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III. THE CASE FOR PROPERTY TAXATION

A. Efficiency Considerations in Favor of Property Taxation

Considerations of economic efficiency strongly underpin the case for exploiting property taxes to their fullest potential. Their well-known efficiency enhancing properties derive mainly from the immobility of the tax base which, when underpinned by efficient and accurate valuation systems, entail clear benefits in different respects as outlined in this section. Property taxes in the form of recurrent taxes levied on land and buildings, are generally considered to be more efficient than other types of taxes in that their impact on the allocation of resources in the economy is less adverseby not affecting decisions to supply labor and to invest (including in human capital) and innovate. The immobility argument must be qualified, though, in the sense that only land is truly immobile, while capital invested in structures (or improvements), and particularly nonresidential structures, is indeed mobile, and a higher property tax can conceivably drive capital to lower taxing jurisdictions.18 In particular, if a newly introduced (or an increase in an existing) property tax is fully capitalized in property prices, present property owners would suffer a one-off loss in wealth, while new property owners would not be affected: once introduced (or increased), property taxes do not affect the rate of return and are therefore considered neutral to investment behavior.19 This quality follows from the fact that the property tax, to the degree it is a tax on accumulated wealth, does not alter future behavior.

International evidence suggests that immovable property taxation may be more benign than other tax instruments with respect to its effect on long-term growth. In recent studies, in part based on a broad review of the literature, OECD (2008 and 2010) establishes a tax and growth ranking with recurrent taxes on immovable property (and residential property in particular) being the least distortive tax instrument in terms of reducing long-run GDP per capita, followed by consumption taxes (and other property taxes), personal income taxes, and finally corporate income taxes as the most harmful for growth. Hence, a revenue neutral growth-oriented tax reform would involve shifting part of the revenue base from income taxes to consumption and immovable property.

Property taxes are considered good local taxes but raise intergovernmental issues. In addition to its considerable revenue potential (as discussed above), the property tax is generally

18 However, present levels of taxation particularly in developing countries render this distortion less of a concern (Bahl, 2009).

19 If a property asset yields US$1,000 in untaxed return and the discount rate is 5 percent, its market price in a competitive market will be US$20,000. If a tax of 20 percent is introduced, the (net-of-tax) return will fall to US$800, and the market price to US$16,000 assuming an unchanged discount rate. The (net-of-tax) rate of return will thus remain unchanged at 5 percent for new buyers. This in principle also applies to business properties, although the effect may be more complex if other taxes are affected (for example, if the tax is deductible for CIT purposes).