The problem of municipal revenue deficit is not insurmountable and can be addressed by increasing existing local taxes. The scope of property tax has not been harnessed in India and is plagued by under-assessment, poor collection and widespread exemptions, say Soumyadip Chattopadhyay and Arjun Kumar
Many Indian cities have limited municipal revenues and hence they fail to provide urban infrastructure and services, which in turn, come in the way of harnessing their potential as critical drivers of economic growth and development. However, the problem of municipal revenue deficit is not insurmountable and can be addressed by increasing existing local taxes and strengthening the revenue-raising capacity of municipal bodies or Urban Local Bodies (ULBs) by broadening sources. Such financially sound ULBs would then attract private investors. Property Tax (PT), levied on ownership of any building and land within the municipal area by ULBs, is a significant source of revenue envisaged for the development and maintenance of urban areas. However, PT collections are significantly lower and roughly constitute 0.2 per cent of India’s GDP, while in countries like Canada and the US, they contribute up to 3 to 4 per cent. Even a modest increase in PT can help ULBs raise revenue and enhance development.
The potential of PT is under-utilised because of under-assessment, poor collection and widespread exemptions. Most properties are valued on the basis of gross Annual Rental Value (ARV). Owing to the use of discretionary and corrupt practices, prevailing PT rates hardly correspond to their actual market value and yield very little tax revenue. Wide prevalence of the Rent Control Act has capped potential rent increases to a maximum of 25 per cent of the 1948 benchmark and has given original tenants the right to pass property on to their heirs, preventing any future increase in rent.
In fact, assessed values have been found to be approximate 8-10 per cent of the market value, with varying tax rates for different kinds of properties. Globally, PT is generally around one to two per cent of the market value of the property. However, given the under-assessment of market value in India, the PT rates would be merely a fraction of that. Deficiency in tax management is also pronounced and ULBs generally do not have any system in place to count the actual number of taxable properties under their jurisdiction or even carry out reforms and technological upgradation to the collection system.
On an average, only 37 per cent of the tax demanded is collected, with the corresponding figures being as low as 55 per cent for a city like Mumbai. In spite of penal provision for delayed payments or non-payments, ULBs rarely bring any penal action against defaulters, highlighting the role of local political economy and poor commitment. Further, exempted properties constitute approximately 10 per cent of total urban properties and about 11 per cent of assessed properties. Interestingly, PT is characterised as the tax everyone loves to hate because its visibility and other characteristics make people particularly aware of it and, therefore, any reform initiatives entail significant local political challenges and administrative difficulties. Primarily, PT reforms involve four key areas of intervention — broadening of tax base, assessing property valuation, setting tax rate and collecting taxes.
Past experiences have shown that a well-functioning tax system applies a low tax rate across a broad taxbase. Up-to-date information on properties are required for taking tough decisions like what to tax or exempt and whom to make liable for this taxation. ULBs, presumably endowed with local knowledge of land and property use, are best placed to develop such physical cadastre. Harmonising existing property records with data from utility companies, records from Government departments and digitising these dynamic databases can be useful for bringing a higher number of properties under the tax net and enhance development. Serious rethinking on PT exemptions is required to minimise revenue loss. Sometimes exemptions are justified for providing tax incentives to attract businesses. However, such incentives, as evident from experiences in US cities, may turn out to be counter-productive with a deterioration of the tax base and financial health of the ULBs. This in turn results in lower levels of urban service delivery.
Two distinct assessment methodologies in India — value-based assessment and area-based assessment (with the former being divided into rental and capital value approaches) — have failed to capture the real value of properties. Non-availability of extensive data on market transactions of properties (or the corresponding from revenue departments) makes the valuation under capital value approach inaccurate.
Cities like Bengaluru, Chennai, Hyderabad, Indore, Kolkata, Patna and Pune have introduced the Self-Assessment System as a reform measure. Self-assessment, if supported by a proper legal framework, is genuinely an appealing procedure for our cities with little administrative capacity.
However, the possibility of underestimation could produce significant revenue losses. Fair initial assessment and periodic re-evaluation of properties reflecting changes in value could be useful for addressing PT inelasticity and volatility. While most ULBs follow a progressive PT rate structure, Bengaluru and Ludhiana have a flat tax rate, with differentiation between residential and non-residential units and lower rates for owner-occupied as compared to rented houses. Differential tax rates increase complexity as well as administrative costs. Given the low administrative capacity of ULBs, a single rate may be the best option for policymakers. It is crucial to allow ULBs to set the tax rate as that would make them accountable for tax decisions at the municipal level, leading to improved municipal services with accountability.
Such PT reforms may result in major tax shifts. Attendant political resistance and public resentment can be mitigated by strengthening the linkages between local taxes and local expenditure and involving citizens at each stage of the design and implementation of municipal tax policy processes. Undoubtedly, people are happier to pay taxes when they relate them with improvements in service delivery and when they are consulted and kept informed about the reform processes and a firm, predictable policy.
Phase-in mechanism, in which tax changes are spread out over several years along with improved services, can also be used to make tax reform acceptable and sustainable. Instead of tax rebate, tax deferral schemes, that defer tax increases until the property is passed to someone else, can also be used to help asset-rich but lower income people. It is important to make people aware about PT payments by showcasing various costs and benefits of compliance or non-compliance.
The Centre’s push for urbanisation and competitiveness among cities (Smart Cities Mission), rankings (Swachh Survekshan), ratings (credit ratings of ULBs), should also prioritise empowerment of ULBs through capacity development to harness PT as a primary source of revenue.
(Chattopadhyay is Assistant Professor of Economics at Visva Bharati University and Kumar is Director of IMPRI)
