Institutionalizing Local Property Tax in China - as Revenue-Service Link and Tool for Higher Efficiency and Accountability via Public Choice

Abstract

With progress of the housing reform that started in the late 1990s, “home ownership” (with property rights and transferability on the market) among the Chinese people has been increasing rapidly. In the early years of this century, the Chinese government placed on its agenda a new reform to adopt the “real property tax”. At that time, the tax on “real property”, a concept in the Chinese context that covers the structure but not the land on which the structure stands, was called the wuye tax (物业税, which referred only to the structure on the land or the housing unit, for distinction from the real property tax). In October 2003, the Chinese ruling party made a decision “to reform current taxes and charges on real estate, and levy a wuye tax (real property tax) when it is necessary while eliminating related charges”. At that time, the goal of the wuye tax reform was to rearrange the taxes on transactions and possession of real properties. Also, the central government hoped to make the wuye tax an important revenue source for local governments and to rationalize intergovernmental fiscal relations between the central, provincial, and other local governments. From 2003, as China’s economy gradually steps out of the Asian economic downturn that started in 1998, the real property market entered a period of rapid expansion. However, speculation in real property was rampant. In the last 10 years, the price of real property in most cities more than tripled. This problem was more severe in metropolitan areas, such as Beijing, Shanghai, and Guangzhou. Meanwhile, local governments obtained large amounts of revenue from selling the use right of state-owned lands. In response to this abnormal market, the central government frequently adopted monetary, fiscal, and administrative measures as an effort to regulate/control the market. It was against this background that Shanghai and Chongqing, two metropolitan areas, began to levy a real property tax on residential housing from January 28, 2011. As expressed in official documents, the short-term goal of this new tax is to curb sky-rocketing housing prices. Beyond this apparent target, we assume the Chinese central government may be “muddling through” in an effort to determine whether the property tax can be a stone that shoots multiple birds. Among these birds are stable own-source revenue for localities, readjustment of intergovernmental relations, and improvement of local governance in the long term. If we are correct in making this assumption, then the pilot local tax prepares China for some fundamental reform in tax administration, local governance, and government structure in the next few decades in China.In this monograph we argue that the local property tax is one candidate as the “magic” stone; the installation of local property tax can help solve multiple problems that are deep rooted in the society and entangled with many previous reform measures. Our analyses unfold as follows. Section one offers a three-stage framework of China’s financial reforms. Its focal point is that China is now in the third stage wherein it needs to reform the underlying operating mechanisms in order to improve local governance. Section two defines modern real property tax and explains why China urgently needs to introduce this tax as an institution. Section three traces the history of real property taxes in China and compares them with modern real property tax in developed countries. Section four considers the requirements and background of implementing the modern real property tax. Section five analyzes the pilot real property tax in Shanghai and Chongqing and compares them with counterparts in China’s history and the modern real property tax. Section six describes the practice of pilot real property tax in the two metro cities and the effects of the pilot tax on fiscal revenue and housing price. Section seven offers the outcome and analysis on the surveys of residents and government officials on their perception of the pilot tax. Section eight highlights a comparison between two frameworks that have appeared in China. Under the first, local governments depend on land transfer fees to finance infrastructure, and under the second, localities shift to real property tax. Section nine conducts a simulation of real property tax that can be collected with a broader tax base and lower tax rate. Section ten concludes with policy recommendation for the Chinese government in its effort to conduct the third stage of financial reform and improve local governance.