Capitalisation of Property Tax: Some Empirical Evidence for Greater Mumbai

Abstract

During the course of my earlier research on property tax in Greater Mumbai it has been explicit that builders and construction industry quite often lobby with the municipal authorities to reduce the property tax rates for their jurisdiction. It is an intriguing question as to how precisely are the market value of properties affected by the property tax incidence in a segmented property market with enduring presence of Rent Control provisions. A testable implication of the famous and widely quoted eTiebout Hypothesis' in urban political economy is the concept of capitalization, which traces a theoretical link between the market values of properties and property tax liabilities. A plethora of studies attempts its empirical verification subsequently for cities in developed world and finds significant but varying degree of such linkage. In case of developing countries, however, such explorations are nonexistent, perhaps, primarily due to the lack of reliable information at the disaggregated level of city governments. The complex realities of the property market and property tax institutions in these countries also do not render an easy examination of such relationship and necessitates a number of crude assumptions. I make an attempt in this paper to estimate the inter-jurisdictional capitalization rate for recent residential properties in Greater Mumbai taking into consideration the institutional and data constraints. The wide prevalence of Rent Control Act in the city has segmented the rental market and the choice of only recent residential properties, which are outside the purview of this regulation, has been to ward off the distortionary impact. The capitalization model includes all feasible variables that the empirical literature in the field suggests; however, data constraint to some extent restricted the choice. A few alternative models are estimated taking into cognizance the oftenhighlighted methodological intricacies. This procedure also helps in purging the relevant variables for final estimation. The results of all alternative estimated models clearly suggest substantial over-capitalisation. The paper traces plausible grounds for this phenomenon. The class of properties chosen for this analysis falls outside the purview of Rent Control Provision and shoulders a disproportionate excessive share of the tax liability. Thus, these properties are most sensitive to the changes in tax liability. In addition, the institutional aspects, substantial inequity in the property tax incidence and strong consciousness of city dwellers regarding the impossibility of any reform in the noticeable time horizon render a very high capitalization rate for this susceptible property class. The study findings clearly demonstrate the urgent requirement of a major property tax reform followed by regular periodic assessments.