In both developed and developing countries, there is significant potential to increase property tax revenues.
- Property taxes are a key part of financing local government.
- Property taxes capture the increase in value arising from government investment.
- Despite being efficient and non-distortionary, they tend to be unpopular among taxpayers.
In most developed countries, property tax has been the backbone of municipal finance for many years. Increasingly, it is playing an important role in financing local services in less developed countries. The tax on residential and nonresidential properties is most often levied on the market value of the property but, in some jurisdictions, it is levied on rental value, land value, or area of the property.
Property tax — a good tax for local governments
Property tax connects the types of services funded at a local level (for example, schools, roads, transit, parks, and so on) and property values. When public services increase the value of property and result in higher property taxes, property tax may be thought of loosely as a benefits tax. In other words, taxpayers are paying for the benefits they receive from local services. To the extent that property taxes are not fully matched by expenditures on public services, there may be an impact on where people locate to, but this impact is considered to be smaller than the impact of income taxes on the decision to work or sales tax on consumption patterns. For this reason, property tax is considered to be less distortionary than other taxes.
In terms of public investment in infrastructure, property tax is an obvious way to capture the increased land value arising from that investment. When a local government invests in roads or transit, for example, land values increase. The increased land value is the result of the public investment and not any investment on the part of the landowner. Governments can capture the increase in land value that they have created to recoup their initial investment.
Another reason why taxes on land and property are considered to be appropriate as a local revenue source is, in part, because real property is immovable: It is unable to shift location in response to the tax, and thus, it is difficult to evade. Property tax revenues also tend to be stable and predictable.
Property tax is visible and accountable. Unlike income tax, property tax is not withheld at the source. Unlike sales tax, it is not paid in small amounts with each daily purchase.
Property tax is visible and accountable. Unlike income tax, property tax is not withheld at the source. Unlike sales tax, it is not paid in small amounts with each daily purchase. Instead, property tax generally has to be paid directly by taxpayers in periodic lump sum payments. Moreover, property tax finances services that are also very visible, such as roads, garbage collection and neighbourhood parks. Studies show that residents are more willing to pay for local services when they rate their government and service provision highly; if services are considered inadequate, however, they are more likely to complain about their property taxes. This visibility makes local governments accountable to taxpayers, but it also makes it difficult to increase or reform the tax.
Despite these virtues, property taxes yield only 3 percent or more of GDP in only three OECD countries (the UK, Canada and the US) and more than 2 percent in only four other OECD countries (France, Israel, Japan and New Zealand). In 22 OECD countries, property taxes yield less than 1 percent of GDP. In less developed countries, property taxes are even smaller.
Criticisms of property tax
So, why is property tax so unpopular? It has been criticized for being unfair because it is unrelated to ability to pay. It has been said to be unsuitable as a tax for local government because it supports services that are not related to property (such as social services), and it is considered to be inadequate because it does not provide sufficient revenue to meet local expenditure needs. It has also been criticized for its negative effects on housing, land use, and urban development.
Taxpayers also dislike property tax because they may not agree with or indeed understand the base of the tax (usually market value). Unless the property subject to tax is sold in an arm’s-length transaction between a willing buyer and an unrelated willing seller on the precise valuation date specified in the law, someone has to determine the value that serves as the basis on which to assess the tax. In other words, property tax is inherently a presumptive tax. Property tax valuations are thus always arguable, so it is not surprising that the results of this administrative process, no matter how technically good, are often perceived to be unfair and arbitrary.
Local governments complain about property tax revenues because they are relatively inelastic. Unlike income or sales taxes, the revenues don’t increase automatically with changes in the economy. Even if the potential tax base does increase with growth, as with a tax based on market value, property values generally respond more slowly to changes in economic activity than do incomes or sales. In those countries where property taxes are based on the area of the property, the tax responds even more slowly to annual changes in income. In order to maintain property tax revenues in real terms (let alone increase them), it is therefore usually necessary to increase the rate of the tax. Inelasticity thus makes local authorities more accountable because they have to persuade taxpayers that they are justified in increasing tax rates, but it also makes it difficult to increase or reform the tax.
Tax administration matters
How well property taxes are administered will determine how much revenue is collected and the overall fairness of the tax. The process of taxing property involves a number of steps: property identification and management; valuation; billing and collection; enforcement; and adequate taxpayer service. Few countries do all of these things well. Particularly in less developed countries, there is often little or no information on property ownership or the characteristics of the property needed to provide an estimate of the tax base. Valuers are few in number and property values are often out of date. Low tax rates and inadequate tax collection procedures are additional reasons why revenues are low.
There is significant potential to increase property tax revenues in developed and less developed countries and many countries are attempting to do that. New technology, in particular, has improved tax administration. GIS, for example, has made it easier to identify properties. Successfully increasing property tax revenues, however, requires taxpayer support, which is more likely to be forthcoming if taxpayers receive improved local services and perceive taxes are being administered fairly. Adequate resources (human and financial) need to be dedicated to the administration of the tax and, last but not least, there needs to be political will to undertake reform.
Download the full "What to Tax?' publication here.
Enid Slack is the director of the Institute on Municipal Finance and Governance and an adjunct professor at the Munk School of Global Affairs at the University of Toronto. She is one of Canada’s foremost experts in municipal finance. Enid received her B.A. in Economics from York University (Glendon College), and an M.A. and Ph.D. in Economics from the University of...