The Residential Taxation Landscape

Participants agreed that the taxation of land cannot really be looked at in isolation as it forms part of the wider tax system. Additionally, the considerations around taxing business property are different from those around taxing residential dwellings - the former being a business tax and the latter, a form of wealth tax. Transactional taxes like stamp duties were generally considered distortive, but likely to remain as they raise significant amounts of revenue; while Land Value Tax was considered theoretically economically efficient, but difficult to implement both practically and politically. It was also agreed that any reform should try and remove some of the inherent complexities, inconsistencies and unfairness in the way that many regimes levy property taxes. It was felt that a reform of commercial land and property taxation would be much easier to implement from a political perspective than any reform of tax on residential land and property. On the basis that governments (at least in developing countries) are likely to put off many tax increases until their economies start to rebound, it was thought that now might be a good time for a root and branch review of land and property tax.

8th Roundtable - 3rd Septemnber 2020

The eighth roundtable in a series on potential tax policy responses coming out of COVID-19 was held on Thursday 3 September 2020. Sponsored by KPMG International and Jericho Chambers, a more detailed overview of the program can be found here. Eleven stakeholders from a wide spectrum of backgrounds attended the virtual event which focused on the taxation of land, in particular, what changes or reforms governments may make to their land taxation policies following COVID-19.

The event was held under the Chatham House Rule and this note is a summary of the views expressed. The attendees are listed below, 1but all opinions are anonymized and do not represent official views of any organization or any KPMG member firm.

Participants agreed that there are many ways that governments can seek to tax land and property. These include traditional recurrent taxes such as business rates or their residential equivalent versus transactional taxes such as Stamp Duty Land Tax or Real Estate Transfer Tax. Land Value Tax and Land Value Capture were highlighted as potential alternatives not commonly used by governments. There are different considerations to be applied in taxing various types of real estate – e.g. business property and residential dwellings.

A Cluster of Taxation Types

There was general agreement that while it was easy to talk about land taxation in a general sense, when doing so, what people are usually referring to is a cluster of many different taxes that are applied to various types of land and property in many ways. The taxation of residential land and property versus commercial land and property was highlighted as an example where – in most countries - there are differences in how they are assessed, the mechanics of the tax charge and the economic impact. It was pointed out that we should be cautious about making sweeping statements on the taxation of land in general, and that we should instead consider that different types of land may need different taxation regimes in order to be taxed effectively.

Taxing the value of land – as opposed to the building on it (through Land Value Capture or Land Value Tax) was discussed with one participant giving an example of London having supplementary business rate taxes for the new rail system - Crossrail - albeit this is really an example of business taxes being increased for specific reasons rather than a standalone land tax. Consideration was given to the fact that Land Value Capture is entwined with the planning permission regimes that many countries operate. For example, if a government changes the planning permission for a plot of land to allow a twenty-story development rather than a ten-story development, the impact on the land value is potentially significant, but the question is how should this increase in land value be taxed, or to whom does the increase in land value belong, the land owner or the governmental agency which created the increase?

Another participant commented on the fact that China has a Land Appreciation Tax which largely does what any form of Land Value Capture tax would do. However, it was noted that the fact that the state owns the land in China makes it easier to administer such a tax. Most other countries are not in the same position.

There was consensus that there is a distinction between taxes on property (buildings) and taxes on land. When people talk about land tax, they often mean property tax. Participants commented that taxing land (as opposed to property) was theoretically a sound economic idea, but, difficult because of practical issues, political considerations and the difficulty of transition from existing regimes.

There was agreement that governments will likely need to increase and/or reform taxes following COVID-19 and to address wider issues of inequality. Land taxes and residential property taxes were identified as a likely target for increases although, where they were able to borrow, governments were likely to hold off significant tax raises until an economic recovery was underway.

It was noted that the tax base in respect of business property tax is likely shrinking as a result of less office space being needed with more people working from home. This general trend was occurring anyway as a result of businesses moving to online platforms and flexible working arrangements, but COVID-19 has potentially accelerated this trend dramatically.

One participant pointed out that the decline in the business property tax base will likely impact local government to a much greater extent than national government. The reason being that in many countries business property taxes are collected by local governments in order to fund the services that they are responsible for providing. This issue is likely compounded by the fact that transit revenues (for buses, trains, etc. where these are relevant) have also likely been significantly negatively impacted by COVID-19.

That same participant commented that central governments in many countries were supporting local governments for now, but that this was unlikely to last forever and at some point, local governments will need to increase taxes in order to make up for their shortfall in income.

The group generally agreed that the likely method of increasing revenue for local governments would be via residential property tax. Income taxes and indirect taxes generally bypass local government - although in some countries there are either local sales taxes or local business trade taxes. Combine this with the fact that most of the historic reasons that land and property have been good targets for taxation continue to exist – e.g. it is an immoveable tax base, easily identifiable and provides a stable and predictable income. With the current economic crisis being faced in most countries the group agreed that it was unlikely that business could make up for the shortfall in tax revenue and therefore residential property will be the likely target. Furthermore, tax on residential property is considered more equitable than tax on business property as the former is more closely linked to the benefits received from local services while it is less distortionary then tax on business income or sales. It was however pointed out that the current situations indicated a need for a full review of the split of responsibilities between central and local governments and of taxing rights. First it is necessary to decide who should be responsible for providing certain services – schools, transport, healthcare infrastructure; then the next step would be decide the best form of taxation to raise the required revenue.

Political complications

It was also pointed out that the main problem with targeting residential properties is that it is politically very difficult to do so. People are acutely aware of how much their property is worth; property tax is very visible as is not withheld at source; and people will likely not react favorably to being taxed more in these difficult times. There was general agreement that this is likely to be a very contentious political issue in many countries and that the outcome will depend on the local environment.

One participant also pointed out that taxing land and property was, in effect, just another form of wealth tax. The reality is that in most parts of the world residential land and property is the single largest asset that most people have. Therefore, taxing it is in principle the same as introducing a wealth tax on the population. Although it was also noted that land and property as a percentage of wealth overall is falling.

The consensus was that where governments can borrow to fund the current situation, they would likely do so in order to hold off raising taxes immediately. They could then wait for the economy to recover sufficiently so that they can more accurately assess the effect of raising taxes and how they will impact the various demographics of their societies. The general opinion was that it may take 2 or 3 years before governments start implementing any significant changes or reforms. Nevertheless, it was pointed out that now would be the right time to consider longer term reforms, before it became a time critical issue to increase tax revenues.

The consensus was that transactional taxes such as stamp duty or other forms of transfer tax are distortive, unfair and counterproductive to workforce mobility, but likely to remain in many countries as they raise considerable amounts of tax.

Transaction Taxes are Distortive

Participants agreed that transactional taxes are not efficient and are distortive as they have the obvious side effect of reducing workforce mobility. They discourage people from moving to a new house when they want or need to. Again, the comment was made that in some countries these taxes are levied by local government and it is hard to see a connection between the transactional taxes raised and the services that these local authorities are meant to provide.

Participants also discussed the observation that transfer taxes are often “unfair” in that – at least under some regimes - the participants in the highest value transactions may be able to use complex structuring which means that they can avoid paying them. However, comments were also made that the EU is starting to crack down on the avoidance of transfer taxes by way of share deals and therefore this may have positive impact on revenue raising in the near term.

There was general agreement that the primary reason many governments continue to use transfer taxes as a source of raising revenue, is that they generate a lot of money that is simply very easy to identify and collect.

The group agreed that business rates are simply a form of business tax and should be reviewed as part of an overall package of taxation. It was noted that some industries that operate primarily from digital platforms pay less property taxes than traditional ones and this was one of the arguments put forward for having digital services taxes. However, there was disagreement over whether it was better to have different forms of tax which applied depending on the business model or whether this caused unnecessary complexity and it was preferable to have a system which applied equally to all businesses.

Some members of the group commented that taxes on business property are distortionary and lead to the inefficient use of land and end up falling unevenly on companies that require land and property to operate.

The Digital Economy

“Internet companies” usually require much less land and property to operate than “traditional bricks and mortar companies” so it is therefore not surprising that they should pay less in the form of property taxation. The remark was made that this unequal burden of property taxes has been one of the arguments put forward for countries introducing some form of digital services tax to level the playing field. Internet enabled companies may also make substantial use of public services such as roads (to make deliveries) as part of their business model and therefore there should be some form of additional tax applied to them for the public services that they use. Some participants argued having multiple types of taxes to address different business models, risks creating too much complexity in the tax system; but some thought it was acceptable and unavoidable given the different characteristics of different businesses.

One participant made the point that land and property used to be fundamental for the creation and storage of value. However, with the ongoing trend of movement to the digital economy there is a shift away from this. Strategically there is an ongoing question on how governments can find an effective form of taxation to reflect this changing situation. It was also pointed out that, globally, business property is taxed more heavily than residential property and from an economic perspective this seems paradoxical as business will generally be less reliant on local services than households and are usually more mobile.

Nevertheless, it was noted that the growth and scale of server farms is not inconsequential, and these require substantial land and buildings. This raises an international dimension about the comparative rates of tax on land and property. The group concluded that the taxation of land and property is basically just the taxation of one input into the process of value creation. It would be better to take a holistic review of the overall taxation of land and labor as a whole.

The Green Economy

Finally, one participant asserted that any decisions on tax reform should be made to support a green economy in the long run. The built environment was cited as being responsible for a significant percentage of carbon emissions (e.g. one study suggests 40% of emissions in the UK2) and one potential option would therefore be to tax carbon emissions rather than apply business rates. This would create an incentive for a reduction in carbon emissions while raising revenue and removing the abovementioned distortions between types of businesses.

Although participants generally agreed that Land Value Tax had merits from an economic theory perspective, they also mostly agreed that it would be very difficult to implement in the short term due to practical, political and transitional complications. Most participants thought that it would be easier to implement on land used for commercial property rather than residential property.

Land Value Tax

Some members of the group thought that there were strong economic and equity arguments for the introduction of a Land Value Tax. Taxation of land is less distortionary than other taxes. Land is a common resource which is easy to find so should be easy to tax. However, the conversation swiftly turned to the potential challenges and complications associated with it.

The first complication discussed was the political difficulty associated with implementing it, particularly from a residential perspective. An individual’s home is very important to them as an asset and increasing taxation of it would likely be met with opposition from the general public. A Land Value Tax could also evidence a growing divide in many countries between those who own property and those who do not.

The group agreed that due to the complexities and political ramifications, if a country wanted to introduce LVT, some form of commission of technical experts or cross-party working group with the mandate of investigating its introduction may be the best way forward. It was thought that a reasonable timeframe for its introduction, given the need for a transition period may be 10-15 years (although some participants thought 20 -30 years maybe more realistic). However, this again would be practically very difficult from a political perspective, because politicians tend to work on an approximate 5-year cycle between elections in many countries. As such, political parties and priorities could change over the envisioned span of time it is estimated it would take to investigate and implement Land Value Tax.

Despite the above political difficulties, some participants of the group thought that the current COVID-19 crisis may be the perfect time to start such a complicated reform. If it is assumed that governments will try not to raise tax immediately, but will need to do so in the longer term - not only to address COVID-19 deficits, but because of other needs such as demographic change (aging population, etc.), it could make sense to start such a fundamental review now. The change could be introduced on a revenue neutral basis but change the incidence of taxation or could be introduced with a view to increasing revenues over time.

Nevertheless, there was still some skepticism about political will to introduce LVT – for example one participant pointed out that in the UK the Mirrlees review commissioned by the Institute of Fiscal Studies took place over a decade ago with the mandate of investigating tax reform. Since it was completed, nothing has happened with it.

The second complication which was discussed is the difficulty in determining the optimal value of the land. Many of the participants struggled with how the optimal use of the land could be determined in a fair and equitable way and implementing LVT may also require a change of planning laws in some countries. It was noted that in trying to make a community thrive you need a variety of businesses/ community spaces. As such, ultimately it would have to be local government that designates what the optimal use of land should be in order to effectively set up their communities.

The question then becomes what happens if a person’s land gets “zoned” as its optimal use being something other than what it is? Would they effectively be compelled to change the use or sell up? This may also lead to an abundance of certain types of property. For example, building flats rather than houses may become preferable because the cost of the Land Value Tax could be split between multiple flats rather than being due on a single house. One participant thought that this may also exacerbate the gentrification issue that many communities have, i.e. local people being unable to afford homes in their own communities.

One participant commented that if the power to decide optimal use was vested in local authorities it could create an incentive for corruption – particularly in countries with weak governance.

Participants also agreed that there would almost certainly be challenges in getting the details right in how Land Value Tax would interact with and transition from the swathe of other taxes that are already in existence, in particular, taxes on property. The systems that many countries have in place for the taxation of land and property are often complex, inequitable and inconsistent. It may be better to focus on addressing the immediate issues than trying to implement a whole new system. It was also thought that developing countries may find it easier to introduce a Land Value Tax than developed ones, if they did not have widespread forms of property or land taxation (i.e. starting from a blank canvas may be much easier).

Problems of Land Value Tax

Other problems with the introduction of a Land Value Tax that were discussed included:

  • The fact that it is still a tax on land and therefore does not resolve any of the “level playing field” concerns about the taxation of businesses which do not rely on land. While the thought was that it was a fairer way of taxing land itself – rather than looking at the value of the building placed on it- it was also thought that it did not solve the issue of the trend in movement to the digital economy;
  • The difficulties in valuing land in dense inner-city areas. Land Value Tax assumes that you value the land as if it is vacant, but finding any sort of comparison in an already developed city center may be difficult; and
  • Difficulties with the transparency of any system. People know and understand the value of their properties, but they do not really know how much their land is worth without that property.

The consensus – albeit not unanimous view - of the group was that it would be much easier to implement a Land Value Tax on commercial property rather than residential property. However, that would still leave the complexity of operating two different tax systems and it would not resolve the need for the increase in residential property tax that was outlined as likely being needed above.

With regards to other forms of taxation on property and land, the group agreed that countries which currently do not tax capital gains on the sale of a principal residence may look to restrict this relief.

Capital Gains Tax Exemption

Many countries have an exemption from Capital Gains Tax for the primary residence of an individual. Participants agreed that this exemption was a target for removal with the potential to significantly increase tax revenues. There may well be public resistance to the taxation of private homes but, given the demographics of population in many developed countries, they may soon be in position where the proportion of non-homeowners may exceed homeowners. As such, there might be political will to push it through. Several options were mentioned including taxing all gains; allowing a roll-over of any gain into a new dwelling; and allowing only part of the capital gain to be exempt. It was noted however, that some countries which (partially) tax gains on dwellings also allow tax relief for some element of mortgage interest and property taxes.

One participant pointed out that capital gains tax tends to be collected at the national level and if such a tax replaced annual taxes on dwellings, an alternative source of funding would need to be found for local authorities.