the entries (Mumbai 2014). Objections against the provided entries have to be addressed to the office of the Assistant Assessor and Collector of the respective Ward (20th November–14th December). Thereafter, the Assessing Authority investigates and disposes the objections. If objection fails, the taxpayer may appeal. The decisions made by the Appellate Authority (Small Cause Court) are final and cannot be questioned in any court (218D MMC-Act). The Municipal Commissioner authenticates the Assessment Book for the ensuing year from 1st April. The property tax bill is issued once a year to the person responsible for the property tax (owner or occupier). The bill has to be paid in advance and in two separate instalments (on 1st April and 1st October). Property tax payments might be made through Internet (Online payments), Cyber Cafe´, Bank Aggregators, and SMS. They facilitate citizens for 24  7  365 mode of service availability. In the case of not-payment within 15 days from the date of service of the bill, a notice of demand is served on the responsible person for property tax payment. Thereafter, during an additional 15 days from the service of the notice of demand, if the tax is not paid, the property tax enforcement includes measures such as the sale of the goods or chattel of the defaulter, or sale of the immovable property. Consequences in the case of not-payment or delay (within 3 months and/or the date of service of Notice of Demand) in payment of Property Tax, the property owner will be liable to pay a penalty of 2% per month on the outstanding property tax to BMC (Table 3.49). In order to prevent such late- or non-payments the BMC introduced, on an experimental basis, an ‘early bird incentive’ for the year 2014–2015 for prompt property tax payers/payments.

3.2.2.4

What Is the Administrative Performance?

A deeper assessment of the property tax administration is imperative in order to identify the inherent administrative weaknesses that appear due to the resources needed for accurate and efficient property tax levitation. In this context, a ratio study regarding fundamental administrative aspects, such as coverage, assessment, collection, and enforcement illustrates areas for administrative and, respectively, revenue improvement—even without increasing, for instance, zonal rates or

122

3 Property Taxes Within the BRICS States

property tax rates. Therewith, the ratio study provides information on the overall property tax performance and on potential revenue yields. Due to a lack of administrative property tax data with regard to Greater Mumbai, the following analysis concentrates on Greater Bangalore only. The first important step within the property tax administration is the management of all relevant property tax information in order to successfully assess, collect, and enforce the tax. The coverage ratio in Greater Bangalore depends first and foremost on the taxpayers due to the self-assessment scheme in place. Taxpayers are asked to actively hand in the property characteristics, i.e. physical aspects and valuationrelated information. However, it is in the hand of the administration itself to validate such information and to identify properties outside the tax net. Therefore, Greater Bangalore has assigned each property a unique property identification number (IPD) since 2012. These improvements with regard to coverage are not reflected in the following calculations, as the latest data is from 2007–2008.88 However, the BBMP provides very detailed coverage information on all properties within its jurisdiction for the year 2007–2008 (Table 3.50). The coverage ratio is generally defined as the number of recorded properties in the fiscal cadastre against all properties located within the jurisdiction. In Greater Bangalore 69.2% of all properties were assessed for property taxation in 2007–2008 (Table 3.51). The ratio has sharply declined against the previous years due to the formation of Greater Bangalore in 2007–2008. The Third State Finance Commission, TSFC (2008: 168) noticed in this context, “in many areas coming under the jurisdiction of Bruhat Bangalore Mahanagara Palike property tax is not being imposed and penalty is also not levied.” From those properties being assessed, only 73.1% pay the property tax in 2007–2008, which constitutes the real coverage. Reviewing the effective coverage, which represents the properties where tax is paid against all properties, the result arrives at merely 50.6% in 2007–2008—after the formation of Greater Bangalore. The assessment ratio is defined as property values assessed in the fiscal cadastre as a share of the total market property value. The main obstacle to this approach, however, is that the necessary information is not available, i.e. neither the assessed value in the fiscal cadastre nor the (estimated) market value to calculate the assessment ratio. However, Table 3.50 illustrates that 38.5% of all properties in the jurisdiction are unassessed, comprising statutory exempt properties, properties below a certain threshold value, properties not counted for property taxation, etc. Therefore, the assessment ratio is assumed to be 61.5%, which constitutes a rough—and most likely over—estimation. This would mean that all those

88

The number of properties has increased from a total number of 1,300,000–1,512,850 in the period 2007–2008 to 2011–2012; see Budget Presentation of Bruhat Bengaluru Mahanagara Palike for the year 2011–2012 by Sri. Manjunatha Raju. Available at: http://218.248.45.169/ download/budget/Budget%20Speech.pdf [Accessed: 26 November 2015].

3.2 Case Studies: Megacities in Brazil, India, and China

123

Table 3.50 Classification of properties—Greater Bangalore Nature and classification of properties A. Number of total properties B. Number of properties assessed for taxation a. Number of assessed properties that paid taxes b. Number of assessed properties that defaulted on payment c. Number of assessed properties that disputed the assessment C. Number of un-assessed properties Statutory and other form of exemptions a. Number of properties whose value are below a certain threshold b. Number of properties which serve a public purpose c. Number of properties whose occupants belong to a disadvantaged category Estimated number of properties not counted or enumerated for purposes of taxation Number of slum properties connected to municipal services, i.e., street lighting, solid waste collection and paved roads a. Number of slum properties paying property taxes b. Number of slum properties not paying property taxes c. Number of properties paying charges for water or other services D. Number of under-assessed properties a. Approximate number of properties under rent control b. Approximate number of rent controlled properties paying taxes c. Appropriate number of properties whose values have remained unchanged for 5 years or more

2004–2005 686,000 612,400

2005–2006 715,000 645,000

2006–2007 755,000 668,535

2007–2008 1300,000a 900,000a

425,890

429,279

585,900

657,540

195,510

215,721

82,635

243,460

250

300

350

600

64,600 215

70,000 228

86,465 235

500,000a 295

3000

3500

3800

8700

1550

1580

1650

2550

5450

6600

7500

21,000

1350

1380

1395

1855

5000

6000

7000

18,800

2800

2800

2800

3500

2650

3800

4700

17,500

5000

6000

7000

18,500

5000 500

5000 500

5500 500

25,000 1000

500

500

500

1000

150,000

150,000

150,000

260,000

Source: TSFC, Karnataka (2008); Greater Bangalore The figures provided do not add up correctly

a

properties are assessed to their full potential. Although estimated (assessed) market values are generally lower than market values, the plus in this case is that guidance values were updated within the same year (2007–2008), therefore, approximating market values. In order to improve the assessment results, strict actions are

124

3 Property Taxes Within the BRICS States

Table 3.51 Coverage ratio of Greater Bangalore 2004–2005 2005–2006 2006–2007 Coverage ratio (Assessed properties/Total properties  100) 89.3 90.2 88.5 Real coverage (Tax paying properties/Assessed properties  100) 69.5 66.6 87.6 Effective coverage (Tax paying properties/Total properties  100) 62.1 60.0 77.6

2007–2008 69.2 73.1 50.6

Source: Author, Table 3.8

necessary within the self-assessment scheme against dishonest property owners that try to evade the tax by deliberately providing false information with regard to their property tax assessment. Therefore, according to the Budget Speech (2011–2012) Teams of Revenue officials check 30% of the properties under SAS to prevent the pilferage of revenue. The collection ratio illustrates the administrative efficiency at its best, since it reflects how much of the annual property tax billed is actually collected within the same year. The collection ratio is the ratio that the administration should focus on most, because it translates previous measures on coverage and assessment into actual increase in tax revenues. In other words, collection is the ultimate administrative action within the property taxing processes, where all other administrative improvements on coverage and assessment come to nothing if collection is poor. Tax collection is also linked with property tax compliance, which is of most importance, as otherwise tax evasion or free-riding runs rampant. Therefore, in order to achieve an efficient and equitable tax system, the collection ratio should yield the highest result. Greater Bangalore provides a detailed revenue statistic, which allows a deeper insight on collection results (Table 3.52). The collection ratio is usually defined as collection of both, current liability and tax arrears (Kelly 2003: 14). However, the ratio can be split into a collection ratio (reflecting the current tax liability) and an enforcement ratio (reflecting the outstanding tax liability). The collection ratio (here: excluding arrears) for residential properties was 53% in 2007–2008, while almost all commercial properties paid their taxes (98%). Table 3.53 illustrates furthermore that all collection ratios have declined steeply with the formation of Greater Bangalore. The former Bangalore City Corporation that was merged with surrounding municipalities obviously had a much stronger property tax administration. The supplemental part of the collection ratio, the enforcement ratio, is at least of the same importance for overall efficiency and equity. Property taxes have to be enforced with sanctions and penalties to achieve tax compliance at high levels. The result shows that more than three quarters of all property tax arrears are collected in the case of residential as well as in the case of commercial properties (Table 3.54). Overall, the property tax performance indicators outlined in Greater Bangalore are above the average in India with regard to tax administration. A survey of the property tax practice conducted by Mathur et al. (2009) in the 36 largest urban local

3.2 Case Studies: Megacities in Brazil, India, and China

125

Table 3.52 Property tax receipts and administrative cost—Greater Bangalore Rs. in million 2004–2005 2005–2006 A. Property tax receipts a. Amount of property tax 2610 2790 demanded (excluding arrears) i. From domestic properties 1650 1760 ii. From non-domestic properties 960 1030 b. Amount of property tax arrears 390 410 demanded i. From domestic properties 240 250 ii. From non-domestic properties 150 160 c. Amount of property tax collected 2320 2580 i. From domestic properties 1320 1460 (current) ii. From domestic properties 120 180 (arrears) iii. From non-domestic proper790 630 ties (current) iv. From non-domestic proper90 130 ties (arrears) d. Amount of property tax under 230 260 dispute e. Amount of unpaid/defaulted 680 620 property tax B. Service charges receipts from Central government and State Government properties: a. Amount of service charges 4.3 5.2 demanded Central/State Government properties b. Amount of service charges col- 2.3 2.1 lected from Central/State government properties C. Estimated expenditure on property 3.0 3.2 tax assessment, billing, and collection

2006–2007

2007–2008

3480

5800

2230 1250 520

3780 2020 680

380 140 3470 1840

310 370 4490 1990

260

240

1190

1970

180

290

290

350

530

1610

6.2

8.0

3.3

3.2

3.5

5.0

Source: TSFC, Karnataka (2008); Greater Bangalore

governments revealed that 44% of all parcels are excluded from the tax net (coverage ratio of 0.56), properties are assessed at about 30% of market value (assessment ratio of 0.3), and the average collection rate is about 40% (collection ratio of 0.4). In contrast, Greater Bangalore has an overall coverage of 69.2%, an estimated assessment of 61.5%, and collection and enforcement of 68.3% and 77.9%. Taking the property tax revenue for 2007–2008 and the outlined administrative performance ratios into account, one might estimate the potential property tax yield that would have been achieved in Greater Bangalore under perfect administrative conditions (Table 3.55).

126

3 Property Taxes Within the BRICS States

Table 3.53 Collection ratio (excluding arrears)—Greater Bangalore 2004–2005 2005–2006 Collection ratio (Tax collection/Tax demanded or assessed  100) Collection ratio, residential properties 80.0 83.0 Collection ratio, commercial properties 82.3 61.2 Collection ratio, total 80.8 74.9

2006–2007

2007–2008

82.5 95.2 87.1

52.6 97.5 68.3

Source: Author, Table 3.11

Table 3.54 Enforcement ratio—Greater Bangalore 2004–2005 2005–2006 2006–2007 2007–2008 Enforcement ratio (Tax arrears collected or enforced/Tax arrears demanded  100) Enforcement ratio, residential properties 50.0 72.0 68.4 77.4 Enforcement ratio, commercial 60.0 81.3 128.6 78.4 properties Enforcement ratio, total 53.8 75.6 84.6 77.9 Source: Author, Table 3.11

According to the Jawaharlal Nehru National Urban Renewal Mission (JNNURM), a reasonable administrative tax system is given with a coverage ratio of 85% and a collection ratio of 85%. This yardstick serves as an indicator of raising potential property tax revenues. Furthermore, an administrative performance of 100% is illustrated in Table 3.55. For instance, by simply raising the collection ratio for residential properties from 52.6 to 85.0% would lead to a property tax increase of Rs. 1226 million, which is also the single measure with highest revenue outcome for residential properties. Overall, by merely increasing collection and enforcement of residential and commercial properties to 85%, the revenue surplus would amount to Rs. 2938 million. Against the single administrative measures on increasing coverage, or assessment, or collection, the ratios may develop a much higher combined revenue potential. Administrative measures undertaken at the same time on all the ratios unfold a multiplicative effect on the property tax revenue, i.e. the assessment ratio is applied on the higher coverage ratio of 85%, the result being the basis for the collection ratio, where tax collection could be higher as in the current situation. The overall result constitutes a rough estimate of an administratively well-performed property tax, which would result in more than doubling tax revenues—from Rs. 3960 million to Rs. 9707 million. As municipal GDP is not available, the results cannot be set in context; however, it would have substantial impact on local own-tax revenues. In this context, it needs to be emphasized that the property tax ratios have declined significantly since 2007–2008 due to the formation of Greater Bangalore in 2007–2008. Since then, there have been many measures undertaken to improve the ratios. Therefore, Greater Bangalore might have drawn on the potential of the property tax—at least to a certain amount.

Tax enforced (billion Rs.) 0.24 0.29 0.53

CVR (%) 0.69 0.69 0.69

Source: Author Ratios: CVR ¼ Coverage; AR ¼ Assessment; CLR ¼ Collection a 0.975% is taken into account

Residential Commercial Total

Tax collected (billion Rs.) 1.99 1.97 3.96

Table 3.55 Potential tax revenue, Greater Bangalore

AR (%) 0.62 0.62 0.62

CLR (%) 0.53 0.98a 0.68

EFR (%) 0.77 0.78 0.78

CVR 85/100 2.4 2.9 2.4 2.8 4.9 5.7

AR 85/100 2.8 3.2 2.7 3.2 5.5 6.4

CLR 85/100 3.2 3.8 2.0a 2.0 4.9 5.8

EFR 85/100 2.2 2.6 2.1 2.5 4.3 5.1

Potential tax revenue (85 and 100%) Single administrative measure and result

Administrative measures combined, multiplicative result 85/100 6.3 11.8 3.9 6.4 9.7 18.2

3.2 Case Studies: Megacities in Brazil, India, and China 127

128

3.2.2.5

3 Property Taxes Within the BRICS States

Is It a Rational Local Tax?

The question regarding ‘rationality’ is generally difficult to answer in a comprehensive manner. However, there are elaborated public finance criteria, which provide a systematic approach in order to assess a local tax system. They are subdivided into vertical and horizontal ones. First, we will review the vertical criteria that apply to a rational local tax. The most important criterion, visibility, links the tax burden with tax benefits in form of public goods and services rendered or capitalization in property values arising from local public goods provision. The property tax is commonly classified a benefit tax in India with a large share of municipal expenditures on public services being covered by property tax revenues (Mathur et al. 2011: 75). Furthermore, the relative share of property tax amount paid is transparent due to the property tax formula applied in Greater Bangalore and Greater Mumbai. With the property tax formula and self-assessment scheme, the property tax becomes very transparent for each taxpayer. Furthermore, the discretionary power of tax officers diminished with the introduction of the new property tax self-assessment in both cities. In India, the property tax constitutes the most important local own-tax; besides Octroi, where in place. This also applies to the sample cities, where Greater Bangalore is mainly dependent on property tax and Greater Mumbai’s own revenues are dominated by Octroi. In both cases, the property tax is a source of local own revenues. While Octroi, the local tax on domestic trade, provides a significant revenue stream, the alleviation of the tax has distortionary effects, such as high compliance and administrative costs, and tax exporting. Consequently, all States have abolished the tax—except the municipal corporations in Maharashtra. Therefore, Greater Mumbai should focus on further reforming/improving the property tax as compensation for the distortionary Octroi. As long as Greater Mumbai relies on Octroi, the property tax needs to be a particularly revenue-generating tax in Greater Bangalore to compensate for Octroi and constitute an appropriate local finance instrument. The property tax applies to residential and non-residential property owners; therefore, the balance of interest criterion is fulfilled. However, within the boundaries of Greater Bangalore, 50% of the property tax is exempt on self-occupied buildings used for residential purposes. Beyond that, the slum population constitutes about 16.5% in Greater Bangalore, and above 50% in Greater Mumbai, with a very low number of properties being taxed.89 Furthermore, rent control, i.e. the imposition of legal maximum rents (rent ceilings), which are below the equilibrium rent, may have an impact on the balance of interest criterion. As housing is a State subject, Rent Control Acts are enacted by the States. Although it was conceived as short-term measure due to a scarcity of housing and high inflation rates after the World War, all States still have Rent Control (Dey and Dev 2006). Rent Control

89

According to Table 3.4, about 0.4% of total slum properties pay property tax in Bangalore. Mumbai is about to tax slum properties, which make up more than 50% of total properties.

3.2 Case Studies: Megacities in Brazil, India, and China

129

restricts rent to increase and therefore has a substantial impact on the rental values, and in the case of ARV system, property tax revenue. While both cities have abolished the ARV system, the zonal rates applied under the (quasi) Capital Value system are still the same as under ARV. Therefore, rent control might still have an effect on property values under the CV system. However, in both cities, rent control is applied to residential and non-residential properties likewise. While the Maharashtra Rent Control Act 1999 applies to “any building or part of building”, the Karnataka Rent Control Act 2001 applies to “residential and non-residential properties”, but excludes residential properties with specified standard rent.90 Depending on the number of properties falling under Rent Control, on the number of exempt (non)residential properties, and the slums not being taxed, the balance criterion might be substantially affected to the detriment of other (possible) local revenue sources such as residents (income tax) and businesses (corporate income tax, business tax). The rationale of Rent Control is highly questionable and involves the interaction of two main antagonistic rationales, an economic and a social one. Rent Control has economically the effect that investments in the rental housing market are deterred, buildings are less maintained, redeveloped or sold, supply constraints increase due to withdrawal of properties from the market, the best and highest use of urban properties is distorted, and municipal revenues eroded (Dey and Dev 2006: 3–5). From a social welfare perspective, Rent Control protects the tenants from paying more than a ‘fair rent’ or ‘standard rent’. With regard to the high property values in the two megacities, applying Rent Control might be—to some extent—reasonable. Housing is within both cities unaffordable. According to Demographia (2014: 2) housing becomes “seriously unaffordable”, if the House Price-to-Income Ratio91 ranges between 4.1 and 5.0 and housing is “severely unaffordable” if the Ratio is 5.1 or over. According to this criterion, housing is severely unaffordable in Greater Mumbai and seriously unaffordable in Bangalore (Table 3.56). Therefore, Mumbai’s City Development Plan (2005–2025) aims to “bring down housing rental costs from their current 140% of per capita income to about 50%”. Because of the serious economic drawbacks, the economic rational outweighs the social one, which would imply a major reform with regard to Rent Control. The outlined Rent Control also has impacts on the proportional growth sensitivity of the property tax. In a long-term consideration, the property tax should be linked to economic growth with a revenue elasticity of one, i.e. the property tax revenues increase to the same extent as the respective Gross Regional or Gross Municipal Product (GRP/GMP). Octroi was the only local tax that has the potential to grow over time with economic activity as the property tax was based to Area 90

Excluded are all residential properties with standard rent being less than Rs. 3500 per month in the areas of Karnataka Municipal Corporation Act of 1975 and Rs. 2000 per month elsewhere. Beyond that, commercial buildings having a plinth area of less than 14 sq. m are exempt in the state of Karnataka. 91 The house price affordability is measured in terms of median house price to yearly income. It indicates the average number of yearly incomes required to own a house.

130

3 Property Taxes Within the BRICS States

Table 3.56 Status of ownership and median house price-to-income ratio in urban Bangalore and Greater Mumbai

Greater Mumbai Bangalore

Ownership status Owned Rented 67.1 29.0 36.8 60.3

P/I 2009–2010 4.8 4.8

2013–2014 5.4 4.5

Source: Author; Government of India, Ministry of Home Affairs, 2011 Census Data, Reserve Bank of India (2015)

Rental Value systems in Greater Bangalore and Greater Mumbai. Due to Rent Control, the overall revenue elasticity of the property tax was lower than one. However, the reformed assessment methods, towards (quasi) Capital Values, better reflect market values in Greater Bangalore and in Greater Mumbai. With a reformed property tax as in the sample megacities property tax has the growth potential derived from the economic growth in the cities. This is of major importance. India’s municipal governments have, at best, been a passive participant in the process of economic growth (Mathur et al. 2011: 1). Their linkages to growth are weak. Municipalities are not capable of capturing the urban-based growth, which is a major shortcoming in the ability to finance adequate public goods and services, such as infrastructure and poverty reduction. In order to manage the process of the upcoming urbanization of India, the municipal sector has to be prioritized, which would promote and accelerate economic and human development. Therefore, improving municipal finance is a fundamental goal, especially for the megacities in India. Due to the higher administrative and revenue performance of most megacities, they should be at the forefront—more than ever before. Second, we will review the horizontal criteria that apply to a rational local tax. Fiscal autonomy is one of the most important criteria for a rational local tax system in order to achieve fiscal equivalence: The legal right to set a tax rate according to the taxpayer’s priorities, fiscal needs, and economic structure, is important for local governments. Furthermore, the flexibility of adjusting the tax rate enhances visibility about the cost of public goods and service provision, and this, in turn, fits the benefit principle as soon as the additional tax money is spent for public goods and services. The sample cities (the Standing Committees of the Corporations) have certain discretionary powers, however, determined by their respective States. Greater Bangalore—for instance—is allowed to set the tax rate between 20 and 25% (KMC 1976: 108A). However, both cities refer within their assessment process to zonal rates that are adjusted frequently. In Greater Mumbai— for instance—the zonal rates of the CV system are revised every 5 years and are allowed to increase up to 40%. Furthermore, Greater Bangalore has shown that the shift to the UAV system and the recalibration of zonal rates can yield sufficient buoyancy to the property tax. Consequently, both megacities are allowed to enhance their property tax by increasing the property tax rates within their discretionary power set by the State Government and by revising the zonal rates in accordance with the property tax board.

3.2 Case Studies: Megacities in Brazil, India, and China

131

The criterion inefficient migration among the cities is difficult to determine. It is not the local tax system that seems to determine the choice of local residence. First, total intra-state and inter-state migration (98 million) was dominated by moving into rural areas (62%), instead of urban areas (38%) (Census 2001). Second, 38% of total ‘male’ migration into urban areas occurred because of ‘work/employment’. ‘Female’ migration into urban areas was mainly happening due to marriage (65% of total female migration). Given the strong urbanization that has occurred since 2001—i.e. the urban population increased from 288 million to 420 million in 2015—and the projected urbanization to come—i.e. the urban population will further increase to 814 million by 2050—‘work/employment’ as an explanation for urbanization is already given and will be further emphasised. Due to industrialization, higher productivity of the secondary/tertiary sector against the primary sector results in economic growth and increasing employment and education opportunities within the cities, which in turn, attracts people to move from rural areas to urban ones. In India, it is not the tax burden that makes people move as most low-income groups do not pay property tax. Therefore, urban migration in India seems to account for more of the urban contribution to economic growth, and less tax burden and public services rendered. In order to make people move more ‘efficiently’, municipalities should tax all properties (including slums) appropriately by reflecting local public services provided.92 Finally, there is the criterion of an evenly distributed tax base, which is largely given in the case of India. Within the States, land and buildings are taxed no matter where the property is located. However, within the megacities reviewed, the tax base is limited by a Floor Space Index (FSI) in Mumbai and Floor Area Ratio (FAR) in Bangalore. Both, FSI and FAR give name to the same restriction on the efficiency of using urban land and, therefore, restrict the tax base in some way within their cities. An FSI or FAR of two, for instance, allows only the build-up of floor area equal to twice the area of the plot area; e.g. a FSI/FAR of two would allow a floor space of 2000 m2 to be built on a plot size of 1000 m2.93 By applying such a restriction, the height of the building is automatically limited. A restriction of innercity floor space leads inevitably to spatial expansion of the city. In other words, an increase of FSI/FAR results in more floor space per unit of land, which, in turn,

92

This argumentation refers to people living in urban areas with adequate public service provision, which might include parts of slum areas where public services are rendered (water and wastewater supply, waste collection, healthcare, street lighting, etc.). Overall, with regard to migration the rule of Glaeser (2011, 70) applies, “the presence of poverty in cities [. . .] reflects urban strength, not weakness. Megacities are not too big. Limiting their growth would cause significantly more hardship than gain, and urban growth is a great way to reduce rural poverty”. 93 The FSI in Central Business Districts varies substantially among the megacities worldwide. According to the Wold Bank, Shanghai (China) applies a FSI of 1:8, Honk Kong (China) 1:12, Singapore 1:12–1:25; see World Bank (2013). Urbanization beyond Municipal Boundaries— Nurturing Metropolitan Economies and Connecting Peri-Urban Areas in India. The World Bank, Washington DC, 53ff.

132

3 Property Taxes Within the BRICS States

results in a more efficient land use and a broader property tax base.94 In Greater Bangalore, for instance, FAR is between 1.75 and 3.25 for residential properties in regard to plot size, ground coverage, and road width.95 In Greater Mumbai residential FSI is currently between 1.0 and 1.33, whereas the FSI has decreased since its first introduction in 1964.96 Reducing the FSI over time—instead of increasing it—further discouraged the redevelopment of older buildings, as redevelopment would have caused less floor space. This may explain a low average living floor space of 9 m2 per person in Greater Mumbai, which ranges between 1–5 m in slum areas up to 26 m2 for the richest decile.97 By setting low FSI/FAR, the outlined megacities provoke an artificial shortage of floor space, which is at the same time a potential property tax base.

3.2.2.6

What Are Current Reform Initiatives?

The megacities reviewed have already realized comprehensive property tax reform (s)—e.g. Greater Bangalore introduced the Unit Area Value System in 2007 and Greater Mumbai shifted to the Capital Value system in 2010. Therefore, generally incremental steps of improving the property tax have been targeted ever since. The measures undertaken, aim at increasing the most-needed property tax revenues.98 The gains expected form the 2007-merger of BBMP could not been realized; therefore, a restructuring of BBMP is to be expected (see BBMP 2015). Herewith, BBMP could be restructured into a three-tier governance structure headed by the Greater Bengaluru Authority (GBA), with five underlying municipal corporations (2nd tier), and Wards (3rd tier). The holistic restructuring process also involves the property tax. BBMP (2015: 169) recommends the full devolution of powers to set tax rates and the underlying tax base to GBA—instead of the State. In this context, GBA shall set property tax rates and base values and the split rate of property tax revenues (between GBA, municipal corporations and wards) shall be recommended 94

With an increase of floor space there is higher demand on open space surrounding the building, on public services, and on infrastructure, such as broader roads the higher the building is, higher water pressure, better waste disposal, etc. (Bertaud and Brueckner 2003). In order to achieve an increase on FSI/FAR, an overall urban planning strategy is necessary, which takes populations’ prospects, employment growth, infrastructure need and investments, and urban spatial planning and zoning, into account. 95 Bangalore Development Authority. 2015. Revised Master Plan 2015, Zoning of Landuse and Regulations. 96 Bertraud, Alain. 2011. Mumbai FAR/FSI conundrum. Available at: http://alainbertaud.com/wpcontent/uploads/2013/06/AB-Mumbai-FSI-Conundrun-Revised_June-2013_kk-ab1.pdf [Accessed: 13 December 2015]. 97 Nair, Shalin. 2015. Mumbai Floor Space Index: Moving up leaves problems aground. The Indian Express. Available at: http://indianexpress.com/article/india/india-others/mumbai-floor-spaceindex-moving-up-leaves-problems-aground/ [Accessed: 13 December 2015]. 98 The following remarks are mainly based on current Budget Speeches held by Sitaram Kunte (Mumbai Budget Speech 2015–2016, 17-2-2014) and BBMP (2015) report.

3.2 Case Studies: Megacities in Brazil, India, and China

133

at that time by the newly founded Greater Bengaluru Finance Commission. As the Wards are the smallest unit responsible for the property tax administration, a further financial devolution is also planned in order to incentivize property tax collection (BBMP 2015: 8). When established, the Greater Bengaluru Finance Commission shall devolve revenues on a fair and equitable manner, with the property tax being part of it. The Wards shall hold a minimum amount of the property tax within the discretionary power of the Ward in order to finance Ward projects. This could result in higher tax compliance and higher local own-tax revenues. The measures explicitly planned with regard to property tax focus on property identification, assessment, collection, and enforcement (BBMP 2015: 27, 171ff; Budget Speech 2014–201599): • Identification: linking property tax payers to spatial geo-referenced building database by assigning all properties a unique identification number will identify non-payers and those paying below estimated areas. According to the budget speech, Greater Bangalore has identified 70% of all properties under Greater Bangalore jurisdiction with a unique PID (property identification) number. The process will be continued and completed at the ‘earliest time’. • Assessment: Even though the State has been issuing revised guidance values at frequent intervals, they have not been used to timely update the values in BBMP (BBMP uses currently 2007 values), which resulted in poor assessments. A rigorous assessment process is in the focus. • Billing and collection: Both administrative functions might be outsourced to external partners after a rigorous evaluation process. Until then, collection efficiency and completeness of assessment shall be the benchmark for performance-linked incentives. Furthermore, the bank payments shall be strengthened. According to the budget speech, tax collection will be intensified by revising and effectively collecting ‘High-Value Properties Tax Recovery Cells’. In this context, about 2000 high-value properties have been identified. This measure is of importance as many property owners under-assess their property under the self-assessment scheme (IPTI-Xtracts, April 2015). Greater Mumbai has to increase its property tax revenues substantially to compensate for their major own-tax revenue source Octroi, which will be eliminated by 2016–2017. Therefore, they aim at levying and recovering property tax on the hutments in slums, where more than 50% of Greater Mumbai’s population live. For this purpose, panoramic images (“360” degree Leader Survey) will be prepared in order to gain information on properties and structures out of the tax net.100 Beyond that, Greater Mumbai makes use of the maximum increase allowed at times 99

Dr. M. S. Shivaprasad, Bangalore Budget Speech 2014–2015, 4-2-2015. Taxing slums is not an easy measure, because a legal property tax is put on (typically) illegal property. Consequently, levying the tax would result in de facto legalizing slums. The slum dwellers will have to be issued property registration certificates in order to make them pay the tax. The main question in this regard is, however, if public services are rendered anyway, because if this is not the case, the benefit principle would be ignored.

100

134

3 Property Taxes Within the BRICS States

of revising property rates (every 5 years) by 40% in order to generate tax revenues; however, they decided to further exempt houses below 500 sq. ft. Additionally, they are trying to increase the property tax revenue by setting incentives for early payment (3% since 2014–2015). The two megacities’ reforms show that property taxes are and should be increased by all administrative means available. The focus is on property identification, revision of self-assessments, effective tax collection, and tax enforcement.

3.2.2.7

Critical Summary

The megacities presented—Greater Bangalore and Greater Mumbai—are by no means representatives for local India, though they nicely represent the megacities within India. India looks back on a fruitful experience with regard to property taxation. Every municipal corporation/megacity has already (Ahmedabad, Bangalore, Delhi, Patna, Hyderabad, and Pune) reformed its property tax or is about to implement a new property tax assessment system (Chennai and Kolkata). The reason for such reform shift is the Area Rental Value (ARV) system, which is generally applied across India. Because the principle of valuation under ARV has been questioned on grounds of fairness, equity and efficiency, the megacities reformed their assessment method. They are now applying the (quasi) Capital Value system, which splits into the ‘real’ Capital Value System as in Mumbai and a ‘quasi’ Capital Value system (so-called Unit Area Value system) as in Bangalore. Consequently, one might say that both systems are quite the same; however, the system applied in Mumbai is more comprehensive in order to assess capital value. Nonetheless, a further improvement in order to assess market value is preferable by making use of real estate transaction data. Actually, the ARV system and the CV system would both reflect market values, and would thereby result in the same assessment values, if the property were designated to the ‘highest and best use’. In this case, the discounted stream of net rent payments would be equivalent to the capital value of the property (Lall and Deichmann 2006: 3210). Or in other words, the ARV system reflects the income from the current use, while CV reflects the income the property will generate in future including more intensive use of the property (Gosh and Kundu 2011: 96). However, ARVs and CVs fall apart in India, as rental values and their assessment base are facing several problems: • Rental values cannot increase appropriately, due to Rent Control applied; Rent Control was designed 50 years ago in order to protect the lower and middleincome groups. • It refers to the ‘current use’ of the property, which does not necessarily reflect the ‘highest and best use’. This is especially true in the case of vacant land. • In the case of mainly owner-occupied properties that have never been let out, the rental value assessment is anachronistic due to the absence of sufficient and reliable reference rents.

3.2 Case Studies: Megacities in Brazil, India, and China

135

• The rental values have been determined by authorised tax officers having broad discretionary power. The assessment process contains subjective features, which provoke misuse and corruption. The shortcomings of the ARV with regard to fairness, equity, and efficiency have led to a major shift of the assessment base. The introduction of the Unit Area Value (UAV) system could be seen as a close proxy to market value, because it does not only reflect physical (i.e. land and buildings) characteristics (i.e. area-based assessment), but includes value components that mainly determine market value, such as location (by defining value zones), usage (residential, commercial, industrial, agricultural), age of building, and type of construction. The Unit Area Value system has inherent advantages over the ARV system (see Mohanty 2003; Karnik et al. 2004): • The assessment is de-linked from rental values. • Fairness in property tax assessment and, respectively, tax payment; propertyowners within the same location (zone), with the same construction type, usage, and age of building face uniform assessments. This promotes equity in tax payment. • The formula-driven property tax calculation allows the application of a selfassessment scheme, which is supported further by a property tax handbook published, property profiles in the internet, tax calculators, etc. • The formula-based property tax calculation results in a simplified (administration) and transparent (taxpayer) assessment procedure leaving no/minimal administrative discretionary power in the tax assessment. The new assessment method leaves less room for disputes (between taxpayer and administrative tax authorities) with regard to overall property tax calculation. • The assessment base includes an inbuilt elasticity to increase revenues by revising zonal tax rates (guideline values); this leads to sufficient buoyancy as the property tax rate is narrowly defined by the respective States (tax corridors). • Due to the zonal rates applied, there is a benefit link established between public service provision and property values. The UAV system features mayor advantages over the ARV system in India. Due to its reference to values, the UAV system approximates market value and is therefore referred to as a quasi-capital assessment system (Lall and Deichmann 2006: 5; Gosh and Kundu 2011: 109). However, the UAV system has some drawbacks that have to be mentioned. The UAV system is not the same as the Capital Value (CV) system: The usage of location specific rates (guidance values) for the land and the application of weightage factors (age, usage, type of construction) for the building might reflect market values, but they do not necessarily correspond to market values. The unit area values reflect minimum values for properties located in particular area which needs further scientific analysis, especially with regard to the influence of rent control regulations that might still have an impact. Beyond that, the weightage factors need to be rationalized as they are not based on scientific analysis (e.g. regression analysis). This shows that there is still

136

3 Property Taxes Within the BRICS States

some degree of subjectivity given within the UAV system, i.e. at the time zonal rates are revised or weightage factors are changed. So far, the UAV system could be seen as first best assessment base under the given circumstances, until real estate market data provides reliable data (particularly market transaction results) to apply the Capital Value system, which, in turn, would result in a fairer value measurement approach. Furthermore, the tax burden would shift from developed land to undeveloped land as the distribution of the tax burden differs between rental and capital value. This would be especially important for the megacities, in order to encourage the ‘highest and best use’ of all properties within the municipal boundaries. Overall, the CV system would be the golden way, because it is fair, equitable, and has an elastic tax base that will grow with the economy (i.e. inbuilt tax-buoyancy), and therefore would enhance the property tax revenue. However, although legislation has been approved to introduce a capital value system (CVS) in Karnataka for property tax assessment—the legislation came into effect from April 2002—the CV system is not yet (fully) implemented in Greater Bangalore. Even though Greater Mumbai provides a more comprehensive assessment method, the system applied only reflects market values more precisely without determining the real market values. Under the CV system, property tax has to be levied on the total cost of the property, i.e. the cost of land and the cost of construction less depreciation. Nonetheless, the introduction of the (quasi) Capital Value system within the outlined municipal corporations under reform has had a very positive impact on fairness, equity, efficiency, and per capita property tax revenues. Gosh and Kundu (2011: 96) summarize the reform effects as “successful in the short run”, “revenues have increased significantly”, “the problem of a badly outdated valuation roll has been addressed”, and “the taxpayers have accepted the reform measures”. The property tax reforms were mainly triggered by the national Jawaharlal Nehru National Urban Renewal Mission (JNNURM), aimed at strengthening municipal governance in accordance with the 74th Constitutional Amendment Act. It was run from 2005 to 2014. Of great significance in this respect is that the flagship reform program was initiated by the Government of India to support urban development. Therefore, it is the central government incentivizing the reform of the local government’s property tax regimes. JNNURM was—inter alia—focused on improving methods of property tax assessment, accompanied by appropriate administrative reforms. Property surveys and usage of GIS technology were encouraged within an integrated framework to ensure better coverage of the properties. The introduction of self-assessment schemes, computerization of property taxes, regular revision of rates, and making tax enforcement a priority were principles to achieve the target measures of 85% with regard to coverage and collection ratio. The sample megacities tackled main shortcomings of their property tax regimes in order to demand JNNURM funds by augmenting property tax revenues. Both heavily depend on the property tax revenues—especially since Octroi is (will be) abolished in all States (except municipal corporations in Maharashtra where Octroi will be phased out in 2016–2017). Octroi was (still is in Mumbai) the main revenue

3.2 Case Studies: Megacities in Brazil, India, and China

137

source. Its loss has to be compensated fully or at least to a large extent by the property tax. Both megacities realised that the revenues heavily depend on aspects such as methodology for assessment of properties, coverage of properties under tax net, collection efficiency, and regularity in periodic revision of rates. To this end, they focused on these aspects: the politically determined tax base and rate, and administrative performance with regard to coverage and collection of property tax revenues. While the rationalization of the property tax base is laudable, especially because all exempt Central Government—and even State Government and local properties in the case of Greater Bangalore—pay a service charge instead of property tax, the administrative aspects are mainly in the spotlight of reform. According to Kelly (2013: 26), the basic sequencing of a property tax reform is either ‘valuation-pushed’ (i.e. strengthening the fiscal cadastre in order to push coverage and valuation) or ‘collection-led’ (i.e. strengthening property tax collection in order to push collection ratio). The reform strategy of the sample cities followed both strategies at the same time: they updated property tax rolls via discovery of properties outside the tax net and new properties constructed or altered; they computerized billing and collection, they introduced self-assessment where taxpayers are able to self-assess and calculate the property tax, and they strengthened the property tax enforcement by incentivizing early-bird payments and having strict legal regulations in case of non-or late payments. The case study on Greater Bangalore’s and Greater Mumbai’s property tax system indicates that the property tax promises a large revenue potential with regard to further reforms, as past reforms had shown significant impact on property tax yields. Increasing revenues were yielded by increasing coverage, rationalizing exemptions, improving assessment methods, and strengthening collections. Nonetheless, the local revenue yields could be further increased if reliable financial data on municipal revenues and expenditures, and statistical data on administrative property tax aspects, and market transaction data of the real estate market were available and utilized. While the first aspect would feature the immanent position of the urban local bodies in the federal fiscal architecture, the second would feature the current potential of self-financing local governments. Lastly, the third aspect would constitute the basis of sound local policy decision-making resulting in an efficient and equitable property tax system according to the benefit principle. Especially the latter—the real estate market—is of great importance in order to further improve the property tax and human and economic development. Given the lack of information on the real estate market the policy decisionmaking is uninformed or limited. Furthermore, inconsistent and untimely data on real estate or property tax-relevant facts makes it very difficult to project property tax revenues. The fiscal cadastre is underdeveloped, incomplete, and not up-to-date, therefore, property tax revenues are difficult to estimate, which is the case of the revised sample cities, i.e. the budget plans reveal the scope of information lack, because the budget plan is set much higher than the revised estimates realized. Furthermore, the lack of clarity, consistency, and predictability on municipal finance and municipal expenditures opens room for unfunded mandates. Furthermore, potential own-tax revenues and fiscal transfers cannot be related to the fiscal

138

3 Property Taxes Within the BRICS States

need of municipal tasks assigned. Organising a reliable data base for local finance should be among the first priorities in any scheme of property tax reform. Most important would be an efficient operational real estate market, where properties (land and buildings thereto) are exchanged “between a willing buyer and a willing seller in an arm’s length transaction” [. . .], where the parties had each acted knowledgeably, prudently and without compulsion” (RICS 2014a: 67). For the CV system, the resulting market values that arise on such a free and open market would be the necessary database. The availability of such transactions within centralized and computerized databases would constitute the overall basis for an objective property tax assessment. Only with such a database can the overall tax burden be divided relatively or equitably to the existing properties (according to their values) within the municipal boundaries. At the same time, the relative tax burden would reflect the public benefits received, as public goods and services are capitalized in the property values. A functioning real-estate market and a computerized database on property transactions is a prerequisite for the CV system. Consequently, it is of urgent need to collect property market information; not only for taxing purposes, but also for political/administrative decision-making. Land and property is considered an important entity for both, property owner and municipal government. It is a valuable personal asset and constitutes a centre-stage for urban governance. The information collected is therefore best for property tax assessment and crucial for urban planning decisions. To ensure assessment accuracy and correct decisionmaking, contemporary data through monitoring of trends in demand and supply, as well as prices of real estate and rigorous analysis thereof, is needed—e.g. to revise guiding values on which property taxes and stamp duties are based on. More precisely, information on the real estate market is urgently needed in order to prevent the current erosion of the property tax base (Annez 2010: 25) or faulty decision-making, because: • Many taxes are linked to transaction of properties, with the result of underdeclaring the property values in order to evade those taxes. With information on market values those revenue losses could be prevented. • FAR/FSI is an urban planning instrument that artificially limits the tax base. Due to missing market information, effects of such instruments cannot be assessed and therefore remain uncertain. In particular, shrinking FSI/FAR over the years has impeded investments in the housing market. The properties are not used to their ‘highest and best use’, leading to erosion of the tax base. • Rent Control affects the property market as landlords impede investments for maintenance and redevelopment of urban housing structures. This policyinstrument inevitably leads to a shortage of residential housing. • Widespread public land ownership restricts the tax base, as is usually exempt from property taxation. As outlined, there is much room for improvement in order to make the property tax work and in order to make it fair and equal. With the future prospects of urbanizing India in mind, reliable information on property values is imperative.

3.2 Case Studies: Megacities in Brazil, India, and China

139

Furthermore, property tax revenue could grow—as the overall economy—if the tax base were not restricted. Housing is an engine of economic growth, which had not been utilized so far. Investments in the housing market have multiplicative effects on the economy. Strong backward and forward linkages on about 250 ancillary industries make investments in emerging and urbanizing economies as India lucrative. According to the Government of India (2013: 1), “a unit increase in the final expenditure on the construction sector would generate additional income in the economy as a whole, which would be almost 5 times as high as the direct income generated within the construction sector itself. Furthermore, investment in housing has an employment multiplier effect of almost 8”. These estimates illustrate the significance of the housing sector on economic and human development of emerging India. Besides increasing personal incomes due to the construction sector, the living conditions of the urban population could be substantially improved by the construction sector itself. 50–60% of the urban populations in Greater Mumbai live in slums. Further urbanization will result in further growth of slum and squatter settlements. Urban housing is posing a challenge to policy-makers and urban planners that has to be tackled in the context of property taxation.

3.2.2.8

Reform Options

Reforms need to focus on the basic issues of fiscal federalism with regard to the assignment of taxes. Specifically, these include the objective/incidence of taxation (i.e. should the tax fall on ‘wealth’ and ability-to-pay, unearned economic rents— ‘windfalls’—generated, or public ‘benefits’ received); well elaborated public finance criteria in order to assign rational taxes to the municipal level (i.e. equitability, ease and cost of administration, visibility, growth sensitivity, fiscal autonomy, etc.); and administrative aspects that have to be in accordance with the taxing environment (i.e. trained tax officers for identification and assessment, availability of tax-relevant information for assessment, collection and enforcement, etc.). Following this sequence of analyzation, shortfalls of the property tax and consequently reform needs might be identified. While there have been considerable reforms undertaken among the municipal corporations in India with regard to property taxation—as outlined, the focus of reforms was on improving the ‘benefit’ principle with the introduction of the UAV system and on adopting administrative reform measures with regard to identification, assessment, collection, and enforcement—the present fiscal structure has been a neglected field of reform discussion since local bodies gained constitutional status in 1992 (74th Constitutional Amendment Act). Therefore, the focus of reform is put on the fundamentals of assigning property taxes to megacities within the multilevel governance structure of India. The 74th Constitutional Amendment Act assigned a list of functions (18 tasks) that are in the domain of the Urban Local Bodies in the 12th Schedule. So far, there is no matching list with regard to finances for the ULBs. For more than two decades, the ULBs have faced a clear assignment of functions heavily determining

140

3 Property Taxes Within the BRICS States

expenditures without a corresponding assignment of revenues. A “municipal revenue list” was recommended by the Fourteenth Finance Commission (FC XIV 2014); however, it does not appear that it will be amended to the Constitution in near future. Therefore, the local bodies are heavily dependent on the states and devolved tax arrangements, which are far from satisfactory, in order to cope with tasks assigned. With the abolishment of Octroi, the municipalities need a buoyant tax in lieu that is able to compensate for the revenue loss. Assigning a revenue list, with the property tax as local benefit tax, would be the first best reform option for all ULBs in order to have a predictable and plannable budget. In this context, a financial constitution could specify tax base, exemptions, assessment base, and assign the revenues generated to the ULBs. Herewith, the tax rate should be the only instrument in the hand of the local bodies in order to adapt property tax revenues to local preferences. As the development status of local bodies differs widely in India—from rural to local, from municipal corporations (first-tier urban local bodies) to municipalities (second-tier) to nagar panchayats (third-tier local bodies), the administrative capabilities should be considered. The megacities should be in the position and legally bound to make use of the CV system and to achieve a certain degree of administrative performance (as under JNNURM). By doing so, the large amount of Central and State transfers could be dispersed according to the fiscal needs, because the fiscal power of each urban local tier would be centrally determined. This measure could help solve the financial problems of the megacities. As they are facing above-average infrastructure costs (i.e. public transport, social housing, slum development, etc.) due to urbanizing India, the Central and State Government focus should be on the megacities. Within the megacities/metropolitan areas the tax revenues should be assigned to the municipalities and nagar panchayats in order to better reflect the benefit principle. This would follow the example of London, which has an equivalent population size to Bangalore. Here, the property tax is actually levied by 32 separate Boroughs (municipalities) within the Greater London Metropolitan area, in order to ensure a correspondence between taxes paid and benefits received. A similar plan is followed by the restructuring of BBMP (2015). Nonetheless, the State Government has to agree upon the devolution of powers. Another reform approach, which is much more radical, could be achieved by assigning megacities a City-State status. This approach was addressed by Roy Bahl (2012) and practical references are to be found in Germany (referred to as CityState being at the same time a municipality and a federal State) and in China (referred to as municipality with the same political, economic, and jurisdictional rights as a province). By declaring City-State status to the Indian megacities, they could set their own property tax rules, being less dependent on the devolution of powers than under the current federal arrangement. Bahl (2012: 21) sketched a precedent for the case of Greater Mumbai: The state of Maharashtra would be divided into two states: metropolitan Mumbai and the remainder of Maharashtra. There would be no hierarchical relationship between the two. Both states would be represented in the national Parliament, following the normal rules. The new city-states would have the same constitutional fiscal powers as any other state.

3.2 Case Studies: Megacities in Brazil, India, and China

141

This means that these cities would be empowered to levy VAT, property tax, automobilerelated taxes, etc. In short, their taxing powers and access to revenues could be dramatically increased. So would their expenditure responsibilities, as Maharashtra state level programs within these cities (including parastatals) would be turned over to the new Mumbai state. Those presently responsible for administering state level activities within Mumbai would be shifted to the new state. Properly planned, this transition could be accomplished without major service level disruptions.

The rank of a City-State has many advantages for the respective megacities, such as decentralization benefits by better reflecting local preferences and having an adequate revenue stream due to discretionary power on local own taxes and being empowered to levy VAT instead of Octroi. However, as the megacities are typically the economic power house of their respective State, such a reform plan seems to be outside the bounds of practicality.

3.2.3

China

At this time, China is on the brink of introducing a property tax with the underlying stated reason of curbing speculation and housing prices. Therewith, China argues that the property tax can be seen as a windfall tax on urban property owners in particular, who are often passive beneficiaries due to urbanization, natural population increase, zoning (e.g. transformation of rural to urban land), and/or speculation. Because of increasing demand against land supply constraints, property values raise and they became rich(er) while sleeping. However, more important reasons for the property tax concept appear. The property tax can be seen as a benefit tax, where local citizens experience the cost and benefits of local public services rendered. As taxes are not seen for a specific service in return, the benefit tax could provide a collective benefit (or public good benefit) to local citizens. Furthermore, the property tax can be seen as a wealth tax. Property taxes are often defined as an ad valorem (based on value) tax. As property is a primary finance asset of wealth accumulation that is highly visible, immobile, and concentrated, one can argue that the property tax could be used because of ability-to-pay. However, from a public finance point of view, the benefit tax character should be the centre of attention, because local tax money is reinvested in local infrastructure and public services for the benefit of the respective taxpayers: In this case, the property tax is a tax in lieu of charges. The introduction of property taxes has been discussed in China since 2003; pilot programs followed in 2011 within the megacities of Chongqing and Shanghai, and by 2017 a nationwide property cadastre will be in place, with the first step already having been undertaken by the establishment of the Bureau of Real Estate Registration. The World Bank and the Development Research Centre of the State Council, 2013, proclaimed that the property tax is to be seen as an important instrument to achieve a “modern, harmonious, and creative society” by 2030. With the

142

3 Property Taxes Within the BRICS States

introduction of a modern property tax, local governments could shift away from unstable transaction-related revenues. The new sources of own revenue could be granted to local governments—especially megacities—in order to cover local expenditures, to encourage efficient use of urban land, and to increase accountability of officials at the local level. The objective of this chapter is to analyse the existing local tax structure with a specific focus on taxes on residential property in four megacities that are directly under the administration of central government in China—Beijing, Chongqing, Shanghai, and Tianjin—against the backdrop of outlined normative public finance principles and criteria. The People’s Republic of China is divided into the central government level and the sub central, officially designated as local, government level (IMF 2008, GFSY, Institutional Tables). The megacities within the sample have the same political, economic, and jurisdictional rights as a province, but they are officially referred to as municipalities. As data is only available on provincial and municipal levels, the focus is restricted to these megacities.

3.2.3.1

Is the Tax System Equitable and Efficient?

Although China is classified as a unitary state, it must be acknowledged that they have a highly decentralized fiscal structure (Rao 2003: 27). Besides the central government, there are three (de jure) levels of local government: provinces and centrally controlled municipalities, villages and townships.101 Each level administers and collects local taxes, but central government sets the legislation governing taxation and the rate of each tax rate (corridor). Since the 1994 tax reform, a Tax Sharing System (TSS) is in place, e.g. tax revenues are assigned exclusively to the central or the local government level, and some taxes are shared among central government and local governments (Table 3.59). Although there has been a shift from frequently negotiating the tax revenue assignments to a clear Tax Sharing System, there are still negotiations between the different levels of government to cover expenditure needs. Especially opaque are the supplementary revenue assignments on sub-national government level, i.e. between provinces and subordinate levels of government. The higher levels of government share their tax revenues with the lower levels. However, there is considerable difference with regard to financial assignments among the provinces. Nonetheless, the tax reform is labelled a big step forward to “unified and simplified taxation, fair tax burden, rational decentralization of authority, clear distribution relationships, and sound fiscal revenue” (Hong 2013: 26). Further, a second reform wave started in 2003 focusing on excessive taxes and fees involved in real estate development and transaction, which resulted in the adoption of a uniform and standardized property tax system for fixed assets and

101

De facto, there are five levels of local government with prefectures under provinces and townships under counties (Wang and Herd 2013: 5).

3.2 Case Studies: Megacities in Brazil, India, and China

143

cancellation of other taxes and fees. Both reforms improved the tax system substantially although they were not guided with an explicit strategy with regard to formal expenditure assignments. Therefore, local governments accounted for 85% of total expenditures, but received only 52% of total revenues in 2012 (Annex A.6). The revenue assignments and intergovernmental transfers might provide adequate revenue to pay for all public services, such as cultural, educational, scientific, public health, social security, and urban maintenance and construction. However, pensions, unemployment insurance and minimum income support are also assigned to local governments. Local governments (i.e. provinces, municipalities, villages, and townships) play a crucial role in ensuring socially sustainable development by providing public services; therefore, revenues and expenditures should be assigned according to Musgrave’s model of public sector and Oates fiscal decentralization theorem. According to the decentralization theorem, benefit taxes and user fees, should be assigned to local government level. That is the case in China. Property taxes and fees are classified as local revenue (Table 3.57). Overall, local taxes make up to 30.3% of total tax revenues or 5.9% of GDP in 2012. The largest share of local revenues constitutes the business tax (15.7% of total and 3.0% of GDP), which is a sales tax on services. After that follows the transaction tax—City Maintenance and Construction Tax, Land Appreciation Tax, and Deed Tax—being the second most important source of local revenue with a share of total tax revenues of 8.7% and 1.7% of GDP respectively. The urban property tax consisting of the Urban and Township Land Use Tax and the House Property Tax show, combined, a share of 2.9% of total tax revenues or 0.6% of GDP respectively. Beyond that, local governments directly receive a percentage of shared tax revenues consisting of Value Added Tax, Income Tax, and Stamp Tax. The sample megacities present the same situation for the local level (Table 3.58). In Beijing, Chongqing, Shanghai, and Tianjin the Business Tax constitutes around 30% of general local tax revenues, thereby, being the main source of local tax revenue. The transaction taxes combined rank second with an average share of local tax revenues of about 20%. Beyond that, the shared taxes constitute, on average, more than 40% of total local tax revenues. The Urban and Township Land Use Tax and the House Property Tax constitute about 7% of total taxes. In sum, taking the three local beneficiaries of local public services into account—citizens (income tax), businesses (business tax, corporate income tax), and homeowners (property tax)—they add up to 60% of local own revenues across the four cities. Overall, according to the National Bureau of Statistics data for 2013 (Table 3.58), the four cities face a substantial revenue gap with general budgetary expenditures exceeding general budgetary revenues in excess of more than 51.3 billion yuan in Beijing, 136.9 billion yuan in Chongqing, 41.9 billion yuan in Shanghai, and 47.0 billion yuan in Tianjin. As local governments are not allowed to run a budget deficit (Brys et al. 2013: 12) and central government transfers do not cover the deficit, they need to turn to other sources of revenue, such as Land Transfer Fees (LTF), administrative fees, and sometimes to (illegal) borrowing

144

3 Property Taxes Within the BRICS States

Table 3.57 Local taxes within the tax sharing system in China 2012 Central Taxes Domestic Consumption Tax VAT and Consumption Tax from Imports VAT and Consumption Tax Rebate for Exports Tax on Ship Tonnage Vehicle Purchase Tax Tariffs Shared Taxes Domestic Value Added Tax Enterprise Income Tax Individual Income Tax Stamp Tax Local Taxes Resource Taxa Business Taxb City Maintenance and Construction Taxb House Property Tax Urban and Township Land Use Tax Land Appreciation Tax Tax on Vehicles and Boat Operation Farmland Occupation Tax Deed Tax Tobacco Leaf Tax All Taxes

Legal sharing rate C L

Tax revenue as % of all taxes

Tax revenue as % of GDP

100 100

0 0

7.8 14.7

1.5 2.9

100

0

10.4

2.0

100 100 100

0 0 0

0.0 2.2 2.8

0.0 0.4 0.5

75 61 60 30

25 39 40 70

26.3 19.5 5.8 1.0

5.1 3.8 1.1 0.2

5 1 6

95 99 94

0.9 15.7 3.1

0.2 3.0 0.6

0 0

100 100

1.4 1.5

0.3 0.3

0 0

100 100

2.7 0.4

0.5 0.1

0 0 0 75.5

100 100 100 25.5

1.6 2.9 0.1 100.0

0.3 0.6 0.0 19.4

Source: Author; Chinese Statistical Yearbook 2013 Classified as local tax, as central share is due to offshore petroleum resources b Classified as local tax, as central share is due to taxes on the Ministry of Railway, head offices of banks, and head offices of insurance companies captured in a centralized way a

through public corporations. The main source, however, is the LTFs that have been assigned to local governments’ level in the 1994 tax reform to compensate for revenue losses due to the implemented TSS. They are now part of the local governments’ fiscal autonomy. As indicated, the taxes granted to local governments are supplemented by LTFs, i.e. land sales revenues. The LTFs reach a high share of total tax revenues or even substantially exceed the local government tax revenues (Table 3.59 vs. Table 3.60); Beijing, for example, received tax revenues of 351.5 billion yuan and 182.2 billion

3.2 Case Studies: Megacities in Brazil, India, and China

145

Table 3.58 Local tax revenues of sample cities, billion yuan Beijing 2013 General Budget Revenue General Budget Expenditure Shared Taxes Domestic Value Added Tax Enterprise Income Tax Individual Income Tax Stamp Tax Local Taxes Resource Tax Business Tax City Maintenance and Construction Tax House Property Tax Urban and Township Land Use Tax Land Appreciation Tax Tax on Vehicles and Boat Operation Vehicle Purchase Tax Deed Tax Tobacco Leaf Tax All Taxes

Chongqing % 169.3 306.2 29.8 26.8 10.7 9.6 13.6 12.2 3.8 3.4 1.8 1.6 81.5 73.2 0.8 0.8 42.4 38.1 6.6 5.9

%

Shanghai % 411.0 452.9 210.0 55.3 84.8 22.3 83.7 22.1 35.5 9.4 5.9 1.6 169.7 44.7 – – 96.3 25.4 16.8 4.4

Tianjin 207.9 254.9 51.8 22.6 20.4 5.8 2.9 79.3 0.4 42.5 8.5

39.5 17.2 15.6 4.4 2.2 60.5 0.3 32.4 6.5

%

366.1 417.4 176.3 57.5 80.2 33.4 5.2 175.1 0.1 103.5 17.7

50.2 16.4 22.8 9.5 1.5 49.8 0.0 29.4 5.0

12.3 1.6

3.5 0.5

3.1 4.4

2.8 4.0

9.3 3.1

2.5 0.8

4.9 2.3

3.7 1.7

18.7 2.6

5.3 0.7

8.1 0.6

7.3 0.6

19.7 1.8

5.2 0.5

8.2 1.0

6.2 0.8

0.9 17.7 – 351.5

0.3 5.1 – 100

3.7 11.2 0.4 111.3

3.3 10.1 0.4 100

1.2 21.5 – 379.7

0.3 5.7 – 100

1.6 10.0 – 131.1

1.2 7.6 – 100

Source: Author; National Bureau of Statistics Bold values indicate orientation

Table 3.59 Land Transfer Fee (LTF), billion yuan

2008 2009 2010 2011 2012 2013

GDP 31,405 34,090 40,151 47,310 51,947 56,885

Beijing 50.3 92.8 162.8 105.5 64.8 182.2

% GDP 0.16 0.27 0.41 0.22 0.12 0.32

Chongqing 38.2 104.3 151.3 127.0 99.1 226.2

% GDP 0.12 0.33 0.48 0.40 0.32 0.72

Shanghai 43.9 73.2 90.1 82.6 64.1 80.5

% GDP 0.14 0.23 0.29 0.26 0.20 0.26

Tianjin 11.7 44.8 50.6 81.9 89.8 181.8

% GDP 0.04 0.14 0.16 0.26 0.29 0.58

Source: Author; National Bureau of Statistics; SouFun-CREIS 100 Cities Index

yuan for selling land (i.e. land transfer fees) in 2013. The relationship between tax revenue versus LTFs is in the case of Chongqing 111.3 vs. 226.2 billion yuan, in Shanghai 379.7 vs. 80.5 billion yuan, and Tianjin 131.1 vs. 181.8 billion yuan. Land developers have to pay upfront for making use of a plot of land ranging between

146

3 Property Taxes Within the BRICS States

Table 3.60 Property Tax—Urban and Township Land Use Tax and House Property Tax, billion yuan

2008 2009 2010 2011 2012 2013

GDP 31,405 34,090 40,151 47,310 51,947 56,885

Beijing 7.9 9.0 10.0 11.5 12.7 13.9

% GDP 0.03 0.03 0.02 0.02 0.02 0.02

Chongqing 2.2 2.6 3.3 4.6 5.8 7.6

% GDP 0.01 0.01 0.01 0.01 0.01 0.01

Shanghai 8.6 8.7 9.0 10.3 12.4 12.4

% GDP 0.03 0.03 0.02 0.02 0.02 0.02

Tianjin 3.0 3.4 3.7 4.3 5.7 7.1

% GDP 0.01 0.01 0.01 0.01 0.01 0.01

Source: Author; National Bureau of Statistics

40 and 70 years.102 LTFs are typically used for infrastructure to facilitate economic development and attract business investment. LTFs have been increasing steadily in all megacities reviewed because of rural land turned into urban, public expenditures for infrastructure and services and—of course—because demand for urban land is growing faster than the supply. However, it is questionable how much revenue from LTF remains in the megacities reviewed. According to Yangpeng, 79.6% of LTF was spent for compensation and land development, i.e. only 20.4% remained for urban infrastructure and social housing.103 Nonetheless, the figures imply that saturated land markets characterized by high population densities in Beijing and Shanghai lead to a tax-fee-ratio greater than one, i.e. tax revenues exceed Land Transfer Fees, and in the unsaturated land markets with lower population densities of Chongqing and Tianjin being less than one, Land Transfer Fees exceed overall megacity tax revenues. With regard to property tax revenues—Urban and Township Land Use Tax and House Property Tax—they are negligible in comparison to LTFs (Table 3.61). The figures illustrate that LTF is unstable and due to the fact that land supply is becoming scarcer in dynamic cities a time-limited revenue model. Nonetheless, public officials are promoting land sales and higher expenditures on infrastructure with the intention of stimulating GDP growth, which is the measure that paves the way for higher positions. According to interview partners, Chinese mayors are typically appointed by the communist party and serve about 5 years in office. Once they prove themselves, they strive for higher positions in the Communist Party or public enterprises. 102

Ownership of state-owned land is limited to a certain term of years, depending on the purpose of use. Urban land, for example, is leased for different terms: 70 years for residential, 50 years for industrial, and 40 years for commercial use. The government provides the land via tender, negotiation or auction. After the land-use right expires and in absence of renewal, the land itself and all adjunct improvements officially fall back to the state government. So far, it has not happened and a detailed procedure is not specified by law. With homeownership rates of more than 80% of the formal urban housing stock (Youngman 2012: 16), homeowners live under a ‘veil of uncertainty’. 103 Yangpeng, Zheng (2015): Payouts eat into land sale revenue for 2015. China Daily, latest update 2016-04-06.

3.2 Case Studies: Megacities in Brazil, India, and China

147

Table 3.61 Property tax in national context, 100 million yuan 2013 House Property Tax Urban Land Use Tax In % of National House Property Tax Urban Land Use Tax

National 1581.5 1718.77

Beijing 122.54 16.34

100.0 100.0

7.7 1.0

Tianjin 65.86 25.19 4.2 1.5

Shanghai 93.05 30.77 5.9 1.8

Chongqing 40.37 63.36 2.6 3.7

Total 321.8 135.7 20.3 7.9

Source: Author; National Bureau of Statistics

3.2.3.2

Taxes on Property in China: An Overview

China has eight different taxes on property. Following is a summary of the main characteristics of Chinese taxes on property including the year firstly enacted (SAT [State Administration of Taxation] 2012; Hong 2013). A chart containing additional details on the features of each tax is presented in Annex A.4: • House Property Tax (1986) is a recurrent tax levied on houses located within urban areas; rural areas excluded. The tax base is either the acquisition cost (construction or transaction cost minus discount rate, 10–30%, set by provinces) or the annual rental value. The tax rate is moderate at 1.2% on acquisition value and 12% on rental value. Within urban areas, owner-occupied residential housing is excluded, i.e. not included in the tax base. In summary, the tax is paid almost exclusively by businesses. • Urban and Township Land Use Tax (1988) is a recurrent tax imposed on land plots located in urban areas. The tax is to be paid for the allowance to make use of urban state-owned land. The tax is based on the size of land occupied times the rate per m2. The tax rate is set according to city size and reflects some relative locational value among the cities, but not within a city. Each provincial government within a tax corridor set by central government determines the tax rate. The local tax authorities are allowed to exclude the tax for privately owned residential housing and for rental residential housing by real estate management departments. In summary, the tax is paid almost exclusively by businesses. • Tax on the Use of Arable Land (1987) is a recurrent, area-based tax on the use of arable land. The tax is sometimes referred as Farmland Occupation Tax. It applies to agricultural land, state owned or collectively owned, used for agricultural and non-agricultural purposes (e.g. for construction of housing). Central government sets an average tax rate (yuan per m2) for each province. • City Maintenance and Construction Tax (1985) is a value-based transfer-related tax, based on the VAT, Business Tax, and Consumption Tax. The surtax is levied at a rate of 7% in urban areas, 5% in county towns, and 1% elsewhere. The revenue is used exclusively on urban maintenance and construction. • Land Appreciation Tax (1993) is a transaction tax applied at progressive rates ranging from 30–60% at the time of land transfer.

148

3 Property Taxes Within the BRICS States

• Deed Tax is a transaction tax based on transaction price of land use rights and/or residential property. The tax rate ranges between 3–5%, set by provinces and cities directly under central government. • Stamp Tax (1988) is a transaction tax levied on documents with regard to securities and immovable property. The tax is based on the price specified in the document itself or constitutes a fixed amount due to the specifications of the document. • Income Tax (1994) is a tax on transfer and/or lease of property. It is levied on the income obtained from the transfer and/or rental income of property taxed with a proportional tax rate. Out of these, three taxes could be classified as property tax: the House Property Tax, the Urban and Township Land Use Tax, and the Tax on the Use of Arable Land. Combined, they comprise a property tax. However, they are split into three taxes due to different types of property—national (e.g. urban/suburban areas), collective (e.g. agricultural land, forests, grassland, wasteland), and private property (e.g. apartments, commercial units) (Keilbach and Nann 2010: 9–11). Therefore, different taxes apply to these different rights on ownership.104 Analysing the taxes on property shows that most taxes are paid at the transaction stage, as a result being non-recurrent taxes. Furthermore, the central or the local authorities exclude owner-occupied residential properties with regard to the recurrent property taxes (House Property Tax, Urban and Township Land Use Tax), hence leaving a major source of local own-revenues apart. Overall, the tax system is revenue-weak and the revenue gap is closed by the LTF system, where lessees pay a fee for the right to make use of state owned land in a lump sum (also referred to as land premium). In the following chapters, the House Property Tax and the Urban and Township Land Use Tax—from now on indicated as ‘urban property tax’—are in the focus of analysis in order to identify their capacity to be a good local tax for megacities in China.

3.2.3.3

What Are the Operational Facts of the Property Tax?

Integral elements of property taxation may be subdivided into political decisions and administrative practices. Overall, to gain a basic understanding of the nature of the Chinese property tax these two separate bodies and their decisions and practices determining the property tax have to be analysed.

104

A privately owned property in an urban area, such as an apartment, always goes along with co-ownership of a land use right and the right to profit from the use of the state-owned land. Hence, everyone who possesses a piece of urban real estate in China is by legal definition the owner of the house (or apartment) but only the user of the state-owned land.

3.2 Case Studies: Megacities in Brazil, India, and China

149

Political Decisions First, the urban property tax has no constitutional basis, which apparently follows the trial and error policy in China, i.e. if reforms are conducted, there are always pilot programs testing the water with regard to public tolerance, political acceptability, and technical feasibility. Following such an approach, the constitution and/or the property tax law would need to be readjusted too often. The State Administration of Taxation (SAT) states that “for more than 30 years since the beginning of the reform and opening up, the taxation system of China has gone through several major reforms, and been improving day by day (SAT 2012).” The frequent revision of the tax system causes the most difficulties in understanding the Chinese tax system. However, the following provisional regulations define the main political property tax elements—tax base, assessment base, and tax rates of the urban property taxes reviewed: • Provisional Regulations of the People’s Republic of China on House Property Tax (1986) • Provisional Regulations of the People’s Republic of China Governing Urban and Township Land Use Tax (1988) Generally, the tax base may constitute all types of properties, such as residential, commercial, industrial, and agricultural. In China, all types of properties are part of the tax base. Furthermore, the tax base could be specified with regard to its nature (land and/or buildings) and scope (urban and/or rural). A recurrent property tax exists only for urban land and adjunct buildings in China. Thus, urban land and buildings constitute the property tax base for the Urban and Township Land Use Tax and the House Property Tax respectively, i.e. land and buildings are taxed separately. Both taxes are imposed on land and houses in cities, county towns, administrative towns, and industrial and mining districts. With regard to assessment, both taxes are not assessed in the proper sense. First, because owner-occupied residential properties are excluded, they are not part of the tax base and therefore are not assessed. Second, the Urban and Township Land Use Tax is based simply on area (m2), and the House and Property Tax is mainly based on the original value (construction or transaction cost minus a discount rate of 10–30%), with an exception for rental housing being based on rental income. Overall, the assessment base is of importance as it allocates the tax burden to the taxpayer. The distinct approaches on house property are troublesome as the rental value reflects the current use of the property while the residual value (original value minus discount rate) reflects neither the highest and best use nor the current use. Furthermore, one main determinant of property value, the location, is only reflected in the rental value approach of the house property. Therefore, the Chinese government obviously gives a strong incentive to homeownership. Leasehold property is disadvantageous, especially in dynamic urban areas. With regard to tax rates, homeownership is further stimulated. While the applicable tax rate on homeowners is 1.2% in case of residual value, leasehold property (rental value) is generally taxed with 12% or 4% in the case of individuals

150

3 Property Taxes Within the BRICS States

leasing their property at market prices. The higher tax rates on rental value further increases the downsides of leasehold property. The tax on the use of land is graduated according to city size (large, medium, and small) with tax rates ranging from yuan 0.2 to yuan 10 per m2. Within this tax rate corridor the local governments can determine a municipal specific tax rate, and by doing so, they can take the location of the urban land, which is one main determinant of land value into some consideration. However, the tax rate applies to the entire city; variations according to the location—respectively value—within the city are not possible. The central government sets overall all political determinants of the urban property tax (i.e. tax base and tax rate). Local governments have minor discretionary powers on determining tax rates within tight corridors as in the case of Urban and Township Land Use Tax or in determining discount rates of the House Property Tax. Further, they have some authority with regard to exemptions to the local government level.

Administrative Practices The administrative competencies for the property tax are assigned to the local government level, although they are extensions of the national taxing authority. Simultaneously with the 1994 tax reform resulting in a tax distribution system, the administrative practices have been developed further with the introduction of the State Administration of Taxation (SAT) at central governmental level. SAT is directly located under the State Council (Fig. 3.4). Furthermore, the state tax bureau

State Council State Administration of Taxation (SAT)

Peoples Governments at Provincial Level

State Administration of Taxation (SAT)

Local Tax Bureau at Provincial Level

Municipal or Regional Governments

Municipal or Regional Offices of SAT (SAT)

Municipal or Regional Local Tax Bureau

County Governments

Municipal or Regional Offices of SAT (SAT) Tax Stations

County Local Tax Bureaus Tax Stations

Fig. 3.4 Organizational chart of China’s tax administration. Source: Author; State Administration of Taxation

3.2 Case Studies: Megacities in Brazil, India, and China

151

system and the local tax bureau system respectively were established for the tax authorities at the provincial level and below, i.e. each sample city has had an Office of State Administration of Taxation and a Local Taxation Bureau since 1994. The offices of the state administration are organized in a top-down scheme. They are responsible for the vertical tax administration management. In contrast, the local taxation bureaus are under dual leadership of top-level SAT and the governments of the provinces (here the governments of the sample cities). The SAT provides guidance and coordination with regard to tax administration. Therefore, day-today administration is at the local level, but all policy and administrative guidance are the responsibility of the Central State and SAT as implementing body. The tax discovery and identification was spread among several institutions on various governmental levels; i.e. municipal government institutions, such as the Ministry of Housing and Urban-Rural Development, administer urban land. Other land (and water) resources were under the authority of a wide variety of agencies such as the Ministries of Agriculture, Water Resources, Railways, Communications, National Defence, and Civil Affairs. The different authorities and responsibilities complicated the coordination of issuing land permits and resulted in confusion about land ownership titles. Currently, the Land Administrative Agency is responsible for the land registration system and the Engineering Administrative Agency is responsible for the building register (Keilbach and Nann 2010: 20). However, there are justified grounds to doubt that this system is reliable in the practical implementation. According to interview partners, ‘not even the mayor knows how many properties there are within his own city’. Therefore, a unified and consistent land register would be necessary from an administrative perspective. So far, every owner of an apartment receives a certificate of ownership (Keilbach and Nann 2010: 26f), which needs to be transferred to a fiscal cadastre, i.e. a system that provides specific data for property and taxpayer identification to ensure a suitable property tax assessment and treatment of administrative aspects such as billing, collection and enforcement. Tax (re)assessment is not done in China. The simple assessment base of the property tax means fewer administrative resources. However, questions of equity might be raised; the lower the administrative burden (e.g. area-based property tax), the less equitable the assessment system. Administrative tasks, such as billing, collection, and enforcement, are split according to TSS. Responsibilities for central and local taxes are divided between SAT office(s) and the local taxation bureau(s) respectively. While central and shared taxes are administered and collected by the SAT offices, the local taxation bureaus collect the local taxes. The Beijing local taxation bureau is, for example, responsible for billing, collection, and enforcement of all local taxes (excluding the central government part identified in Table 3.57*) and fees (Beijing Local Taxation Bureau 2014).

152

3.2.3.4

3 Property Taxes Within the BRICS States

What Is the Administrative Performance?

The question with regard to administrative performance is a rather rhetorical one. At this time, the statistical data are not available on the number of property parcels that are or are not taxed, or on the number of properties assessed, or on the overall tax collections. It is known that residential properties are excluded from the property tax and, overall, there is—so far—no consolidated cadastre system in place. Therefore, it is impossible at this stage of research to estimate coverage, assessment, collection, and enforcement ratios. However, research involving the collection and analysis of these data should be conducted in the future.

3.2.3.5

Is It a Rational Local Tax?

Local taxes in China constitute both, shared and local own taxes. It is questionable whether the Chinese property tax meets the requirements of a rational local tax. Herewith, the Chinese urban property tax that consists of the Urban and Township Land Use Tax and the House Property Tax is analysed by the example of Beijing, Chongqing, Shanghai, and Tianjin according to the local tax postulates. First, we need to review the criteria that apply to a vertical rational local tax system. A basic criterion for a rational local tax is visibility, i.e. the property tax should connect property taxes collectively paid and local public services collectively received. Therefore, property tax is perceived as fair because local government goods and services offset the tax. However, urban residential land and adjunct houses are excluded from property tax payment, i.e. a major source of local own revenue is not included in the tax base. A further problem is posed by the exclusion of urban residential property owners: Every group that makes use of public goods and services, including citizens, businesses and land/homeowners, should pay for the public service provision accordingly. The same problem occurs for migrant workers that cannot change their hukou (household registration); i.e. by moving from rural to urban areas, migrant workers cannot officially move and become resident of the respective city. Therefore, the balance of interest criterion is on several grounds not fulfilled. The exclusion of residential property to encourage private investment and private homeownership in order to improve the living standards has done well— especially with increasing GDP and, accordingly, incomes since the 1980s. In the last decade alone (2004–2013), GDP and urban income has almost tripled—in some cases even quadrupled—within the megacities reviewed (Table 3.62). In the same period, urban living standards have improved significantly: per capita floor space, for example, has increased by more than 5 m2 (from 26.47 to 32.9 m2 per person). Therefore, actual urban challenges are not that much linked to living standards but to housing affordability as housing prices have increased with GDP and incomes. Housing affordability is measured as median housing price (P) in relation to median

3.2 Case Studies: Megacities in Brazil, India, and China Table 3.62 GDP and Urban income per capita (pc) Beijing Chongqing Shanghai Tianjin

GDP-pc 2004 40.916 10.845 44.839 30.575

153

2013 93.213 42.795 90.092 99.607

Income-pc 2004 15.638 9.221 16.683 11.467

2013 40.321 25.216 43.851 32.393

Source: National Bureau of Statistics China Table 3.63 Floor price (yuan/m2) and house price to income ratio (P/I)

Beijing Chongqing Shanghai Tianjin

Floor Price 2004 2013 4747 17,854 1573 5239 5761 16,192 2950 8390

P/I 2004 8.1 4.5 9.1 6.8

2012 14.9 6.9 11.4 8.9

Source: Author; National Bureau of Statistics China

incomes (I). The formula needs to be adopted in order to calculate P/I with available statistical data.105 For the Chinese sample cities, we see that the average floor price has, in some cases, more than tripled in the reference period, resulting in an increase of house price to income ratio (P/I) of more than 50% (Table 3.63). A house-priceto-income ratio beyond 5.1 is classified as severely unaffordable (Demographia 2014: 2), which is the case in all sample cities. As housing prices increase at a higher rate than incomes in Beijing and Shanghai politics demands that skyrocketing housing prices, due in part to urbanization and speculation, have to be curbed by the introduction of an urban residential property tax (China Daily, 2012). In order to meet the criterion of sensitivity, the property tax has to be assessed according to value (capital or rental value). With value as property tax assessment base and consequent reassessments, the assessment base increases with the economic circle, so called proportional growth sensitivity, which furthermore results in repeatedly higher property tax revenues. In a long-term consideration, the property taxes should be linked to economic growth with a revenue elasticity of dT dY one (ɛ¼ = ¼1).106 Reviewing a ten-year period (2004–2013) we see that the T Y property taxes, more precisely the Urban and Township Land Use Tax and the House Property Tax, are elastic (ɛ > 1), i.e. the property tax revenue increases faster than the respective Gross Regional Product (GRP) (Table 3.64). This is surprising because the Urban and Township Land Use Tax is based on unit-area

105

The calculation is as follows: Per capita floor space of residential buildings in urban areas, sq. m, multiplied average selling price of commercialized residential buildings, yuan per sq. m, in relation to per capita disposable income of urban households, yuan. 106 The revenue elasticity is an empirical measure between the relative change in the individual tax (dT/T ) amounts and the relative change of the social product (dY/Y ).

154

3 Property Taxes Within the BRICS States

Table 3.64 Long-term revenue elasticity of Chinese local tax system, 2004–2013 Shared Taxes Domestic Value Added Tax Enterprise Income Tax Individual Income Tax Stamp Tax Local Taxes Resource Tax Business Tax City Maintenance and Construction Tax House Property Tax Urban and Township Land Use Tax Land Appreciation Tax Tax on Vehicles and Boat Operation Deed Tax Total Tax Revenue

Beijing

Chongqing

Shanghai

Tianjin

1.2 1.2 1.1 1.2

1.0 1.2 1.0 1.2

1.2 1.2 1.2 1.1

1.0 1.1 0.9 1.1

1.0 1.0 1.2 1.1 1.2 1.4 1.3 1.4 1.1

0.9 1.1 1.1 1.1 1.3 1.3 1.2 1.3 1.1

N/A 0.9 1.2 1.1 1.5 1.5 1.5 1.6 1.2

1.2 1.0 1.1 1.1 1.2 1.3 1.2 1.3 1.1

Source: Author; National Bureau of Statistics China

of urban land occupied and the House Property Tax reflects mainly construction costs or the purchase/transaction price. In addition, rental value only constitutes the assessment base for rental properties, which make up a small proportion of residential housing units. While the rental value increases in a dynamic economy, the remaining assessment base does not. This implies that the growth sensitivity in the Chinese case is mainly based on rural or agricultural land that was transferred to urban land. Therefore, the Urban and Township Land Use Tax is within this period more elastic than the House Property Tax. Turning rural land into urban land is the easiest revenue-generating way for urban local governments in China as rural land is only taxed for agricultural use. Growth sensitivity is especially worthwhile in urban areas that record a boom in housing prices. So far, the Land Appreciation Tax only captures a share of the increase of value of land and above-ground buildings. With regard to the criterion of minor economic cycle sensitivity, we see in Annex A.7 that the House Property Tax is a stable source of local own revenue in Chinese megacities. However, the Urban and Township Land Use Tax is not as predictable and certain as the House Property Tax—especially the financial crisis of the year 2008 had a substantial impact. Second, we need to review the criteria that apply to a horizontal rational local tax system. Each local tax system should be designed in such a way that inefficient migration is avoided. Migration is common in dynamic economies and it is efficient as it allows scarce resources to be used in the most efficient way. Overall, the local tax system should not distort the location of businesses or the choice of residence in the case of citizens. However, the tax burden should be different among the local municipalities in such a way as it reflects the differences in local public services.

3.2 Case Studies: Megacities in Brazil, India, and China

155

Therefore, migration could be efficient in the case of municipalities that better account citizens’ preferences, have lower production cost, or municipalities that have a higher contribution to growth. The criterion is not fully met in the case of China due to the hukou system. To date, only locally registered persons are allowed to purchase land. With the hukou system in place, only urban residents are allowed to buy urban land, excluding a large part of the population.107 The most important criterion from the local government perspective is fiscal autonomy. Without local discretionary power in setting tax rates, the benefit principle is not fulfilled. Local governments should have discretionary powers on local tax rates in order to meet their local priorities, economic structure and fiscal status. Yet, local governments do not have discretionary powers as tax rates (tax rate corridors) are set by the central government. While the tax rates of the House Property Tax are fixed (residual value 1.2%, rental value 12%), the Urban and Township Land Use Tax is locally determined within a tax rate corridor (yuan 0.2–10/m2). The last criterion is an evenly distributed tax base, which serves to avoid strong disparities and fiscal equalization systems. Local taxes should be oriented on municipal needs, i.e. the revenue capacity of local taxes should be sufficient to meet the local expenditure needs. Thus, an evenly distributed tax base with the capacity of being taxed according to the municipal needs would theoretically make fiscal equalization schemes redundant. However, in practice, transfers could be lower in the case of an evenly distributed tax base. For urban areas, the criterion is met, but the separation of urban and rural land with recurrent taxes on urban land and adjunct buildings and recurrent taxes for agricultural use only (without including any buildings) result in unevenly distributed tax bases within the whole country.

3.2.3.6

What Are Current Reform Initiatives?

Since 2003, the Chinese government has been discussing a reform of the outlined property tax system, and at the same time, putting an end to excessive taxes and fees on real estate development and transaction. According to Hou et al. (2015: 23) and Youngman (2012: 17) the interim property tax reform initiatives could be outlined as follows: • 2003: A resolution of the Central Committee of the Chinese Communist Party calls to “Launch a reform of taxes and fees on urban construction; levy a uniform and standardized property tax when prerequisites for it are met, then repeal related fees and charges”. • 2005: The Party Central Committee called on the government to “smoothly advance adoption of the property tax”. 107

Migrants might pay for local services through their rents. However, they mostly live in the outskirts of the cities in the informal sector rental market. From a public finance perspective, they make use of public infrastructure not (tax) paying for it accordingly.

156

3 Property Taxes Within the BRICS States

• 2006: Six cities were selected to conduct pilot programs on the property tax. • 2007: The Property Rights Law was passed to secure private property. • 2009: The work report of the Central Government proposed “to study how to promote a reform of the property tax”, and in the same year, the State Reform and Development Commission recommended “deepening the reform of real property tax and considering levying a property tax”. • 2010: The Party Central Committee recommended “studying the reform of the property tax”. • 2011: A recurrent ‘property tax’ on urban residential buildings was introduced overnight—January 27, 2011—within the urban districts of the cities of Shanghai and Chongqing. The pilot programs in Shanghai and Chongqing were understandably different from each other with the purpose of gaining insight into the differing property tax functions (Table 3.65). However, they shared the short-term goal of curbing skyrocketing housing prices. According to Hou et al. (2013: 50–54) Shanghai introduced a twofold strategy addressing registered permanent residents (i.e. hukou) and non-registered permanent residents differently. While the first group has to pay the tax once they buy a second (and above) apartment or house, the second group has always to pay regardless if it is the first, second or third apartment. The privileged status of registered permanent residents is even further increased by exempting 60 m2 per household member of overall floor space (first and second home). The focus of the Chongqing property tax trial is on single-family

Table 3.65 Facts on property tax of pilot programs

Chongqing

Object Single family villas, new purchase of luxury housing, and second housing units

Shanghai • Registered permanent residents: second (or more) homes • Non-registered permanent residents: first (or more) home(s)

Taxpayer Tax base Owner of Transaction property price

Owner of 70% of property transaction price

Source: Author; Hou et al. (2013: 50–52)

Tax rate • Villas and new purchased luxury housing: 0.5–1.2% • Second homes: 0.5% • 0.6% or 0.4%

Collection Stage/ Payment Possession/ before December 31

Exemptions 100 m2 or 180 m2 per household

Possession/ 60 m2 per household between member October 1 and October 31

3.2 Case Studies: Megacities in Brazil, India, and China

157

villas, new purchases of luxury housing, and second housing units for nonpermanent residents, and non-investors or non-job-holders in Chongqing. ‘Luxury’ is classified as market price per square meter exceeding the average price of new construction in urban districts of Chongqing within the previous 2 years. Exemptions are limited to one property only; property owners benefit from a tax exemption if villas were bought before the introduction of the tax (180 m2) or in the case of new purchases (100 m2). Besides the tax base, the assessment rate and tax rate differ among the pilot cities. While the assessment base in Shanghai constitutes 70% of the transaction price, Chongqing considers the full transaction price. With regard to the tax rate structure, the main difference is that Shanghai applies a proportional tax rate and Chongqing a progressive one. Shanghai sets generally a rate of 0.6%, but if the transaction price is lower than twice the average price for new construction of the previous year they apply a rate of 0.4%. The progressive tax rates in Chongqing are 0.5% of the transaction price, if the price is less than three times the average price of newly constructed property within urban districts of the previous 2 years; 1% for those priced three to four times the average construction price; and 1.2% for those properties priced more than four times the average construction price. Both taxes were introduced without any legal basis, i.e. there was no national law guiding the pilot programs; Shanghai released the “Interim regulation of Shanghai Municipal Government on the pilot real property tax on certain categories of residential housing” and Chongqing the “Decree No. 247”. Consequently, there have been no legal implications for those taxpayers ignoring the tax bill. With regard to administrative practices, the two pilot cities collected some valuable experience (Hou et al. 2013: 55–57): The property identification is a relatively easy task as mainly newly purchased properties are taken into account. Furthermore, the transaction price constitutes the ‘assessment base’. In Shanghai, for example, all purchasers are reviewed at the transaction stage, before the property is registered, whether they have to pay the tax or if they are exempt (“Original Housing Information Query Application”). A “Notice of Real Estate Tax Identification” and, accordingly, a tax bill is issued within 10 days after the inquiry from the Local Tax Bureau. Both cities run a strict enforcement approach—on paper, not in practice—that can range from prohibiting the transaction of property in times of outstanding tax liabilities to restricting personal credits and loans from commercial banks. Furthermore, defaulters may not leave the country until the tax bill is paid off. Both pilot cities charge a penalty of 0.05% of the overdue amount per day. Finally, in order to prevent unreasonable transaction prices, manifested in part by under-priced properties with the intent of evading tax payments, both cities introduced a “Housing Stock Trading Price Comparison System” at the Local Tax Bureau. The comparison illustrates that both pilot programs target only a very small fraction of the residential urban housing market (second and/or luxury housing). It is estimated that there are about 8000 parcels taxed in both cities only (Youngman 2012: 18). Both cities apply a moderate tax rate. In addition, the property tax does not apply to registered owners of ‘normal’ apartments in either city (except for non-registered property owners in Shanghai after 28 January 2011).

158

3 Property Taxes Within the BRICS States

Overall, the focus was on the cadastre and valuation, without focus on the collection and enforcement. Due to the limited revenue scope of the introduced property tax, academics assume that the administrative cost might have been even higher than the tax revenues collected. Furthermore, the missing legal basis and the resulting enforcement difficulties might be another reason why the property tax in Chongqing and Shanghai could be evaluated a failure from revenue perspective. A further step in the history of a nationwide introduction of the property tax was undertaken in 2014 by the establishment of the Bureau of Real Estate Registration, which will be operational in 2017. It is a valuation-pushed approach with little attention paid to the taxpayer service, collection and enforcement side. In the first instance, the focus is on the property registration. The registration system will be compiled in such a way that all relevant departments, such as land, tax, finance, audit, statistics etc., are linked to the same system. Later the bureau will also be responsible for drafting and enforcing land management regulations and resolving land disputes. Further, the system combines data from all levels of government (provincial, prefectural, county, township, and village level). The system will be an administrative key tool introducing the property tax nationwide and for billing, collecting, enforcing property taxes at each governmental level. Currently, the Standing Committee of the National People’s Congress, China’s top legislature, is working on property tax legislation, with an estimated introduction by the end of 2016. The legislation will most likely include both housing and land; a housing tax on homeowners and a land tax on land developers (China Daily, 2014-08-11). The decision upon the separation on homeowners and land developers indicates that transfer-related taxes or even the land transfer fee are not going to be amalgamated with the new property tax.

3.2.3.7

Critical Summary

‘One size fits all’ does not exist in the context of property taxation. However, there are important lessons that can be learned from international local public finance experience and elaborated principles and criteria being the basis for sound local public finance systems around the world. The strength and weaknesses of each property tax system can be revealed by taking these guidelines as a blueprint for an analysis. An objective discussion of the Chinese property tax design and resulting implications for the local level illustrate property tax-related and further problems involved, among others, the financial situation of local governments, tax-benefit issues, the functioning of real estate markets, and the affordability of housing. The results can be separated to the current property tax and the pilot programs conducted in Shanghai and Chongqing. The implications of the current propertyrelated taxes can be summarized as follows: Mismatch of Local Revenue and Expenditure Assignments Since the 1994 tax reform that introduced the Tax Sharing System (TSS), i.e. specific tax revenues are assigned to central or local level or to both levels combined, local governments do

3.2 Case Studies: Megacities in Brazil, India, and China

159

face a significant mismatch between local revenues and expenditures. They have even increased to this day: local governments account for 85% of total expenditures, but receive only 52% of total revenues in 2012. Local taxes combined constitute 47% of total taxes or 9.2% of GDP. The high share is relativized by the fact that all levels of government below the central government are summed up as local governments in China. The municipal level—Beijing, Chongqing, Shanghai, and Tianjin—faces a similar situation: general budget expenditures exceed general budget revenues without considering central transfers. The most important tax on the local level is the Business Tax, a sales tax on services, accounting for, on average, 24% of overall local tax revenues in 2013. Thereafter, the Enterprise Income Tax (12%), the Value Added Tax (16%), and the Individual Income Tax (7%) play the most important role. Property taxes are split into the Urban and Township Land Use Tax, and the House Property Tax. They account for 3% and about 2% respectively of local tax revenues. The main source of local revenue originates from the Land Transfer Fees (LTF) assigned to local governments in 1994, i.e. fees that have to be paid to make use of state-owned land. The LTFs even exceed local tax revenues in the very dynamic cities of Chongqing and Tianjin. Local Discretionary Powers Local governments in China have very limited discretionary powers to meet local priorities, economic structure and fiscal status. With regard to property taxes, local governments may only vary the tax rate of the Urban and Township Land Use Tax within a centrally determined tax rate corridor. Windfall Tax(es) The main argument for property taxes is based on the taxbenefit-correlation (benefit principle); either in a direct way by making use of public goods and service rendered or in an indirect way by the capitalization of public services in property values. The Chinese local tax system is mainly based on windfall tax revenues collected at the transaction stage. This holds especially true for the local Land Appreciation Tax, the Deed Tax, and—in a broader sense—for the local LTF. The size of these non-recurrent revenues is mainly based on external determinants such as speculation and urbanization, which further increase land demand against land supply constraints. The increment value is skimmed only at the transaction stage. Therefore, these revenues are rather volatile, not because of the economic circle but mainly because of the scarcity and amount of land sold within a year. The greater the local tax revenues in this case, the greater the windfall effect. The urban state-owned land rental system implies a strong incentive on attracting companies that increase local GDP, which further attracts workers and residents. The land tenure system implies that only dynamic cities benefit, and they benefit in a disproportionate way, for example, from windfall gains, while less dynamic cities face relative revenue losses. However, the scarcity of state-owned land or, respectively, increasing population densities are limiting sustainable urban areas and their respective revenue model: Therefore, the windfall-tax revenue model is time-limited. Marginalized Property Tax With regard to the urban property tax, we find that both taxes are static due to their tax bases: urban area occupied in the case of Urban

160

3 Property Taxes Within the BRICS States

and Township Land Use Tax and transaction price or construction cost in the case of House Property Tax. These values do not reflect the scarcity of state-owned land or the location of the building. This is especially problematic for dynamic urban areas. With regard to the House Property Tax, the tax revenue might even decrease in purchasing power terms due to inflation. More concerning is the fact, that urban residential properties are excluded in China. The tax applies almost exclusively to businesses. Furthermore, the House Property Tax is a stable source of own revenues, the Urban and Township Land Use Tax is much more sensitive to the economic cycle (especially the 2008 crisis). Housing Affordability Taxes and fees constitute a great share of housing prices. First, they have to be paid in full upfront. The buyer of a property has to pay at least eight property-related taxes plus Land Transfer Fees at the transactional stage. Second, the Land Transfer Fee makes up a large share of the overall house price, as it constitutes an once-in-a-lifetime rent paid by land developers passed on to purchasers at transaction stage for 70 years. If the LTF is spread over the lifetime of the ownership period of state-owned land rather than an once-in-a-lifetime payment, the entrance price would decrease and the entrance time into the housing market would be reached at a significantly earlier point. This would have a positive impact on the affordability by pulling down the house-price-to-income ratio. Public Services Rendered So far, there is only one local revenue source with a benefit link in China, the so-called City Maintenance and Construction Tax with revenues exclusively spent on public infrastructure and maintenance. Apart from that, the tax-benefit link is disregarded in several ways. First, residential property owners do not pay property taxes at the possession stage, as they are excluded. Therefore, they do not pay according to the balance-of-interest criterion. All user groups of public services should pay collectively according to their public services provided, i.e. local governments should receive (at least parts of) income tax paid by local citizens, business or corporate income tax paid by local businesses, and property tax paid by homeowners. Therefore, a major source of local ‘own’ revenues is left aside. Second, the LTF constitutes the main source of local revenue, which is spent on public infrastructure and services, such as police, fire protection, schools, and hospitals. As the fee is paid once in 70 years only there are inevitable time gaps between fees paid and public services rendered. The institutional symmetry—i.e. the spatial identity between decision-makers, beneficiaries, and tax payers—does not apply. Private Ownership The legal basis of private property ownership has substantially improved since the Property Rights Law was introduced in 2007. However, it has to be realized that private property, such as an apartment, might fall back to the state government in absence of a renewal of the land use right usually set for 70 years for residential properties. It is uncertain how the political forces will deal with this case considering the lack of a legal precedent. Property owners live beneath a veil of uncertainty.

3.2 Case Studies: Megacities in Brazil, India, and China

161

Analysing the Chinese property tax according to public finance guidelines, we find challenges that are still to be solved, as summarized, and there are difficulties that are already addressed. The most important developments can be summarized as follows: Pilot Program The most important step was the introduction of the property tax in two pilot cities in order to gain an insight into the property tax and to demonstrate to the public that property tax reform is on its way. However, the introduced property tax constitutes from several perspectives just a pilot level. The tax is only levied on a limited number of urban buildings—second (and more) houses and luxury apartments—and therefore does not include all urban residents. Next to the limited properties involved, there are exemptions granted, further reducing the number of taxed properties. The tax rate is moderate and is applied on the transaction value. Properties are still not assessed but based on transaction values that do not necessarily reflect market value. Market value and selling price are not the same, as real estate markets are imperfect. A first step into the direction of properly assessing market values as tax base constitutes the implemented “Housing Stock Trading Price Comparison System” within the pilot cities. National Cadastre System From an administrative perspective, a fiscal cadastre is necessary in order to identify the properties (e.g. unique property identification number, size, value, and record of improvements) and the taxpayers (e.g. physical address, and postal address). Further, the information is needed to assess, bill, collect and enforce the property tax. The establishment of the Bureau of Real Estate Registration constitutes an important step into the property tax direction. Overall, detailed knowledge about the real estate market is of high value for the national and municipal level in order to set the right macro/micro policies. Property Tax Law The implemented pilot programs were not based on national law. Enforcement of overdue property taxes is problematic. China’s legislative body (the Standing Committee of the National People’s Congress) is currently elaborating a nationwide property tax law, thereby paving the way for the nationwide introduction of property taxes. Summarizing the current property tax and the developments in the recent past show that the Chinese property (related) tax (system) is shifting from a current windfall tax—especially for dynamic urban areas as in the sample cities reviewed— to a wealth tax by the introduction of the pilot program. However, to put local governments’ public finance on a sound basis, it is essential that the property tax follow the public finance argument of a benefit tax. How this might be achieved is to be discussed.

3.2.3.8

Reform Options

Before implementing the tax nationwide, the central government must clarify its purpose. Is the goal a windfall tax, a wealth tax or a benefit tax? Is such a tax aimed

162

3 Property Taxes Within the BRICS States

at curbing rising housing prices and speculation in the real estate market or at creating a stable tax revenue source for local governments? The following reform options assume the latter as main concern. Financial theory suggests a ‘golden way’: a well-administered recurrent tax with market values as tax base and a high degree of local autonomy—for a rational local tax. However, each state has its own institutional framework, tax-specific legislation, and political, fiscal and administrative environment that has to be taken into account in order to design a rational local property tax (McCluskey et al. 2013; Salm 2014). With regard to the Chinese case, some recommendations could be drawn up with regard to the further improvement of the property tax design: First, in order to prevent any confusion regarding land or property ownership, the property owner should pay respectively for both the land leased from the state and the property privately owned. However, a housing tax on homeowners and a land tax on land developers as currently under discussion would be a wrong decision. This kind of distinction would neglect the property tax being a recurrent source of revenue. Land developers would pay once only for the right to make use of stateowned land (and pass the tax to the purchaser) as is currently the case. Therefore, the tax should be paid by the property owners in one annual instalment (one tax bill) with distinction on state-owned land and private housing. By doing so, the tax-benefit connection with regard to the institutional symmetry would be established. Taxing businesses and residents would increase the tax base, making the tax amount moderate for each single property. Furthermore, there could be a higher tax on land, which is less ‘elastic’ than on buildings, which would decrease the excess burden of the property tax. Second, by shifting from once-in-a-lifetime payment (for a 70-year land-useright) with regard to Land Transfer Fees to a recurrent tax on land would produce positive effects. For example, land developers would gain relief favouring the development timing (Andersen 2008), and the fee would not be passed on to homeowners, therefore lowering the entrance price into private ownership. Overall, the life cycle of buildings and homeownership would be enhanced, by speeding up the development time and lowering the entrance price of homeownership. This might have a substantial effect on the affordability of housing. The question of course arises of how to deal with the older urban properties that already have paid the LTF. The urban property owners benefited from increasing property values in the past; they passively became rich(er) as property values rose. Because of that, the enactment of a property tax in this particular case may be in order. Third, the large amounts of property-related taxes and fees have to be merged into a single property tax comprising a tax on state-owned land and an urban housing tax. All other taxes and fees could be amalgamated with the two parts of the tax. The City Maintenance and Construction Tax already has a tax-benefit character and could be integrated into the new property tax. The Land Appreciation Tax could be eliminated from the date the properties are frequently re-assessed. The Stamp Tax and the Deed Tax could be abolished and/or transferred into an administrative fee, which is directly related to the administrative services provided. The LTF could be integrated into the part taxing state-owned land in recurrent

3.2 Case Studies: Megacities in Brazil, India, and China

163

instalments. As a result, the tax burden would shift from the transaction stage to the possession stage. The simplified local tax system would constitute a stable and adequate own revenue source for the Chinese local governments. Fourth, the biggest challenges with regard to property taxation in China are related to administrative aspects of realization. Most challenging will be a proper assessment (this is one of the most challenging aspects within all property tax systems around the world) based on a functioning cadastre with a functional crossreferencing system among the different government agencies. There are cities in China already practicing computerized-assisted mass appraisal (CAMA), which would constitute the most up-to-date assessment technique. Until this infrastructure is in place, there could be a land tax based on the land’s market value, derived from land auction or land rental. The buildings could be taxed according to benefits received by applying equivalence factors to living area, which depends on the usage of the area (residential, commercial, industrial, or agricultural). This approach follows the basic framework of the German property tax reform (Fa¨rber et al. 2013). Fifth, the property tax should be implemented gradually with dynamic megacities being on the forefront—as happened in the case of the pilot programs. Larger cities generally have a larger per capita property tax base due to enhanced urban public services, urbanization, speculation and/or higher property values in general. Therefore, such cities can impose property taxes without losing their tax base to more competitive localities. Furthermore, megacities host administrations that are more efficient in order to establish a new property tax. Overall, this step would free up transfer payments from central government that could be allocated to poorer regions (World Bank and Development Research Centre 2013: 58). Finally, local government officials might deny the introduction of the property tax, as LTFs have constituted a lucrative revenue source so far. Sustainability is not in the focus of a short-term mayoralty (on average 5 years) and their performance being evaluated against the backdrop of GDP growth. With this incentive structure on the local level, that being the selling of as much land as possible, pushing public infrastructure projects, and gaining industry, the property tax reform might face several opponents on local level. Local performance should not be based on GDP growth alone but might be expanded to property tax ratios (see Sect. 3.2.3.4) to increase public officials’ commitment on the local level. In summary, there is a current shift from the windfall taxes in place to the emerging trend of wealth taxation with regard to property taxation in China. The primary concern of this paper is recommending a benefit tax as guiding reform approach. The reform objective should be a separate tax on state-owned land and privately owned buildings to avoid confusion of property ownership in the future. Both taxes could be part of a ‘single’ property tax that is billed once, but separately. The property tax should preferably be based on all urban residential households and businesses, following a broad-based and low-rate approach. Market value should be the assessment base (at least in the case of state-owned land). Except to setting the tax rate, central government should define all other features of the property tax.

164

3.3

3 Property Taxes Within the BRICS States

Comparative View on Stylized Facts of the Property Tax in BRICS

The case studies chosen already mirror the broad spectrum of property tax designs. In this chapter the two States Russia and South Africa are integrated in the comparative design by reviewing the megacities Moscow and Johannesburg. Herewith, national and/or municipal tax codes are reviewed.108 Furthermore, the comparative view draws on the property tax database of the International Property Tax Institute (IPTI), which contains 40 detailed country profiles, and on comparative studies, such as Martinez-Vazquezet et al. (2010: 326–346), which contains basic property tax characteristics of 84 countries. The performance of the property tax is generally determined by policy decisions made about the tax base, tax rate, exemptions, and assessment in conjunction with administrative practices for assessment, billing, collection and enforcement. While the latter is—of course—set within a legislative framework, performance is based on administrative efficiency and effectiveness. Assessment could be seen as an important intersection between politics and administration and best shows that politics does transform into administrative realities. While policy decisions are typically provided within the tax law; administrative efficiency and effectiveness need more detailed analysis, which is not provided in this chapter. The comparative view will therefore reveal the diversity and uniqueness in the application of residential real property taxation within the five states and their megacities even though overall normative criteria for a rational decentralized tax are common.

3.3.1

Tax Policy Decisions

The local property tax is typically protected by the National Constitution, except in China and Russia. However, in 2015 the Individual Property Tax was introduced by Chapter 32 into the National Tax Code in Russia. The legislation already reveals certain differences among the BRICS tax systems. While Brazil splits the property tax into an urban and rural property tax and therewith separates local from Union property taxes,109 Russia and China levy separate taxes on land and buildings.110 China has numerous taxes on property due to various types of ownership

108

Federal Tax Service of Russia (https://www.nalog.ru/eng/individuals/nalog/), Tax Code of the Russian Federation Part II, Unofficially Translated by Ernst and Young; City of Johannesburg, Property Rates Policy 2015/2016. (http://www.joburg.org.za/images/stories/2015/Sept/Rates% 20Policy%202015-16.pdf) 109 Brazil divides the property tax into an urban Imposto sobre a Propriedade Predial e Territorial Urbana (IPTU) and a rural Imposto sobre a Propriedade Territorial Rural (ITR) property tax. 110 The Tax Code of the Russian Federation was extended by Chapter 32, which is not included in the Tax Code of the Russian Federation Part II, Unofficially Translated by Ernst and Young.

3.3 Comparative View on Stylized Facts of the Property Tax in BRICS

165

(e.g. state-owned land and privately-owned buildings).111 It also recently started to introduce property taxes on newly constructed homes with the aim to amalgamate the different taxes on property. Different property tax designs could be found within India, as the states have the power to determine tax parameters. South Africa levies ‘Rates’ only within the boundaries of municipal (urban) areas. The differences have severe implications on the property tax base and thereby on property tax revenue. Legislation B The Brazilian Constitution of 1988 allocates authority for urban property taxation (IPTU) to municipalities; the rural property tax is assigned to the Union (ITR). Supplementary authority with regard to IPTU is provided in the National Fiscal Code (defining components of tax base, tax liability, exemptions). Local legislation is used to define specific aspects of the tax, such as the methodology for estimating assessed values and the tax rates, as well as additional exemptions from property tax R The property tax is established by the National Tax Code and normative legal acts of representative bodies of municipalities • Tax Code Chapter 31: Land Tax • Tax Code Chapter 32: Individual Property Tax I Entry 49 in the State List of the Seventh Schedule of the Constitution; thereby, state governments set the framework for the property tax in regard to tax base, procedure for assessment, rebate and exemption policies, rate setting, tax liability, and measures for dealing with delays and tax evasion – Traditional-ARV: Rent Control Act – Area-Value-Based: Urban Local Bodies Act, 1998; in conjunction with various local enabling legislation C – Provisional Regulations of the People’s Republic of China on House Property Tax (1986) – Provisional Regulations of the People’s Republic of China Governing Urban and Town ship Land Use Tax (1988) – Provisional Regulations of the People’s Republic of China on Farmland Occupation Tax (1987) – Reforms and new legislation are being developed as of 2004 S Section 229 and 227 (2) of the Constitution of the Republic of South Africa allocates authority for property taxation to Municipalities and Metros. For the local government level there is the Municipal Property Rates Act 6 of 2004, which had to be implemented by all municipalities by 1 July 2011

The tax base is prescribed by law. The tax base may be different in nature (land and/or buildings) and scope (urban and/or rural). In all cases examined here both land and buildings constitute the property tax base. In Russia and China, there are separate taxes on land and buildings. While South Africa levies property tax on urban properties only, Brazil and China classify their taxes into urban and rural property tax—in Brazil “Imposto sobre a Propriedade Predial e Territorial Urbana”, “Imposto sobre a Propriedade Territorial Rural” and in China “Urban and Township Land Use Tax”, “Farmland Occupation Tax”. Furthermore, China and in part Russia sell land-use rights for a specified number of years.

111

In this case, the House Property Tax and the Urban and Township Land Use Tax are reviewed as urban property taxes.

166

3 Property Taxes Within the BRICS States

Tax object/Tax base B Land and improvements (all property-use classes, including vacant land, residential and non-residential property) R • Land Tax (Art. 389): land plot; • Individual Property Tax (Art. 401): apartment, houses, garages, other buildings I – ARV: Land and buildings, sometimes with reference to location, type of construction, age and use – Area-Value-Based: Land and buildings, with reference to location, type of construction, age and use C Land (Urban and Township Land Use Tax, Farmland Occupation Tax) and buildings (House Property Tax) Generally, all land is owned by the state. Purchasers buy land-use rights for a set number of years S All “rateable property”; immovable property (land and buildings)

South Africa excludes rural properties from the tax base and China leaves urban residential properties outside the tax net. Further forms of tax relief are exemptions and rebates. In the case of exemptions, the property is assessed first and exempt thereafter. Most exemptions are granted to governmental bodies, organizations/ institutions with religious and/or charitable purposes, and properties below a specific value threshold. Overall, property exemptions are complex from an administrative perspective and corruption issues may be involved. This seems to be the case in China, where exemptions are not specified but rather have to be appealed for. In all other cases, exemptions and rebates are specified within the National Tax Code and/or are further specified in municipal legislature. As the case studies show, exemptions and rebates are often provided in various stages, such as tax base, assessed property tax amount, or the final tax amount to be paid. With increasing number of exemptions and increasing number of levels on which exemptions are granted, the overall impact of exemptions and rebates on the property tax is getting more and more opaque. In addition, from an administrative point of view, the complexity increases with each exemption or rebate granted. Exemptions B Exempt properties: governmental, religious, political parties, trade unions, educational, health and non-profit organizations. Additionally, capping systems are sometimes used to guarantee that tax bills do not surpass ability-to-pay. The Chamber of Councillors, a group of politicians elected by the local community, is responsible for promoting and arguing in favour of the capping systems in order to protect the poor and retired taxpayers R • Land Tax (Art. 389): Land on World Heritage List, historical and cultural reserves, objects of archaeological heritage, common property of apartment buildings, etc. Further tax incentives are provided in Art. 391 for heroes of the Soviet Union, people exposed to radiation, disabled, pensioners, etc. • Individual Property Tax (Art. 403): For apartments a deduction of 20 m2 cadastral value is granted, for houses it is 50 m2. Further tax incentives are provided in Art. 407 for heroes of the Soviet Union, people exposed to radiation, disabled, pensioners, etc. • Representative bodies of municipalities have the right to increase the size of the tax deductions provided by National Tax Code (continued)

3.3 Comparative View on Stylized Facts of the Property Tax in BRICS

167

Exemptions I Article 285 of the Constitution of India exempts properties of the Union government; state government properties and select properties of other levels of government; charity, medical relief, and education; burial grounds; places of worship; residential properties with rateable values below a minimum threshold; slum dwellings not having any title over land C Urban residential property owners are exempt from House Property Tax. By appealing for reductions, the Urban Land Use Tax can be reduced up to 30% below the minimum tax amount S Municipalities decide on exemptions and rebates. Few properties are excluded: residential properties below R 15000; places of public worship. Further exemption or rebate is granted for e.g. municipally owned properties, properties up to R 200,000 of market value (they have to pay a mandatory R 60 a year for municipal public services), limited income (according to City of Johannesburg Poverty Index), pensioners (from 60 years onwards, property value below R 2000,000, linked to income tax assessment), heritage properties, new building incentive, public benefit organizations; indigent owners, etc.

The tax assessment allocates the tax burden to the taxpayer. Most BRICS states make use of property values as the assessment base: From ‘capital market value’ in Brazil, ‘cadastral value’ in Russia, ‘annual rental value’ or ‘area-based-value’ in India to ‘original value’ in China as well as ‘capital improved value’ in South Africa. The closer these assessed values to the capital value, the better from a horizontal equity perspective, because this is the only way to allocate accurately the (relative) tax burden to the taxpayers. However, all BRICS states—some more than others—face huge heterogeneity with regard to properties existing—from skyscrapers in city centres and wealthy high-income suburbs to informal housing at the city’s periphery. Assessment constitutes, therefore, a particular challenge in BRICS states. The assessment method used varies, as does the accuracy of assessments. In Brazil, the capital market value is the assessment base with each municipality independently deciding on the method. A broad spectrum of assessments is to be found: Rio de Janeiro assesses land and buildings combined, while S~ao Paulo does separately. In both cases, assessment values are far from market values. Russia’s ‘cadastral value’ was introduced in 2015 for residential properties with no information provided on the assessment. In India, all megacities have changed their assessment base to (quasi) Capital-Value-Based assessment, because the former Annual Rateable Value (ARV) has been questioned on grounds of fairness, equity and efficiency. However, the assessment base for ARV and the new area-value-based system seems to be quite similar—in both cases, the stamp duty ready reckoner determines the base value. Due to the Rent Control Act, the development of rental values is restricted; therefore, the new areavalue-based assessments are more accurate by taking into account other factors, such as location, type of construction, etc. The underlying assessment base in China is the construction or transaction cost, which is merely applied to businesses. The soundest assessment system is in South Africa, which can be seen as a role model for the remaining BRIC states. The BRICS show the broad variance of value-based assessment techniques. China makes use of construction or transaction cost; however, both values are

168

3 Property Taxes Within the BRICS States

only indicative of what an estimate of the value of the property could be. More parameters have to be taken into account to estimate/determine market value based on the highest-and-best-use concept that brings the property owner the highest longterm economic rent (regardless of the current use). As the Chinese real estate market is restricted, this seems to be the only way for value-based assessment. The Indian and Brazilian assessment system takes into account base values, which are further specified by characteristics that determine the value of the subject property; therefore, they better reflect market value. At the same time, it is another small step towards more advanced mass appraisal approach (CAMA), as found in South Africa. Overall, value-based systems are more resource-intensive than areabased, which permit self-assessment; they require a minimum level of valuation skills and capacities and they have to be maintained (i.e. reassessed) in order to realize the advantages of value-based assessment (i.e. equity, uniformity, revenue elasticity, etc.). However, this approach is accompanied by the disadvantage of being less transparent to the taxpayer due to the statistical approach applied. Assessment base B Capital market value of land and improvements R “Cadastral value” for land (Art. 390) and buildings (Art. 402). Cadastral value of land is based on the capital value with the use of mass appraisal techniques. Buildings are assessed by tax authorities based on data provided by the cadastral authority and by surveying companies that maintain technical building records I – ARV: Annual rental value “fair rent”; Annual rateable value (ARV) with rent as the basis (hypothetical rent) and annual rateable value (ARV) with unit area characteristics representing the base – Area-Value-Based: Greater Mumbai makes use of capital value system, Greater Bangalore of Unit Area Value; both assessment values self-reported based upon unit area values provided by the stamp duty ready reckoner, which is also used for ARV. Further, improvements, use, construction, and location are taken into account C Property is not assessed in proper sense. The assessment is mainly based on the original value (construction or transaction cost minus a discount rate of 10–30%), with an exception for rental housing being based on rental income S Market value, defined as “the most probable price that a property would realise if sold on the open market, at the date of valuation, between a willing buyer and a willing seller”. In Johannesburg, the sales comparison approach is used as basis for Computer-assisted Mass Appraisal (CAMA) of properties. A basic form of CAMA is applied. Various sources are used to reach estimations of property values: aerial photography, property publications and estate agents; Title Deeds and recent sales; building plans; on-site inspections; and rental information, where the property produces an income. Factors such as land size, location, age of improvements, quality of construction and type of accommodation are also considered

Local government typically sets the tax rate, which converts the assessment into the tax bill. In China and Russia, the local governments decide upon a tax rate within a tax rate corridor defined by the central government. Differential tax rates are found in all states. These may be due to political, equity or efficiency reasons. While Brazil, India and South Africa have different rates according to use categories (residential, non-residential), Russia has specified non-residential property tax (Corporate Property Tax). By setting higher rates on commercial property than

3.3 Comparative View on Stylized Facts of the Property Tax in BRICS

169

residential property, tax exporting (‘subsiding residential property’) may become a problem. Beyond that, differential rates may involve issues of complexity from an administrative perspective and entail corruption. Tax rates B Differential rates are applied to different property-use classes. Rates vary considerably among the municipalities. Generally, higher rates are applied to vacant land (to stimulate land development, deter land speculation). Additionally, rates applied to non-residential property are higher than those on residential property. Progressive rates are common due to different zones and sliding rates. Typical rate is 2–2.5% R • Land Tax (Art. 394): Rates are established by local legislative acts and cannot exceed the rates specified by Russian Tax Code: 0.3% for agricultural and residential land; 1.5% for other types of land. Various tax rates according to categories of land, use, and location allowed • Individual Property Tax (Art. 406): Representative bodies of municipal government determine tax rate within certain limits: 0.1–2%. Different tax rates are allowed depending on cadastral value, type, location, or zone of the property I Different tax rate structures: consolidated rate including imposts of various kinds on the same tax rate; statutory specification of maximum and/or minimum rate (‘ceiling’); progressive rates; rates according to use, location, etc. – ARV: Residential: 2.5–30%; Non-residential: 2–10%, – Area-Value-Based: Residential; Rs. 10/m2 to Rs. 40/m2; Non-residential: Rs. 22/m2 to Rs. 80/m2 C Differential tax rates; owned buildings—1.2% of assessment; rental properties—12% of rental income; land use: 2.0–100.0 yuan/m2 (increasing with city size) S Generally, the structure of rates should take account of the ‘ability to pay’ principle, i.e. should be progressive. However, the level of rates charged should comply with the ‘benefit’ principle. Central Government may regulate property rates, including the provision of exemptions, maximum levels of rates and rates ratios between categories of property, in order to ensure that property rates are equitable and support national policy objectives Differential rates are set by the council of Johannesburg for different property categories (e.g. residential, business and commercial, education, mining, vacant land, public benefit organizations, illegal use, etc.). Tax rates are set in relation to rate applied for residential property, e.g. residential is 1, business and commercial 2.8. While residential properties value is multiplied by 0.006531 cents, business pays 2.8 times of residential, i.e. 0.018287. Vacant land and illegal use have a ‘penalty tariff’ of 4 each, i.e. 0.026124 cents

A unique feature with regard to property tax rates applies in South Africa. Here various rate ratios in between residential and non-residential property are set. While residential is fixed at 1, business and commercial is set at 2.8, i.e. the relation is set 1:2.8 between residential and commercial. There are various rate ratios applied, such as agricultural residential (1:0.9), agricultural business (1:2.8), state (1:1.5), public benefit and education (1:0.25), etc. Thereafter the tax rate is determined for residential, e.g. 0.018287, and thereby the tax rate for all other property tax categories. Split-rate taxation, i.e. different tax rates on land and buildings, are found in China and Russia only due to their specific taxes on land and buildings. Another unique feature is to be found in Brazil, where progressive tax rates are common. In S~ao Paulo, for instance, the several tax rates may apply to the sum of market value assessed, i.e. depending on the value bands, another tax rate applies (sliding scale of rates).

170

3 Property Taxes Within the BRICS States

Within the property tax formula, the tax rate is applied to the assessment value. The outcome determines the property tax to be paid by the property owner. Property tax formula B Assessed Market Value  Tax Rate R Individual Property Tax (Art. 408 of Tax Code): H ¼ (H1  H2)  K + H2, where H is the tax payable, H1 is the cadastral value, H2 is a tax relief granted on the cadastral value (e.g. 20 m2 in case of apartment), and K is an coefficient depending on the fiscal tax period (0.2 for first period, 0.4 second period, 0.6 third period, 0.8 fourth period).a Furthermore, a deflator coefficient is applied on H2. I – ARV: Assessment  Tax Rate – Area-Value-Based: Greater Bangalore: Total Area  Unit Area Value  10 months less applicable depreciation  Tax Rate Greater Mumbai: Total Area  Base Value  Weightage Factors C Not available S Monthly Rates ¼ Market value  Applicable Rate (Cent amount)/12 a

The calculation is not transparent, which is proved to be true by reviewing the example provided by the Federal Tax Office. Available at: https://www.nalog.ru/rn77/taxation/taxes/nnifz/ [Accessed: 18 March 2016]. The example is based on an apartment with 53 m2 and a cadastral value of 1,432,320 rubles. A tax rate of 0.3% is applied. Beyond, a tax deduction of 20 m2 of the cadastral value is granted. The tax to be paid at first fiscal period is calculated as follows:H ¼ 412 rubles ¼ ((1,432,320  (1,432,320/53  20))  0.3%  1/2–181 rubles (calculated before tax))  0.2 (factor for the first tax period) + 181 rubles

3.3.2

Administrative Practices

The administrative competencies for the property tax are mainly devolved to the governmental level, although they are in some cases extensions of the national taxing authority, as is the case in China and Russia. While the tax administration is centralized in Russia, a process of deconcentration has been observed in China since 1994. Administrative structure Level of government responsible for Level of government responsible for assessment taxation B Local government Local governments R Federal Tax Service of Russia is the only tax administration authority in the country. It administers taxes in accordance with federal law for all levels of the Russian Government I – ARV: State and Municipal – ARV: Local governments – Area-Value-Based: Municipal – Area-Based: Municipal C The State Administration of Taxation (SAT) has overall control of the taxation process. It has offices at both the national and the local level. However, there are local taxation bureaus next to SAT. Day-to-day administration is at the local level but all policy and administrative guidance is the responsibility of SAT (continued)

3.3 Comparative View on Stylized Facts of the Property Tax in BRICS Administrative structure S The law requires municipalities to employ the services of professional valuers who are registered as valuers in terms of the Property Valuers Profession Act, 2000 (Act No.47 of 2000)

171

Municipalities set their own rates annually. National government may limit yearto-year increases on rates and/or set maximum rates and may determine ratios for residential and different categories of non-residential properties

The assessment process is very resource-intensive due to the large number of property parcels. Therefore, it might be better to have an area-based or an areavalue-based assessment that requires less administrative resources, because selfassessment could be applied. This is the case in India. In all other cases, it is up to the tax administration to up-date consistently and continuously the relevant databases (properties, property details and transaction prices) in order to determine precisely the value for each single property. Therefore, the main concern of the tax administration is an efficient assessment, which minimizes cost per property parcel. An efficient cost framework that covers assessment and reassessment in order to maximize tax revenue is above all dependent on the administration. However, this involves also questions of equity, because the more equitable the assessment system the higher the administrative burden. Assessment process B Local authorities are entirely responsible for assessment R Self-assessment in case of organizations, tax authorities make assessments for individuals based on data provided by the cadastral and federal registry authority and by surveying companies that maintain technical building records I – ARV: None – Area-Value-Based: Self-assessment to be reported by owners C Self-assessment; the business owner is required to give the taxation bureau information on the value of the building, from which the tax is then levied S Municipalities and Metros must put in place and maintain a property valuation roll. The valuation roll needs to comply with the ‘horizontal equity principle’ in that similar properties should have similar valuations. Approximately 1300 municipal valuers are registered with the South African Council for the Property Valuers Profession (SACPVP), which allows them to undertake municipal assessments. Assessors inspect properties and may require information pertinent to the valuation of the property from the owner or occupier of the property

The reassessment period is of high importance, especially in urban centres where property values increase (sometimes even decrease) rapidly. The price spread between assessed market values and real market values is to be eliminated by reassessments because of equity reasons; thereby the tax burden shifts to the ‘winners’, i.e. owners of property with above-average increase of market value. Often reassessment periods exist de jure but are not carried out de facto. Upward and/or downward movements can be ‘bridged over’ with indexation, i.e. impacts on the property (sub)markets are analysed by measuring market movements and taken into account, until reassessment takes place. Additionally, the assessment base

172

3 Property Taxes Within the BRICS States

could be adjusted for inflation rates, as applied in Brazil and Russia. Reassessment cycles of 5 years are generally common, also in the case of BRICS. However, the large number of properties and the administrative resources involved often leads to major reassessment time gaps—for instance, the last reassessment in Rio de Janeiro was in 1997. Period between reassessments B No legal requirement; intervals vary considerably, e.g. Rio de Janeiro’s last reassessment was in 1997, S~ao Paulo is reassessing its values every 2 years R Updated at intervals of 5 years I Typical valuation cycle 3–5 years C Not applicable S Reassessments at least once every 4 years (Municipal Property Rates Act, Act 6 of 2004). A municipality may decide to produce general valuation rolls more frequently, as does City of Cape Town (once every 3 years)

Law usually guarantees objection and appeal against the assessed value. The appeal deadline is usually 30 days from notice (Brazil, India and South Africa). Appeals are submitted on the local level that is responsible for the assessment, e.g. Municipal Councillor in Brazil, Municipal Valuation Committee in India and Municipal Valuer in South Africa, and then moves up the courts level by level. China and Russia have a still weak appeal process. Objections and appeals B – Appeal deadline – Appeal process requirements – Appeal process

R

I

C

– Appeal deadline – Appeal process requirements – Appeal process

– Appeal deadline – Appeal process requirements – Appeal process – Appeal deadline – Appeal process requirements – Appeal process

– 30 days after delivery of tax bill – Administrative appeal to municipality, then advances through court levels up to Federal Supreme Court – In the administrative level, each municipality defines procedures for objections, e.g. taxpayers can object against the decision to a Municipal Councillor. In the judicial level, a formal appeal can be made to the Court of State and, finally, to the Supreme Court of the Nation – Not available – Not available – The appeal process in Russia is still in the early stages of development: Upon receipt of tax notice, the taxpayer may appeal for a revaluation of a property under section 8 of the Federal Law regarding appraisal activity – 30 days from receipt of notice – Submission of a standardized appeal form – Municipal valuation Committee – Not available – Appeals are submitted to the legal department of the Taxation Bureau, then to a higher court if unsuccessful in the first-instance – Weak appeal provisions. Taxpayers can verify liability and legal provisions (continued)

3.4 Future Significance of Property Tax in a Transitional Setting Objections and appeals S – Appeal deadline – Appeal process requirements – Appeal process

173

– 30 days from notice – Objector continue paying rates while his/her objections are being processed and finalised – Objections are addressed to the municipal valuer who revises the valuation; thereafter, appeal can be made to valuation appeal board (30 days after valuer’s decision)

Property tax payment requires, first, informing the taxpayer of the tax liability (billing). This involves issues of up-to-date data sources on all property owners. As urban populations are more fluid, Brazil, China and South Africa define also the occupier or user of the property as liable for the property tax. In India, the tax could be attached to the owner if the occupant does not pay the tax. The payment arrangements have major influence on obtaining payments in time. In Brazil and India, there are substantial discounts if the tax is fully and/or timely paid. Furthermore, the payments are usually spread out over the course of the year in order to decrease the tax burden: e.g. into four payments in Russia, 10 payments in Brazil and 12 payments in China. Property tax payments B Due between January and August for the previous year; sometimes financial incentives are given to encourage payment in full (e.g. Porto Alegre), or payments may be split into 10 monthly instalments R The tax and advance payments are made on dates as established by local legislative acts of municipalities I – ARV: Up to four payments. Typically, early-bird incentive granted in the form of a rebate for timely property tax payments in full – Area-Value-Based: Two instalments. Greater Mumbai provides early-bird incentive in the form of a rebate for timely property tax payments in full C Monthly instalments, taxes collected by local government; deadlines determined by province, region or municipality S Determined locally by municipalities. The rate is payable in twelve equal instalments on fixed days in Johannesburg. The ratepayer who wants to pay the rates 12 months in advance would be required to make an application. The ratepayer will receive the rebate. The Council can recover rates in arrears for a period of up to 30 years

3.4

Future Significance of Property Tax in a Transitional Setting

The development of expenditures and public finance is not static; on the contrary, it develops very dynamically in times of transition. The BRICS states are on transition towards developed economies. The megacities are key driver of such process.

174

3 Property Taxes Within the BRICS States

Therefore, comprehensive public finance policy is needed in order to finance steady growth of megacities and their respective economies. Transition is typically marked with rising degrees of decentralization and, therewith, local self-governance. Therefore, local governments become more and more reliable on local own-source revenues. An appropriate portfolio of local revenues—especially user charges, fees, and property taxes, as well as business and income taxes—should be in place in order to mobilise revenues to finance a sustainable transitionary process. The future significance of property taxation as part of transition is mainly determined by further decentralization of expenditure responsibilities to local governments and a general expanding local public sector. In this context, the German public finance literature refers to three ‘laws’ that (at least partially help to) explain increasing financial needs of local governments in times of transition: First, Adolph Wagner (1893) formulated the “law of increasing state (including local governments) activity” for industrializing nations based on spatial and temporal comparison of various countries. According to Wagner, the main reason for the increase in state activity is the development from a regulatory state (that mainly provides legal certainty to its citizens and the maintenance of internal and external order) toward a welfare state. More specifically, Wagner’s law postulates in a strict sense a long-run elasticity of public spending above unity. Among others, Lamartina and Zaghini (2010) provided empirical evidence of a long-run positive correlation between public spending and GDP growth.112 Given the presence of rising incomes in industrializing countries, the demand for the public sector will increase more than in proportion. Following Wagner’s idea, there are three reasons for such a development (Bird 1971: 2f): Firstly, the government substitutes private activities with regard to administrative and protective functions. Secondly, there is an increasing need for cultural and welfare goods and services to be provided by the government—especially with regard to education and redistribution of income. Finally, government intervention is needed in order to manage natural monopolies and to ensure smooth operation of market forces. Wagner’s law only refers to the industrializing nations; therefore, it might only operate within a specific ‘framework’, such as rising per-capita incomes, technological and institutional change, and democratization with regard to wider political participation (Bird 1971: 3). Second, Arnold Brecht (1932) formulated the “law of progressive parallelism between agglomerations and expenditures”. One explanation is that agglomerations provide a wider range of public goods and services, such as public parks, theatres, metro, etc. Beyond that, expenditures increase also due to negative consequences of urban concentration (e.g. increasing crime rates and accordingly more need of police and security forces). Finally, Johannes Popitz (1927) formulated the “law of the power of attraction of the central state”. Popitz found that central government gets increasingly involved

112

However, there might be other factors explaining the expanding role of government, such as an increased feasibility to levy taxes and along with that an increasing ability to finance public expenditures (Lamartina and Zaghini 2010: 162).

3.4 Future Significance of Property Tax in a Transitional Setting

175

in state and local government’s affairs with the latter facing an increasing lack of resources to execute central governments legislation and solving emergencies (Blankart 1999). These laws do not guarantee exhaustiveness; however, they provide some guidance on the transitionary process of the BRICS states and the local expenditure needs. Referencing on these economic ‘laws’ might appear problematic as there is no deterministic relation given in economics as in physical or natural sciences, but they have a normative character and their findings are still discussed as of today. These laws were formulated when European countries were moving toward industrialization. With the invention of the steam engine, labour was freed up from working the land; therefore, people were moving into urban centres for work. Natural population growth rates were high and urbanization further fuelled the urban centres of industrialized production. Cities grew rapidly, economically and in terms of population and area, which, in turn, led to increased demand for public services. This pattern seems to be repeated in BRICS states and—to even greater extent— to the megacities located herein. The megacities are the centres of urbanization, which goes hand in hand with increasing public expenditures because of infrastructure needs, housing shortages, the rising need for public investments, the acceleration of poverty and creation of slums, rising crime rates, growth of social inequality, and environmental degradation. Furthermore, these urban centres are typically embedded into poor governance arrangements. Likewise, there are also positive effects linked to urbanization: The concentration of major economic activities in urban areas produces economies of scale and leads to various social and economic benefits like employment, better access to health and education services, trade and cultural activities, which, in turn, have impact on public expenditures. This growing need for public sector involvement could be summarized under the law of Wagner and Brecht. The urbanization process entails risks, but also opportunities; ‘urban advantages’, if they are fully exploited by the local governments, might exceed increasing expenditures for public infrastructure and services in order to absorb in-migration into the urban centres. The positive correlation between urbanization and wealth generation broadly defines the urban advantage. Incomes increase due to growing productivity. Cities are the ‘engines’ for municipal, regional and national economic growth due to localization and urbanization economies, also referred to as agglomeration economies. External factors, such as input sharing, labour market pooling, and knowledge spillovers, lead to increasing productivity.113 Furthermore, proximity and scale advantages, as well as technological spillovers, enrich ideas and encourage innovation. Therefore, cities are the key to prosperity (Yusuf 2013: 33–35) and the basis for transition: from a rural to an urban economy and from a low-income to a high-income country.

113

Marshall, Alfred (1920). Principles of Economics.

176

3 Property Taxes Within the BRICS States

100

88

89

89

90

90

87

75

75

76

79 75 73

80 76 74

67

69 65

77 73 71

90 86 80 74 70 65

71 69

91 Brazil 81 77 76

India

61

60

Russian Federation

56 50

China

2050

2045

South Africa

2035

2030

2020

2015

30

2025

35

33

42

39

37

2040

40

50

48

45

Fig. 3.5 Level of urbanization within the BRICS states 2015–2050. Source: Author; United Nations (2014)

With a share of 42%, BRICS states represent almost half of the global population and, simultaneously, 38% of its global urban population already (in 2015; UN 2014). They have gained a tremendous position on a global scale and BRICS’ cities play a major role in tomorrow’s worldwide urbanization processes. In 2017, the BRICS-group will surpass the rural one, while this barrier was surpassed already in 2007 in a worldwide context.114 The ten-year delay is caused by India, whose population will not live mainly in cities any earlier than 2048. In Russia, Brazil, and South Africa the urban population is already larger, since 1956, 1964, and 1987 respectively (Fig. 3.5). China reached this point in 2011. Thus, with the only exception of India, the BRICS have already moved into the urban century. While rapid urbanization already occurred in Russia and Brazil by 2015, only a slightly increase is expected until 2050. In the same period, India, China, and South Africa will face higher levels of urbanization.115 Herewith, rural-urban

The calculation of ‘tipping points’ (the point when the urban population outweighs the rural population) is merely a mathematical one based on statistics of the United Nations, Department of Economic and Social Affairs, Population Division: World Urbanization Prospects: The 2014 Revision. 115 Urbanization can be traced back to different explanatory variables, such as (i) natural population increase with a declining infant mortality and an increasing life expectancy outweighing the gradual reduction in fertility, (ii) rural-urban migration and (iii) reclassification of rural areas as urban areas (UN-HABITAT 2010: 22). 114

3.4 Future Significance of Property Tax in a Transitional Setting

177

migration accounts for approximately 25% of total urbanization occurring (UN-HABITAT 2010: 22). The forces of urbanization are also mirrored in the BRICS states’ numbers of megacities. Almost every second megacity worldwide is located in BRICS, while there were 13 (out of 29) in 2015, there will be 18 (out of 41) in 2030 (Table 3.66). These megacities are only the tip of the urbanization iceberg. Another 50 BRICS cities will emerge with more than one and less than ten million inhabitants by 2030. With regard to the BRICS megacities, population rates and thereby level of population density (population per km2) also is about to increase (Table 3.67). If the Table 3.66 Number of agglomerations according to size class

Size class of urban settlement 10 million or more 5 to 10 million 1 to 5 million

Number of agglomerations 2015 World BRICS 29 13 44 17 428 173

Number of agglomerations 2030 World BRICS 41 18 63 19 558 221

Source: Author; United Nations (2014) Table 3.67 Population size and density of BRICS urban agglomerations

B

R I

C

S

Rio de Janeiro S~ao Paulo Moscow Ahmadabad Bangalore Chennai Delhi Hyderabad Kolkata Mumbai Beijing Chengdu Chongqing Guangzhou, Guangdong Shanghai Shenzhen Tianjin Johannesburg

Land areaa (km2) 2020

Population estimateb 2015 12,902,000

Density 2015 6387

Population estimatec 2030 14,174,000

Density 2030 7017

Increase in density (%) 9.9

2707 4662 350 1166 971 2072 1230 1204 546 3820 1541 932 3432

21,066000 12,166,000 7,343,000 10,087000 9,890,000 25,703,000 8,944,000 14,865,000 21,043000 20,384,000 7,556,000 13,332,000 12,458,000

7782 2610 20,980 8651 10,185 12,405 7272 12,346 38,540 5336 4903 14,305 3630

23,444,000 12,200,000 10,527,000 14,762,000 13,921,000 36,060,000 12,774,000 19,092000 27,797,000 27,706,000 10,104,000 17,380,000 17,574,000

8661 2617 30,077 12,660 14,337 17,403 10,385 15,857 50,910 7253 6557 18,648 5121

11.3 0.3 43.4 46.3 40.8 40.3 42.8 28.4 32.1 35.9 33.7 30.4 41.1

3820 1748 2007 2590

23,741,000 10,749,000 11,210,000 9,399,000

6215 6149 5585 3629

30,751,000 12,673,000 14,655,000 11,573,000

8050 7250 7302 4468

29.5 17.9 30.7 23.1

Refers to ‘built-up urban area’ or ‘urban agglomeration’ Source: Author; Demographia (2015)b; United Nations (2014)c a

178

3 Property Taxes Within the BRICS States

urban land area remains the size of 2015, population increase will lead to a tremendous increase in population densities. Although the calculation is based on a rather hypothetical assumption (i.e. static land size of the urban agglomerations), the results express the magnitude of urbanization, illustrating the increasing complexity of managing these agglomerations, and indicate additional needs for public investments in goods and services. In this case, the city would grow against the sky and not in a spatial manner. Urban space becomes increasingly important, especially in India, where the urbanization rate is far below the BRICS average. However, Chinese cities show also high rates of density growth. Moscow, in turn, remains the size as of today. The increasing numbers of inhabitants makes it necessary to invest in—more and more costly—infrastructure and housing. Especially India seems to be unprepared for this growth. Here, urban infrastructure and housing need urgent attention, especially among the low-income populations. According to the National Housing Bank of India (2015), “[t]he unofficial urban housing deficit [. . .] currently stands at 40 million while the official estimate from the Ministry of Housing and Urban Poverty Alleviation is 24.6 million units.” They are largely needed to house the poor.116 Other states face lower levels of housing backlog, such as Brazil and South Africa. Brazil faces a shortage of 5.5 million, accounting for 15% of the required total stock.117 South Africa would need about 2.4 million additional housing units (Bhana et al. 2011: 130). This undersupply of housing, which already exists, will be further fuelled by the urbanization process to come. From a macroeconomic perspective, construction and provision of affordable housing could not only elevate the living conditions of the urban poor, but the construction industry could also set the pace of economic growth. Most of the BRICS economies have a strong link between improving living conditions (housing development/construction and infrastructure) and economic growth. Massive investments in housing and infrastructure boost national economic growth rates, which increase national income, which, in turn, raises property and housing prices. China has made use of housing as an economic stabilizer throughout the financial crisis. In India, the housing sector constitutes the second-largest employment sector (after agriculture), one with a significant economic multiplier effect. Housing is an ‘engine of economic growth’ itself through its strong backward and forward interindustry linkages with about 250 ancillary industries.118 The housing and/or

116

National Housing Bank of India. 2015. Social and Environmental Assessment for the Low Income Housing Finance Project—Revised 19 June 2015. Available at: http://www.nhb.org.in/ Publications/Social-and-Environment-Assesment-for-the-Low-Income-Housing-Finance-Proj.pdf [Accessed: 1 April 2016]. 117 Needs estimates in Brazil take into account: Excessive spending on rent (more than 30% of household income); Involuntary cohabitation (when more than one household lives in the same unit); Substandard physical quality of buildings and access to infrastructure; Overcrowding (although this does not fully allow for overcrowding of children), see RICS (2014b: 27). 118 Government of India Ministry of Statistics & Programme Implementation New Delhi, 20th Conference Of Central and State Statistical Organisations (COCSSO) Gangtok, Sikkim 10–11 January, 2013 Urban Statistics.

3.4 Future Significance of Property Tax in a Transitional Setting

179

construction sector have strong multiplier effects on income and employment. According to the Ministry of Statistics, Government of India, a unit increase in expenditures on the construction sector generates an additional income of almost five times the income generated within the construction sector itself.119 Beyond that, investment in housing has an employment multiplier effect of almost eight.120 For this reason, housing and construction are amongst the most important economic and social developmental activities.121 As urbanization cannot be solved by the local governments, and due to the macroeconomic effect of urbanization and housing, the national governments have introduced housing policies to tackle these rising problems. Brazil, for instance, created a ‘Ministe´rio da Cidades’ in 2003 and introduced the ‘Minha Casa, Minha Vida’ programme in 2009, with the goal of creating four million new housing units by 2015. China has introduced different policy measures in order to increase construction output and drive down housing prices and vacancy rates.122 India, in turn, has initiated two taskforces on ‘Affordable Housing’ (2010) and ‘Rental Housing’ (2013). Further, the ‘Rajiv Anas Yojana’ initiative aims to create a slum-free India by 2020. Nonetheless, it must be observed that housing prices are increasing within BRICS’ urban centres. Some reasons for this development are, inter alia123: Inelastic Supply of Urban Land There is a shift in housing demand due to in-situ population growth, rural-to-urban migration, increasing longevity, higher educational levels, rising incomes and a shift from several-family-homes to singlefamily-homes. However, urban land and housing supply is (in the short term) very inelastic. As a result, there is major shortage in the urban housing stock. Speculation Resulting in High Vacancy Rates Especially China and Brazil have been concerned with housing market bubbles in their recent past (since 2009 and

119

Ibid. Ibid. 121 Ibid. 122 Latest Chinese State Council policy interventions are: 2003; the real estate market became a major pillar of economic development following the “Announcement of State Council on Promoting the Continuous and Healthy Development of the Real Estate Market”. 2010; the “Notice on Firmly Suppressing the Rapid Increase of Housing Price in Some Cities” introduced first purchase controls (mortgages were limited to two houses). 2011; according to the “Further Improvements Real Estate Market Regulation” the mortgage and purchase control policies were reinforced (minimum payment of 60% directly and mortgage interest rate for second homes increased to 1.1 times the base rate). 2013; the “Notice on Continually Improving Real Estate Market Regulation” resulted in a further strengthening of controls. 123 The points are retrieved from the RICS report (2014a, b) on “Global Affordable Housing: BRICS Plus Mortar”. The report reviews the housing needs and supply in Brazil (pp. 19–34), China (35–55) and India (56–70). Further, they discuss the effects on economic growth and compare the government housing policies. 120

180

3 Property Taxes Within the BRICS States

2013 respectively). In S~ao Paulo and Rio de Janeiro prices have increased (2008–2012) by 159% (98% inflation-adjusted) and 194% (124% inflationadjusted). First-tier cities in China, such as Beijing and Shanghai, saw price increases of 20% between March and December 2013. However, the housing boom is reflecting not just increasing demand but also speculation. Due to the latter, there is a high rate of vacant housing units: It is estimated that Brazil has approximately 5 million vacant urban housing units. China faces a vacancy rate of 20–30% in newly completed projects in major cities. Restrictions on the Housing Market Strong demand is further fuelled by policy measures on land-use. Restrictions on land-use are especially problematic in India, which increases housing prices, because: – Floor Space Index (FSI) or Floor Area Ratio (FAR) limit the total floor area to the size of the land upon which it is built, i.e. an FSI of 2 indicates that the floor area of the total building should not surpass twice the ground floor upon which it is built. – Under rent control, a rent ceiling is imposed which is below equilibrium rent. Due to minimal rents, the capitalization effect on property values is less than would be the case in a non-regulated market, which implies higher property values. – Taxation concerning residential housing is mainly applied to the transaction stage (transfer taxes, stamp duties, levies etc.) instead of the possession stage (recurrent property tax), which has substantial impact on housing affordability, as in the case of Land Transfer Fees in China.

Market Failure and Informal Market A deeper market culture and infrastructure is still missing in China and, to certain extent, in Russia. Most notably, there is need to create an efficient second-hand and rental housing market. The same holds true for the financial system. Access to mortgage finance systems plays a vital role for both developers and purchasers and yet is still lacking in most of the BRICS countries. Furthermore, the informal market plays a major role in the overall economy and housing market: In Brazil, approximately half of the housing output is produced within the informal sector. The construction costs are 30–40% below those in the formal market. In India, three out of five employees (approx. 60%) work in the informal urban markets. As a result, much of the housing output is built without local permission or official planning approvals; titles are not administratively registered, and the properties are often inadequately serviced. Corruption Corrupt rent-seeking occurs especially in the areas of the land and housing markets experiencing growth. Governmental authorities’ decisions are often not transparent, e.g. in the case of competitive tendering, land auctions, taxation, etc. Decentralization or Fiscal Embedment of Cities Naturally, housing is a local task. Therefore, central governments have devolved the powers for designing and

3.4 Future Significance of Property Tax in a Transitional Setting

181

delivering housing policy to the municipalities. As the housing markets are large and complex, the new role is challenging local governments when it comes to effectively regulating price and quantity outcomes. However, they lack spatial information, which is indispensable for urban development, planning and management, and taxation. The situation in the reviewed megacities is typically marked by increasing property values, land-use restrictions, missing spatial information for urban planning, management, and taxation in the context of increasing urbanization and resulting public expenditures. Beyond that, local governments are not assigned taxing powers needed for sustainable transition. To the contrary; local revenues are more and more centralized, i.e. to the benefit of the central government level. Examples for such development is the Chinese tax reform of 1994 (see Annex A.6), which resulted in a large gap between expenditures and revenues on local level. In India, expenditures functions are assigned by the constitution while local finances are not listed (finances are assigned by the States). Brazil has also shown high dependency of national transfers, which clearly indicates dependency on the central state. The law of Johannes Popitz, which indicates the power of attraction of the central state, seems to be still pressing today, which makes the property tax as a local own source more important than ever in a transitional setting. As shown, property tax in urban BRICS states has many interlinkages with positive effects assigned in times of transition: it finances public goods and services, and it enables local self-government within a multi-level state. Property tax database/characteristics are essential for urban planning, which, in turn, is necessary in order to guide urbanization. In and of itself, housing/construction accelerates economic growth and improves the living conditions of the urban poor, who live far from social and economic opportunities, and it establishes a tax base for property taxation. Therefore, megacities need to focus on social housing provision to the urban poor and to middle-income groups. To give an example for the interlinkages mentioned: In Brazil, direct investment incentives, such as tax deferrals or exemptions, are provided to the private sector in order to address housing supply shortage. However, to fully play out the advantages of property tax, the tax needs to be based on market value. During transition, a second-best property tax system might be applied, however, without losing sight of constantly adopting the property tax system into direction of an accurate valuation of the tax base. The BRICS states megacities are already on the right track. Within the BRICS’ states megacities, property tax is an ad valorem tax. However, the taxable amount typically varies significantly from the open market value. Therefore, transition should be reflected in the concept of property tax. Only if the market value is applied, there is an incentive to update and maintain a property tax database; the tax burden achieves horizontal equality between taxpayers (i.e. each property regardless of size would pay the tax burdens on their relative property value), the revenue elasticity is about one, and accountability from a political (democratic) perspective is established, where property owners will be involved in decision-making to maximize public investment in the neighbourhood in order to raise own property values (capitalization effect). Accurate valuation is key to success with property tax and it positively supports transition.

182

3 Property Taxes Within the BRICS States

References Afonso JRR, Araujo EA, da No´brega MAR (2012) The urban property tax (IPTU) in Brazil: an analysis of the use of the property tax as a revenue source by Brazilian municipalities. Working Paper, Lincoln Institute of Land Policy Andersen JE (2008) The path to property taxation in China. Paper presented at Lincoln Institute of Land Policy’s annual China conference, Cambridge, MA, 12 May 2008 Anderson JE (2011) The path to property taxation. In: Chinas local public finance in transition. Lincoln Institute of Land Policy, Cambridge, MA, pp 145–165 Anderson JR, Eckert JK, Renaud B (2009) Property rights and real estate privatization in Russia: a work in progress. In: Property rights and land policies. Lincoln Institute of Land Policy, Cambridge, MA, pp 96–113 Annez PC (2010) Financing Indian cities – opportunities and constraints in an Nth best world. Policy Research Working Paper 5474, World Bank Bagchi S (2003) Politics and economics of property taxation. Econ Polit Wkly 38(42):4482–4490 Bahl RW (2007) Opportunities and risks of fiscal decentralization: a developing country perspective. In: Fiscal decentralization and land policies, Proceedings of the 2007 land policies conference. Lincoln Institute of Land Policy, Cambridge, MA, pp 19–37 Bahl RW (2012) Metropolitan city finances in India: options for a new fiscal architecture. Working Paper Series, International Centre for Public Policy Bahl RW, Wallace S (2008) Reforming the property tax in developing countries: a new approach. International Studies Program, Working Paper 09-19, Andrew Young School of Policy Studies Bahl RW, Martinez-Vazquez J, Youngman J (2008) The property tax in practice. In: Making the property tax work: experiences in developing and transitional countries. Lincoln Institute of Land Policy, Cambridge, MA, pp 3–16 Bandyopadhyay S (2013) Property tax reforms in India: a comparison of Delhi and Bangalore. Working Paper 13–21, Georgia State University, Andrew Young School, International Centre for Public Policy BBMP (2009) Property tax handbook, Bruhat Bengaluru Mahanagara Palike (BBMP). http:// bbmp.gov.in/property-tax-handbook BBMP (2015) Bengaluru: way forward. Expert Committee: BBMP Restructuring, June 2015 Bertaud A, Brueckner J (2003) Analysing building-height restrictions: predicted impacts, welfare costs, and a case study of Bangalore, India Bhana K, Hendricks M, Tonkin A (2011) Land and property taxation in post-apartheid South Africa. In: Innovative land and property taxation. UN HABITAT, Nairobi Bird RM (1971) Wagner’s law of expanding state activity. Public Financ 26:1–26 Bird RM, de Jantscher MC (1992) Improving tax administration in developing countries. IMF, Washington, DC Blankart C (1999) Local autonomy and Popitz‘ law in Prussia and in Germany. Paper dedicated to James M. Buchanan, Humboldt-University of Berlin. Available at: http://publicchoice.info/ Buchanan/files/blankart.htm. Accessed 4 Apr 2016 Brecht A (1932) Internationaler Vergleich der €offentlichen Ausgaben. Teubner, Leipzig Brys B, Matthews S, Herd R, Wang X (2013) Tax policy and tax reform in the People’s Republic of China. OECD Taxation Working Papers, No. 18. OECD, Paris Carvalho PHB (2013) Situac¸~ao atual do IPTU no Rio de Janeiro e sua possı´vel reforma. Cadernos do Desenvolvimento Fluminense, Rio de Janeiro, no. 1, fev 2013 Carvalho PHB (2014) Property tax performance in S~ao Paulo. J Prop Tax Assess Adm 11(2):63–89 Chary VS, Prasad DR (2014) Municipal finance and service delivery in India. Administrative Staff College of India (ASCI), Hyderabad De Cesare C, Ruddock L (1999) The property tax in Brazil. In: Property tax: an international comparative review. Ashgate, England, pp 266–282 De Cesare CM, Smolka MO (2010) Property tax and informal property: the challenge of third world cities. Working Paper. Lincoln Institute of Land Policy, Cambridge, MA

References

183

de Paula Giffoni F, Villela L (1987) Tributac¸~ao da Renda e do Patrimoˆnio. Texto para Discuss~ao no. 105, March. IPEA, Brası´lia Demographia (2014) Housing affordability survey: 2015. Ratings for metropolitan markets Demographia (2015) World urban areas, 11th annual edition 2015.01 (built-up urban areas or world agglomerations). Available at: http://www.demographia.com/db-worldua.pdf. Accessed 30 Nov 2015 Deryugin A, Kurlyandskaya G (2007) The Russian Federation. In: Property tax: an international comparative review. Ashgate, England, pp 236–261 Dey PD, Dev S (2006) Rent control laws in India: a critical analysis. National Institute of Urban Affairs, New Delhi Dillinger W (1991) Urban property tax reform: guidelines and recommendations. Urban Management and Municipal Finance, World Bank, Washington, DC Domingos OP (2011) Implementing local property tax. Lincoln Institute of Land Policy, Land Lines, Jan 2011 European Parliament (2012) The role of the BRICS in the developing world. Directorate-General for External Policies of the Union, EXPO/B/DEVE/FWC/2009/01/Lot5/24 Fa¨rber G, Salm M, Hengstwerth S (2013) Property tax reform in Germany – eternally unfinished or an instrument of a more equitable (local) tax system? In: The Copenhagen workshop 2013. Korea Institute of Public Finance and the Danish Ministry for Economic Affairs and the Interior, Copenhagen, pp 167–202 FC XIII (2009) Thirteenth Finance Commission 2010–2015, Finance Commission India, Dec 2009 FC XIV (2014) Report of the Fourteenth Finance Commission, Finance Commission India, Dec 2015 Franzsen RC, Kamarudin N, McCluskey WJ, Zulkarnain D (2013) Property tax in Malaysia and South Africa: a question of assessment capacity and quality assurance. J Prop Tax Assess Adm 10(4):5–18 Gaffney M (1999) Tax reform to release land. Land-value taxation. In: Land-value taxation: the equitable and efficient source of public finance. Shepheard-Walwyn, London, pp 58–99 Glaeser E (2011) Triumph of the city. How our greatest invention makes us richer, smarter, greener, healthier, and happier. Penguin Books, New York Gosh D, Kundu D (2011) Innovations in property taxation systems in India. In: Innovative and property taxation. UN HABITAT, Nairobi Government of India (2013) Urban statistics – 20th conference of Central and State Statistical Organisations (COCSSO); Ministry of Statistics & Programme Implementation, New Delhi, Sikkim, 10–11 Jan 2013 Hong Y (ed) (2013) An introduction to China‘s taxation. Enrich Professional Publishing, Hong Kong Hou Y, Qinag R, Zahng P (2013) Institutionalizing local property tax in China – as revenue service link and tool for higher efficiency and accountability via public choice. Lincoln Institute of Land Policy, Cambridge, MA Hou Y, Ren Q, Zhang P (2015) The property tax in China: history, pilots, and prospects. Springer, Cham IGBE (2011) Produto Interno Bruto – Dos Municı´pios, Contas Nacionais, nu´mero 41, Instituto Brasileiro de Geografia e Estatı´stica (IGBE) IMF (2004, 2008) Government finance statistics yearbook, International Monetary Fund, Washington, DC IMF (2008) Government finance statistics yearbook. International Monetary Fund, Washington, DC IPTI Xtracts (2015) India – What’s inside. Property tax and assessment news from around the world. International Property Tax Institute, Apr 2015 Karnik A, Rath A, Sharma JC (2004) Reforming property tax system: simulated results for Mumbai city. Econ Polit Wkly 39(34):3818–3826 Keilbach D, Nann W (2010) The Chinese property rights law 2007. Logos, Berlin

184

3 Property Taxes Within the BRICS States

Kelly R (2003) Property taxation in Indonesia: challenges from decentralization. Lincoln Institute of Land Policy, Cambridge, MA Kelly R (2013) Making the property tax work. Working Paper 13-1, International Centre for Public Policy, Andrew Young School, Georgia State University Khumalo B, Mokate R (2007) Republic of South Africa. In: The practice of fiscal federalism: comparative perspectives. McGill-Queen’s University Press, London, pp 263–286 KMC (1976) The Karnataka Municipal Corporations Act, 1976 Lall SV, Deichmann U (2006) Fiscal and distributional implications of property tax reform in Indian cities. National Institute of Public Finance and Policy, New Delhi Lamartina S, Zaghini A (2010) Increasing public expenditure: Wagner’s law in OECD countries. Ger Econ Rev 12(2):149–164 Man JY (2011) Local public finance in China: an overview. In: China’s local public finance in transition. Lincoln Institute of Land Policy, Cambridge, MA, pp 3–17 Martinez-Vazquez J, Qiao B (2011) Assessing the assignment of expenditure responsibilities. In: Chinas local public finance in transition. Lincoln Institute of Land Policy, Cambridge, MA, pp 21–40 Marshall A (1920) Principles of economics, Revised edn. Macmillan, London Martinez-Vazquez J, Luc N, Rider M (2010) Assignment of the property tax – should developing countries follow the conventional view? In: Challenging the conventional wisdom of the property tax. Lincoln Institute of Land Policy, Cambridge, MA, pp 299–349 Mathur OP, Rajadhyaksha N, Thakur D (2009) Urban property tax potential in India. National Institute of Public Finance and Policy, New Delhi Mathur OP, Thakur D, Halen AK, Chowdhury S, Mehrotra S, Rakshit R, Sarkar C (2011) Municipal finance matters – India Municipal Finance Report (IMFR). National Institute of Public Finance and Policy, Aug 2011 McCluskey WJ, Cornia GC, Walters LC (2013) A primer on property tax – administration and policy. Wiley-Blackwell, West Sussex Ministry of Finance Brazil (2002) Tax system and administration in Brazil – an overview. Ministry of Finance, General Revenue Service, Tax Study 08. ahl Mohanty PK (2003) Reforming property tax: the approach of municipal corporation of Hyderabad. Working Paper, Centre for Good Governance, Hyderabad Mumbai (2012) Rules for fixing capital value of lands and buildings. No. AC/NTC/1310/2011-12 dated 20 Mar 2012 Mumbai (2014) The handbook updated on 31.07.2014 under the right to information act – 2005. Assessment and Collection Department, Published by the Assessor & Collector of the Mumbai Municipal Corporation. Available at: http://portal.mcgm.gov.in/irj/portal/anonymous/ qlandcele?guest_user=english. Accessed 12 Nov 2015 Mumbai (2015) Rules for fixation of capital value of lands and buildings. No.AC/NTC/1147/201415 Naresh G (2004) Property taxation in India. In: International handbook of land and property taxation. Edward Elgar, Northampton, MA, pp 129–151 National Housing Bank of India (2015) Social and Environmental Assessment for the Low Income Housing Finance Project—Revised 19 June 2015. http://www.nhb.org.in/Publications/Socialand-Environment-Assesment-for-the-Low-Income-Housing-Finance-Proj.pdf. Accessed 1 Apr 2016 Ondetti G (2015) The social function of property, land rights and social welfare in Brazil. FLOOR, Working Paper No. 26 Pethe A (2013) Metropolitan public finance. The case of Mumbai. In: Financing metropolitan governments in developing countries. Lincoln Institute of Land Policy, Cambridge, MA, pp 243–271 ¨ berblick über den Entwurf des Reichshaushaltsplans für das Rechnungsjahr Popitz J (1927) U 1927. Heymanns, Berlin

References

185

PWC (2010) Financing strategy and advice: municipal corporation of Greater Mumbai, assessment report. The World Bank and Government of Maharashtra, PPIAF-SNTA program Rao MG (2003) Fiscal decentralization in China and India: a comparative perspective. Asia Pac Dev J 10(1):25–45 Rao MG (2007) Republic of India. In: The practice of fiscal federalism: comparative perspectives. McGill-Queen’s University Press, London, pp 152–177 Rao MG (2013) Property tax system in India: problems and prospects of reform, Working Paper No. 2013-114. National Institute of Public Finance and Policy, New Delhi Reserve Bank of India (2015) Recent trends in residential property prices in India: an exploration using housing loan data. Available at: https://rbi.org.in/Scripts/PublicationsView.aspx? id¼16223. Accessed 10 Dec 2015 Rezende F (2007) Federal Republic of Brazil. In: The practice of fiscal federalism: comparative perspectives. McGill-Queen’s University Press, Montreal, pp 74–97 RICS (2014a) The role of international and local valuation standards in influencing valuation practice in emerging and established markets. Royal Institute of Chartered Surveyors (RICS), London RICS (2014b) Global affordable housing report: BRICS plus mortar. Royal Institute of Chartered Surveyors (RICS), London Salm M (2014) Property taxes in BRICS – comparison and a first draft for performance measurement. German Research Institute for Public Administration, Speyer Shah A (2007) Principles of fiscal federalism. In: The practice of fiscal federalism: comparative perspectives. McGill-Queen’s University Press, London, pp 3–42 State Administration of Taxation (SAT) (2012) China’s tax system. http://www.chinatax.gov.cn/ 2013/n2925/n2959/c307248/content.html Souza C (2004) Subnational constitutionalism in Brazil: taxing, spending, and borrowing, prepared for conference “Federalism and subnational constitutions: design and reforms”, Bellagio, Italy, 22–27 Mar, 2004 TSFC (2008) Report of Third State Finance Commission (TSFC), Government of Karnataka UN (2014) World urbanization prospects: The 2014 revision. United Nations, Department of Economic and Social Affairs UN-HABITAT (2010) State of the world’s cities 2010/2011 – bridging the urban divide. United Nations Human Settlements Programme, London Villela L (2001) A Tributac¸~ao Subnacional, o Imposto Predial e os Desafios para Moderniza´-Lo. Porto Alegre. Paper presented at the Semina´rio Internacional sobre Tributac¸~ao Imobilia´ria in March 2001 ¨ konomie. 3. Aufl. Winter, Leipzig Wagner A (1893) Grundlegung der politischen O Wang X, Herd R (2013) The system of revenue sharing and fiscal transfers in China. OECD Economic Department Working Papers No. 1030 Wetzel DL (2013) Metropolitan governance and fiscal finance in S~ao Paulo. In: Financing metropolitan governments in developing countries. Lincoln Institute of Land Policy, Cambridge, MA, pp 309–338 World Bank and the Development Research Centre of the State Council, P. R. China (2013) China 2030: building a modern, harmonious, and creative society. World Bank, Washington, DC Wu W (2011) Fiscal decentralization, infrastructure financing, and regional disparity. In: Chinas local public finance in transition. Lincoln Institute of Land Policy, Cambridge, MA, pp 41–56 Youngman JM (2012) China’s property tax reform: progress and challenges. Land Lines Article, Lincoln Institute of Land Policy Yusuf S (2013) Metropolitan cities – their rise, role, and future. In: Financing metropolitan governments in developing countries. Lincoln Institute of Land Policy, Cambridge, MA, pp 31–56

Chapter 4

Summary and Way Forward

“While the world has changed rapidly, the tax systems that support all levels of governments have largely stayed the same”. The quote from David Brunori (2003: 114) is largely right with regard to the overall BRICS tax systems, but not with regard to the property tax within the megacities. It seems as if there is a bottom-up movement originating from the megacities to adopt their own-tax system in order to meet their financial needs, which is expressed in property tax reforms across the megacities. These megacities are in particular facing changing economic and social environments. The megacities are in a state of constant flux—not only with regard to their population numbers, the quantity and quality of public amenities to be provided, and resulting complexity in service delivery, but also with regard to their property tax systems. In such a changing world, the fiscal framework provides megacities ideally with access to revenue sources that correspond with the powers and functions they are responsible for. Local public finance, more precisely, local public taxes, should link urban costs and benefits. However, finances often lag behind and have thereby a negative impact on the financial sustainability of municipalities, on the reliability and quality of municipal services, and municipalities’ contribution to supporting economic growth. In an urbanizing world, public finance is more important than ever before. Herewith, local tax systems, and especially property taxation, has to be in line with the changing local environment in order to offset the financial burdens megacities are facing. Therefore, reviewing the property tax systems in order to further evolve the local tax system is of urgent need. The property tax in the BRICS and their respective megacities has been reviewed case-by-case and in a comparative manner. The property tax is embedded into interplay of exogenous and endogenous factors that have effect on property tax systems and their performance across the countries and even within the countries reviewed. The megacities being similar in a broader context are contrasted with the knowledge obtained from the megacities, which enables the identification of variances. Similar megacities with different performances on property tax constitute a fruitful basis for comparative research and the Most Similar Case Design (MSCD) © Springer International Publishing AG 2017 M. Salm, Property Tax in BRICS Megacities, Contributions to Economics, DOI 10.1007/978-3-319-62671-0_4

187

188

4 Summary and Way Forward

applied. Identified similarities of the megacities with regard to the broader framework in which they operate is of importance in order to identify the variances, which, in turn, explain the property tax performance to be found across the megacities. MSCD helps to explain the tax performance by testing endogenous and exogenous independent property-tax related variables. While endogenous variables have a direct impact on property tax, exogenous variables may have an indirect impact via property values. The analysis and respective reform measures will lead the way towards a modern, equitable, efficient, and benefit-related property tax.

4.1

Similar Megacities

The megacities reviewed have a similar context from economic, social, and public finance perspectives, which is of importance in order to apply MSCD: Population/Economic Size Even though the urbanization rates vary tremendously among the BRICS states (Brazil 86%, Russia 74%, South Africa 65%, China 56%, and India 33%), the megacities themselves are the most populous urban agglomerations within each respective BRICS state. The megacities face substantial growth due to natural population increase and urbanization. An exceptional role comes to India, where rural population still dominates the urban one, and China, where a major relocation process is taking place in order to accelerate economic growth. The sample megacities are the most populous cities and the economic powerhouses within their respective states. Both economic performance and population growth are interlinked and mutually reinforcing. Furthermore, megacities play an outstanding role within their respective states. They are engines of national economic growth: Shanghai generates 3.9% of GDP in China, S~ao Paulo accounts for 10.4% of GDP in Brazil, and Johannesburg yields about 17% of GDP in South Africa. They make their countries rich because they provide economies of scale and proximity that generate enhanced productivity. The BRICS megacities are the key for (individual, municipal, and national) prosperity. Urbanization and economic prosperity are positively correlated, which explains why a small fraction of the national population (1.8% Shanghai, 5.9% S~ao Paulo, and 8% Johannesburg) is capable of contributing such large shares in national GDP. Socio-economic/Social Conditions An accelerating economy results in increasing incomes and increasing property values. Urban land is furthermore limited in supply. Rising demand occurring due to urbanization and rising incomes generated in urban centers leads to increasing property values, which is further fueled by speculation. Public service provision—especially infrastructure—may also lead to property price increases. The House Price-to-Income Ratio (P/I) measures the affordability of housing, which expresses a major problem of megacities. Housing becomes ‘seriously unaffordable’, if the P/I ranges between 4.1 and 5.0 and housing is ‘severely unaffordable’ if the Ratio is 5.1 or over. According to the ratio, housing

4.1 Similar Megacities

189

is severely unaffordable in Greater Mumbai, seriously unaffordable in Bangalore, and Chinese megacities fall outside the scale with ratios reaching results as high as 11.4 in Shanghai or 14.9 in Beijing. This has impacts on poor and middle-income households likewise, both being priced out of standard property market. The megacities outlined emphasize not only the urban advantages, but also the urban downsides, such as social inequality and exclusion, spatial separation, housing scarcity, thereby typically illustrating the meaning of a divided city. The poor are Tiebout-voting with their feet into the megacities. However, they cannot afford the costs of housing and, likewise, the megacities are not prepared. 50% of Mumbai’s population and 16.5% of Greater Bangalore’s population lives in slums. S~ao Paulo has the largest slum population in Latin America with a population share of 20% living in favelas. Furthermore, it is estimated that 70% of the urban land in S~ao Paulo is covered with substandard housing. The divided megacity is expressed in both high housing scarcity for low income (e.g. 500,000 units in S~ao Paulo region) and, at the same time, high vacancy rates (e.g. 5 million units in urban Brazil, 24.6–50 million units in urban India, 20–30% of newly completed projects in China’s major cities). This contradictory situation is fueled by inadequate social housing policy, by land developers focusing on luxury high-income housing units with high profit rates, and by speculation in the urban real estate market. The poor are marginalized, either by living in peripheral areas of the megacities where public services and transport supply are at their worst (e.g. S~ao Paulo) or by having living spaces far below the average, for instance, 1–5 m per person in slum areas against 26 m2 per person for the richest decile in Greater Bangalore. Decentralization, Finance and Expenditure Assignment The decentralization process has been going on for ten to fifteen years and was recently revised in most BRICS states. Two waves of decentralization could be identified: the first could be dated to the early 1990s; the second wave, revising the tax and expenditure assignments, started about ten years later. The decentralization process in South Africa and Russia began after the breakdown of apartheid and the USSR respectively. The process in Brazil, India and China may be traced back to the external financial crisis that has hit emerging economies worldwide since the mid-1990s. The main indicator of the first wave was when the Constitutions came in force regulating the division of taxing and expenditure powers: In Brazil the Constitution came into force in 1988, in Russia in 1993, India in 1992, China with its fiscal reform 1994, and in South Africa in 1996. As the vertical tax assignment structure is troublesome, known in the literature as the ‘tax-assignment problem’ (MacLure 1983), a revision process seems or seemed to be necessary, thus explaining the second wave. The BRICS states follow the concept of fiscal federalism; which also includes China to some extent, because it features elements of fiscal federalism by having a highly decentralized public finance system. China has implemented a tax sharing system in the 1994 tax reform, which allocates taxes to the central and local governments. In all cases the local governments levy property taxes at the local

190

4 Summary and Way Forward

level, which typically forms the most important local revenue source. Beyond that, all megacities reviewed have faced property tax reforms. The assignment of functions to the megacities within the multi-level states typically follow the spatial benefit incidence, i.e. public goods and services are limited to the municipal boundaries. The functions assigned to the megacities are fairly similar across the megacities reviewed. All local levels of the BRICS states render basic public services such as sewage, public transportation, streetlights, primary education, and basic healthcare. They follow the efficiency argument where the focus of attention is on local preferences. Within this concept, China constitutes a grey area with subnational governments having budgetary discretion and political leadership responding to local preferences, but they are not elected by local population. In this context, the subsidiarity principle is followed in Brazil, India, and South Africa (alphabetical order is in line with degree on decentralization of functions). China, in contrast, has strict centre-based expenditure assignments, which are not specified in the constitution.

4.2

Different Tax Designs

The framework in which megacities are embedded is quite similar, nonetheless showing differences, which, in turn, is the basis of the MSCD design applied. Due to MSCD, variances could be identified which help explain the difference in property tax performance. Variance is identified in the general public finance framework and within the characteristics of the property tax itself; both define the framework for the property tax design. Multi-Level Governance Structures The BRICS show high variance with regard to the location of megacities in their multi-level states and in their practical implementation of fiscal federalism: While each local government in Brazil constitutes its own tax jurisdiction, they are subordinates of their respective states in India and South Africa (i.e. dual federalism). In China, in contrast, the megacities of Beijing, Chongqing, Shanghai, and Tianjin are assigned provincial status, but they are officially referred to as municipalities. Therefore, they are capable to directly interact with the national government, and they participate in shared VAT revenues. Within the concepts of fiscal federalism (China included), in-built mismatches of functions and finances are observable. The local governments in Brazil and South Africa make up about 20% of total expenditures, but receive less than 9% of total revenues. In China, the vertical mismatch is of more concern; local governments (provinces, and municipalities included) face a share of national expenditures of 85% against 52% in national revenue. However, most problematic is the situation in India, which is based on three-tier government structure, but withholds two-tier finance statistics. The municipal finance situation in India is entirely unknown. Fiscal decentralization is still far from satisfactory in India.

4.2 Different Tax Designs

191

Governance Structure of Megacities The megacities typically follow a multimunicipal structure, where municipal preferences are ideally expressed by elected officials on smaller self-governing units. With China playing an exceptional role, the remaining megacities tend to turn from a solitary to a multiple governance structure at the time the population ranges 7–8 million (BBMP 2015: 44). Johannesburg is an exception by having multiple municipalities even at lower population levels. Greater Bangalore and Mumbai have an exceptional role by having a single Corporation. As Mumbai turns into multiple Corporations on the regional level, there is only Greater Bangalore being a single Corporation. The integration of the underdeveloped peri-urban area into Bangalore (BMP) had significant impact on the administrative performance and, therewith, on property tax revenues. Therefore, Greater Bangalore is about to turn into a multi-municipal structure in order to increase responsiveness to the individual citizen by better reflecting the citizens’ preferences in public service provision and, respectively, determining the taxes, charges, and fees to finance them. This is especially advantageous as horizontal heterogeneity across these megacities is vast. Decentralization and devolution of powers within the megacities are necessary even within municipal boundaries. This approach consequently applies the concept of fiscal federalism, which has a huge impact on accountability from an economic (hard budget constraints) and a political (democratic) perspective. Roles and responsibilities within the local subdivisions have to be clear, as within the metropolitan regions. The megacities are all located within a metropolitan area, which needs the same attention on assigning functions and finances. Herewith, Brazilian federalism shows shortcomings as states are able to implement metropolitan areas, although the states have the same constitutional status as each municipality of a metropolitan area. Financing of Megacities Megacities should generally be revenue self-sufficient. They have major residential and commercial tax bases that steadily increase and they seem to have the administrative capacities to tap them. In Brazil and India, for instance, metropolitan municipalities levy above-average tax revenues (in total and per capita). Furthermore, South Africa illustrates that municipal self-sufficiency is not only public finance rhetoric: some metropolitan areas finance up to 98% of their expenditures through own-revenues. In most megacities, the property tax constitutes the most important revenue source. However, there are some cases, where property taxation takes second place in the local revenue portfolio that has impact on the current property tax performance: Greater Mumbai still levies Octroi, a local tax on domestic trade. Octroi provides significant revenue stream (37% of total revenue income in 2010–2011), but the alleviation of Octroi has distortionary effects. Consequently, all States have abolished the tax—except the municipal corporations in Maharashtra. The buyer of a property in China has to pay at least eight property-related taxes plus Land Transfer Fees (LTF) at the transactional stage. The collection is much easier at the transaction stage rather than recurrent taxation. Therefore, Chinese megacities reviewed rely heavily on these revenues—especially on Land Transfer

192

4 Summary and Way Forward

Fees. LTFs are off-budget revenues being higher than overall tax revenues in Chongqing and Tianjin. LTFs have to be paid by land developers who make use of state-owned land for a certain amount of years. LTFs are problematic in the sense of being non-recurrent and highly volatile revenues, as well as depending on the scarcity and amount of land sold within a year. It is therefore a time-limited revenue source—especially for highly developed land markets in megacities (i.e. Beijing and Shanghai). Furthermore, LTFs seem to be the main reason for the unaffordability of housing in Chinese megacities. Next to Octroi and Land Transfer Fees, there are indirect taxes that undermine the role of property taxation, such as ISS in Brazil, which constitutes a municipal tax on services. It typically dominates municipal own-taxes by approximately 50%. This importance is of no surprise, because the tax collection of ISS is less expensive than property tax—from a financial and political perspective. Property Market and Policy The megacities show generally the need for further improving property markets—especially India, China, and Russia. Property markets in the BRICS are highly immature due to policy interventions (e.g. commandbased China), informal rather than free and open markets, and scarcity of information. The Jones Lang La Salle Global Real Estate Transparency Index (2014) classifies 102 countries’ real estate markets where first-tier cities of South Africa and Brazil are classified ‘transparent’, while first-tier cities of China, India, and Russia are classified ‘semi-transparent’. The property market information has a huge impact on property tax administration, especially property assessment; therefore, it is of no surprise that South Africa and Brazil are at the forefront of property taxation. Furthermore, India illustrates policy impacts on the property market and prices thereof. To begin with, the ‘Floor Space Index’ (FSI) and ‘Floor Area Ratio’ (FAR) applied in Indian megacities artificially limit the development of urban land to its full potential. They impede investments into the housing market and the properties are not used to their ‘highest and best use’ leading to erosion of the tax base. Furthermore, applied ‘Rent Control’ has economically the effect that investments into the rental housing market are deterred, buildings are less maintained, redeveloped or sold, supply constraints increase due to withdrawal of properties from the market, the best and highest use of urban properties is distorted, and municipal revenues eroded. Property Tax The variables analysed illuminate the variances across the BRICS megacities and thereby indicate first impacts on the property tax performance. Even though they are only indirectly linked to property taxation, e.g. via property values as the case with FAR/FSI, they limit the revenue performance. Direct linkages are given in form of political decision on tax base, exemptions, assessment method, and administrative practices, such as billing, collection, and enforcement. Here, similarities and differences across the megacities further specify the reason for variance in property tax performance to be found. The case studies chosen mirror the broad spectrum of property tax designs. The diversity in the application of residential real property taxation within the five states

4.2 Different Tax Designs

193

reviewed shows that every property tax design is unique although overall normative criteria for a rational decentralized tax are in common. Even though the property tax design differs significantly in some aspects, the megacities reviewed outperform the national property tax: S~ao Paulo collects 23.3% of national urban property tax; Rio de Janeiro collects 7.5%, reaching a property tax to municipal GDP of 1.01%, respectively 0.74%, against the national average of 0.46% in 2012. A similar high level of property tax revenues is achieved by Johannesburg, which collected about 27.1% of national property tax in 2013–2014. Greater Bangalore collected 7.2% of national property taxes ‘only’ in 2011–2012, because of the 2007 amalgamation. The inclusion of the administrative week peri-urban area into Bangalore (BMP) in order to raise efficiency and quality of public service delivery was not achieved. Controversially, the property tax revenues decreased, because of missing administrative capacities. The Chinese megacities fall far behind by reaching 28.2% of national property taxes jointly in 2013. This is of less surprise. They have provincial status; therefore they have the same tax assignments as a province, which includes, for instance, the assignment of shared Value Added Tax. A further reason for property tax yields below the average in China is the dominance of Land Transfer Fees. In the megacity context, property tax plays an outstanding role as well. The property tax constitutes a high share in megacities’ total revenues, reaching 13.5% in S~ao Paulo and 8.2% in Rio de Janeiro in 2012. The property tax makes up to 24.8% in Bangalore and 12.4% in Mumbai in 2010–2011. Johannesburg’s total revenues were driven by 18.2% property tax in 2013–2014. In China, the property tax against general budget revenue was 3.8% in Beijing, 4.4% in Chongqing, 3.0% in Shanghai, 3.5% in Tianjin in 2013. In a comparative view, the exogenous limitations outlined become visible. The property tax shares in megacities’ revenue composition are limited in the case of Mumbai due to Octroi being still in place and high revenue generating Value Added Tax for Chinese megacities. However, there are also endogenous arguments that have to be brought into the examination of property tax performance. For instance, the Chinese property tax excludes residential properties, therefore not making use of the full property tax potential. In order to gain a deeper insight into the property tax performance endogenous variables have been reviewed. Property tax involves political and administrative aspects and decisions that may prevent the tax from realizing its advantages. Within the case studies, a policy gap and a compliance gap might be identified, which have a limiting effect on the property tax performance (Fig. 4.1). In both cases potential property tax revenues fall apart from current revenues generated, i.e.: • Due to policy decisions deviating from the normative public finance literature (e.g. exhaustive exemptions) potential and actual property tax revenues fall apart, which is defined as policy gap. • Due to a lack in efficiency and effectiveness with regard to administrative practices potential and actual collections within a given policy framework fall apart, which is defined as compliance gap.

194

4 Summary and Way Forward

Fig. 4.1 Limitations on property tax (PT)—policy and compliance gap. Source: Author, IMF (2014)

The detailed examination of the property tax systems of Brazil, Russia, India, China, and South Africa and their megacities provides illuminating comparative insights into the nature and the limitations of property taxes:

4.2.1

Policy Decisions

Tax Base The tax base is predominantly defined by national law (central government), as is the case in Brazil, China, Russia, and South Africa. In India, the state level is in power to define the tax base; therefore, different property tax bases are to be found. Regarding the nature of the tax base, the BRICS states have decided to make use of both taxing land and buildings together in Brazil, India, and South Africa and land and buildings separately in China and Russia. With regard to extent of the property tax base, Brazil and South Africa levy property taxes only within urban areas, i.e. all BRICS states levy the property tax within urban areas, but not necessarily in rural ones. In Brazil and China specific rural property taxes are levied. Exemptions and exclusions limit the tax base, which has huge impact on property tax revenues. China, for instance, does not make use of a full-fledged property tax. Residential property is (effectively) not included. It is still in the communist self-conception that housing has to be provided by the government.

4.2 Different Tax Designs

195

Beyond that, 65% of residential properties and 90% of vacant land registered in Rio de Janeiro is exempt. Greater Bangalore exempts fifty percent of the property tax to self-occupied buildings used for residential purposes. As slum population is not taxed so far in Mumbai, about half the population is not taken into account in the tax base; however, from 2015 to 2016 onwards they have to pay an annual lump sum. Benefit-related features with regard to tax base are found in Brazil and India. The property constitutes only part of the tax base in Brazil if at least two public services are provided nearby and maintained by the municipality, such as pavement with water drainage, water supply, sewage system, public lighting system, and primary school or health centre. This guarantees the benefit character of the property tax. Furthermore, Greater Bangalore in India levies service charges on all properties that are fully exempt from property taxation, which are grounded on benefits received. The decision upon the tax base should be connected to the objectives set and is linked with advantages and disadvantages—not only on the tax performance—that have to be examined carefully: • Land Only (“site value taxation”): A tax on land only improves the efficiency of land use. It is a tax on location rents, which typically increase due to public infrastructure projects. It is therefore the ideal base for a benefit tax. Both, location rents and property tax, are capitalized in the property value. In a Tiebout-world, both effects would offset one another. The tax falls on the land (owner) and cannot be shifted. Because improvements are not taxed, it is ‘neutral’ in terms of development decisions. From an administrative perspective, less data is required, it is cheaper to administer, and easier to maintain (especially in fast-growing urban areas). Shortcomings with regard to ‘land only’ are high nominal rates, because of the narrow tax base and misleading ability-topay, because of the absence of buildings. • Land and buildings: Buildings constitute visible wealth. The broad tax base results in low nominal tax rates. The tax is more buoyant as the tax base is constantly changing due to land development. It stifles land development, and more importantly with regard to megacities, it downsizes square-meter living spaces to an amount which is affordable for average income groups. The tax on ‘land and buildings’ has negative effects on the administration, as a megacity is in constant flux, and it is costly to maintain the property tax register. • Land and buildings separately: Here the same advantages apply as in the case of ‘land and building’, such as broad tax base with low nominal tax rates and buoyancy given due to land development. However, splitting land and buildings might be necessary due to different ownership rights on land and buildings, e.g. state-owned land and private-owned buildings. Splitting the tax base has furthermore the advantage of setting higher tax rates on land than buildings. While location rents could be taxed according to benefits received, lower tax rates on buildings would improve (less stifle) land development. However, from an administrative point of view, it is costly to maintain, and defendable values must be provided for land and buildings separately.

196

4 Summary and Way Forward

Tax (re)assessment The second critical policy issue is deciding upon the tax assessment, which has a huge impact on the property tax performance and the allocation of the property tax burden to the taxpayers. Because all BRICS states make use of property values as an assessment base, each property should pay the tax according to its relative property value. Brazil makes use of the ‘fair market value’ by estimating the value of the land according to the market conditions and attributes of the property recorded within the cadastre. Each municipality in Brazil may decide the assessment system for assessing fair market value. Most Brazilian municipalities make use of a separate assessment of land (i.e. value of the location) and buildings (e.g. reproduction cost), but not so in Rio de Janeiro, which has huge impact on assessment values. Especially richer neighbourhoods in Rio de Janeiro get tax relief of up to 50% on land and buildings jointly, depending on the age of the building. Russia’s taxes are assessed according to government inventory valuations or book values, called ‘cadastre value’. The assessment base in India differs among the municipalities as the states decide on its base. The Indian megacities reviewed apply a ‘unit-area-value’ system with reference to location, type of construction, and nature of use. The BRICS show the broad variance of value-based assessment techniques. China makes use of construction or transaction cost; however, both values are only an indication of what an estimate of the value of the property could be. More parameters have to be taken into account to estimate/determine capital value based on the highest-and-best-use concept that brings the property owner the highest long-term economic rent (i.e. regardless of the current use). As the Chinese real estate market is restricted, transaction and construction values seem to be the only practicable way. The Indian megacities reviewed have abolished rental value as an assessment system because of rent control restricting the increase of rent/ property tax revenues. The Indian megacities make use of zonal values with regard to the land and refer to location, type of construction, and nature of use for buildings. The Brazilian assessment system takes into account zonal rates, which are further specified by characteristics that determine the value of the subject property, therefore better reflecting market value. From there, it is the right step towards a more advanced mass-appraisal approach (CAMA), as found in South Africa. Political decision on the assessment system has huge effects on the tax administration, on the property tax revenues, and horizontal equity. The (dis)advantages of the different assessment systems are as follows: • Area-based assessment: One of the main benefits of the area-based assessment is the administrative simplicity; less information and less assessment expertise is required and necessary data is easier to obtain than in the case of value-based approaches. Therefore, this approach involves no/less subjectivity of the assessors as they only refer to area, and it might result in fewer disputes. In the case of non-value tax assessment, reassessment is generally redundant because all relevant data could be obtained from relevant governmental institutions or by applying self-assessment. The administrative simplicity is converted into

4.2 Different Tax Designs

197

transparency for taxpayers, because they know their land/building sizes and the assessment typically follows an easy understandable assessment formula. The simplistic assessment enables the devolution of administrative responsibilities to the local level. However, the simplicity is beneficial from administrative perspective, but detrimental to horizontal equity. Only if the market value is the assessment base can the tax burden be divided relatively or equally among the taxpayers—according to the property value. Furthermore, the property tax will not automatically increase as in the case of value-taxation, but—on the other hand—is more stable and predictable. • Area-value-based system: If the adjustment factors are empirically determined (e.g. regression analysis) they might proxy market value without collecting sales price records. Therefore, this approach might be applied in the case of underdeveloped property markets. This approach brings together the advantages of simplicity achieved by area-based assessment and horizontal equality achieved by market value assessment. However, the adjustment factors are typically without objective proof, which might have contrary effects with regard to horizontal equity. • Rental value assessment: The ability-to-pay principle holds under this quasimarket-value approach to the extent that an efficient use of land is given. With a low number of real estate transactions or a high share of rented apartments the rental value may be simpler to determine (e.g. based on rent index). However, rental value has many shortcomings. Current use does not necessarily reflect the highest and best use; undeveloped land is therefore not taxed at full potential; it may even discourage the use at full potential. The assessment may be challenging in practice—especially in developing countries—as every tenant or taxpayer has to be identified. Beyond that, the administrative elaboration increases because of data collection on actual rent payments; because rental values are not in the public domain as sales prices; and because more assessment expertise is required within the administration. Furthermore, rental values are difficult to estimate if there is rent control or rent subsidization. • Capital value assessment: The assessment base provides a valid valuation basis for other asset values and may be used for other taxes and charges (e.g. inheritance tax, wealth tax, stamp duty). Value assessment best reflects the ability-to-pay principle. The assessment basis increases automatically due to price inflation, economic growth and other value-increasing effects (e.g. ruralurban migration). Therefore, it discourages vacant land possession for speculative reasons and intensifies overall land use. Furthermore, it returns the value of government investment to the local government. The capital value is typically determined within a specific point in time (i.e. acquisition or transaction), with no buoyancy in the tax over time if the capital value is not frequently reassessed. Only reassessing guarantees horizontal equity—especially in booming central/ metropolitan cities/areas—resulting in higher administrative costs. In the same context, free and open property markets are imperative to assess capital value, i.e. sufficient property transactions against which an objective assessment can be made are necessary. Furthermore, in metropolitan cities the purchase or selling

198

4 Summary and Way Forward

price does not reflect the true ‘use’ value, but often a speculative value. The inclusion of refurbishment costs, the degree of maintenance, etc. is difficult to estimate and a basis for disputes if transactions are not in place. Taxing buildings in the case of improved value may discourage their development; furthermore, there is no capitalization impact on the value of buildings by local public investments. Buildings are not necessarily an ‘objective’ ability-to-pay indicator as the location may determine to a larger part the property value.

Tax Rate Tax rate setting is the third critical policy decision. The tax rate is determined on the local level in Brazil and South Africa, which follows the decentralization concept where local governments can set a tax rate according to the taxpayer’s priorities, fiscal needs, and economic structure. Furthermore, the flexibility of adjusting the tax rate enhances visibility about the cost of public goods and service provision, and this, in turn, fits the benefit principle as soon as the additional tax money is spent for public goods and services. In India, China, and Russia local tax rate setting is constrained by a tax-rate range set by a higher level of government (minimum and maximum tax rates are ‘dictated’ by higher government levels). Differential tax rates can be found in all states: While Brazil, India and South Africa have different rates according to use categories (residential, non-residential, and sometimes vacant land), China and Russia have specific non-residential tax rates (China levies a Business Tax and Russia a Corporate Property Tax). South African cities apply ratios between residential and non-residential rates in order to tax commercial and residential properties according to benefits received. The differential tax rates applied have influence on the efficiency of land use (non-revenue goal) by setting higher rates on (improved/ unimproved) land than on buildings. Split-rate taxation is applied in China and Russia only, with specific rates on land and buildings. Generally, the higher tax rate should apply to the tax base that is less elastic in order to prevent tax exportation (e.g. by setting higher tax rates on land than buildings). The greater the extent and number of differential tax rates or split rates, the higher the administrative costs and the greater the risk of corruption. Furthermore, the progressive tax rates aiming at ability-to-pay in Brazil are noteworthy. While Rio de Janeiro applies a single tax rate on residential properties, S~ao Paulo applies a progressive tax rate, i.e. while the tax burden increases proportionally with the value in Rio de Janeiro, it increases progressively in S~ao Paulo. Herewith, S~ao Paulo refers more to the ability-to-pay principle (i.e. local wealth), which has, in turn, effects on the property tax performance. The imposition of progressive rates in S~ao Paulo—and since recently in Chongqing—illustrates the property tax being used as an urban policy instrument. Summarizing, major drawbacks of the property tax from a political perspective in the context of megacities’ property taxes could be summarized by the following political realities to be found:

4.2 Different Tax Designs

199

• High visibility: While visibility is good from an economic perspective, leading to higher accountability and productivity, it is less good from a political perspective since identifying the tax base, increasing the tax rate etc. affects a large number of statutory taxpayers and thereby voters. Therefore, political commitment is crucial in the case of property taxation. • Lack of reckoning realities: Decisions about an inappropriate tax base and tax assessment/valuation not reflecting local administrative/assessors’ skills and lack of property market information, such as insufficient numbers of property sales, will result in dysfunctional property tax systems. • Static nature of property tax revenue: Misguided politics may increase the effective tax rate as an immediate measure to increase revenues, not taking into account that inequities in the incidence of the tax will increase. Reassessment is politically difficult due to the large number of taxpayers/voters affected: “the buoyancy of the tax is held hostage to the timing of general revaluations” (Dillinger 1991: 4). • Local elites or “distributional coalitions”:1 Political pressure by elites and/or coalitions may influence the tax base and/or the tax rate structure (e.g. a regressive tax rate structure whereby properties with higher valuations get away with lower tax burdens), resulting in free-riding. • Large scale of tax reliefs: Politics can easily ‘buy’ popularity. In addition, exemptions once granted are difficult to reverse. • Capacity limitations: The institutional framework for the property tax administration is set by political decisions. The tax administration—like the property tax—has to be designed according to reality (e.g. under-/developed property markets). It has to ensure that the administrative capacity, which includes qualified property assessors, is sufficient to levy, collect and enforce property taxes.

4.2.2

Administrative Practices

Identification, Assessment, Billing, Collection, and Enforcement Politics is only one side of the coin, administration is the other. Next to policy decisions, there are administrative practices influencing the tax performance. The tax administration needs to be effective and efficient; otherwise, defining a tax base, tax rate and assessment is redundant. Due to the megacities’ sizes and populations, they have the ‘critical number of property cases’ to fulfill the administrative efficiency criterion, but this also means that major resources to run key administrative

1 Olson (1982) addresses special-interest groups striving for redistribution of income/resources rather than generating new income/resources.

200

4 Summary and Way Forward

functions, such as keeping the fiscal cadastre up-dated, reassessing properties, billing tax calculated, and enforcing non-payment are needed. Tax collection and administration fall to the local level in Brazil, India, China and South Africa. In China, local tax bureaus collect local taxes; however, they are supervised by the State Administration Authority (SAT). In Russia the tax administration falls to the federal and state level only. As Moscow withholds the status of a full-fledged state, all megacities in in the sample administer their own local taxes. Generally, the tax administration on the federal and state level may involve economies of scale and fewer issues of corruption; however, it may result in under-collection of local taxes due to a lack of incentives at the higher governmental level. The tax administrative practices in the megacities follow hierarchical authority with sign-off procedures (e.g. Indian megacities) and/or designate responsibility for supervision to specific departments (e.g. S~ao Paulo). Mostly, procedures are written rules, processes and procedures that are indirectly outlined in job descriptions, or they are directly formulated in duties and responsibilities. Indian residents, for instance, have a ‘Right to Information’ provided by legislation. All megacities have to provide written rules, processes, and procedures; mostly a list with names, responsibilities, and telephone numbers is provided. Furthermore, the different functions or duties within the administration—e.g. property identification, assessment, collection, and enforcement—are typically separated from each other in order to prevent any type of corruption. Greater Mumbai, for instance, separates assessors and collectors between ‘Indoor’ and ‘Outdoor’ and S~ao Paulo has three separate departments, where collection, supervision, and assessment/judgment are separated from each other. Administrative practice starts with property identification, i.e. gathering, verification, and/or maintenance of all data necessary to tax the property, e.g. civic address, site and building areas and attributes. Chinese megacities, for instance, are at the very early stage of preparing a unified and consistent property tax register. Another challenge in China is the lack of inter-municipal department linkages that would help to further levy economies of scale and improve synergies. Brazilian and Indian megacities face high numbers of informal, illegal properties that make identification resource-intensive from an administrative point of view. In order to limit administrative resources, Indian megacities make use of self-assessment schemes, where property owners have to provide relevant property data. Here, tax inspections and severe punishments are necessary in order to prevent false declaration. The (re)assessment process seems to be the most challenging aspect for the tax administration. The case studies have shown the problems involved in assessing urban properties at market value, e.g. due to missing technical and human resources, inappropriate adjustment factors, and/or infrequent reassessment cycles. Furthermore, assessing informal property is challenging. However, informal properties are also bought and sold and a vibrant informal property market is typically observed. Informal real estate has a price tag that can be determined. In order to ease the administrative workload, self-assessment systems are in place in Indian

4.2 Different Tax Designs

201

megacities. In India, the taxpayers self-declare and self-assess the property by making use of tax calculators provided on the megacities’ homepages. For proper assessment, trained valuers and contemporary assessment practices (e.g. aerial photographs and georeferenced mapping of properties using GIS) are needed. These practices are in place in Brazil, India, and South Africa. Furthermore, Greater Bangalore provides a ‘Property Tax Handbook’ that explains the assessment process. South Africa has the soundest assessment system by making use of a basic form of ‘Computer-assisted Mass Appraisal’ (CAMA) in order to estimate property values. Properties are reassessed every 3–5 years. The two megacities in Brazil are exceptional in two respects; while Rio de Janeiro’s last reassessment was in 1997, S~ao Paulo has been reassessing the property values every two years since 2013. In order to prevent sharp increase of assessment values, and respectively, property tax amount to be paid, the periods between reassessments are inflation-adjusted in Brazil and Russia. Furthermore, Brazilian megacities apply tax caps to limit increase in property tax. Billing and Collection After the assessment of the property, the administration calculates property tax for each taxing body and starts tax billing and collection thereafter. The tax billing should provide all necessary information, such as the taxpayer’s name and address, assessed value of the property, tax rate, tax amount (including arrears if any), number of instalments, statutory deadlines for tax payment, penalty dates and amounts, alternative ways of payments (online, lottery, banking network, etc.). Greater Bangalore is planning to outsource billing and collection to external partners. Enforcement In the case of late or non-payment, collection turns into enforcement measures, such as penalties and fines, which are automatically due. Rio de Janeiro has increasing fine rates (4%, 8%, and 12%) that apply if one of three due deadlines has passed. Thereafter monthly arrears of 1% are due. Similar measures are applied in S~ao Paulo, and they also ‘bill’ attorneys’ fees and legal fees of tax enforcement. Furthermore, they provide a blacklist of tax debtors. Greater Mumbai even includes enforcement measures such as the sale of goods or chattels of the defaulter, or sale of the immovable property, which is not done so far in the Brazilian megacities. Summarizing, major drawbacks of the property tax from an administrative perspective in the context of megacities’ property taxes could be summarized to the following administrative issues related to efficiency and accuracy of taxable property data, tax assessment, collection and enforcement: • Limited data: For various reasons, data on the tax base and taxpayers has several shortcomings and missing information, including: unclear tenure rights, informal property markets, rapid urban growth and missing property records due to lack of up-to-date fiscal cadastre. Further, there might be fragmented and unshared property tax related data (fiscal cadastre, deeds registry, etc.) in different governmental/administrative bodies.

202

4 Summary and Way Forward

• Accuracy and efficiency: Low accuracy in property information and low efficiency of tax collection leads to reduced revenues from property taxes, as taxpayers do not pay the correct and/or adequate amount of taxes. • Low service quality: Low public service quality and efficiency result in low tax compliance; furthermore, low service quality with regard to tax administration (taxpayer education) results in a lack of knowledge and awareness. • Corruption: Decentralized corruption in the case of local tax authorities having discretion on the tax base/tax assessment could result in rent-seeking (“win-winsituation” for taxpayer and tax official). Overall, performance of the property tax is determined by exogenous and endogenous factors, of which the latter is further subdivided into politics and administrative practices. The factors outlined explain the differences in the property tax performance of the reviewed megacities within the respective state and across the BRICS states. While it is not possible to empirically establish the impact of the exogenous factors’ on the performance, endogenous factors’ impact may even be monetarized. In the case of S~ao Paulo, Rio de Janeiro, and Greater Bangalore the potential property tax revenues with an more efficient and effective tax administration—an increase to 85% and 100%—have been calculated. The calculation indicates that the tax revenues generated could be increased about three-fold to the tax revenues collected in the respective financial year within the moderate 85% aim. They could even increase about four-fold in an ideal administrative world. Moreover, this approach nicely illustrates that single measures already have substantial impact on the property tax, while combined measures display a multiplicative effect on the revenue outcome. An increase in the tax ratios with regard to coverage, assessment, and collection unfolds the full potential of property taxation.

4.3

Way Forward

Besides the general setting of megacities in national context, local public finance is the key to balance urban (dis)advantages. Within the toolbox, the property tax is the ideal instrument to generate needed local revenues to cover the costs of urbanization. The way forward should be marked by better achieving the institutional symmetry and, therewith, the focus should be on the benefit principle. The property tax is the only financing instrument that may achieve a balance between public services rendered and taxes paid, even though this link may only be established on collective basis. To the extent the benefit-link is achieved, the tax has the character of a non-distortionary user charge. Megacities have an outstanding role—not only in terms of population and in terms of economic power, but also in terms of local own-tax revenue collection, which, in turn, implies a very strong administration against the national average. Megacities are able to make use of their urban advantages to offset corresponding urbanizing costs. Therefore, more functional and financial responsibilities should

4.3 Way Forward

203

be assigned to them. This could either be accomplished by giving megacities a citystate status, as is the case in China, or by applying asymmetric federalism in favour of megacities. The first approach (i.e. city-state status as in China) enables megacities to directly interact with the national government and employ different taxation norms; however, this approach seems to be outside the bounds of practicality as the megacities are typically the economic powerhouses of their respective states. Therefore, the latter approach (i.e. asymmetric federalism) would serve the needed varying speeds between well-advanced megacities and the other local governments—especially rural ones. Both approaches might help further improve the financial sustainability of megacities, the reliability and quality of their services, and megacities’ contribution to supporting economic growth. Furthermore, selfsufficiency of megacities would free up resources (e.g. transfer payments) for the less advantageous local government units in their respective states. The megacities should follow a multi-municipal governance structure, where municipal preferences are ideally expressed by elected officials on smaller selfgoverning units. They are more responsive to the individual citizen by better reflecting the citizens’ preferences in public service provision and, respectively, determining the taxes, charges, and fees to finance them. This is especially advantageous within the very heterogeneous megacities outlined. This would follow the benefit principle and the evidence found by Gramlich and Rubinfeld (1982). According to them, Tiebout-grouping is found in larger metropolitan areas due to smaller mobility costs and greater satisfaction with public goods provision. Outside metropolitan cities, employment factors more likely determine the location than preferences for public services. The more homogeneous the urban districts, the better the benefit principle is achieved, if decentralization and devolution of powers go along. Therefore, the concept of fiscal federalism is to be thought through right to the end, even within the megacities boundaries. In addition, homogenous urban districts push the voice of the urban population—rich and poor. As large parts of the poor live typically in informal, illegal or irregular settlements, the rich typically have a stronger voice than the poor do. Both have to rely on voting (preferably at the ballot, not with their feet) in order to influence politics. Thereby they are capable of optimizing public goods and service provision and of maximizing the capitalization effect on their own property values. Overall, multi-municipal governance structures have a positive impact on accountability from a political (democratic) and from an economic (hard budget constraints) perspective. In this setting, the roles and responsibilities within the local subdivisions have to be clear, as within the regional levels. The megacities are all located within a metropolitan area, which needs the same attention to assigning functions and finances (see Brazil). Coordination and harmonization within megacities and metropolitan areas is of high importance in order to avoid distorting incentives, tax arbitrage and/or Tiebout shopping. The property tax of a Tiebout-Oates-Hamilton-Fischel-type does fit well into the context of BRICS states and their megacities, even though the benefit tax character is merely partly achieved in the megacities reviewed, especially in China. The BRICS states’ property tax is an ad valorem tax (at the very least location factors are taken into account), therefore reflecting to a certain extent (unearned) economic rents from rising property values due to urban population growth, capitalized public

204

4 Summary and Way Forward

service provision and speculation. Megacities should aim at skimming these rents in order to offset costs of urbanization and public service provision. Otherwise, these unearned economic rents fuel already booming property markets and prices thereof, which make properties more and more unaffordable, which, in turn, would further price out middle and low-income households of the market. Therefore, appropriate taxing of these rents could lower property values, making housing more affordable and encouraging that the land be put to its highest and best use. At the same time, it could improve the own-tax revenues of the megacities to adjust their revenue need to extend and further improve public goods and services. Even though public finance theory constitutes the overall normative yardstick for property taxation, zoning and therewith exclusion of households that are ‘fiscally undesirable’ should not constitute the path to be followed. Of course, it would follow the benefit principle, because it prevents the poor from free-riding by limiting a megacity to those who can afford the prix fixe menu that fits their preferences. However, urbanization—even of the rural poor—should be seen as part of the “Triumph of the City” (Glaeser 2011: 70), because metropolitan cities function as a catalyser of wealth generation and social advancement. Urban poverty reflects municipal strength, not weakness. It shows that urban economic and population growth turn cities into poverty fighters. If possible, the urban poor should pay property tax or a service charge as it is part of the future revenue strategy of Greater Mumbai. This approach fits public finance rationale, but could also go along with public housing. The construction sector fuels economic growth rates, has social impact, and generates property tax revenues. For both the poor and the megacities, it would be fair if social costs would (at least to a certain extent) be borne by the national rather than local governments. In general, even the strongest megacities cannot handle the cost of urban poverty by themselves. The BRICS states outlined have different ways to financially support megacities with regard to urban poverty and adjunct challenges, with India nicely illustrating that these funds should be linked to a reasonable benefit-related local tax system: • Brazilian municipalities receive next to formula-based general transfers from the Municipal Participation Fund, 60% of their health-care costs covered by the Federal Government (municipalities and state governments split the remaining costs). Health-care costs are provided on a cost-free basis to every Brazilian citizen. The health care funds constitute a larger share in megacities’ total revenues than general transfers provided. • In India, JNNURM funds were put in place by the Indian Government aiming at supporting urban development. In order to receive funds by the JNNURM program, an administrative ‘reasonable’ property tax system needs to be established. Within the JNNURM scheme, 85% of total properties should be subject to taxation and 85% of the tax should be assessed and collected. • In South Africa, municipalities receive formula-based transfers that utilize population, poverty, and household income to determine the capita share for each municipality. The local tax systems in BRICS states have shown some shortcomings, which have considerable distortionary effects on local revenues. Especially Greater

4.3 Way Forward

205

Mumbai should focus on further reforming/improving the property tax as compensation for the distortionary Octroi, and Chinese megacities should be at the forefront of introducing property taxes in order to offset Land Transfer Fees. By doing so, the benefit-tax link of local tax revenues would be improved. The property tax design itself leaves room for further improvement. However, administrative practices have to be in accordance with local tax administrations’ capabilities. Therefore, a systematic approach is necessary in order to further improve the property tax design, also with regard to the demanded benefit-tax link. First and most importantly, the improvement of property tax-related information is needed. This includes all information necessary for site analysis, such as dimension, shape, location, topography, identity, on- and off-site improvements, zoning restrictions, soil and subsoil conditions, access to the site, etc. These aspects are comparable to other site characteristics of neighbourhood properties. Furthermore, information on improvements needs to be collected, such as dimensions of the building and its rooms, quality and type of construction, year of construction/ remodelling, interior (floors, walls, ceilings, etc.), mechanical systems (plumbing, heating, etc.), etc. All characteristics of the site and improvement that determine the market value are needed for market analysis and to estimate the current market value or the most probable price that a property would bring from a fair sale in a competitive and open market. In addition, the current use of the property might not be the highest and best use, which maximizes the long-term economic rent. Rethinking the use concept of the property is important—especially in rapidly and constantly changing megacities. With detailed information given, more contemporary mass appraisal (Computer Assisted Mass Appraisal, CAMA, is typically to be found in North America, but also in South Africa) could be applied. Computer mass-appraisal is a statistical approach to property assessment which enables the assessment of entire classes of properties even with scarce price data. It creates more objectivity and accuracy if properly applied. The model is fed with detailed information on neighbourhood properties and calibrated in order to achieve horizontal equity. It is an effective and efficient administrative way to (re)assess properties. Such applied standardized methods and models make quality insurance and oversight management easier to handle. The shift to a more precise market value assessment could be incremental. Overall, the property tax should be as close as possible to market value (i.e. value of highest and best use) in order to reach its full potential: • Market value reflects benefits received, e.g. in form of public infrastructure investments capitalized in property values. The tax thereof has a user charge character. There is no other (local) tax that is able to establish such benefittax link. • The capitalization effect could raise homeowners’ interest in politics, which has effect on accountability from a political (democratic) perspective. • Unearned economic rents that are not the result of the property owner are part of the market value (e.g. due to urbanization process) and should be skimmed by the local government (e.g. to finance urbanization).

206

4 Summary and Way Forward

• Even though the benefit principle should be in the focus, market value as assessment base could also be used to establish the ability-to-pay principle. S~ao Paulo nicely illustrates that even both principles might apply. Property is only taxed if public amenities are provided, which reflects the benefit principle, and thereafter, progressive tax rates are applied, which reflect ability-to-pay. • For market-value assessment and to ensure assessment accuracy, contemporary data by monitoring of trends in demand and supply as well as prices of real estate and rigorous analysis thereof is needed. The information also constitutes a foundation for urban governance and informed political/administrative decision-making. It is important for effective land management, the development of feasibility studies (e.g. the design of urban infrastructure) in order to improve the quality of life, and for taxation purposes. • Property tax should be based on market value in order to deter speculation in the property market. If capital gains are taxed at higher rates than property, the property market ‘attracts’ speculative money. Investments into the property market become less attractive if based on market value and comparable tax rate as capital gains. • Market value guarantees a buoyant tax that increases with the economic cycle. Furthermore, it reflects inflation, which may reach significant levels in BRICS states. • The tax burden is allocated relatively to the market value to the tax payer; therefore, horizontal equality is achieved. The tax is fair, and is perceived to be fair by the taxpayers. • Market-value assessment undermines the practice of undervaluation (e.g. in the case of self-assessment) in order to evade property tax, property transaction tax, stamp duties, capital gains tax, etc. • The market value constitutes a perfect tax base for other taxes, such as property transfer tax, stamp duty, inheritance tax, wealth tax, etc. • Assessment of market value and collection indicates local own-tax effort and is a good basis for central government funds or transfers. Market value estimated by mass-appraisal technique is the way forward for the megacities to unfold the benefits provided by a local property tax. By doing so, the megacities would have sustainable finances in order to provide reliable and highquality municipal services. With them, the megacities are a cornerstone for transition.

References BBMP (2015) Bengaluru: way forward. Expert Committee: BBMP Restructuring, June 2015 Brunori D (2003) Local tax policy: a federalist perspective. The Urban Institute Press, Washington, DC Dillinger W (1991) Urban property tax reform: guidelines and recommendations. Urban Management and Municipal Finance, World Bank, Washington, DC

References

207

Glaeser E (2011) Triumph of the city. How our greatest invention makes us richer, smarter, greener, healthier, and happier. Penguin Books, New York Gramlich EM, Rubinfeld DL (1982) Micro estimates of public spending demand functions and tests of the Tiebout and median-voter hypotheses. J Polit Econ 90:536–560 IMF (2014) Revenue administration – gap analysis program (RA-GAP). Presentation held by David Kloeden, 5th IMF-Japan high-level tax conference for Asian countries, 21–23 Apr 2014 McLure CE Jr (ed) (1983) Tax assignment in federal states. Australian National University, Canberra Olson M (1982) Rise and decline of nations. Yale University Press, New Haven

Annex

A.1 Taxes on Property in Brazil Assessment base

Object

Taxpayer

IPTU (Imposto sobre a Propriedade oredial e Territorial Urbana) ITBI (Imposto sobre Transmiss~ao de Bens Imo´veis)

Urban land and buildings

Individual Market value of or corporation urban property

Tax rate

Transfer of immovable property and rights relating thereto

Defined by Individual Market value of real municipalities or corporation estate sold

ITR (Imposto sobre a propriedade Territorial Rural) – Federal Tax

Individual Land value Property located out- or corporation side the urban area

Defined by municipalities

Progressive rates

Collection stage/ payment Possession (recurrent tax)

Exemptions Defined by municipalities

Transaction Property belonging to the Union, the Federal District and Municipality, churches of any denomination; political parties, including their foundations and unions of workers; education, social welfare and non-profit organizations Possession Rural land. . . • Under 100 hectares if located in the Western Amazon; • Under 50 hectares if located in the Eastern Amazon; • Under 30 hectares if located in another municipality; • If the rural land is incorporated within the official program of land reform

(continued) © Springer International Publishing AG 2017 M. Salm, Property Tax in BRICS Megacities, Contributions to Economics, DOI 10.1007/978-3-319-62671-0

209

210

Annex

Assessment base

Object

Taxpayer

IRPF (Imposto de Renda das Pessoas Fı´sicas) – Federal Tax

Income from immovable property (renting or leasing)

Individual Income or corporation

ITCMD (Imposto de Transmiss~ao Causa Mortis e Doac¸~ao) – State Tax

Transfer of property and rights thereto

Individual

Source: Author

Tax rate

Collection stage/ payment

Recurrent 2016 • Up to R$ 22,499
0.0% • From R$ 22,4499 to 33,478
7.5% • From R$ 33,478 to 44,477
15.0% • From R$ 44,477 to 55,374
15% • Above 55,374 – 27.5% Transaction Maximum of 8% defined by the Federal State of Brazil, mostly levied at 4%

Exemptions

• If property is used solely for housing the surviving spouse or heir; • If the property is in a rural area of up to 25 ha and its ongoing usage is the only means of sustenance for the family; • If property is for land reform; • If the property is used for approved housing programs (such as Minha Casa, Minha Vida)

Residents

Income from letting

Source: Author; Federal Tax Service of Russia

Businesses in possession of property objects which are identified as taxable objects

Immovable and movable assets recorded in the balance sheet as fixed assets

Corporate Property Tax – Regional Tax (50% assigned to local) Income Tax

Owners of land (organizations, individuals and individual entrepreneurs)

Land plot

Land Tax

Object Taxpayer Individual Residences, apartments, Property owner Property Tax rooms, country homes, or – Local Tax other structures, premises and buildings, as well as ownership shares in such property

A.2 Taxes on Property in Russia

Tax rate • Lower than 300,000 Rubles: 0.1% (inclusive) • From 300,000 to 500,000 Rubles: 0.1
0.3 % (inclusive) • Higher than 500,000 Rubles: 0.3
2.0% (inclusive)

Collection stage/ payment Recurrent

Income

Flat tax, 13%

Recurrent

Rates are established by local Recurrent legislative acts and cannot exceed the rates specified by Russian Tax Code: 0.3% for agricultural, residential and utilities infrastructure lands; 1.5% for other types of land use Tax rates may be differentiated according to use of land Annual aver- Is established by laws of the sub- Recurrent age value of jects (i.e. regions) of the Russian property Federation and cannot exceed 2.2% of taxable value

Cadastral value of the land plot as of January 1st of the tax period year

Assessment base Cadastral value specified in the state cadastre of real estate as of January 1

Exemptions Apartment: cadastral value minus cadastral value of 20 sq. m of total area Room: cadastral value minus cadastral value of 10 sq. m Residential building: cadastral value minus cadastral value of 50 sq. m of total area of the house

Annex 211

Capital Gains Tax

Property Tax (sometimes there is a separate Vacant Land Tax) Taxes on Income

Seller of property

Individuals, companies, local authorities, artificial judicial persons

• Self-occupied property (excluding one property) • Let-out property

• Profit/capital gain

Taxpayer Owner, Occupier

Object • Buildings and lands

A.3 Taxes on Property in India

• Annual lettable value (ALV) minus municipal taxes paid & unrealized rent & standard deduction of 30% & interest on housing loan • Transfer of property less cost of acquisition and cost of improvement • Sale price less cost of acquisition and cost of improvement

Assessment base • ARV, CV, UAV

Property held. . . •  3 years, individual tax rate (as per Income Tax Slab Rates) • > 3 years, 20%; reinvestments into specific fields are exempt from Capital Gains Tax

Age below 60Yrs (2015/16): 0%: up to ` 250,000 10%: `250,001–500,000 20%: `500,001–1,000,000 30%: above `1,000,000

Tax rate Varies within tax rate corridors set by respective States

Recurrent tax/31 July of assessment year for individuals

Collection stage/ payment Recurrent

(continued)

Exemptions Varies within tax rate corridors set by respective States One property

212 Annex

Net wealth (total value of assets minus debt related to assets) exceeding Rs. 30,000,000

Assessment base • Size and purchase price

Source: Author; Income Tax Department, State Finance Commission Reports

Stamp Duty on Property (officially classified as tax)

Abolished 1985

Estate Duty (Inheritance Tax) Gift Tax

Individuals

Taxpayer Paid by the buyer to the seller who deposits it with the government

1% in excess of Rs. 30,000,000

Tax rate 14% (if construction service cannot be shown separately, 25% of purchase price are tax base, taxed with 14%, resulting in an effective tax rate of 3.5%)

Recurrent tax/31 July of assessment year for individuals

Exemptions • Vacant land, residential units let-out as Residence • Single residential unit, and low cost housing (up to 60 sq. m) First house

Abolished 1998; however, the tax was revived partially in 2004. A new provision was introduced in the Income Tax Act (section 56 (2)). Gift received in excess of ` 50,000 are taxable. Exempt are gifts from blood relatives Property transaction Purchaser of Rate differs from state to state, Transaction property some states give concession if of property new owner is female. Maharashtra: 6.5%

Net wealth consisting of immovable and movable property

Object • Rent • Property under construction (construction service provided) before Issuance of Completion Certificate received

Wealth Tax (abolished from Fiscal Year 2015–2016)

Service Tax on. . . • Rent • Sale of Property

Collection stage/ payment

Annex 213

Urban Land Use Tax

House Property Tax

All land within cities, counties, towns, industrial & mining districts

Object Houses within cities, towns, industrial, mining districts (rural areas excluded)

Assessment base “Ad valorem” tax: • Original value of the house minus 10–30% (¼ residual value) • Gross annual rental value

• Units (Enterprises, Area of urban land public institutions, occupied social organizations, government offices, military) • Individuals (privately or individuallyowned businesses & other)

Taxpayer Foreign-invested enterprises, foreign enterprises & organizations, foreign individuals

A.4 Taxes on Property in China

Tax rates are set per year per sq. m according to city seize: • 0.5–10 yuan in big cities, • 0.4–8 yuan in medium-sized cities, • 0.3–6 yuan in small cities, • 0.2–4 yuan in county towns

Tax rate Proportional tax rate: • Residual value 1.2% • Rental value 12%, (4% for individuals that lease a house at market price)

Possession (recurrent tax)/calculated annually & paid in instalments

Collection stage/ payment Possession (recurrent tax)/calculated annually and paid in instalments, time of payment is determined by the people’s governments at all levels

(continued)

Exemptions Residential housing, State organs, people’s organizations, military, religious temples. Under the Department of Finance: schools, medical treatment & public health units, child-care centres, units of culture, sports & art , branches of People’s Bank of China, elderly, service organizations, student hostels Privately-owned land, rental housing, government offices, mass organizations, military, religious temples Approved by Department of Finance: Urban Streets, green belts, productive land, People’s Bank of China offices, civil aviation, railway, key industry (petroleum, electricity, water)

214 Annex

Object Tax on the State-owned Use of Arable and Land; some- collectivelytimes owned referred as farmland Farmland Occupation Tax City Mainte- Value added nance & tax, consumpConstruction tion tax, & Tax business tax paid (excluded consumption tax & VAT on imports) Land Appre- Transfer of ciation Tax State-owned land use rights & aboveground buildings & other attached objects

Assessment base Use of agricultural land for urban houses and non-agricultural construction purposes

Certain proportion of the payment amount of the “three taxes”

Increment value of transfer of Stateowned land use rights & above ground structures minus land transfer fees, development cost, & expenses for land improvement

Taxpayer Units & individuals

Entities & individuals paying the “three taxes”

Enterprises & individuals Four grades of progressive rates, i.e. 30%, 40%, 50% & 60% depending on the ratio of value added to the sum of deductible items

• 7% urban area • 5% county towns, towns & • 1% elsewhere

Tax rate Average tax per sq. m: • Shanghai: 9 yuan • Beijing: 8 yuan • Tianjin: 7 yuan • Chongqing: 4.5 yuan

Transaction (non-recurrent): paid within limit designated by the tax authority, Within 7 days of contract signing

Transaction (non-recurrent)/paid together with VAT, consumption tax & business tax

Collection stage/ payment Land Development (non-recurrent)/paid within 30 days upon the approval by the land administration department on the use of land

(continued)

Exemptions The farmer revolutionary base areas, areas inhabited by minority nationalities, remote and border areas and poverty-stricken areas

Annex 215

Assessment base Tax rate Contract price or fixed Four proportionate tax amount per document rates (1‰, 0.5‰, 0.3‰ & 0.05‰), e.g.: • 1‰ of the lease amount of property leasing contracts • 0.3‰ of the value of the purchase & sale Transaction price Flat rate within a determined in transfer range of 3–5% detercontract mined by provinces & municipalities directly under central government (1% for houses less than 90 sq. m) Income obtained from Proportional tax rate transfer of property, (20%) rental income Deductions: • Lease—yuan 800 if income less than yuan 4000; 20% if more than yuan 4000 • Transfer—original value and reasonable expenses

Source: Author; State Administration of Taxation, Hong 2013

Transfer of real Individuals with estate (houses, domicile in PRC buildings, & land use rights), lease of properties

Individual Income Tax

Chinese & foreigners

Transfers of land-use rights & ownership (house property)

Taxpayer Entities & individuals

Deed Tax

Stamp Tax

Object Levied on securities & immovable property

Quarterly instalments

Non-recurrent: paid within 10 days of contract signing

Collection stage/ payment Transaction (non-recurrent) Exemptions

216 Annex

Estate Duty

Transfer duty

Rates

Collection stage/ payment Recurrent

Tax rate Differential rates (residential, non-residential) possible but within a ratio set by national government. Ratios are set for agricultural properties (1:0.25), public service infrastructure (1:0.25) and public benefit organizations (1:0.25) Acquisition of legal title to a Natural per- Value of the Rate for all persons is on a sliding scale: Nonproperty; No transfer duty is sons and purchase 0–600,000 Rand: 0% recurrent payable if the transaction is legal price or fair 600,000–1 million Rand: 3% on the subject to VAT entities value of value above 600,000 immovable 1–1.5 million Rand: 12,000 Rand plus property 5% on the value above 1 million Rand 1.5 million and above: R37,000 plus 8% on the value above 1.5 million Rand Exempt: Registered VAT vendor, Public benefit organization Estate duty is levied on the Beneficiary Dutiable Flat Tax, 20% Nondeath of a person and is not amount of recurrent limited to residents; the estate Certain admissible deducexceeding tions from the total value of R3.5 the estate are allowed million

Object Land and improvements

Assessment Taxpayer base Landowners Market value

A.5 Taxes on Property in South Africa

(continued)

Nett estate in excess of R3.5 million

Exemptions Municipalities decide on exemptions and rebates

Annex 217

Object Property

Source: Author

Capital Part of the income tax sysGains Tax tem and is based on capital gains made on the disposal of assets

Donations Tax

Individuals, Companies, Trusts

Taxpayer Residential

Tax rate Flat Tax, 20%

Capital Maximum effective rate for individuals gain; differ- 16.4%, companies 22.4% ence between the proceeds and the base cost

Assessment base Value of property Nonrecurrent

Collection stage/ payment Nonrecurrent Exemptions The first R 100,000 of the value of property donated is exempt from donations tax R 2 million gain or loss on the disposal of a primary residence; annual exclusion of R 40,000 capital gain or capital loss is granted to individuals

218 Annex

0

2000

4000

6000

8000

10000

12000

1991

1989 1990

1988

1985 1986 1987

1982 1983

1981

1979 1980

1978

Total Revenue Central Government Revenue Ratio (%) Central Government Expenditure Ratio (%)

1984

1975 1976 1977

Source: Author; National Bureau of Statistics China

Total Revenue & Expenditure, Billion Yuan

14000

1992 1993 1994 Year

2010

2009

2007 2008

2005 2006

2004

2003

1999 2000

Total Expenditure Local Government Revenue Ratio (%) Local Government Expenditure Ratio (%)

2001 2002

1997 1998

1996

1995

A.6 Local and Central Revenue and Expenditure Assignments in China

0

10

20

30

40

50

60

70

80

90

100

Annex 219

Government Revenue & Expenditure Ratio 2011 2012

Source: Author; National Bureau of Statistics

02 03 04 05 06 07 08 09 10 11 12 13 20 20 20 20 20 20 20 20 20 20 20 20

Shanghai

99 00 19 20

0

500

1000

1500

2000

2500

3000

3500

4000

4500

5000

Business Tax House Property Tax Urban & Township Land Use Tax Deed Tax

02 03 04 05 06 07 08 09 10 11 12 13 20 20 20 20 20 20 20 20 20 20 20 20

Beijing

99 00 19 20

0

500

1000

1500

2000

2500

3000

3500

4000

4500

01

01

02 003 004 005 006 007 008 009 010 011 012 013 2 2 2 2 2 2 2 2 2 2 2 20

Tianjin

99 000 2 19

0

500

1000

1500

2000

2500

3000

3500

4000

4500

5000

City Maintenance and Construction Tax Stamp Tax Land Appreciation Tax Gross Regional Product

02 003 004 005 006 007 008 009 010 011 012 013 2 2 2 2 2 2 2 2 2 2 2

20

Chongqing

99 000 2

19

0

500

1000

1500

2000

2500

3000

3500

4000

4500

5000

01 01

20

20

20

20

5000

A.7 Development of Local Tax Revenues in Sample Cities, 1999–2013 220 Annex