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July 15th, 2015

Land leasing vs property tax?

1 comment

Estimated reading time: 5 minutes

Blog Editor

July 15th, 2015

Land leasing vs property tax?

1 comment

Estimated reading time: 5 minutes

African governments, and their international advisors, need to join up their thinking more effectively when pursuing ‘big urban reform’, says Tom Goodfellow.

Tax is back in fashion in international development circles.  We know that in the history of much of the world developing taxation systems was virtually synonymous with state-building; we believe that taxation enhances accountability and builds the ‘social contract’; and consequently we understand that ‘domestic resource mobilisation’ is more desirable and sustainable than foreign aid (with important caveats about who and what is taxed and how).

Submerged somewhere beneath recent reforms to customs duties, profit taxes and VAT lies a sleeping giant: property tax.  The potential benefits of this tax are well-known and have been highlighted in the work of the International Centre for Tax and Development, as have some stories of success and failure.  The fact remains, however, that in many countries across Africa (and elsewhere) it is barely implemented and efforts to reform it are stymied at every turn.

property taxation is inseparable from the political economy of the real estate sector, the planning system, the degree of decentralisation to municipalities and the relationship between the capital city and other urban centres Photo by oledoe via Flickr http://bit.ly/1IYbTyb (CC BY-SA 2.0)
property taxation is inseparable from the political economy of the real estate sector, the planning system, the degree of decentralisation to municipalities and the relationship between the capital city and other urban centres Photo by oledoe via Flickr http://bit.ly/1IYbTyb (CC BY-SA 2.0)

I refer to property tax reform here as ‘big urban reform’ despite the fact that local tax is usually treated as marginal to the urban development challenge – a peculiar preoccupation of public finance geeks.  Instead, urban reform is commonly taken to mean injecting new forms of management and competitive tendering into moribund city councils.  Arguably, this has done little of significance to improve the state of African cities and the living conditions of the urban poor.

However, donors and politicians like administrative reforms because, although they might ruffle bureaucratic feathers, they don’t have much impact on the electorate or hit the pockets of elites.  Yet this is exactly what progressive urban transformation requires.  If taken seriously, introducing effective property taxation is a hugely significant urban reform. Property-related taxes can constitute as much as 4% of GDP in the developed world, but in Rwanda, for example, they amounted to just 0.02% of GDP in 2013-14.

One might object that comparing low-income countries in this respect with the developed world is unfair.  After all, is there even much property to tax?  Yet, increasingly, there is.  In Africa cities like Kigali, Addis Ababa and Dar es Salaam are witnessing extraordinary booms in the property sector, with construction and real-estate growth massively outstripping overall economic growth in the absence of industrialisation.  One expert speculated that in Rwanda property tax could potentially generate around 5% of GDP – a higher proportion than in the UK.

Meanwhile, in most of the world almost everyone is concerned today about inequality (even Tony Blair, who once famously dismissed the idea that it was a problem).  Contemporary inequality is underpinned by huge disparities in access to housing across the globe. So where elite wealth is being funnelled into high-end real estate (which also creates new dynamics of spatial and social exclusion) what better way to approach the problem than by targeting these assets for redistributive ends?

Unfortunately, however, property taxation is hugely complicated and constitutes a massive bureaucratic and political headache.  This is precisely because it is fundamentally a big urban reform – not just a technical tax reform.  In a new paper I argue that property taxation is inseparable from the political economy of the real estate sector, the planning system, the degree of decentralisation to municipalities and the relationship between the capital city and other urban centres.

In addition – and most importantly here – it is inseparable from questions of land tenure.  National land regularisation programmes are often primarily conceived with the aim of enhancing agriculture, but, when executed in cities, they too are big urban reforms.  They alter how people can use, acquire, transfer and profit from extremely valuable pieces of land.  The fact that land tenure systems are in flux at the very time that cities are booming enables governments to mobilise very substantial resources just from the reallocation of land rights in cities. Thus, while the proportions of local revenue from property tax cited above are miniscule, this is not the case for revenues garnered from urban land.

Much of this revenue is generated by issuing land leases to private developers, as well as to ordinary residents already living there.  These are different processes with very different implications, but in both cases the revenue generated from land is not a tax: it is a finite sum, with no clear link to recurrent expenses, infrastructure investment or accountability.  Nor does it reflect the value of what is built on the land, which is critical in an urban context.

There are many good reasons to tackle property taxation and land tenure reform in tandem. However, this has to be done with great care in ways that are strategic for both land use and fiscal objectives.  All sorts of unintended outcomes can emerge at the intersection of the two reform processes, with the combination of land lease fees and property taxes creating much complexity and confusion.

For example, under Rwanda’s land tenure regularisation programme, ordinary city-dwellers are given leases and have to pay a land-lease fee.  When they have paid this off in full and developed their land, they can acquire a freehold title.  This is meant to incentivise the efficient use of scarce land.  However, few understand why they should want freehold titles, because under tax law freeholders are obliged to pay property tax.  Others opt to pay property tax even when they aren’t freeholders, because their properties are so undervalued that it means them paying less than they would in lease fees.  Administrative systems are too weak to prevent ‘gaming’ the system.

The introduction of land-leasing systems can also create new political obstacles to property tax.  In Ethiopia, where all land has been state-owned since 1975, urban-dwellers until recently paid miniscule rents to the state for their land.  A controversial reform in 2011 means they now have to purchase leases from government for a substantial fee.  To ease the passage of this reform, the government announced that it would not tax property.  This has created a huge public relations problem in relation to current efforts to modernise the property tax system, which many now see as an urgent concern.

In both these countries, land reform has largely won the day in the context of trade-offs between land-related objectives and fiscal ones.  This is unsurprising, as the former generate new streams of revenue for governments without consistently taxing the elites that support them.  Yet the sustainability of the situation is highly tenuous; there is a finite amount of land that government can sell off in this way and the scarcer it becomes, the greater is the likelihood of further expropriations of the poor from prime urban land.

Meanwhile, the more that urban land is held as lucrative real estate by powerful elites, the greater become the vested interests resisting progressive urban tax reform.

This was first published on the Sheffield Political Economy Research Institute (SPERI) blog.


 

Tom Goodfellow is a Lecturer in Urban Studies and International Development at the University of Sheffield and Associate Fellow, SPERI. He is also an LSE alumnus.

 

The views expressed in this post are those of the authors and in no way reflect those of the Africa at LSE blog or the London School of Economics and Political Science.

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