This is even though property values have increased significantly over the years, and are likely to continue to increase as Pakistan’s cities grow. On average, market value of residential plots increased by 85 percent in Lahore, and by nearly 120 percent in Karachi between 2013 and 2018.
By not taxing land and properties adequately, Pakistan not only leaves out a significant revenue source but also incentivises further investment in this non-tradable sector that has detrimental impact on the balance of payments crises. This has been made worse by a wide-ranging amnesty scheme launched by the previous government that further pushed capital into the real estate sector.
So, Pakistan is making its twin deficit problem worse by not taxing property enough.
A few days ago, in these pages Yousuf Nazar wrote an apt article outlining five areas of priority that suggests financial emergency, and asks provinces to collect at least Rs100 billion in property taxes. Following from Nazar, in this article, I chart certain measures the government can consider to quickly expand this tax source, both immediate and medium-term.
By not taxing land and properties adequately, Pakistan not only leaves out a significant revenue source but also incentivises further investment in this non-tradable sector that has detrimental impact on the balance of payments crises. This has been made worse by a wide-ranging amnesty scheme launched by the previous government that further pushed capital into the real estate sector.
Immediate Steps
Pakistan’s federal government can immediately take steps to encourage provinces to increase property tax collection in major cities, and undertake direct measures in Islamabad. A time-bound committee of experts, including several researchers who have conducted research on property taxes in Pakistan, and government officials can be set up to agree upon and coordinate these immediate measures.
This can potentially include:
- First, make changes to the annual rental value system that undervalues properties presently to bring it closer to market-value of properties. Currently area (how big a plot is) is the biggest driver of the valuation but this is unfair – a house of the same size in Lahore’s Zaman Park can’t be considered to have the same value as the one in Shahdara. Other countries have realised this: Mumbai’s tax collection increased by 170 percent after shifting to capital value-based tax.
- Second, focus on enforcement constraints, considering how tax collectors can be adequately incentivised and how more data can be collected and used. This could include prioritising tax collection in high-income residential neighbourhoods and commercial properties.
- Third, where ownership is unclear and difficult to establish make legislative changes so as to tax the occupant of the property, rather than the owner.
- Fourth, eliminate the differential in tax rate between owner-occupied and rented properties.
- Fifth, all exemptions should be reconsidered, and any exemptions provided should have a clear rationale linked with fairness.
- Sixth, consider earmarking a portion of property tax revenue to be spent on neighbourhoods from which the corresponding revenue is collected, strengthening the tax-service delivery link.
It is critical that people must see benefits from taxes in their local communities. Lagos’s Governor Babatunde Fashola implemented property taxes successfully to deliver public services and got re-elected in 2011. Public investment in Lagos led to increased property values, which in turn led to shared financial benefits, resulting in further public investment. Once citizens see and feel the benefits of this virtuous circle, they buy-in. There is no reason why Pakistan can’t do the same.
Mid-Term Steps
Over the medium-term, the government must frame expansion of property taxes along these four lines:
- Actively capture the real value of properties: Pakistan can learn from cities like Addis Ababa and Freetown, where cities reformed the tax design to capture closer to the real value of properties through using satellite imagery and mass property valuations. Because property values change quickly, it is important to update valuations regularly.
- Administratively and politically feasible: A pragmatic property tax reforms agenda would require political ownership from key political and governmental officials in major cities, along with a roadmap to build administrative capacity of provincial E&T departments. A reform agenda that tries to achieve too much will likely fail. Instead a reform agenda that looks at the capacity and political constraints and charts a way would achieve more.
- Demonstrates fairness: The tax design can make provisions for low-income, retired, and other groups that may be asset rich but income poor. A broader study on the distributional impacts can be conducted to measure how the tax liability will look like.
- Links directly with local public services: Over time, property tax compliance will increase if it is linked directly to urban public services, ideally led by empowered urban governments. It is critical that people must see benefits from taxes in their local communities. Lagos’s Governor Fashola implemented property taxes successfully to deliver public services and got re-elected in 2011. Public investment in Lagos led to increased property values, which in turn led to shared financial benefits, resulting in further public investment. Once citizens see and feel the benefits of this virtuous circle, they buy-in. There is no reason why Pakistan can’t do the same.