Lack of a property tax is leading to oversupply in the commercial sector

June 16, 2014 / By  

When I look out our office window and see the amount of construction taking place, I cannot help but think that the government needs to implement a property tax. Normally, I would not be an advocate of a tax of any kind, but local government dependency on land sales and commercial development are leading to oversupply in the commercial markets across China.

View from my office window of the construction of a 600-metre-office tower

At present, local governments generate a large portion of their tax revenue by selling land to developers. As local government debts have risen, local governments have needed to sell more land. The most highly sought after land is residential land, because residential units can be pre-sold to generate a quick cash flow, and because residential projects have been highly profitable for developers over the past decade. However, for local governments, the sale of residential land only leads to revenues on the initial sale of the land and when the units are sold. Thus, local governments have been trying to encourage developers to buy more commercial land, which in theory can generate taxes in perpetuity from the ongoing business activity.

To incentivise developers to purchase commercial land, the government couples the commercial land with residential land. The problem with the coupling is that local governments allocate commercial land in places where large residential projects are viable, but where a commercial project is uneconomical. In addition, the local governments tend to be too involved in the designs of the commercial areas, instead of letting the developers design commercial projects that might be better suited for an emerging area.

In Tianjin, a prime example can be found on the western outskirts, where a nearly 600-metre-high office tower and adjoining business district complete with convention centre, Broadway-style theater, retail outlets, two hotels, twin office towers and an entirely new residential catchment is under construction, effectively creating a new city in a suburban district. Currently, the area is primarily an industrial and manufacturing catchment and does not warrant an office tower or commercial development of such a size.

Instead of trying to obtain future revenues from commercial areas that might not be commercially successful for years, if ever, the government should focus on a large potential tax base that already exists, the hundreds of millions of homeowners. The government has already moved in the direction of tapping this tax base with pilot property tax programs in Shanghai and Chongqing and the development of a nationwide property registry. By having a steady revenue stream from homeowners, local governments will have less of a need to sell land, especially commercial land.

A property tax would have the benefits of incentivising local governments to invest in their areas, as increasing property values could then result in higher taxes, and give local governments in need of tax revenue less of an incentive to encourage developers to build commercial space they do not want and that the local area does not need.

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