Is It the Right Time for China to Levy a Real Estate Tax?

Leading Real Estate Expert from the Chinese Academy of Social Sciences Reveals Challenges and Strategies for Real Estate Tax Implementation

For a long period of time, the real estate tax has been viewed as a major way to curb high housing prices and generate income for local governments. As a Beijinger, I have benefited from the continuously rising housing prices during the last 20 years; I remain a firm supporter of the real estate tax, which is very important for promoting social equity. In the Third Plenum resolution, we also see expressions such as “Improvements will also be made to the taxation system in the real estate sector.“ However, we have also recently seen the negative impact of a sluggish real estate market on the economy.

So, is now a good time to implement real estate taxes? If not, what measures should be taken to create that opportunity? That is why I am bringing the opinion of Dr.Yin Zhongli(尹中立), who is the director of the Real Estate Finance Research Center at the Chinese Academy of Social Sciences. He is also a counselor to the State Council, specializing in real estate finance and the capital market. This piece was first published in The Chinese Banker magazine.

Here I attached the link to the Chinese ver of the article: https://mp.weixin.qq.com/s/t8PZtGs1Ppc-9-YUh_pSWg

Dr.Yin Zhongli

Challenges and countermeasures in levying real estate tax

The Purpose of Property Tax

Property tax is a levy on real estate ownership, typically based on the assessed market value of the property and collected annually from owners or users. It goes by various names globally, such as "property tax" in the United States, "council tax" in the United Kingdom, and "rates" in Hong Kong. Approximately 187 countries and regions worldwide impose this tax.

The concept of property tax has deep historical roots. Ancient China, for instance, had similar forms of taxation. The Tang Dynasty implemented the "jian jia tax," the Song Dynasty had the "house tax," and the Qing Dynasty imposed the "jia fang tax" and "house levy," all of which were essentially property taxes on housing ownership.

Property tax can play a crucial role in balancing capital gains and labor income, fostering a healthy economic cycle. Global experience demonstrates that financial crises are often triggered by the real estate market. When this market expands, it stimulates credit and monetary growth, leading to rapid economic and wealth accumulation. If managed effectively, real estate market expansion can achieve full employment, accelerate industrialization and urbanization, and create a positive cycle in fiscal and financial systems. However, rapidly rising property prices can also lead to a quick increase in household debt, potentially squeezing other industries, distorting the economic structure, and in severe cases, precipitating financial crises.

Since 2009, China's macro leverage ratio for households (household debt to GDP) has risen dramatically from 23.4% to 63.5% in 2023, an increase of 40.1 percentage points in just 13 years. This rapid rise in household debt correlates with a sharp decline in consumption growth. The excessive expansion of the real estate market has not only led to massive debt but also resulted in an imbalanced distribution of social wealth, contributing to financial instability.

Property tax, along with complementary measures such as inheritance tax, can effectively regulate excessive capital gains and promote a healthier cycle among real estate, the economy, and finance.

Property Tax Legislation and Implementation Practices in China

In January 2011, the concept of "property tax" was officially introduced in China, with Shanghai and Chongqing simultaneously launching pilot programs that levied taxes on personal housing. By late 2013, the Third Plenary Session of the 18th Central Committee of the Communist Party of China (CPC) reviewed and approved the "Decision on Major Issues Concerning Comprehensively Deepening Reforms," proposing to "accelerate property tax legislation and promote reform at an appropriate time." This marked a shift in terminology from "house property tax" to "real estate tax."

The Fifth Plenary Session of the 19th CPC Central Committee, held in October 2020, passed the 14th Five-Year Plan and Long-Range Objectives Through the Year 2035, explicitly including "advancing real estate tax legislation" as a key focus.

On October 16, 2021, the "Qiushi" journal published an important article by General Secretary Xi Jinping titled "Solidly Promoting Common Prosperity." The article emphasized the need to actively and steadily advance real estate tax legislation and reform, as well as to implement pilot programs effectively. Shortly after, on October 23, the 31st meeting of the Standing Committee of the 13th National People's Congress authorized the State Council to carry out real estate tax reform pilot work in select regions over a five-year trial period. The implementation start date was left to the State Council's discretion.

Current Challenges in Implementing Property Tax

Exacerbating Debt Risks for Real Estate Companies

Since 2021, major Chinese real estate developers such as Evergrande, Sunac, and Country Garden have faced severe financial crises. By late 2023, over 60 of the top 100 real estate developers by asset size had defaulted on their debts, indicating a widespread, rather than isolated, financial crisis in the sector. These developers typically employed a "three high" business model—high debt, high leverage, and high turnover. This strategy maximized profits when land price increases outpaced debt costs. However, when land price growth fell below financing costs or when financing growth was restricted, developers faced significant cash flow problems.

The current real estate market has entered a preliminary "negative feedback" loop. Debt defaults have prompted financial institutions to restrict loans to the real estate sector actively. Combined with declining sales, real estate developers are experiencing tight capital chains, leading to failed land auctions. Introducing a property tax in this context could potentially exacerbate market expectations and intensify this "negative feedback" loop.

Some argue that while property tax collection may have short-term impacts on the housing market, long-term effects would be minimal. This perspective draws on experiences from countries like the United States, Japan, and South Korea, as well as pilot programs in Shanghai and Chongqing. However, China's current situation differs significantly from South Korea's in 2005, and the relevance of the decade-old pilot programs in Shanghai and Chongqing is limited. In 2005, South Korea's real estate market was in an upward cycle, whereas China's market was transitioning from an upward to a downward cycle. Moreover, the pilot programs in Shanghai and Chongqing had a narrow tax base and did not include existing housing stock, limiting their comparability to a potential nationwide implementation.

Potential Impact on Market Stability

Implementing a property tax could potentially lead to increased housing rents, directly impacting the sense of economic well-being among young people. Currently, the rental yield for residential properties in China's first- and second-tier cities averages only about 1.7%, significantly lower than mortgage loan rates (3%) and long-term government bond yields (approximately 2.5%). The introduction of a property tax might prompt landlords to pass on these additional costs to tenants through higher rents.

For properties where increased tax costs cannot be transferred through higher rents, the elevated holding costs might force owners to sell. This could potentially cause significant short-term fluctuations in housing supply and demand in certain cities. Since early 2024, housing prices in some Chinese cities, including the four first-tier cities, have been declining at an accelerated rate. Introducing a property tax in this context could further destabilize the market's supply-demand balance, potentially leading to a sharp decline in land transfer income and consequently affecting local government fiscal revenues.

Further Land System Reform Needed for Property Tax Implementation

The legal basis for collecting property tax is a crucial theoretical question that must be addressed. International experience shows that countries with private land ownership often emphasize the public nature of land as the legal foundation for property tax. The essence of property tax is to levy on land value appreciation. Property tax revenue is typically allocated to municipal construction, education, public security, and other public goods related to housing.

In China, however, land is publicly owned, and commercial housing land is leased for 70 years. Developers pay a one-time land use fee for this 70-year period when purchasing land. Theoretically, as land use rights are limited to 70 years, the land value should depreciate over time, potentially negating the need for property tax to ensure fairness.

A related issue is the property rights of "limited property rights" houses, which are prevalent in China. If property tax pilots do not cover residential buildings on rural collective land, then these "limited property rights" houses would also be exempt from property tax. This exemption could indirectly increase the market value of these houses and potentially stimulate the creation of more.

Shenzhen provides a striking example, where "limited property rights" houses account for approximately 50% of the total existing housing stock. If these houses are not taxed, half of Shenzhen's existing housing would be exempt from property tax. The city's "limited property rights" houses have historical reasons for their existence, and integrating these numerous properties into standardized management channels has been a significant challenge for Shenzhen's housing management department. If the issue of "limited property rights" houses remains unresolved, Shenzhen's property tax reform could lose its effectiveness.

Recognizing land ownership rights for residential properties or acknowledging property rights for "limited property rights" houses built on rural collective land would require substantial changes to existing legal provisions. This presents a significant challenge in implementing a comprehensive and fair property tax system in China's unique land ownership context.

Policy Recommendations

First, resolving the existing risks in the real estate industry should be the urgent priority. Implementing widespread property tax pilots at this juncture carries risks that far outweigh the potential benefits. Adhering to the principle of "steady progress," pilot cities could be limited to a small, carefully selected range. Given that Shanghai and Chongqing conducted property tax pilots a decade ago, these existing rules could be refined and expanded to additional areas. Shanghai's experience can serve as a reference for other first-tier cities, while Chongqing's can guide second-tier cities. Consider selecting multiple prefecture-level cities and counties in diverse regions for pilots, thereby accumulating valuable experience for eventual implementation in third and fourth-tier cities nationwide.

Secondly, property tax collection involves sensitive issues such as land use rights duration and property rights for "limited property rights" houses. Shenzhen could be chosen as a pilot city, advancing property tax reform in tandem with reforms to recognize these houses.

The Third Plenum of the 18th Central Committee of the Communist Party of China mentioned, "Policies will be formulated for extending land use rights for industrial and commercial purposes and for renewing them upon expiration." This suggests that extending land use rights might be a viable solution to address some of these challenges.

Legalizing "limited property rights" houses would inevitably impact commercial housing prices in Shenzhen. Drawing from the 2005 stock market "share structure reform" experience, owners of these houses could transfer a certain percentage of housing to Shenzhen's housing security department free of charge as a prerequisite for legal circulation. These houses could then be gradually released for circulation in batches to minimize market disruption.

This approach would allow for a measured, controlled implementation of property tax reform while simultaneously addressing the complex issues surrounding land use rights and "limited property rights" houses. It would provide valuable insights and experiences that could inform a broader, nationwide implementation in the future.