The government of Punjab faces a serious fiscal challenge in paying for the delivery of basic public services. Growing demands for greater accountability by voters now mean that serious efforts to reform the government’s tax capacity must be explored. This blog explores a complement of reforms to urban property tax laws that could have the potential to substantially raise tax revenue collection in Punjab.
Roads, streetlights, policing and sanitation are some of the services for which governments levy the property tax in cities and towns. As a proportion of total local government revenues and a share of GDP, the urban property tax collected in Punjab is about one fifth of that collected by provinces in comparable countries. The costs of urban service provision also far exceed the tax revenues collected. However, Punjab can increase its collection to more than 25 billion PKR with comprehensive reforms. This will be many times more than what is collected today, and will amount to 8 percent of Punjab’s development budget and 31 percent of its health and education budget for 2014-15.
The low levels of tax collected across the country – less than 10 percent of the GDP - puts Punjab’s property tax collection problems into perspective. Pakistan fairs poorly in comparison to other South-Asian countries (India: 15 percent and Sri Lanka: 13 percent) and the average for developing countries (15 percent). Provinces account for a small fraction of the national tax revenue (5 percent of total national tax revenue or less than one percent of GDP). This profile has changed little in the past decade, despite provincial expenditures accounting for an increased share of national spending. Provincial tax collection is also highly inefficient.
This needs to change after the passage of the 18th Constitutional Amendment which assigns more responsibility to provinces for the delivery of social services like education and health. And the voters know it. This means that spending will have to be increased. To make this happen, a stronger revenue-collection effort will have to be undertaken in the provinces.
Provincial and local governments need stable sources of self-generated revenue to plan for the critical infrastructure investments needed to promote economic development in our cities. Based on international experience, a critical source of this self-generated revenue is property tax from urban areas. The Economist magazine reports studies showing that urban property taxes are the most economic growth-friendly of all major taxes.
Problems in Punjab’s Urban Property Tax
The Punjab Urban Immovable Property Tax (UIPT) is a local government tax but is in effect collected by the provincial government, and then shared with local government such as City District Governments (CDGs), Tehsil Municipal Corporations (TMAs) and Water and Sanitation Agencies (WASAs). These local governments are extremely inefficient tax collectors.
Even though urban property taxation has a long history in Punjab, this tax provides for only a small amount of revenue. As a share of the provincial GDP, revenue from this tax is an abysmally low one tenth of one percent. The gap between annual targets and actual collection has become very large, reflecting problems of tax administration.
Figure 1: Urban Property Tax targets and collection in Punjab since 1998
The main problems with Punjab’s urban property tax are:
Valuation of properties: Despite the surge in property values and market rents in Punjab since 2001, the property tax base has not grown because valuation tables – the value which the Government assigns to various properties - are not updated frequently enough to reflect actual market values. According to some estimates, owner-sellers of properties may be under-valuing their properties by as much as 45 percent to avoid being fairly taxed.
Collections and incentives of tax collectors: The World Bank has argued that strengthening tax administration and the billing and collection system can double, if not quadruple, revenue from the property tax in urban areas. A comprehensive research project being done by economists from Harvard University, MIT and the International Growth Centre, in collaboration with the Punjab Department of Excise and Taxation, has shown that providing better incentives to property tax inspectors significantly improves their performance in tax collection. This shows that improving incentives of government servants can help bring in more revenue.
Exemptions from taxation: Punjab’s property tax structure is riddled with exemptions and preferential treatment of properties, which has eroded the tax base. The most extreme case of this is the preferential treatment of properties occupied by owners, to the disadvantage of rented properties. This inflicts a loss of revenue equal to nearly twenty-five percent of existing collection.
Poor Coverage of tax net: The Government’s delay in notifying new “rating areas” – those that fall under the tax net - and extensions in existing rating areas have resulted in a very large number of properties remaining untaxed. In Lahore alone, this figure is approximately 300,000 out of 750,000 properties. A modest estimate (four years old) is that approximately 73 more rating areas exist in Punjab’s cities that need to be brought into the tax net.
High Tax Rates: Property tax rates of 20 to 25 percent of property value are considered too high, creating incentives for tax evasion. Properties occupied by owners are taxed at different rates than those occupied by renters, to the advantage of the former. The differential between renter and owner-occupied properties in Punjab is much higher than in Karachi (1:2) and in Islamabad Capital Territory (1:1). This means that in Punjab, owner-occupied properties pay only 20 percent of the tax levied on the same property if it is rented. This difference in rates is said to be the most important source of corruption in the property tax administration, resulting in substantial revenue leakage.
Suggested Options and Reforms
We propose the following changes to property valuations and the tax rates, to improve the collection of property tax in Punjab.
Valuation of properties: Successive surveys and re-assessments should be done every 3 years. Till this is done, tax collection projections should be annually indexed to inflation. This will ensure that the government’s tax collection will keep pace with the increase in the market values of private properties.
Tax Rates: The tax rate should be reduced to 10 percent of value, while the differential between renter and owner-occupied properties should be reduced to zero in a phased manner. We estimate that by applying updated valuations (based on the market value of properties), reducing the tax rate to 10 percent and bringing the differential down to 1:5, the property tax revenue should double, relative to current values. Completely eliminating the differential would result in property tax revenues increasing nearly four times.
To assess the political viability of these proposed reforms, we estimated their impact on taxpayers. As with any reform, there are winners and losers. However, we found that these increases are highly affordable. A person owning a 10 marla plot in the most expensive area of Lahore would pay an additional monthly tax equivalent to the cost of three McDonald’s burgers.
Recent developments that empower provinces with more responsibility as well as a larger share of tax revenues have changed the landscape of fiscal arrangements in Pakistan. The Federal Government’s historic decision a few years ago to increase the resources of provinces reflects the realization that the provinces need to be held fully accountable for the services they deliver to citizens and the overall investment climate they create for economic growth and employment. It is also clear, however, that the current pool of money available to provinces is insufficient to provide the needed services and infrastructure. Provinces will thus have to tap into under-explored sources of revenue, especially the urban property tax.
A version of this blog originally appeared as an article in the Business Recorder