Property Taxes and Sustainability

Many economists advocate that a higher share of government revenue should derive from taxes on immovable property. Proponents of a sustainability agenda may want to follow their advice.

Read an OECD economic survey for a particular country and chances are high it recommends increasing the taxation of property. In July, the organization called on Austria to raise property taxes “by updating land values on which they are levied” and argued that such a move could expand housing supply and reduce land hoarding. It also highlighted that such a move would support the economy, if the revenues are used to lower “more growth detrimental taxes such as labour taxes.”[1] A month earlier, the OECD Economic Survey for New Zealand recommended introducing “a property or land tax based on land value per hectare”. In order to address concerns that such a tax would be regressive, it also advised to “scale the tax rate by the owner’s marginal income tax rate.”[2] Just earlier, the organization encouraged Mexico to strengthen property tax revenues “by updating property registries, increasing rates, removing exemptions and improving collection”.[3]

With intensive debates raging worldwide about austerity, government revenues, and tax reform, the unequivocal view of the OECD on property taxes and their potential to increase them in order to reduce other more harmful taxes is interesting. It is also supported by a broad body of research.

The “Mirrlees Review” – an international initiative to identify the characteristics of a good tax system for open developed economies – is a case in point. It argues that there is a strong economic rationale for the taxation of land as it does not discourage any desirable activity. “The incentive to buy, develop, or use land would not change.” With the amount of land being fixed, a tax on it – in contrast to a tax on labor or investments – does not alter its supply. In addition, it would capture the benefits that accrue to landowners as their property values rise due to developments provided by the community and local government.[4]

Similarly, a recent paper by John Norregaard at the IMF provides an overview on property taxation worldwide and makes a case for its expanded use. Norregaard echoes the argument that immobility of the tax base render taxes on immovable property more efficient than other types of taxes “by not affecting decisions to supply labor and to invest (including in human capital) and innovate”.[5] In addition, as the Economist points out, “property taxes are a stable source of revenue in a globalised world where firms and skilled people can easily move,”[6] and “you can’t take land offshore”.[7] They are also considered in both theory and international best practice as an ideal local tax for fiscal decentralization.[8] The relationship between property values and local developments is a key factor in this context.

Nonetheless, taxes on immovable property only make up just over 3% of general taxes in OECD countries (though this hides wide differences ranging from less than 1% for Austria, the Czech Republic and Norway to more than 10% for Japan and the United States).[9]

The fact that governments have so far not made more use of property taxes is partly due to many not having either the cadasters needed to identify the owners of land and buildings or the administrative capacity to put a value on them and periodically adjust for inflation. Policymakers will also be conscious that while land can’t be taken offshore, the households and companies that use it can indeed move. Property values and thus the income from property taxation will reflect these movements. The recent financial implosion of Detroit and its effect on property taxes is a case in point for this. Moreover, property taxes often face fierce public opposition. For the US, a 2012 paper by Marika Cabral and Caroline Hoxby underlines the high visibility of property taxes – usually paid by writing one large or at most a few checks – as a key explanation for that. They also point to the fact that the assessment process may be considered as arbitrary and that some homeowners may be property-rich and cash-poor as further factors. [10]

Yet, around 20 countries from China and El Salvador to Ireland and Namibia have recently adopted property tax reforms or launched plans to do so.[11] Alignment of the concrete tax design, i.e. the definition of tax base, tax rate and taxpayer (owner, occupier and/or beneficiary)[12], with a broader sustainability agenda – covering long-term economic as well as social and environmental objectives – can add further support to these initiatives.

Take the social impact and perceived fairness of property taxes as an example. Research suggests that the taxation of land and buildings often has a progressive distributional effect.[13] While landlords may pass such taxes on to their tenants, the wealthier are likely to rent or own larger more valuable places – making the tax supportive of a reduction in inequality.[14] Introducing exemption thresholds, scaling the tax rate according to the owner’s total wealth or income, allowing for deductions that phase out with higher incomes, and establishing safeguard mechanisms for property-rich and cash-poor households – such as tax deferrals until the property is sold[15] – can add to the alignment with social objectives. Ensuring that assessed values are in sync with market prices and that similar properties in a community are taxed in a similar way will further support the acceptance of the tax as fair.

At the same time, governments need to be conscious of the fact that future property taxes – especially on land – are mostly capitalized in the current value of the property. Raising property taxes may thus reduce property prices – a feature that may be welcome in the context of a housing bubble, but can also result in distributive effects. Complementing an increase in recurrent property taxation with a reduction in other taxes, such as those on property transactions, may offer opportunities to counter these effects.

Aligning a property tax with environmental objectives – the sustainable use of land and buildings in particular – is also critical. A property tax, especially a pure land tax, is likely to incentivize landowners to make best use of the land in accordance with planning policies.[16] The fact that landowners who pay tax on previously developed, but unused or underused land, have an incentive to reuse it, is a case in point for this.[17] In addition, levying taxes on second residential properties, as done in the pilot schemes introduced in the Chinese cities of Chongqing and Shanghai, may provide an incentive to slow down the expanding use of space.[18] Eliminating policies that favor low density living can offer further support to counter urban sprawl. The 25% reduction of the Council Tax in the UK for houses that are only occupied by a single person, and a property tax rate in Toronto that is 2.6 times as high for multi-residential properties compared to residential properties, are examples that policymakers may want to review in this context.[19]

Ensuring alignment between property taxes and a broad sustainability agenda does not only increase public support, but is also in the interest of homeowners. Social cohesion and environmental resilience play a critical role for property values and real estate markets. Tax policies that support these factors are thus not only important for the public in general, but also for the owners and developers of property in particular. Against this background, well-designed taxes on land and buildings should be on the agenda – in particular if the solid economic case they rest on is complemented by strong sustainability credentials.

A shortened German version of this article appeared in the Neue Zürcher Zeitung on 6 September 2013.