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Working Group on Public Sector Finance and Accounting /  

Property taxation in CEE and CIS countries

Research Protocol 2008

Goals, Aims and Objectives of the Proposed Research

In all CEE and CIS countries where the transformation of the planning economy has phased in some degree of decentralisation of the state, improvement in local fiscal capacity has become an emerging issue. Different segments of this topic have already been discussed by the working group in the past, such as: grant transfers (Cracow 2001); local government revenue raising capacity (Bucharest 2003); user fees and charges (Vilnius 2004) and local borrowing (Ljubljana 2006). Different types of local taxes were described within the theme of revenue raising capacity. However, we should pay more attention to those local taxes which are widely used in most countries but poorly developed in CEE and CIS countries. To study such taxes may help to assume the local revenue potential from these taxes, but it may also identify the main barriers of a more effective use of these taxes in the countries cited.

Tax on immobile property is the most widely utilised local government revenue across the Anglo-Saxon world including the countries of the Commonwealth. It is not surprising that World Bank, OECD and various aid programs’ (US Aid, Canadian Aid, British Know-how Fund) studies have proposed developing an ad valorem property tax system as a fundamental basis of local revenue over the period of the last 15 years. Based on the strong property tax tradition in these countries, they are right. Literature on tax theories (Oates 1972, Musgrave 1989, Bird and Slack 1993 etc.) have usually listed more advantages of the property tax as a local revenue than disadvantages. However, 15 years after the World Bank study on guidelines and recommendations for urban property tax reform (Dillinger 1991) and a series of proposals by expert reports for CEE and CIS countries, no significant changes have emerged in the use of property tax in these countries and the tax, if levied at all, has remained marginal. This situation raises the question of a more efficient tax in quite a different historical and cultural background.

The main goal of this research is to critically examine the property tax as a traditional system of taxation, the type of local revenue and the procedure of taxation (tax administration) in the context of fiscal decentralisation in the CEE and CIS countries. The final outcome of the research should be 10-12 country papers using this protocol and presented in Bratislava in 2008. The aim is toissuea book in 2009, which would include a final version of all accepted country studies and a comparative study as a first chapter of the book.

Structure of the country papers

The papers have to be up to 12,000 words long (including references and appendices). The authors highly encouraged to be prepared to produce a shorter version of up to 8,000 words as journal articles. Please, try to adhere to the set limit, as this enables preparation of any intended future publication.

The national papers should have the following structure:

1. Introduction

In the introduction the authors have to clearly set out the goals, aims and objectives of their research, what might be the main issues (research questions) that they plan to tackle and how this is going to be done, with a list of expected outcomes. It is acceptable to discuss very briefly the main problems dealt with in literature and how this may relate to their research. It is expected that all authors will demonstrate a very good knowledge of related literature in both local language and in English. At the end of the introductory section the author should set out the remaining of the paper (paper structure).

2. Government Structure and Intergovernmental Relations

In this section the authors will present an institutional framework of the country they plan to focus on. The chapter has to describe the government structure and the intergovernmental fiscal relations.

2.1. Government Structure

Regarding the political nature of the public administration system, CEE countries replaced the Soviet type council system to a local self-government system. The starting point by time of this transition can be different country to country depending on the introduction of Act on Local Government (or the law regulating the municipal level of self-governance). What year the new act came into force?

The chapter has to reflect the direction of changes. What are the most important factors of the transition? For example the Hungarian case has the following characteristics:

- transfer of responsibilities from higher level governance to lower one (e.g. hospitals from the medium level to the local one, fire brigade from national level to the local one)

- transfer of state property to municipal property, and installation of local property (asset) management

- change of the method of local budgeting: from expenditure oriented to revenue oriented

- regulation of local tax by a frame law instead of ministerial decrees

- the government owned municipal bank was replaced by free bank choice and free access of money and capital market for LGs

It has also to discuss the structure of government. Was there any change at the starting point of the new system by the number of government levels? What is the direction of changes in this respect, if any? (E.g. In Poland the public administration reform set up regions in 1999. Hungary replaced the centralised council system with a very fragmented LG system. Over the transitional period the system has become more fragmented.) A table about the changes in the government structure welcomed here. It should indicate the number of government unit regarding each sub-national government level, and the average number of population in the year of 1990 (or the year of the Act on Local Government), 2000 and 2006.

Finally, this chapter should provide information about the duration of election period. Whether national and local elections are the same day or year or there are one or two years difference between the elections of different government level? How the mayor is elected (directly by the citizens or by the elected body or appointed by the president/prime minister etc.)? How many local election periods have finished since the start of the new system? What are the characteristics of political colours from election to election at the local level?

2.2. Intergovernmental Fiscal Relations

This subsection is presenting and analysing the nature of the relationship between the central and local governments. Before that it should indicate the relative importance of LGs within the government system by the share of expenditure in the GDP. Time series are expected (as long as possible).

	1990*	..			2006**
GDP in current price (in national currency)
Expenditure of National Government as percentage of GDP (%)
Expenditure of medium level government as percentage of GDP (%)
Expenditure of Local Government as percentage of GDP (%)

* or the first year of the LG system; ** or the latest available data

It is also very important to analyse the rate of fiscal decentralisation by the central government transfers. It is recommended to explain by the following ways. First, the relative importance of municipal grants in the central government expenditure, and second, the relative importance of government transfers in the local budget. The analysis should look at the time series data in real term to using the Consumer Price Index (CPI) for deflation.

	1990*	..			2006**
Current price (in national currency)
1. Expenditure of CG
2. CG grants to LGs
3. CPI (1990=100*)
Real term (in national currency)
- Expenditure of CG	1/3
- CG grants to LGs	2/3
Share of CG grants in CG expenditure (%)	2/1

* or the first year of the LG system; ** or the latest available data

What are the main types of central government transfers? How the distribution of CG grants has looked like over the period of transition? Is there any fiscal norm or formula for equalisation due to the grant system and/or shared revenues?

2.3. Composition of LG Revenues

This chapter indicates the evolution of the revenue structure of LGs over the transitional period. The analysis should focus on the most relevant changes: fast growing components, hardly decreasing components. The table behind should combine the following revenues as the percentage of total annual revenues:

	1990**	..		2006***
1. Own revenues
2. From this: property tax(es)
3. Shared taxes
4. From this: PIT*
5. CG grants
6. From this: Block grants
7. Specific grant for capital expenditure
8. Other revenues
9. From this: Loans/bonds
Total = 1+3+5+8	100,0

* or the most relevant type of shared tax

** or the first year of the LG system; *** or the latest available data

3. Historical Background

In most country the taxation on immobile property is not a completely new phenomena. It has some tradition, possible before the Communist period or even under the Communist period. If it so, what form(s) of property tax existed in the past? What are the major milestones in the evolution of property taxation in the country?

Does the regulation of property taxation changed parallel to the start of LG system? If it so, this chapter should provide a comparison of the old and the new regulation. What are the main differences between the old and the new system for example by the legal framework, object of the tax, taxpayers, rating system, definition of exemption, tax collection, incentives (benefits) of tax administration?

4. Property Tax as Revenue

This chapter has two objectives. First is to analyse local property tax as the part of the national tax system, and as a component of LG revenues. Second is to implement a tax incidence analysis of the property taxation.

4.1. Property Tax in the National Tax System and in LG Revenues

The chapter provides information on the importance of property tax within the national tax system based on the share in the GDP in selected years over the transitional period.

(%)

	1990*	1995	2000	2006**
Social Security Contribution
Indirect Taxes
- Value Added Tax
- Sales Tax
Direct Taxes on Income
- Personal Income Tax
- Profit Tax
Custom duties
Duties
Local Taxes
- Property Tax(es)

* or the first year of the LG system; ** or the latest available data

The second dimension of this picture is looking at property tax as part of the national and local revenue system. The analysis also uses relative figure here based on the following table:

	1990**	1995	2000	2006***
Local taxes
- as percentage of total taxes
- as percentage of total local revenues
Distribution of local taxes*
- Income tax as percentage of total local tax revenues
- Sales tax as percentage of total local tax revenues
- Property tax as percentage of total local tax revenues

* Figures may not add to 100% owing to ’other’ taxes

** or the first year of the LG system; *** or the latest available data

4.2. Tax Incidence Analysis

A simplified analysis of tax incidence through the term of “formal” and “effective” incidence evaluates taxes in four steps (Musgrave and Musgrave 1989):

1) Formal incidence is the immediate answer to the question “Who pays the tax?”

2) Effective incidence includes the taxpayers’ reaction to the tax and its consequences.

3) Problem of tax evasion and avoidance measures the potential distortion of tax capacity.

4) Changes in price level show significant effects of tax when progressive taxes are being levied in times of rapidly changing prices and money income.

To turn into practice this analytical framework we extend the list above and build up an economic and financial tax analysis framework. The chapter is going through this analysis step by step. Potentially, it compares property tax with other type of local tax or other type of national tax like PIT or Profit Tax. For comparison, it is helpful to use the following categories characterising the relevance of each factors of the analysis:
H – high, M – medium/moderate; L – Low.

Criteria	Description of the Criteria/indicators	Property Tax	Income Tax
Formal incidence: Who pays the tax?	owners/tenants, local residents/foreigners households/businesses
Effective incidence:
A) Economic analysis
- Efficiency
by scale (yields)	the yields of tax revenue and share of collected tax in the total local revenues
by distortion of local economy	people/businesses move from the jurisdiction
- Equity/Fairness	measured by the exemptions
by horizontal	exemption applies to all taxpayers
by vertical	exemptions applies to same group of taxpayers or progressive rating
B) Financial analysis
- Limitation	A self limit is the number of tax unit/taxpayers or the size of tax object. Limit by the law e.g. regarding rating (maximum rate, minimum rate)
- Flexibility	The right to change the rate setting, to install exemption by LG
- Avoidance, tax evasion	Taxpayers avoid and evade paying tax measured by rate of collection (levied tax/collected tax)
- Reliability	Difference of budgeted and realised tax yields. If the difference is large, it is hard to estimate the tax revenue for the next years/periods (unstable budgeting)
- Volatility	The change of tax yield from each year to other. If there are high waves year to year, it is hard to estimate the tax revenue for the next years/periods (unstable budgeting)
- Elasticity	How tax yields reflects to the change of income of taxpayers or the number of tax payers? (income elasticity, population elasticity)
- Cost of administration	What is the share of tax administration costs in the tax revenue

5. Property Tax as Procedure

To implement property taxation the administration has sequences of tasks (Dillinger 1991, McCluskey 1999):

- Identification

- Classification

- Valuation

- Assessment

- Rating

- Collection

- Enforcement

- Appeals procedures

This chapter describes that procedure in the selected country. The description has to reflect on each step of property tax procedure.

Identification:

The basis of the whole system is an accurate cadastre of immobile property within tax jurisdiction. This is nowadays a computerised, periodically revised list of properties. Tax administration should identify from this list the tax objects as potential tax base. Usually the law which has regulated property taxation provides a list of exemptions. Potentially, LGs have also right to declare exempted properties. Most widely exempted properties are the government owned properties, agricultural and forestry land, and in some cases vacant land.

Classification:

Based on the objective of the local tax policy immobile property has different features, market position, tax-paying ability of the owner or the tenant. That is why tax administration classifies the identified immobile properties: The main categories have usually been: residential property, non-residential property or improved land (plot and building) and unimproved land (vacant land). Non-residential properties can be divided into sub-categories like industrial property, commercial property, shops, garage etc.

Valuation:

The basis of the tax is normally established by laws. There is a great variety in the international practice with regard to approaches employed in ad valorem property taxation. There are essentially three basic forms of ad valorem property taxation: 1. the tax may be levied on the annual rental value of the property; 2. the improved capital value; 3. or the site value of the land excluding improvements. The alternative to ad valorem based system is to base the tax on the physical area of the land and buildings.

Assessment:

The assessment procedure modifies the value of the property. It has usually given a lower value the property which is politically more favourable as final tax base. The assessment component is essential in terms of promoting fairness and equity within the property tax system. The assessed value provides the basis upon which the tax levied therefore, it is important to develop valuation methodologies which are robust, cost effective and transparent.

Responsibility for assessment function can normally be classified into three broad groups. Firstly, a centralised sate or nationwide valuation department, secondly, each individual local authority, municipality or city undertaking the assessment function and finally the use of private firms to either assist in the process or to provide a complete service. Some combinations are also possible.

Rating:

Tax rate may be prescribed by law or alternatively determined by the level of expenditure which must be met by property taxation. Normally the basis of the tax is fixed percentage of the assessed value which is annually. Where the tax rates are set by municipal authorities there are instances where central government limits the maximum rates. In relation to local autonomy, there is a general acceptance that each local government should have discretion in terms of determining their own rates as opposed to a uniform national rate. Tax rates can either be proportional or progressive. Differential tax rates can be applied to property according to the use and location and between land and improvements.

Collection:

The collection system attempts to ensure that the tax levied is actually paid with the dual objectives of maximizing prompt payment and minimizing delinquency and arrears. Collection system is varying country to country. In each country collection provided by the higher level or national tax administration, other countries this task belongs to the local tax administration. Practical experiences show that a comprehensive system of collection and enforcement relies on a range of incentives (to avoid corruption), sanctions and penalties, or a combination.

Enforcement:

The range of enforcement procedures tend to be fairly standard across most countries. Unpaid taxes normally become a first charge or lien against the property. Where the property tax payments are in arrears, the debt outstanding accrues a penalty based on either a fix monthly rate or on a sliding scale to the relative to the length of time the tax remained unpaid. Penalty rate is usually some per cent of the total debt per month. Legislation in most countries tends to permit the seizure and sale of goods and chattels belonging to the taxpayers, in addition the subject of property can be seized and sold at public auction, although, this action is normally one of last resort. Other mechanism to recoup delinquent taxes can involve the attachment of wages and salaries or property rents payable to the defaulter.

Appeals procedures:

The appeal system normally comprises two distinct elements. Firstly, appeals can be made against a new valuation list/roll prior to its coming into effect and secondly, appeals against revised assessment made during the currency of the valuation list/roll.

Computerization:

Property tax administration, i.e. cadastre system, collection and assessment, lends itself to highly automated computerized systems. In fact, it is almost essential to have such systems if the property tax is to be administered efficiently, as the large number of properties and taxpayers create problems of scale which can more readily be handled by the processing capacity of computers.

6. Case Study

This chapter provides a short case study on the existing property taxation system at a particular local government. The chapter should discuss two issues. The first characterizes the selected municipality; the second identifies a kind of local tax policy if any.

6.1. Characteristics of the selected municipality

The selection of the LG of the case study is based on the population size of municipality. It cannot be less than 10,000 inhabitants. This size of municipality may have a complex system of local services, financial system behind and local administration capacity.

The subchapter has to give a short overview of the selected municipality first by geographic location part of the etc, size of population, economic structure (the feature of the place e.g. industrial city, religious centre, tourism center etc.).After that it needs a short description of responsibilities of the selected LG. The description should based the table of the expenditure of the municipality by distribution of functions (running costs, capital budget) and sectors (education, social services etc.). The description should reflect the national average figure, too. The description should apply the same time series as happened in the second chapter of the study.

The second part of this chapter investigates the revenue distribution of the LG, again in a comparison with the national average by relative figures. The analysis should focus on the rate of fiscal autonomy of this particular LG by the weight and composition of own revenue sources including local taxes and particularly property tax.

The third part of this chapter has to describe the administration of local taxation, including property tax: place of tax administration within the organizational structure of the municipality, human capacity of local tax administration, division of labor within this unit focusing on capacity turn on property taxation; description of procedure of tax administration regarding the property tax, computerization of the local taxation (which part of the procedure is computerized).

6.2. Identification of local tax policy

Naturally, it can happen if LGs have space to choose between options regarding taxation and particularly regarding property taxation, like LGs have right to decide on

- the type of levied tax (who is taxed households, businesses, non-residents like by some types of local taxes on tourism),

- rate setting within the limitations set up by law,

- exemptions (what group of taxpayers are exempted or should pay lower rate and why) etc.

The analysis also has to reflect on the following questions:

- It is possible to identify a clear relation (written strategy or local tax code or the description of the annual budget) between local tax revenue and a special part of the local expenditure?

- Is there a possibility of taxpayers to earmark of spending of their paid tax?

- Does this particular LG regulate the incentives of local tax administration?

If property tax is used as a general revenue source and goes to finance expenditure benefits it is not always in close alignment with tax contribution. Local tax policy thus involves a difficult choice between: 1. the gain to be derived by shifting tax burdens to outside through the taxation of capital owned by “foreigners”; and 2. the danger of loss to the local economy from the flight of “foreign” capital.

These approaches rise two serious effects among jurisdictions and within jurisdictions: 1. By the way of “tax exporting” residents of particular locality may able to get out-siders to absorb part of the cost of their own local services; 2. The problem of “tax competition” may cause a tendency toward less than efficient levels of output of public services. In an attempt to keep tax rates low to attract business investment, local officials may hold spending below those levels for which marginal benefits equal marginal costs. (Oates 1972) This condition, however, does not apply to local finance and local property tax only.

7. Summary, Policy Recommendations

The last section has to sum up all the major issues raised in the paper and provide a critical analysis regarding property taxation in the framework of fiscal decentralisation and the local political environment. The papers have to be academically strong, but at the same time policy-oriented, offering a credible policy advice. Authors have to discuss the major debates and policy recommendations related to property taxation in the last 3-5 years. It is important to emphasise that what is the role of the Parliament and Central Government to improve local property tax system, and also to define what LGs must and/or able to develop regarding this issue (proposed changes). The concluding section is also to point out possible avenues of future research, trying to align the current trends in (Western) literature to the specific developmental experiences of CEE and CIS countries and their national specifics.

Conclusion

The aim of the project is to assess property taxation as local revenue raising tool in CEE and CIS countries. The World Bank, IMF and different aid programs related to the development of local democracy and local government (finance) system has proposed the improvement or introduction of ad valorem property tax both for Third World Countries and the transitional CEE and CIS countries. Anglo-Saxon traditions are based on the value base property taxation. CEE and CIS countries where local property tax existed in any time, it has usually been area based property taxation. How those countries reflected to this. Is there any effort to utilize this revenue sources more effectively in these countries? Is it really a need to change the traditional area base taxation to an ad valorem one to do that? This research is contributing to this debate by the analysis local property taxation in the framework of fiscal decentralisation, and also in the environment of local decision making. It is hoped that some regional good practices can be established and that common public policy framework can be offered as a result of large scale comparative research.

References:

Bird, R. M. and Slack, E. (1991) Reasons for Decentralisation of Government, In: Owens, J. and Panella, G. (ed.). Local Government: An International Perspective. Amsterdam, etc.: North-Holland, pp. 83-95.

Dillinger, W. (1991) Urban Property Tax Reform - Guidelines and Recommendation, Washington, D. C.: World Bank

Hőgye, M. ed. (2000) Local and Regional Tax Administration in Transition Countries, Budapest: Local Government and Public Service Reform Initiative. Open Society Institute

Kopányi, M. at al ed. (2004) Intergovernmental Finance in Hungary – A Decade of Experience 1990-2000, Washington, D. C.: IBRD/World Bank

McCluskey, W. ed. (1999) Property Tax: An International Comparative Review, Aldershot UK: Ashgate Publishing Ltd.

Musgrave, R. A. and Musgrave, P. B. (1989) Public Finance in Theory and Practice, 5th ed. New York: McGraw-Hill.

Oates, W. E. (1972) Fiscal Federalism, New York, etc.: Harcourt Brace Jovanovich

World Bank. (1999) Reform Toward a Value-based Property Tax: Fiscal and Non-Fiscal Benefits in Transitional Economies, Washington, D. C.: World Bank

The Working Group on Public Sector Finance and Accounting is supported by a grant from The Local Government and Public Service Reform Initiative Open Society Institute, Budapest, Hungary http://lgi.osi.hu/