Reforming the urban property tax in Punjab

Roads, streetlights, policing and sanitation are some of the services for which governments levy the property tax in cities and towns. The urban property tax collected in Punjab, however, is about one-fifth of the collection by provinces in other comparable countries – as proportion of total local government revenues as well as a share of GDP. The tax collected is also far less than the cost incurred to provide urban services. However, Punjab can increase its collection to more than 25 billion 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.

When you look at the low tax collection in the country – less than 10 percent of the GDP – you can see the current property tax collection in Punjab in perspective. Pakistan fares poorly in comparison with 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 an increasing share of provinces in national spending. Provinces also don’t collect their taxes efficiently.

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 and, to make this happen, a stronger revenue-collection effort will have to be made 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 in collecting the tax.

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, which reflects the problems of tax administration.

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. This differential rented 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 a substantial leakage of revenue.

SUGGESTED OPTIONS AND REFORMS We propose the following changes addressed towards valuation of properties 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, the tax collection projections should be indexed to inflation every year. This will ensure that the government’s tax collection will keep pace with the increase in the market values of private properties every year.

TAX RATES: The tax rate should be reduced to 10 percent of value while the differential between rented and self-occupied properties should also 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 almost doubles compared to what it is right now. If this differential is completely eliminated, it would result in property tax revenue increasing nearly four times.

To assess the political viability of these proposed reforms, we also estimated the impact they would have on taxpayers. As in any reform process, some categories gain whereas others have an increase in their tax burden. 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.

CONCLUDING REMARKS Recent developments that empower the 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 realisation 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.