Why a tax won’t work
China has announced that it will likely pilot a property tax in three major localities within the next year. Many analysts have celebrated the move as a blow to speculation. Yawn.
A property tax in China is much less new or radical than you might think. One of them was flown to Shanghai and Chongqing in 2011, but the nationwide expansion plan was abandoned by Xi Jinping when he took power. Taxes have not dampened speculation or inflated values, with average house prices having risen since 2011 by 155% in Shanghai and 108% in Chongqing.
The irony is that China actually does not have private real estate. The buildings are owned by individuals, but private ownership of land is prohibited. Building owners pay a land use fee to the local government. It sounds like a purchase price for the land, but there is no transfer of ownership, just rights of use for up to 70 years. In fact, it’s a bit like a property tax paid to the local government, 100% up front. Buildings constructed by individuals were taxed as early as 1986, but, as noted, a residential property tax was never extended beyond the original two pilot towns.
They are trying again: the property tax plan was included in the 2017 Five-Year Plan, and a recent Council of State authorized the designation of pilot areas. In particular, it is not yet planned to promulgate a law on property tax.
The immediate problem with a property tax is the complexity of enforcement, which relies on various factors that are difficult to determine: whether the property is occupied, the ratio of the total area to the city’s average area, or the book value of the property. property beyond the city’s average real estate value. There is no record that would indicate which units are empty, which are investment units and which are in fact homes for real families.
The second problem is that the tax will hurt land sales by local governments, and governments, especially the poorest, are heavily dependent on land sales. Government statistics show that in 2020, Chongqing earned 7.6 billion yen from property tax and 220.2 billion yen from land sales. Land sales in Chongqing accounted for about 12% of government revenue; in some localities this percentage is 75%. Thus, the localities, which pay for 97% of Chinese infrastructure (often mandated by the central government), are reluctant to kill their goose that lays the golden eggs. The original pilot plan called for 30 cities but reduced to 10 due to fierce local opposition over the expected loss of income.
This is why a property tax cannot work without a structural reform of public financing.
In the rush to centralize control after Tiananmen, the Chinese central government restructured taxation and finance, making the central government the collector of all taxes and handing over portions to localities. The local share then descends through four levels of government in a poorly articulated process that leaves little to the last two levels. Meanwhile, localities bear virtually all social costs – education, health care, roads and water, etc. People with a residence permit in these localities are not free to seek social services in other places. Cities with the biggest real estate booms have built massive housing estates without the need to provide schools and hospitals for intended migrants. As a result, booming coastal towns do not bear the real costs of development and, at the bottom of the pile, the localities cannot afford to lose any income on land use sales as they are grappling with high and increasing costs.
Basically, China’s tax and budget system is based on the premise that people live and work relatively still, a principle at odds with the massive 300 million migrant workers and the overall flow of rural populations to urban centers. Localities are burdened with all the costs and decisions of social protection without reliable arrangements to finance them. Localities do not derive any long-term benefit from investments in education and health, as educated people move out of rural areas and income taxes are paid to the place of employment, not to the hometown of the educated . Large cities are also not required to pay the real costs of migrant labor from which they have benefited so much, as migrant workers do not have to pay. hukou residence and are generally not entitled to most of the benefits available to registered city-dwellers. The boom in real estate investment has strongly exacerbated these trends.
Since 2022 is the year Xi Jinping plans to consolidate his leadership position for life, policy mistakes are not allowed. It seems likely that China will declare the property tax pilot projects a success. To do this, the government may have to put its thumb on the scales. It does so by declaring that the three localities chosen to implement a tax are “pilot zones of common prosperity”. No details have yet been provided, but that likely means the central government is distributing investment capital for Worthy Works, such as affordable housing.
The problem is that without structural reform of public finances, a tax is doomed to fail. Instead, expect the listed real estate developers to be dissected and made to disappear in order to remove the annoying hype. Over the next several years, it wouldn’t be surprising to see China nationalize its real estate industry. Ultimately, Beijing’s vehicle to resolve all price distortions is nationalization. This is what has happened in the energy sector over the past decade, and it is likely to happen in real estate.