Tuesday, January 23, 2018

Property Taxes: There’s a Right Way, and There’s a Wrong Way

Caught this yesterday (excerpt):

Selangor, Penang tax hike woes

ONE part of Pakatan Harapan's manifesto covers cost of living and taxes, and points fingers at federal government policy.

If they are serious about reducing the cost of living and taxes, they should first look at Selangor and Penang.

On Dec 26, the Selangor Mentri Besar's Office scrambled to respond to my assertion that property-related taxes are the main cause of increase in cost of living in Selangor.

Datuk Seri Azmin Ali refused to accept my assertion and blamed Putrajaya and the goods and services tax (GST) for the increase….

…There was a significant increase in cost of living between 2008 and 2011, years before the implementation of GST.

Moreover, the initiatives rolled out in 2016 by the state government were focused on rural residents. The MB's Office said several hundred thousand owners of kampung houses were given exemption on assessments.

But what about urban residents in the cities and towns where over 80% of Selangoreans reside?

The residents in apartments and urban dwellings have had to pay higher quit rent and assessment taxes since 2008?

This is where most of the increase in cost of living happens.

Most Selangor residents live in cities and towns and have been significantly affected by the rapid rise in property prices and rental because of the state government's policy.

I’m not going to play politics here. Property related taxes have increased across most states, and in my opinion probably a bigger factor in the increased cost of living than anything else. We can all argue over who is at fault, but ultimately, nothing much will change unless fundamental reforms are carried out.

The real heart of the matter here is state finances, particularly in the raising of revenue. Something like 70%-80% of state revenue comes from property taxes of one sort or another. I actually don’t mind if this was raised via quit rent or assessments, which directly taxes home owners. These are, in economic terms, efficient taxes – those who consume public services are also the ones who pay for them.

Unfortunately, most of the increase in revenue comes from a different source – land conversion premiums and development charges. Unlike direct taxes like quit rent and assessment, these are hopelessly inefficient.

Here’s why: premiums and charges are paid by land developers. Since these add on to the cost of housing, the price of new homes must rise (holding profit margins constant). But the way the housing markets work is that changes in transacted prices form benchmarks for existing housing, since valuations depend on market prices. So the additions to housing supply have the effect of raising the value of ALL housing, and not just for the new units. This results in a windfall for existing home owners, for which they are NOT taxed (except minimally via marginally higher quit rent and assessment on the higher value of their property).

As a result, on the one hand, the burden of taxation falls primarily on new home owners while existing home owners get a free ride. On the other hand, the state government raises revenue, but only on the value of new housing and not the total increase in wealth that results. Effectively, there’s a wealth transfer from new home owners – and by extension, all future generations of Malaysians who have to live with higher prices – to existing home owners. In other words, raising revenue this way contributes to an increase in wealth inequality.

Note that I’m not arguing here for a unilateral cut in taxation. States have a legitimate need to raise revenue to pay for local public services. The almost total reliance on property taxes however means that state governments have a vested interest in keeping property prices going up, with all that implies in terms of raising wealth inequality. Or, as the immortal Sir Humphrey Appleby put it, “If you must do this damn silly thing, don’t do it in this damn silly way.”

One way to fix this is to shift the burden of taxation from indirect to direct – reduce coversion premiums and development charges while raising the more efficient quit rent and assessment to compensate. Not only will this be fairer but it should also increase housing supply, which is another contributory factor behind higher prices. Given the political fallout such a move will cause, this will probably happen when pigs fly. Another alternative is a land value tax, which I talked about here. I’m not too hopeful about its adoption either.

Ultimately, what’s really required here is a total revamp of state finances. In other countries, sub-national authorities have the right to levy their own income and sales taxes. India’s GST implementation last year, for example, was more about streamlining existing the GST regimes run by each state, more than a national imposition of a new tax. In the United States, most states levy their own income taxes on top of sales taxes. One possible idea here is a revenue sharing formula of federal government GST proceeds with states, which may or may not require an increase in the rate. Or alternatively, states can levy their own VAT on top of GST.

But state finance reform would require rethinking and renegotiating the relationship between citizen and state government, and between federal and state governments. The likelihood of that happening? I think I’ll sit by the window to wait for the pigs.

8 comments:

  1. There's good points to be made here regarding state revenues.

    But I'd argue that the current system seems more optimal for Malaysia currently. History of poor policy coordination in Indonesia and India (and America) across sub-national Governments would likely be replicated. I'd argue that these countries can't roll out cross-state infra as easily as us or Thailand because of that. But that would be my chief argument.

    Anyway, did you get a chance to see our sovereign report? We'd take comments (and criticisms, if any) https://www.ram.com.my/pressrelease/?prviewid=4499

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    1. Hi Jason,

      Actually, I'd think it'd be even easier to achieve coordination after removing the incentive problem that power over land matters gives to the states. One of the biggest barriers to a national policy on housing is that land matters are a state prerogative.

      And thanks for the link.

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  2. Salam brother Hisham,

    I really hope you write this article in Malay too, brother. This crucial issue should reach to wide audience so that they would be well informed on what is the main factor of house price getting crazy nowadays.

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  3. Jason, I read your link and wonder what in your opinion would be a comfortable debt ratio for Malaysia taking into consideration Malaysian aspiration to live in a first world infrastructural country. And in what way could the country achieve this, no development for next 15 years / reduce the civil service by 25%??

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  4. Zuo De,

    Thanks for the query.

    Let me preface by saying that Malaysia still has a development gap that it has to bridge to get us to a developed economy (GNI per capita notwithstanding). Also I'm unashamed in equating infrastructure spending with development spending in answering this question.

    ---

    Generally speaking we don't look at just the debt number (and fiscal deficit) in isolation when assessing any country's fiscal position.

    What Hisham has repeatedly impressed on us, has made the debt burden some what more palatable to us - the constitution makes constrains Federal Government debt for development purposes. Hence, in a perfect world, more Federal Government debt issued would equate to more development.

    Thus, the only constraint would be in the Government's ability to service these debts.

    Unfortunately, not all infrastructure projects are immediately profitable or can immediately generate sufficient economic activity for tax revenue purposes. So you can't just load up on infrastructure projects equivalent to 50% of GDP in a year and hope to be called a developed economy by the outside world.

    Regardless of this constraint, I think everyone would agree that more infrastructure in Malaysia is needed for sustainable growth. The Government's relatively focused view on fiscal consolidation (i.e. smaller fiscal deficits until 2023 at least) means that they're forcing themselves to spend less on development.

    With these seemingly opposing objectives - smaller fiscal deficit and development goals - the Government has gradually tasked more and more of the development responsibilities to other public sector agencies or to the private sector (and example of which would be DanaInfra) - i.e. moving more of the expenditure and immediate debt burden of its immediate balance sheet.

    And it kinda works for the moment. Just that there would likely be some mismatch with those project revenues and associated interest and maintenance costs in the short-term. The gap of which would likely be filled out by tax revenues.

    Phew!

    So back to answering your questions...

    1) No, we aren't looking for a specific ratio. As is with everything, some ratios need to be taken into context. It's more to do with the ability of the Government to service its on- and off- balance sheet debt servicing costs. Which we take it to be a timing and revenue problem.

    2) How to achieve (i'm going to paraphrase) - a more sustainable debt service ratio? 2 ways: (i) The Government could tighten up on project costing while optimizing its own operating expenditure - which there have been some efforts recently; (ii) Find somewhere to grow revenues while not hurting economic growth - i'm really starting to like the idea of a sugar tax in Malaysia (if the Arabian countries can do it....)

    Sorry for the long post :D

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    Replies
    1. Thank you so much. Appreciate the "preface". Probably in future "proclamation", some ideas of what fiscal discipline could be suggested as well as new income generating tax (sugar tax - I like this very much) mentioned. Most time it is debt is "bad" full stop. I think a balance report including other countries debt to gdp ratio might leaves the readers a better understanding of the position they are in. But maybe you are not allowed to do as per your job spec ....

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  5. "Here’s why: premiums and charges are paid by land developers. Since these add on to the cost of housing, the price of new homes must rise (holding profit margins constant). But the way the housing markets work is that changes in transacted prices form benchmarks for existing housing, since valuations depend on market prices. So the additions to housing supply have the effect of raising the value of ALL housing, and not just for the new units. This results in a windfall for existing home owners, for which they are NOT taxed (except minimally via marginally higher quit rent and assessment on the higher value of their property)."

    Thanks for the above enlightenment. Opens a new perspective in viewing housing supply.



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    ReplyDelete