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How to make property tax work for local governments in poorer countries

Written by Gundula Löffler

The upcoming ATI/ITC Tax and Development Conference in Berlin will cover the role of domestic revenue mobilisation in achieving the Sustainable Development Goals. The global conversation around this issue has yielded two realisations:

  • Poorer countries need to step up their efforts to tap into their domestic revenue potential.
  • Urban local governments need to take on a much more central role in providing the required services and infrastructure.

Property taxation comes at the intersection of these challenges as a key local revenue source.

Property tax reform is somewhat of a niche topic: it’s quite complex and cumbersome to administer and requires a large amount of information. Particularly in low-income countries, property taxation tends to face considerable technical and political obstacles, resulting in it being greatly underexploited despite its widely praised revenue potential.

Yet, with pressures on local government finances continuously increasing, there is a new incentive to overcome these obstacles and make property taxation work for cities in low-income countries as well.

Maximising efficiency by mimicking market values

One approach commonly used to address issues around low property tax yields is to assess the tax base by using new ways of valuating properties. Uncovering the market value of a property has long been considered the gold standard for determining the tax base.

The concept of market value has gained prominence not just because it is easy to understand for taxpayers, but because it helps to maximise what most tax policy experts are after: economic efficiency. In principle, it is very useful, but how to get market values in places where there is no dynamic, formal, or transparent property market? How to achieve it in those places where property values are revealed through sales pricing?

Experts have thought of many ways to estimate market values using different methods: projections from existing data, knowledge of sales prices or rental charges, information about the cost of construction or expected income from the property.

Conventionally, their application has relied on the assessment of valuators, whose methods are subjective and often remain implicit and somewhat opaque.

Newer formula-based valuation approaches, such as computer-assisted mass appraisal (CAMA), seek to introduce some objectivity and standardisation into the valuation process by producing models to estimate property values. Also, they address the chronic shortage of trained valuators in low-income countries.

However, these tend to be very sophisticated and complex, using a multitude of variables on observable property features or available price data. Some of these approaches get very close to the ‘true’ market value of a property, thus providing an efficient tax base from an economic point of view. Still, the average taxpayer finds them difficult to understand in places where property markets are only emerging.

Bringing down political resistance to property taxation

For taxpayers to grasp the market value, they need to be able to comprehend how it is formed. While the newer valuation approaches have clear advantages over conventional expert valuations, they run the risk of missing an important point: what makes the concept of market value useful is not so much its efficiency, but the fact that taxpayers can intuitively understand it.

Taxpayers will not accept and resist to property taxation if the way of constructing market value becomes more obscure, abstract or complex. Diminished compliance levels and even lower yields are potential consequences from this fall-out. In the end, technical obstacles are overcome at the cost of creating new political ones.

This adverse effect can be tackled by putting more emphasis on ensuring political acceptability of property value estimates, rather than focusing on economic efficiency. This can be achieved by:

  • Simplifying methodological approaches.
  • Involving concerned taxpayers, not just experts, in the identification and pricing of value-determining property features.
  • Conducting extensive taxpayer education.

This will help bring down political resistance to taxation and, if combined with public discussions about the use of tax, can also link it to service delivery. In the end, it will not only increase compliance and revenue, but it will also help to gain a better understanding of what taxpayers truly value about their properties.