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Tuesday November 30, 2021

The case for taxing land

By I Hussain
June 30, 2021

Budget 2021-22 looks good on paper in so far as it avoids the usual compulsions of belt tightening to meet IMF conditionalities and so can claim with some reason to be expansive with a growth bias. But, as in the past, the problem is that it doubles down on the existing tax structure which means heavy reliance on indirect taxes (customs duties, sales taxes, excise duties). This skews the economy further in favour of the rich.

Besides, fluctuations in the exchange rate lead to variability in tax collections because of concurrent changes in the valuation basis of imports.

Currently, Pakistan collects only around 38 percent of its taxes from direct taxes whereas 62 percent is raised from indirect taxes. Direct taxes collected amount to 4 percent of GDP. This is relative underperformance when contrasted with the situation in other developing countries at a similar stage of development in which direct taxes account for an average 55 percent of tax revenue and 5.5 percent of GDP.

There are certain systemic weaknesses in the tax structure that makes tax collection in Pakistan an intractable problem defying efforts to raise the tax-to-GDP ratio. One serious flaw is the difference in treatment accorded to the source of income, with agricultural income being exempt from federal taxes (agriculture being a provincial domain).

Agricultural land holdings under 12.5 acres are exempt from the provincial agricultural tax. Holdings above this size are taxed at a flat rate per acre which has no bearing on the productivity or market value of the land.

Since about 90 percent of landholdings are under 12.5 acres, agriculture contributes a miniscule 0.1 percent of total tax revenues to the provincial coffers. This despite the fact that the agriculture sector accounts for about 20 percent of Pakistan’s GDP and employs around 45 percent of the country’s labour force.

Further, the tax base is far too narrow, relying on a few industrial sectors (petroleum products, cement, cigarettes, motor vehicles, beverages and one or two others). This leads to lack of tax buoyancy and risk of revenue shortfalls when the economy experiences a slowdown in growth.

To redress part of the imbalance between direct and indirect taxes, Pakistan should impose a wealth tax on the only source of wealth that cannot be secreted abroad or otherwise concealed within the country. This is wealth in the form of land and property ownership.

The importance to tax collection of land taxes can be gauged by the implications of the recent Rawalpindi Ring Road scandal. Without any investment on land improvement or development, the owners of the land abutting the proposed realignment of the Ring Road found that the value of their property had soared overnight.

Of course, infrastructure development is the responsibility of the government – which begs the question as to why in such situations the capital gains should accrue to landowners who did nothing to merit their good fortune. If the government’s proposed development scheme caused the value of the land to appreciate, then taxpayers who fund the government can rightfully lay claim to a part of this gain.

The other main reason why land should be taxed is that currently too much saving goes into land ownership rather than into productive enterprise. Land ownership confers status and has historically appreciated pari passu with inflation. However, this makes land values too high in relation to per capita incomes and home ownership unaffordable for a large majority of citizens.

Transparency of valuation at market rates and an appropriate tax levy thereon should allow much wealth tied up in property to be released and incentivize people to invest in other avenues including national savings schemes and equity funds.

The use of Google Maps and Geographic Information Systems (GIS) should lead to better demarcation of all land parcels and perhaps to identification of their real rather than nominal owners.

Land prices should decline, making home ownership more affordable for a greater proportion of the population. Further, interest rates on government saving schemes can be lowered because of the extra liquidity seeking safe outlets for investment. The country could save billions of rupees in domestic debt servicing costs each year.

Because of the realignment of the rates of return, overseas Pakistanis will be more amenable to invest in the country’s capital markets instead of purchasing property.

Further, a wider tax base should improve the country’s credit rating and allow it to borrow on international markets on more favourable terms than in the past.

The major problem will be that of valuation but there are methods in use around the world to surmount this problem. One procedure is to allow the owner to self-declare their property’s value but with the proviso that the state has the option to buy the property at that declared value.

Since provincial governments already levy property taxes there would have to be some modus vivendi between the provinces and the federal government’s overarching tax as to how to claw back provincial taxes in order to refund the provinces.

To mitigate the negative impact of the tax on lower and middle-income groups, there should be exemptions for a person (or family) owning properties together valued at less than a defined amount. This threshold will of course depend on the number of family members with claims on the property and therefore some maximum allowable per capita wealth holding in the form of property that receives a tax waiver will have to be made.

Another problem with implementation of a land value tax is that a person may be property rich but cash poor and therefore not in a position to pay the tax in cash.

However, to expect that property owners with property whose value exceeds the exempted maximum value do not have access to cash is difficult to believe. Some verification – like through inspection of utility bill payments – may become necessary.

The main obstacle to the proposal here is that of constitutional reform as it is difficult to envisage the ruling class of legislators and power brokers (many of whom don’t pay taxes anyway) consenting to enactment of a law relating to wealth taxes on land as this would undermine their own power and wealth status. But in a crisis as severe as the one we are currently experiencing tough and bold decisions have to be made.

One can conclude that the budget document is different from previous budgets only in tone if not in substance. Without saving and investing significantly more than at our current rate and/or enhancing the productivity of factors of production, economic growth will result in the usual problems: trade deficits; inflation; higher interest rates; higher borrowing costs; and greater income and wealth inequality.

The government has allocated Rs100 billion for Covid-related expenditures which is double the amount spent in 2020-21 but which in absolute terms comes to about Rs500 per head for the upcoming fiscal year. This is certainly far less than needed to buy vaccines commercially so hopefully COVAX, the global alliance formed to procure vaccines on a pooled basis for 190 countries, will be able to distribute enough vaccines so that Pakistan’s vaccination program may proceed with the administration of at least one jab for the majority of the population.

Without mass vaccination and continuation of non-medical interventions such as mask wearing, it is difficult to envisage the economy getting to normal – especially now with the Delta variant becoming the dominant strain.

The writer is a group director at the Jang Group.

Email: iqbal.hussain@janggroup. com.pk