Author: Fan Gang, President, CDI
Editor’s Note: The 15th "China Reform Forum" was hosted by the China Society of Economic Reform in Beijing on December 2, 2017. The theme of the forum was "to learn from and implement the spirit of the 19th CPC Congress, study and make breakthroughs in the reform of key areas". Professor Fan systematically analyzed the necessity of the property long-term mechanism at the conference.
Despite that short-term policy may work under certain conditions, ultimately long-term mechanism must be established to stabilize the market. As seen in the current huge demand for properties, housing demand is far from exhaustion. The high rate of property ownership in China only reflects the underdeveloped rental market, not the exhausted demand. In addition to residential needs, there are also non-residential needs. Problem arises when people invest in property with small intent for letting, which is resulted from the bubble in the property market and the pursuit of value appreciation in properties. In the absence of a mechanism to increase the cost of property ownership, such demand has not been curbed. Therefore, the most important long-term mechanism on the demand side is property tax.
Property tax has three functions. First, it will increase the cost of ownership, and reduce investment demand. Second, it is the internal stabilizer of price fluctuations. Given the same tax rate, the tax on the property will vary based on the current value of the house. When housing price skyrockets, some people will choose to withdraw from the market or switch to smaller ones due to higher tax. This is fully reflected in other countries’ mechanisms. Third, currently, taxes paid upon purchasing the property included future public services such as environmental conservation and transportation maintenance. With the increase in land price and labor cost, the costs of these public services will also increase along with the economic development. Therefore, the current lump-sum tax upon purchase is unreasonable.
Property tax policy must be implemented rationally with a transitional period. For example, for the properties that have paid lump-sum tax upon purchase, property tax should be collected after a ten to twenty-year transitional period when the lump-sum is discounted to present value. Meanwhile low-income property tax deduction can be integrated into construction tax, or grants for suitable personnel which is similar to the minimum living security.
On the supply side, in terms of inhabitable area, China faces severe scarcity of land and its habitable area per person is one third of the world average, combined with other human factors such as regime, strategies, and policies, causing short supply of land and houses. Such circumstance is mainly reflected in the following four aspects. First, the current plot ratio in China is too low. More buildings should be constructed on the limited land to improve efficiency. Second, some local governments should be held responsible for failure to supply land when housing prices rise and its aftermath. Third, property developers acquire land at high prices while housing price is the derivatives of land premium. Four, the rental market is underdeveloped as the result of insufficient supply of affordable rental properties and inadequate legal system that protects the interest of both landlord and tenant.
Last but not least, land allocation system, specifically allocation between major and small cities, is a problem of divergence of urbanization strategy. In the past, the development of small cities was given priority. Small cities were granted large quantity of land while the supply of land to major cities was restricted. However, the majority of people migrated to major cities while middle-sized and small cities, especially third and fourth tier cities, are where the population outflows. Recently, China Development Institute conducted a study on industrial transfer. The central government had policies in place to encourage industrial transfer and identified over 60 cities to be the industrial transfer destinations. For over ten years, 87% of the transfer was to provincial capitals but barely to small cities. Since better services, infrastructure, human resources and logistics services are only available in major cities due to the agglomeration effect and cluster effect, various industries are brought into major cities along with numerous employment opportunities. Therefore, to pursue a better life, people have to migrate to major cities.
To improve the property system, market-oriented strategy is necessary. First, market based resource allocation should take effect, instead of government undertaking. Second, stabilized market does not entail fixed price. Growth of income and predetermined land supply indicates that the relative price of land is basically GDP. If GDP increases constantly, the land price will increase and then the housing price. As such, what truly needs to be stabilized is the proportion of income to housing price. Measures should be taken on both sides of supply and demand while long-term mechanism should be established to gradually achieve long-term market stability of supply and demand.