Why is the Chinese Govt Afraid of Implementing Property Taxes?

According to a report this week in the official Shanghai Securities News, China will expand property taxes into more cities this year, beyond the current test programs in Shanghai and Chongqing. The Shanghai and Chongqing tax programs may also be broadened, according to an official from China’s Ministry of Housing and Urban-Rural Development who was quoted in the report.

So what took them so long?

Given that the government has being trying to restrict the residential real estate market for more than two years, it is moving surprisingly slowly to implement property taxes. Especially considering that property taxes should help to resolve the current conflict between the central government’s drive to cut property speculation in the residential market, and the dependence of local governments on hot real estate markets to support the land sales that provide much of their revenues.

Implementing property taxes would mean that investors who speculate in real estate would at least have to think about the costs of paying taxes on all those apartments before they make additional real estate purchases, and those taxes can be used to help make up for the shortfalls in land sales revenues that have been hurting local governments. Isn’t this what the locals like to call a “WIN-WIN” situation?

Property Taxes are Moving Slowly in China

The pilot property tax programmes currently underway were introduced in Shanghai and Chongqing at the end of January 2011, and while the report in the Securities News indicates that what is likely to be a nationwide program is moving forward, no dates or other details were provided, so it would seem that we are still several months away from implementing more such taxes.

In most parts of the US and other developed nations, property taxes are a major source of revenue for local governments, and help to pay for schools, roads and other projects. Just the sort of things that China has previously been supporting with land sales.

Existing Taxes on Homes are Severely Limited

According the Securities News report, it is the Shanghai model of property taxes that is likely to be propagated to other cities (after all no one seems much keen on emulating anything about Chongqing these days), but if the terms of the Shanghai tax program are copied in other cities, it is unlikely to produce much revenue. Here are some key details of Shanghai’s property tax according to a 2011 report from KPMG.

What Gets Taxed

• For Shanghai resident families, the tax will be applied on newly purchased second or subsequent residential properties.
• Non-Shanghai residents, all newly purchased residential properties will be taxed

Basis for the Tax

Taxed on transaction price of new purchase

The Tax Rate

Tax rate of 0.6% or 0.4% depending on size of the property

How the Tax is Applied

Tax payable = taxable area of newly purchased property (construction area) * unit price*70%*tax rate

Now if the relatively low rate and the limitation of the tax only to new purchases doesn’t convince you that this is not a meaningful revenue source for local governments, then you should also bear in mind that there is a standard exemption for local residents of 60 sqm per family member. On new purchases. On second or subsequent homes. So not a lot of people are paying tax.

Which brings us back to our original question.  If the central government wishes to restrict speculation and control prices, and the local governments need new revenue sources, then what is preventing property taxes from being fast-tracked?

Some observers have suggested that the local governments needs time to build a property database before they can start implementing the tax — but surely tracking new transactions cannot be that difficult. And while it would be better to base the value of properties on some sort of assessment system rather than on purchase price, it should always be possible to modify the system as time passes and valuations drift away from the original sale price.

Perhaps we will see faster progress on property taxes once the new government steps in later this year, but for now it seems like an opportunity for more rational control of the real estate market is being missed.