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Since first holding democratic elections at the national and provincial levels in 1994, South Africa has undertaken far-reaching constitutional changes. Arguably, the most fundamental transformation is taking place at the local government level, where the divisions created by apartheid were most severe. These changes were set in motion by the Local Government Transition Act of 1993, and during 1994-1995 the formerly racially segregated urban local authorities were amalgamated into a variety of non-racial transitional councils:
In non-metropolitan areas, the former regional services councils were transformed into district councils, thereby retaining a secondary tier of local government in rural areas.
In March 1998 the national government published the White Paper on Local Government, which set out its vision for the future of local government. The White Paper resulted in passage of the Local Government Demarcation Act and the Local Government: Municipal Structures Act. Under the Demarcation Act, the Municipal Demarcation Board was established to assign new boundaries for the different categories of municipal governments throughout the country. The present 843 transitional municipalities are to be severely reorganized after the local elections in November 2000 into 284 newly demarcated municipalities (see Table 1).
Within the six metropolitan areas to be established, single-tier metropolitan municipalities will replace the TMCs and TMLCs. In the non-metropolitan areas 47 district municipalities will replace the present 42 district councils. Each district municipality will consist of two or more (primary-tier) local municipalities to replace the present local and rural councils. A typical future local municipality will consist of a number of neighboring towns and their rural hinterland. In sparsely populated rural areas where the establishment of a local municipality is not viable (designated as district management areas), a district municipality will be the only form of local government.
Municipal Finance Reform
The structural reforms at the local government level also require reform of municipal finances. The government is currently preparing two important pieces of legislation in this regard, the Local Government: Property Rates Bill (dealing exclusively with property taxation) and the Municipal Finance Management Bill.
Section 229 of South Africa’s Constitution guarantees “rates on property” (i.e., the property tax) as an autonomous source of revenue for municipalities. It states that the “power of a municipality to impose rates on property…may be regulated by national legislation.” National framework legislation regarding the property tax is indeed needed for the following reasons:
Therefore, the Local Government: Property Rates Bill, currently in its 10th draft, is to be welcomed, at least in principle. It has not yet been published for public comment and may be further amended. However, when this bill is eventually passed into law, it will regulate the levying, assessing and collection of property taxes by municipalities.
Policy Issues in the Property Rates Bill
Diversity of Tax Bases
Urban municipalities generally have a choice between three tax bases, which are spread remarkably evenly throughout the country:
Earlier drafts of the Property Rates Bill retained this diversity as well as local choice. However, clause 5(1) of the 10th draft of the bill now states that a rate levied on property “must be…an amount in the Rand (South Africa’s currency) determined by the municipality on the improved value of the property.” Although it seems that government has opted for a single tax base (i.e., improved capital value), the bill goes on to provide that a rate levied on the “improved value of property may be composed of separate amounts on the site value of the property and the value of the improvements.” By implication, therefore, composite rating and site rating have been retained (if the amount in the Rand on improvements is set at zero).
Extension of the Tax Base and Possible Exclusions
In principle a municipality may tax “all property in its municipal area,” including areas where the property tax has not been levied before, such as agricultural and tribal land. However, the bill also allows a municipality to exclude a category or categories of property from rating. These excluded properties need not be reflected in the valuation roll.
McCluskey and Franzsen (2000) suggest several reasons why municipalities should include all properties in the valuation roll, and then allow specific exemptions rather than exclusions from the taxing process. First, it can be difficult to justify and defend exclusions constitutionally; second, it is politically easier to phase out an exemption than to introduce a tax on formerly excluded properties; and third, if properties are not valued and thus not reflected in the valuation roll, the extent of the tax base relinquished through exclusions is not known.
“Public infrastructure” is to be excluded from the tax base. This will have significant implications, particularly for municipalities with large tracts of land owned by public utility companies, and may need to be reconsidered in light of privatization. International practice suggests that public utilities should be rated at least on their operational land.
Differentiation and Phasing-in of Rates
Current legislation only provides for rate uniformity throughout a municipal area. However, municipalities sometimes achieve effective differentiation by granting arbitrary rebates to certain properties on the basis of zoning. For example, all improved residential properties in the Pretoria TMLC are presently granted a 35 percent rebate.
The bill provides that different rates may be levied for different categories of property according to use, status or location-a critical point in light of the extension of municipal boundaries into rural areas. For example, it would be possible for a future local municipality (comprising various small towns, commercial farmland and tribal land) to have the following different property categories (and therefore different tax rates):
However, a municipality will have to justify its differential rate schedule in an annually revised rates policy document presented to all taxpayers. Although municipalities may be permitted to treat ratepayers differently, they must justify this action. The bill also allows for the phasing-in of rates over a three-year period with respect to property not subject to property taxation before 1 July 1999 (e.g., tribal land). In certain instances the period may be extended for a further three years.
Tax Rates
The bill (clause 5(2)) states that municipalities may set their own tax rates. However, the Minister for Local Government, in concurrence with the Minister of Finance, may set a limit or rate cap on the amount. Apart from reducing municipalities’ fiscal autonomy, rate caps set nationally may not reflect differences in taxing capacity that exist between municipalities (see Table 2).
An alternative, and more practical, “capping” measure that has been inserted in the 10th draft (clause 5(3)(a)(ii)) is to limit the annual tax rate increases, not unlike one part of Proposition 13 in California.
Extension of Property Tax to Tribal Land
Extending property taxation to tribal land is an area of major political concern and is fraught with practical problems. “Ownership” of tribal land is not uniform, and some tribal authorities are not prepared to accept any form of local government within their area of jurisdiction, let alone any form of taxation of “their” land. Identifying the taxpayer may be problematic. Furthermore, formal ownership of tribal land seldom reflects the complex system of tenure rights of the individuals entitled to the use of that land. Even if it were possible to identify a taxpayer and establish an assessed value for (tribal) “property,” the abject poverty and inability of residents in many tribal areas to pay any tax will have to be considered. In fact, few tribal areas presently receive municipal services that could justify the introduction of a property tax.
Rates Policy
Clause 13 of the bill requires municipalities to adopt a rates policy and then levy rates accordingly. This is a welcome change. The rates policy, which is to be reviewed annually, must explain and justify the provision of exemptions, rebates, reductions and relief for the poor. This policy should significantly enhance the transparency, efficiency and accountability of municipal councils, and perhaps encourage compliance.
Valuation Quality Control
Another welcome aspect in the bill concerns monitoring valuation quality for equity and consistency across the country. However, the bill (clause 64) confers this responsibility on the Minister responsible for local government. McCluskey and Franzsen (2000) suggest that an independent and professional valuation agency, preferably at the national level, should be established for this highly technical task. Such agencies exist in Australia, New Zealand and Canada. In South Africa, this type of agency should perform the following primary tasks:
The monitoring service could well be expanded to provide valuation advice, expertise and data to municipalities. Such an agency could also undertake valuations of property for other taxes levied at the national level, such as estate and gift taxes.
Conclusion
The Local Government: Property Rates Bill should provide a solid framework for property taxation as South Africa begins to implement its new local government structure. If municipalities adhere to the principles articulated in the bill, a more uniform, equitable and efficient property tax system will play an even more important role in the future.
Riël C.D. Franzsen is professor in the Department of Mercantile Law at the University of South Africa in Pretoria, South Africa. His research on property tax reform in South Africa has been supported in part by the Lincoln Institute.
References
Budget Review 2000: Chapter 7. South Africa Department of Finance. http://www.finance.gov.za/b/budget_00/default.htm
Franzsen, R.C.D. 1999. Property taxation in South Africa. In W.J. McCluskey (ed.) Property Tax: An International Comparative Review. Aldershot, UK: Ashgate, 337-357.
Local Government: Property Rates Bill. 2000. 10th draft. South Africa Department of Provincial and Local Government.
McCluskey, W.J., and R.C.D. Franzsen. 2000. Some policy issues regarding the Local Government: Property Rates Bill. SA Mercantile Law Journal 12: 209-223.
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In the context of entirely new fiscal policies and new approaches to property rights in central and eastern Europe over the past decade, taxes on land and buildings have taken on significant new roles—politically as adjuncts to privatization, restitution and decentralization, and fiscally as revenue-raising tools for local governments.
The Lincoln Institute is particularly interested in the complex debate over property-based taxes and in how different countries experience the transition from communism to democracy and from planned to market-driven economies. Over the past four years, the Institute has undertaken a series of educational programs to help public officials and business leaders in eastern Europe understand both underlying principles and practical examples of property taxation and valuation through offering varied perspectives and frameworks for decision making.
The Institute is also sponsoring a series of case studies to compare the implementation of ad valorem property tax systems in eastern European countries. These studies provide a unique perspective from which to review the initiation of land privatization, fiscal decentralization and land markets, as well as to compare the various legal and administrative features adopted for the respective tax systems.
Programs in Estonia
The Baltic country of Estonia was the first of the new independent states to recognize the benefits of land taxation and thus has been the focus of several Lincoln Institute programs. The Institute’s work in Estonia began in September 1993 when Fellow Jane Malme and Senior Fellow Joan Youngman participated in a conference with the Paris-based Organization for Economic Cooperation and Development (OECD) on the design of a property taxation system. Estonia had just instituted its land tax program, and since then the Institute has continued to support programs there relating to land reform and property taxation.
The most recent education program, on “Land and Tax Policies for Urban Markets in Estonia,” was presented in the capital of Tallinn in May to nearly 30 senior-level state and city officials interested in public finance, land reform and urban development. President H. James Brown, Jane Malme, Joan Youngman and a faculty of international experts explored current issues concerning land reform, valuation and taxation. They also discussed methods of urban planning, land management and taxation to both encourage development of urban land markets and finance local governments.
Estonia is also serving as the pilot case study for a survey instrument to gather and analyze information from countries adopting new fiscal instruments for market-based economies. Malme and Youngman are working closely with Tambet Tiits, director of a private real estate research and consulting firm in Tallinn, to draft the survey, research and collect data, and analyze the results.
Other Case Studies and Conferences
A second case study examines Poland, where an ad valorem property tax law is under legislative consideration. Dr. Jan Brzeski, director of the Cracow Real Estate Institute, serves as the country research director and liaison with the Institute. Subsequent studies will survey Latvia, Lithuania and Russia. In addition, Professors Gary Cornia and Phil Bryson of the Marriott School of Management at Brigham Young University in Utah are using the Lincoln Institute survey instrument to study property tax systems in the Czech and Slovak Republics.
The Lincoln Institute was a sponsor of the fourth international conference on local taxation and property valuation of the London-based Institute of Revenues, Rating and Valuation (IRRV) in Rome in early June. The conference attracts about 300 senior level officials from central as well as local governments throughout Europe. Dennis Robinson, Lincoln Institute vice president for programs and operations, was on the conference advisory committee and chaired a session on “Case Studies in Local Taxation in the New Democracies,” at which Jane Malme and Joan Youngman discussed the Institute’s case studies on land and building taxation in transitional economies. Other participants in that session were Institute associates Tambit Tiits of Estonia and Jan Brzeski of Poland. Board member Gary Cornia spoke about his research on property taxation in the Czech Republic. Martim Smolka, senior fellow for Latin America and the Caribbean, presented a paper on “Urban Land Management and Value Capture” at another session chaired by Joan Youngman. Jane Malme also was a discussion leader for a session on “Tax Collection and Administration.”
The Institute is planning another program with OECD in December 1997 for public officials and practitioners in the Baltic countries of Estonia, Latvia and Lithuania to examine policy aspects of land valuation and mass appraisal concepts for ad valorem taxation.
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The Lincoln Institute’s China Program was established several years ago, in part to develop training programs on property taxation policy and local government finance with officials from the State Administration of Taxation (SAT). The Institute and SAT held a joint forum on international property taxation in Shenzhen in December 2003, and more than 100 participants attended another course held in China in May 2004. In January 2005, 24 Chinese tax officials from 15 provinces visited the United States for additional programs; many of them are developing property tax systems in six pilot cities. The Institute also supports the Development Research Center (DRC) of the State Council to research property tax assessment in China, and they jointly organized a forum in February 2005.
Economic growth and institutional reforms in China over the past two decades have created profound changes within the society. The central authorities now need to set forth new policies and procedures for modern governance to address devolution of certain authority to local governments, rapid urban and rural development, and changes in land uses and land and fiscal policies. The national government’s commitment to further modernization is most evident in the effort to develop and implement a new property taxation system.
This article describes the current system and discusses issues and challenges that must be overcome to implement a successful property tax policy in China. Given the complexity of this endeavor and the huge variation in economic development across the country, a gradualist approach, which has proved effective in China’s modernization process, may be the best way to initiate property tax reform and development.
Current Taxation System
China collects 24 types of taxes. The central and local governments share the value added tax (VAT) and business tax revenues; the former tax is the primary revenue source for the central government, whereas the latter is the most important tax for local governments. Two other important tax sources for the central government are the consumption (excise) tax and the personal income tax. Twelve taxes are related to land and property, but most do not generate significant revenues. The business tax accounted for 14.41 percent of total central and local government revenues in 2002, but only a small portion of that amount was generated from property-related sources. The reason is that business and income taxes are collected only when land or property is rented or sold, and thus do not provide a steady stream of revenue. It is hard to imagine that any of the 12 property-related taxes could play a key role in resource allocation and local government finance over the long term.
An evaluation of the current tax system reveals additional concerns.
The shortcomings in the current taxation system have resulted in major fiscal problems for the central government, such as declining revenue mobilization and ineffective use of tax policy to leverage macroeconomic policy (Bahl 1997). When the government conducted tax reform in 1993 to overcome some of the problems, one of the largest initiatives shifted responsibility for urban and public services to local governments.
This measure was successful in improving the central government’s fiscal condition; however, the revenue share for local governments was not increased at a level commensurate with their increased responsibility. Consequently, many local governments face increasing budgetary deficits. Figure 1 illustrates the financial deficit for local governments after the 1993 tax reform. More than one-third of county-level governments have serious budget problems and over half of the local governments directly below the provincial level have budgets that merely cover the basic operations of public entities.
Public Land Leasing
One of the means by which local governments increase revenues in the absence of an effective taxation system is through public land leasing. In the late 1980s and early 1990s, the state introduced market principles into the decision-making process regarding land use and allocation by separating land use rights from ownership. This separation promotes the development of land markets, which in turn have created tremendous impacts on real estate and housing development, urban land use and land allocation. Except for a short yet dramatic drop in the early 1990s due to a macroeconomic policy designed to prevent the national economy from overheating, the prices for access to land use rights and public land leasing rates have been increasing steadily.
Despite the significant number of land leasing transactions, the government closely regulates and controls the amount of land being leased by maintaining a monopoly on land supply (Ding 2003). Most land in rural areas still belongs to the collectives, and urban construction is prohibited on rural land unless it is first acquired by the state. Land developments that occur on collectively owned rural land are considered illegal, and administrative efforts such as monitoring and inspecting have been implemented to eliminate these violations.
General land use plans and regulations to preserve cultivated land further control the amount of land available for urban development. The land use plans determine the total amount of land that can be added to existing urbanized areas through an annual land supply quota. At the same time, China’s preservation policy for cultivated land influences both land supply and the location of land available for urban development. The Land Administration Law specifies that at least 80 percent of cultivated land should be designated as basic farmland and prohibited from land development. Land productivity is the dominant factor used to delineate the boundaries of basic farmland. Since most cities are located in areas with rich soil resources, farmland protection designations commonly exist in urbanizing areas. Thus farmland protection inevitably results in urban sprawl and leapfrog development patterns requiring costly infrastructure investments and land consumption.
Financing Local Government. As a result of the government’s regulations and monopoly on selling land use rights, local authorities use the public land leasing system to increase their revenues through land use conveyance fees. For instance, Hangzhou City, the capital of Zhejiang Province with a population of almost four million, is among the top five in per capita national income and GDP. The city generated land conveyance fees of more than six billion YMB in 2002, more than 20 percent of the total municipal government revenues.
Interestingly, these fees were generated largely from selling to commercial users the right to access the state-owned land, yet commercial land development represented only 15 percent of total land uses in newly developed areas. The rest of the land was allocated to users through negotiation in which the sale price either barely covered the costs of acquiring and improving the land, or land was offered free to generate competition for businesses and investments.
Local governments can raise enormous revenues from limited-market transactions of land use rights, in part because land conveyance fees represent lump-sum, up-front land rent payments for a leasing period and in part because local governments exercise their strong administrative powers to require farmers to sell their land at below-market rates. When the government later resells the land at market rates, the price could be more than 100 times the purchase price. After considering the costs of land improvement, however, net revenues may be only ten times the total cost of the land.
Rising land prices resulting from the government monopoly allow local governments to use the land as collateral to borrow money from banks. These loans plus the revenue generated from conveyance fees accounted for 40 to 50 percent of the Hangzhou municipal government budget in 2002. In turn these revenues were used to fund more than two-thirds of the city’s investments in infrastructure and urban services.
Hangzhou City specializes in textiles, tourism, construction and transportation, and generates substantial revenue from business and value-added taxes, although the city’s share of income generated through the public land leasing system is also large. Many smaller cities and towns with fewer commercial and business resources use land leasing directly through land conveyance fees or indirectly as collateral to support up to 80 or 85 percent of their total investments in urban initiatives. These smaller cities must turn to land to generate revenues to fuel economic growth, launch urban renewal projects, and provide infrastructure and urban services that were neglected for a long time prior to the reform era. Land-generated revenue is also used to improve the overall financial environment, attract businesses and investments, and support the reform and reallocation of state-owned enterprises.
Negative Consequences. Despite the importance of public land leasing for income generation, the practice of using this tool to finance local governments may have serious consequences in the long run. The fiscal incentives that compel local governments to control and monopolize the land markets will negatively impact real estate and housing development, industrialization and land use. Furthermore, land is a fixed resource and ultimately there will be no more land left to lease for revenue.
Increasing pressure to protect the rights of farmers also makes it more difficult and costly to acquire land from farmers. As a result, local governments must increase land prices or face reduced revenues from land leasing. Finally, not only does land scarcity and farmer compensation pose a challenge to income generation, but recent policy reform now permits land owned by a collective to enter the land market directly. This change will prevent local governments from acquiring collective lands and exacting conveyance fees for these transfers.
Taxation Reform: Principles and Challenges
The fiscal deficits experienced by local governments and the problems with the resulting public land leasing system provided the impetus for the central government to restructure the entire taxation system. That reform is based on four guiding principles: (1) simplify the tax system; (2) broaden the tax base; (3) lower tax rates; and (4) strictly administer tax collection and management. The central authorities in charge of tax policy and administration offer several specific goals with respect to property-related taxes.
Considerable debate exists over the merits of the proposed property-related tax reform. Despite the lack of consensus as to the best option, the costs and benefits must be assessed to effectively guide the development and implementation of a new property tax system. In addition, several outstanding issues need to be resolved in order to implement the proposed land and property tax reform.
The implementation of a value-based tax also will require the assembly and cataloguing of massive quantities of data, which historically have not been collected systematically. Furthermore, the data that have been collected are stored in different locations and in paper format. The Ministry of Land and Resources records and handles land-related data and information, whereas the Ministry of Construction is in charge of structure-related information. Matching related records from different ministries and digitizing this data will take years if not decades and will require a huge investment of resources.
The Chinese public has limited understanding of property taxation systems, so education will be required to avoid potentially significant political resistance. Capacity building within the Chinese government also will require professional training in appraisal, evaluation, appeals and collection to achieve effectiveness and efficiency in the new tax system.
Conclusions
Despite these unanswered issues and challenges, the Chinese government appears committed to implementing property taxation reform. The application of the widely used and successful gradualist approach for implementing policy and institutional reforms will ensure that the development and institutionalization of the property tax system proceeds on course. For example, data for industrial and commercial structures is more complete and of higher quality than data for residential structures. Furthermore, newer structures tend to have better records than older structures, and records are more complete for structures in urban areas than in rural areas. Thus, applying the property taxation system first to commercial and industrial structures, newly developed land with residential structures, and urban areas will allow the system to take hold before attempts are made to implement change in the areas with greater obstacles to overcome.
References
Bahl, Roy. 1997. Fiscal policy in China: Taxation and intergovernmental fiscal relations. Burlingame, CA: The 1990 Institute.
Development Research Center. 2005: Issues and challenges of China’s urban real estate administration and taxation. Report submitted to the Lincoln Institute of Land Policy.
Ding, Chengri. 2003. Land policy reform in China: Assessment and prospects. Land Use Policy 20(2): 109-120.
Liu, Z. 2004. Zhongguo Suizi Gailan. Beijing: Jinji Chuban She. (China’s taxation system. Beijing: Economic Science Publisher).
Lu, S. 2003. YanJiu ZhengDi WenTi TaoShuo GaiKe ZhiLu (II). Beijing: Zhongguo Dadi Chuban She. (Examination of land acquisition issues: Search for reforms (II). Beijing: China Land Publisher.)
Chengri Ding is associate professor in the Department of Urban Studies and Planning at the University of Maryland, in College Park. He specializes in urban economics, housing and land studies, GIS and spatial analysis. He is also special assistant to the president of the Lincoln Institute for the Program on the People’s Republic of China.
