Regular readers of this blog know that I have been skeptical of both the likelihood of an imminent introduction of a residential property tax in China as well as arguments by pundits that said tax will have a significant dampening effect on real estate prices. [UPDATE: Said “pundit”, Patrick Chovanec, has just posted a good comment clarifying his position.]
Credit Suisse just released a very interesting analysis of the likely impact of possible new residential property taxes in China. The report states that property tax has been decided and its release is imminent, something that is not yet provable unless the Credit Suisse analysts have a very senior source in the central government in Beijing.
That issue aside the report is very much worth reading. It analyzes the likely stock market reaction, the possible effect on home prices and the housing market overall, and the expected impact on local government finances. Among the conclusions:
Property Tax: Would It Crash The Market?
China has decided to extend the holding tax for commercial properties to investment purpose residential ones, to avoid legislation issues for implementing a new property tax. Several industry experts, including those that we brought to meet investors recently, believe that the property tax could cause China’s residential property prices to drop 40% or more. In our opinion, however, property tax is just one component of China’s property policies – it should not crash the property market and its upcoming implementation could actually signal a bottoming in China’s property sector.
Property Tax – Only Part Of The Housing Solution
We expect it to cool the sentiment in the near term for investment and speculation in the property market, but property tax by itself cannot solve the housing issue. The Ministry of Human Resources and Social Security’s proposal to double average wages in China within five years, if approved and implemented, should improve the affordability ratio significantly. The Ministry of Housing and Urban-Rural Development also announced plans of large scale Public Housing construction. If this plan is implemented strictly, we should see a surge in public housing supply in the next few years, although the total amount may stay small in the foreseeable future – as of 2009, public housing stock accounted for less than 5% of total housing stock in China.
Other Countries’ Experience – It’s Unlikely To Crash The Market
We draw this conclusion after studying the property tax situation in many countries. Specifically, we studied countries that started to implement property tax only in recent decades, such as South Korea and Mexico – both started to implement property tax in a hope to reverse the surge of property prices – just like China. Neither of the two countries’ implementation of property tax caused a crash in the property market.
China’s Current Plan – Limited Monetary Impact
Based on the current plan’s tax rate, scope and difficulties on implementation, we expect the impact on the property market to be less than what the current stock market assumes. Our detailed scenario analysis also shows that, even if the full amount of property tax can be successfully collected, the monetary impact on home-buyers should be manageable.
In fact, scenario analysis on Shanghai’s proposal shows that the new property tax’ net impact on monthly payments shoud be only 5% to 6% – an impact even smaller that that caused by a major interest rate increases.
A Gradual Reform – No Near-term Replacement For Land Sales
One of the key targets for property tax is to reduce the local government’s reliance on land sales as the main financing resource. However, this goal cannot be realised in the foreseeable future, in our view.
Land sales has been an important source of revenue for local governments and property tax has been below 4% of local government revenue. Therefore, as discussed earlier in this report, local governments may be willing to implement property tax for additional revenue, but will have to continue to rely heavily on land sales for years to come, in our view.
The report also discusses the likely structure of the property tax and suggests something that I have not seen discussed much elsewhere, that the tax may in fact not be assessed annually but rather upon change of ownership. I am not sure this aligns with the goals of policymakers, but it is an interesting suggestion:
Property Tax Is Likely To Become Transaction-based Rather Than A Holding Tax
Due to the difficulties in tax administration and collection at the local level, residential property-related taxes – from land sales markets to secondary housing markets – are all collected after transactions are through. According to industry experts, although property tax is designed to be a holding tax, it may become feasible to collect upon changes of ownership. In this case, the property tax may actually propel property price appreciation in the long term, although the negative market sentiment in its implementation causes could reduce property prices in the near term.
The full report is embedded below. It is worth reading.
We will only know if China is going to introduce a property tax if and when the central government officially announces it. Until then any “leaks” into the press should be considered speculation that is serving the agenda, and possibly the stock market positions, of the source.
What is quite remarkable about China punditry, both economic and political, is that you can be wrong for almost a decade or more, as Gordon Chang has been, and still be considered a serious and intelligent source of information. The rise of the China bears has certainly invigorated the market for “analysis” supporting their positions, credible or not.