3.1 Property tax is an annual tax on real property. It is usually, but not always, a local tax. It is most commonly founded on the concept of market value. The tax base may be the land only, the land and buildings, or various permutations of these factors. For the purposes of this guide, property tax is restricted to annual taxes and excludes one-off taxes on transfers, on realised capital gains or betterment, or on annual wealth taxes.
3.2 Property tax has been in existence for at least three millennia. It is common throughout the world and has often been the subject of political debate. The strengths and weaknesses of this type of tax are well known and possibly more widely understood than any other tax.
3.3 Several characteristics of property taxes have contributed to their declining relative importance in the 20th century. The maximum yield presently achievable appears on the basis of experience to be less than 12 percent of total national tax revenues, although the actual potential will vary according to the specific structure and incidence of taxation within any given jurisdiction. It is useful to understand these characteristics when designing a new tax or seeking to bring about improvements in existing systems. There is much to learn from the experiences of other countries.
3.4 Advantages of the tax are clear and include:
It is technically and administratively possible to introduce and/or maintain in almost any circumstances.
It is cheap to administer, and it is possible to aim for a cost yield ratio of 2 percent or less.
It is very difficult to avoid or evade, and collection success rates of 95 percent are readily achievable.
It is transparent.
The public understand the concept of market value (whether capital value or rental value) and therefore appreciate the basis of assessment.
In general there is a good correlation between assessed value and the ability to pay.
If designed correctly the tax can be marginally progressive.
The revenue is predictable and buoyant.
It is very well suited as a source of locally generated revenue for local governments.
3.5 The disadvantages of property tax are less clear than the advantages. The tax is not perfect and is often not popular; although it should remembered that there are no perfect taxes and taxation is never popular.
3.6 Some of the advantages incorporate hidden disadvantages. The transparency of the tax reveals any inconsistencies which may become magnified in public perception. These inconsistencies will be both those of assessment (which are inevitable in a valuation list which may consist of thousands or hundreds of thousands of assessments) and those of ability to pay.5 Other taxes, such as income tax, are very much less consistent in practice but the public only know how the tax should work and not how it is actually applied in practice. Confidentiality hides the actual results. With property tax the public see the tax system working with all its imperfections. In a similar way the difficulty of avoiding or evading property tax may make it unpopular. This is particularly the case in societies where the rich and powerful are accustomed to manipulating the tax system for their own advantage. These persons tend to be the most articulate and politically influential and may effectively oppose or undermine the equitable operation of the tax at the political level.
3.7 There is also a more subtle and less well-understood shortcoming. The American war of independence was fuelled by the cry of "no taxation without representation". In some circumstances property tax can provide "representation without taxation" for a large segment of the population. Universal suffrage means that not every voter will be a property tax payer. In some circumstances non-taxpayers may greatly out number taxpayers, which damages the democratic link between democracy and taxation at the local level. There is no sanction on non-taxpayers voting for high tax policies. The adverse effects of this will be magnified if property tax forms the only part of total local revenue over which the local authority has control. In this case, a modest increase in total revenues may require large increases in individual property taxes because of the small number of tax payers.
3.8 There is also the problem of building "buoyancy" into property tax. In theory buoyancy is a function of two mechanisms. The first of these is the revaluation of properties at regular intervals. The second is the increase in the rate of tax to produce the needed revenue. Both are highly political. In theory either one or the other could provide buoyancy. It is technically possible to increase tax rates on an out-of-date valuation list. However, it is known from experience from many countries that the public do not understand and do not accept an out-of-date valuation list. Nonetheless there is always resistance to revaluations and the more out of date the list, the greater the resistance. The biggest factor behind declining yields for property taxes in OECD countries and others is the failure to carry out revaluations.
3.9 The difficulties of implementation should not be underestimated. Although the technical difficulties can be overcome, they can restrict progress, especially in the early stages of implementation. Such technical factors include:
The system is dependent upon a pool of technical expertise (of which there is often a shortage) to create and maintain a valuation roll, and to establish and conduct the appeals process.
Parts of the process can be time-consuming and expensive, for example, compiling a comprehensive list of rateable properties (especially where records are poor or incomplete, or where there are a large number of legal status issues), outsourcing services to the private sector, establishing a valuation tribunal, and administrative and infrastructure support (such as dedicated information technology systems for both the valuation and the financial accounting system for the billing, collection, and enforcement procedures).
While it is true that the public generally understands the concept of market value, confusion does arise in the relationship between 'rateable value' and setting the 'rate'. This is particularly so where revaluations take place after a long interval, and/or where there has been political unwillingness to increase the rate. This often manifests itself in large numbers of ill-founded appeals.
3.10 A source of local revenues. Throughout the world property taxes are commonly employed as the main source of locally generated revenue for the good reason that there is no other major source of taxation revenue that is exactly geographically defined. It is possible to use local income taxes and/or local sales taxes for generating local government revenue but both have difficult administrative problems. Local revenue may be generated from other sources, particularly rents from local government owned properties. In some cases, local income taxes are an important source of revenue. In many cases, however, property tax is the main source of revenue (and even when local income taxes exist, it may be easier for a local government to modify the property tax rate than to adjust the income tax rate).
3.11 As a primary source of revenue, property tax plays an important role in decentralisation and the autonomy of local government. Full decentralisation of government incorporates the power to raise revenue independently in addition to powers allowing local governments to use the funds as they see fit (in accordance with the limits of their legal powers). In practice, local government autonomy is always limited. The duties of local governments are almost invariably such that it is impossible to discharge them without central government grants which detract to a greater or lesser extent from their independence. Increasing independent powers of raising revenues through property taxes thus becomes important.
3.12 Support for other functions. 'Valuation lists' compiled for local government may be used by other bodies, particularly those that can be termed "single function authorities" such as Water Boards. Water charges are commonly based on the assessed value in the valuation lists. Such procedures are very cost effective7 and may have a reasonable correlation with water usage in many circumstances (although cases do exist where commercial and industrial properties have low water consumption but have relatively high values). Drainage boards can also be funded by charges related to the valuation list, which has advantages over charges related only to the surface area of the property.
3.13 Valuation lists may be used in transitional economies for other purposes such to establish lease rates on government owned land. Where land markets are not yet developed, mass valuation results can also be used as a basis for establishing market values for properties. In addition, local bodies may have to take over functions previously controlled and administered centrally (such functions include local drainage boards,8 common grazing facilities, and consolidation bodies9). They are not able to rely on central government funding and have to raise their own revenue. Depending on the tax rates and cost of collection, valuation lists may provide a fair and cost effective basis for doing so.
3.14 There are sound reasons for introducing or extending property tax into rural areas:
Property tax provides a basis for local autonomy and facilitates decentralisation
It provides a revenue base for single function authorities
It encourages the economic use of land10
It tends to reduce land and property prices thus facilitating access to land
Apart from agricultural land and buildings, rural property tax may be applied to commercial, industrial and residential properties located in rural areas.
3.15 Almost invariably the benefits of rural property tax will be local rather than national. It will be apparent in almost every country, including those in transition, that the extension of the property tax net into rural areas will have limited impact on the total national tax revenue. The rural tax base is very much smaller than the tax base constituted by the urban economy. Frequently a national capital city and two or three other major cities produce a major part of the GDP. The relative size of the regional GDP gives a good indication of the magnitude of the tax base. Thus if for instance an improved property tax covering the entire country has a potential to produce 10 percent of total tax revenues, the proportion arising from rural areas is unlikely to be more than 20 percent of this. Even in such circumstances the rural property tax base will constitute only 2 percent of the national tax total and be more proportionately expensive to administer.11
3.16 In most instances the above illustrative figures will overstate the potential yield from rural areas. However, this does not diminish the importance of a rural property tax. It is a vital part of decentralisation. It is not so much its size relative to the national tax base but its magnitude in relation to local revenues especially those locally generated revenues. This is why it is a vital instrument in improving rural livelihoods.
3.17 In most transition countries the issue of property tax in rural areas will be linked with agriculture. First, there tends to be a carry-over from the socialist period of the emphasis on primary industries. Many will tend to believe that agriculture is more important in the national economy than is the case. Second, there may be a belief that exempting agriculture from tax will reduce food prices although there is little evidence that it has ever done so. Economic theory suggests that the exemption tends to increase the price of land relative to other assets and there is evidence that this is the case. Third, there can be an erroneous belief that access to land is facilitated by exemption from tax. In practice, tax relief causes the price of agricultural land to rise and makes it more difficult for newcomers to gain access to farms.
3.18 There are few, if any, sound reasons for exempting agriculture from property tax. Most of those commonly proposed do not bring about the desired result. Furthermore by exempting agriculture damage is done to perceptions of the role of the tax as a fair way of apportioning local expenditure. It also renders it of little use for raising revenue for single function authorities.
REVIEWING PROPERTY TAXES
Factors listed below may lead to governments reviewing the scope for introduction of property tax where it does not exist, or considering the scope for increasing taxation rates where it does, and examining the administrative machinery with the purpose of making it more efficient.
Scope for increased yields: While many taxes are now bumping up against ceilings created by economic factors, or international competition, or public acceptance, in most countries property taxes could yield more.
Probable ceiling: Although there is often scope to increase the yield from property taxes there are few if any examples of property tax accounting for more than about 12 percent of total tax revenue and this may represent a limit of public acceptance. Property tax in most countries is much less than this theoretical ceiling.
The relatively small size of the rural tax base: The rural tax base will always be comparatively small in comparison with the urban tax base. The importance of property tax in rural areas is of local significance. The benefits to the national economy are indirect.
Importance beyond its relative size: The importance of a property tax covering rural areas is greater in political terms than might be supposed from the absolute size of the property tax yield. As the foundation of local government autonomy, and as a means of financing some single function authorities, there is sound justification for the introduction of the tax.
Administrative feasibility of property tax: The wide application of property tax and its long history shows that, if there is sufficient political will, there are no insuperable technical or administrative problems to the introduction of property tax.
Political will: All taxes require political determination and public acceptance. The openness and transparency of property tax mean that it is impossible to introduce the tax by stealth. Political determination is therefore essential. If there are political doubts do not waste time and money considering the introduction of property tax.