GOVERNMENT POLICIES : SUBSIDIES AND TAXATION

Key Messages
 Housing plays a key socio-economic role and represents the main wealth of the poor in most
developing countries
 3 billion people will need new housing and basic urban infrastructure by 2030, according to UN-
Habitat. Without available and affordable housing financing solutions, many urban poor can't get
decent formal housing.
 Our work in housing finance helps clients provide market-based safety nets, and fund long-term
investments to support sustainable economic growth.
Subsidies Overview:
Housing plays a key socio-economic role and represents the main wealth of the poor in most developing
countries. The UN estimates that the global population will reach 8.5 billion by 2030, with almost 60% of
the population living in urban centers. An estimated 3 billion people will need new housing and basic
urban infrastructure by 2030. Against the backdrop of rapid urbanization putting pressure on housing
delivery systems, many urban poor will not be able to afford formal housing without proper housing
finance solutions. This puts the issue of housing finance at the forefront of global development agenda.
Housing Finance business line assists clients in developing and deepening resilient and affordable
housing finance markets that are accessible to the lower & informal income and middle-income
households. This requires managing risks and regulating the lending industry, as well as implementing
targeted and fiscally responsible policy interventions. The business line is important because it provides
economic stimulus across the economy – leverage on growth, investment, and jobs – through the
constructive value chain, helps in maintaining overall financial stability (housing finance markets
representing a large share of the financial sector), and addresses the issue of urban poverty.
What World Bank Do:
They work on a variety of housing finance development challenges by providing client countries with the
tools to build and expand housing finance markets, fund housing finance (often through the mobilization
of long-term mortgage securities where possible), develop sustainable and affordable housing finance
markets, and respond effectively to housing finance crises.
Their Core interventions include:

 Developing Resilient Housing Finance Markets: They conduct diagnostic analysis, advise on
legal & regulatory frameworks and policy reforms, support institution building to create a
sustainable and efficient housing finance system, and work on other building blocks of housing
finance markets development.
 Designing and Implementing Long-Term Funding Solutions: They provide solutions to
improve access to long-term finance through capital markets instruments such as liquidity
facilities and covered mortgage bonds as well enhanced systems to incentivize longer-term
savings. They also help diversify long-term funding options, including through local currency
bond markets.
 Expanding Access to Lower-Income and Informal Markets: They enhance access to lower-
income and informal workers’ segments of the population through credit markets, housing
microfinance, rental housing, residential leasing, contractual savings, effective targeted subsidies,
and guarantee schemes.
 Addressing Obstacles to Affordable Housing: In addition to the finance side that affects the
demand, affordability reflects the cost of housing and its supply, so increasingly, they work on
various supply side issues: tilting, land use and land infrastructure issues, construction finance,
and housing policies including supply subsidies. Furthermore, they apply innovative thinking to
reduce costs – both financial and environmental costs – of formal housing through the
introduction of new, cheaper, technologies and supporting energy-efficient buildings.


How to measure expenditures on housing subsidies?

Subsidies on budget: expenditures on those subsidies should be forecast, allocated and monitored and
they should be easily obtainable.

Subsidies through tax code provisions: Measuring the implicit expenditure in this case is not
straightforward. An accurate measure would need to rely on models incorporating the whole tax (and
benefit, in the case of the household) system, to account for behavioral responses of agents to changes in
the tax system. As a rule, those responses do matter in determining the magnitude of the changes in tax
revenues. However, this approach is rarely used because it is both time and data-consuming. This is not
always obvious. Although controversial, this simple method is very often the only one available. Since it
usually gives at least correct orders of magnitude, it should be used when more detailed estimations are
not available.

Land subsidies: Very often land is given or sold at below market price to producers or directly to
households. In this case, the amount of subsidy should be computed from evaluating a market price for
the land, from which the price paid by beneficiaries will be deducted. Interestingly, in some countries the
size of those subsidies is not computed by the government, because state-owned land is perceived as a
“free” resource, at least in the short run. The issue one may face here is that so much land is publicly held
and allocated that it is not clear what the “market” price should be.

Direct subsidies through housing finance instruments: Frequently, instruments of housing finance
such as Housing Contract Savings Schemes (HCSS) serve as vehicles for housing subsidies, or have been
subsidized to ensure their [Link] is not directly concerned with housing finance; however, the
subsidies or premiums given to households should be included in the total amount of housing subsidies.
The availability of figures in that case will vary by the type of instrument, but can be expected to be high,
since those subsidies are typically budgeted.

Indirect subsidies through finance instruments: This includes the value of State commitments on
instruments such as mortgage insurance schemes, liquidity facilities, hedging instruments for mortgage
lenders, etc. Pricing those products (which in the case of guarantee schemes amounts to estimating the
contingent liabilities faced by the State) is possible in theory, and is effectively done under private
schemes. Historically, however, this type of instrument is initially introduced by the State, and
subsequently taken over by the private sector.
Taxation
What is Taxed?

Property taxes are generally levied on all types of properties – residential, commercial, and industrial, as
well as on farm properties. Sometimes different categories of property are treated differently. 4 below.
Sometimes certain classes of property, or property owner, or uses of property, are exempt. Sometimes
land only is taxed.

Some countries tax only land. A few tax only buildings. Most tax both land and buildings (or
“improvements”), usually together but in some countries (e.g. Hungary) separately. Some also tax
machinery (or “tangible business assets”).

How is It Taxed?

Area-based Assessment

Under an area-based assessment system, a charge is levied per square meter of land area, per square meter
of building (or sometimes “usable” space), or some combination of the two. Where measures of area are
used for both land and buildings, the assessment of the property is the sum of an assessment rate per
square meter multiplied by the size of the land parcel and an assessment rate per square meter multiplied
by the size of the building.

The tax rate is set at 8 percent if there are one to two services; 10 percent if there are three to four
services; 12 percent if there are five to six services; and 14 percent if there are other services or
better quality services.

Market Value Assessment

Market value (or capital value) assessment estimates the value that the market places on individual
properties. Market value is defined as the price that would be struck between a willing buyer and a willing
seller in an arm’s length transaction.

A variation of the market value approach is used in the United Kingdom. Under the British council
tax, the value of each residential property is assessed and placed on a valuation list in one of eight
valuation bands. The value assigned to each property only indicates the valuation band and not the
actual value of the property. Any change in value because of a change in house prices generally
does not affect the banding.

Rental Value Assessment

Under the rental value (or annual value) approach, property is assessed according to estimated (not actual)
rental value or net rent. One rationale for using rental value is that taxes are paid from income (a flow)
rather than from wealth (a stock) and thus it is appropriate to tax the net rental value of real property.

There are some problems with the use of rental value assessment. First, it is difficult to estimate rental
value when there is rent control. Controlled or subsidized rents cannot be directly used to assess market
rents unless the majority of properties are rent controlled.
This has been an important problem in India. Second, because vacant land is not taxable under a
tax based on rental value in current use (since there is no current use!), an incentive is created in
favour of low return uses over high return uses and to withhold rental properties from the market
altogether.13 If vacant properties are not taxed, the tax has to be higher on occupied properties to
yield the same amount of revenue. These higher taxes further discourage investment.

Area-based vs. Market-based Assessment

Where it is possible to use market value, it is generally regarded as a better tax base. First, the benefits
from services are more closely reflected in property values than in the size of the property. For example,
properties close to transit systems or parks enjoy higher property values. The benefits from these services
are not reflected in the dimensions of the property but rather in the value of the property. Even those
services where the benefits may relate more closely to property dimensions (such as sidewalks and street
lighting, for example) are related more to front footage than to lot size or building size.

Second, market value has the advantage of capturing the amenities of the neighbourhood, amenities that
have often been created by government expenditures and policies. Areabased assessments (particularly
unit assessment) are unlikely to capture these amenities because they do not take into account differences
in the quality of buildings nor their location. Consider, for example, the taxes paid by two properties of
identical size and age but in different locations. Specifically, one is located next to a park; the other is
adjacent to a factory. Under an area-based assessment system, both properties would be levied the same
property tax. Under a value-based assessment system, the property next to the park would pay higher
property taxes. In this example, area-based assessments would not be fair.

Third, area-based assessment results in a relatively greater burden on low-income taxpayers than high-
income taxpayers when compared to value-based assessment. The reason is that average household
incomes in high-value neighbourhoods are higher than in low-value neighbourhoods. A tax on area taxes
all properties that are the same size the same amount, whether they are in high-income or low-income
neighbourhoods. Similarly, older houses in a bad state of repair but with a large floor area will pay
relatively high taxes.

Self-Assessment

Self-assessment requires property owners to place an assessed value on their own property. In Hungary,
for example, the current local tax system is based on the principle of self-identification. Taxpayers are
obliged to register and report their tax obligations to the local tax administration. The verification for the
tax on buildings and tax on idle land in Hungary requires verification only of the property size and not its
market value. In practice, the responsibility of self-registration is not particularly effective because not all
owners comply.

In Thailand, self-declaration of property owners is made to local assessors who assess the self-declared
value and identification in terms of how well it matches their data. Selfdeclaration of properties by
landowners is also required in the Philippines, once every three years. The local assessor then prepares the
assessment roll.
At What Rate?

Who determines the tax rate?

Tax rates are sometimes determined locally and sometimes by the central government. There are very
considerable differences between countries with respect to the extent to which local governments are free
to determine tax rates. Sometimes (Japan, Ukraine, Chile, Thailand, Tunisia) rates are essentially set by
the central government. Sometimes (Hungary, Colombia, Philippines) there is some local discretion,
within centrally-set limits. Sometimes (Canada, Argentina, Kenya) there is complete local discretion.

Differentiated Tax Rates

Many local governments levy rates that differ by property class.16 Different tax rates may be imposed
for different classes of property (residential, commercial, and industrial, for example). This system gives
local governments the power to manage the distribution of the tax burden across various property classes
within their jurisdiction in addition to determining the size of the overall tax burden on taxpayers.

Getting to 15 percent: addressing the largest tax gaps

Recent literature supports this idea. Using historical data from 139 countries, estimate that over 10 years,
per capita GDP is 7.5 percent larger than would otherwise be expected in countries with tax revenues
above the 15 percent “tipping point.”

In countries below that tipping point, increasing domestic resource mobilization (DRM) is key — both for
economic growth and meeting development goals. Getting to at least this 15 percent level helps countries
generate sufficient domestic resources that can be invested in health, education, and infrastructure.

Policy initiatives like Maximizing Finance for Development and moving from Billions to Trillions also
require fair, efficient, and effective tax policies and administration. To this end, the Addis Tax Initiative
and the 2030 Agenda for Sustainable Development Goals (SDGs) call for more technical cooperation on
taxation.

In cases like China, for example, the development path follows the 15 percent narrative, with rising tax
revenues preceding increases in per capita income. In countries with significant non-tax revenues, the
relationship is different. Malaysia or Saudi Arabia, for example, enjoy significant oil revenues.

The countries with a tax-to-GDP ratio below 15 percent can be divided between haves and have-nots —
those with significant non-tax sources of revenue and those without. For example, this group includes
wealthy oil exporters like Kuwait and Saudi Arabia. But it also includes oil exporters, such as Nigeria,
that experience revenue shortfalls.