A hundred and thirty years ago, the American economist Henry George wrote a famous tract called “Progress and Poverty”. It argued that all natural resources, including land, are a gift of nature. Any private person owning them is only entitled to be compensated for the effort he has put in with his labour and capital to raise its productivity. Any increase in value that comes not from any effort of the owner, but from some other factor like infrastructure development or policy changes by the government, should not accrue to the owner.
George’s ideas rested on the classical notion of rent as the income that accrues to the owner of a resource simply because of ownership. He argued that a land tax was a better, non-distorting way of raising resources for public purposes than taxes on labour and capital, which are borne by productive activities.
His ideas were criticised by capitalists who did not see any reason for distinguishing between capital gains from the ownership of land or natural resources and other forms of income like wages or interest. They were also criticised by Marxists, because they did not accept that the return from ownership and deployment of capital was any different from unrequited gains from land and natural resource ownership.
George’s views were shaped by what he saw in the late-19th century post-Civil War United States, when a high-growth economy rested on an alliance between robber baron industrialists, land speculators and pliable and corrupt politicians who preserved privilege by exploiting ethnic vote banks. If this sounds familiar, it is because the India of today has a lot in common with the America of the Gilded Age, when great fortunes were made. In India, as in the United States, land transactions are the route to quick riches and are at the root of the rot in the political system. They are part of the politics of exploitation since much land speculation involves expropriating land at low prices just before it shoots up in value, say, because of a new railroad or highway.
A single land tax may be plausible as the revenue source if the requirements of the public budget are modest, say, five per cent of gross domestic product — but quite unrealistic when they go up beyond 20 per cent of GDP, as they would in an urbanised industrialised economy. Nevertheless, the broader message remains relevant: that taxing ownership of land and natural resources and the unearned increments in the value of these is socially justifiable and economically optimal.
The big gains from land value increases come from the conversion of permitted uses from low-value to high-value uses. The most typical case involves the conversion of agricultural land for residential or commercial purposes. This is how the large land-based fortunes have been made. We have seen many examples of these in India, including the high-profile one that hit the headlines recently. The capital gain arises entirely because of a discretionary dispensation by the government concerned. Hence it would be entirely appropriate for the state to capture the bulk of the value increase by making the conversion right conditional on a lease premium or revenue sharing that would give the developer a fair return, but no windfall gains from the increase in land values.
As for direct taxation of land and real estate, we have the land revenue and the urban property tax. There is another impost, the stamp duty, which is collected when a transaction in land or real estate is registered. All of these are state-level taxes. At the central level, the only property-related taxes are the taxation of house property in the income tax and the capital gains payable when a property changes hands.
The land revenue was once a major source of revenue, which has now dwindled into insignificance. According to the 2010-11 Revised Estimates, the states collected Rs 7,000 crore in land revenue and agricultural tax. This amounted to a derisory 0.5 per cent of agricultural income in that year. The next Finance Commission must address this issue, because of the loophole that the virtual absence of any tax on agricultural income provides for tax evasion and whitewashing black money.
The urban property tax levied by municipalities is an equally underused revenue source. In a study done for the 13th Finance Commission, property tax revenues in the 36 largest cities in India were estimated at Rs 4,522 crore, yielding per capita revenue of Rs 486 with large inter-city variations. The all-India collection of property tax yield blown up from the 36-city sample was estimated to be between a low of Rs 6,274 crore and a high of Rs 9,424 crore. Even at the high end, it would amount to just six per cent of the gross rental value of urban dwellings as estimated in the National Account Statistics.
Apart from rates that are low relative to the cost of municipal services, there are problems in setting the tax base because of the absence of a reliable count of properties. Collection efficiency is low, with only 63 per cent of assessed properties actually paying taxes in the “large city sample”. The large sums that are being made available for urban development must be made conditional on radical reforms in the property tax system, starting with reliable surveys, rates that yield a significant proportion of municipal costs and effective collection mechanisms.
The stamp duty, a much more substantial source of revenue, raised Rs 53,600 crore for the states in 2010-11. Not all of it is on property transactions. The stamp duty on the registration of property transactions and the capital gains tax are evaded with impunity with gross under-declaration of sale values. One answer to this is the establishment of a system of announced land prices at least for urban land, which would provide a presumptive basis for registration and capital gains assessment. We do have such a system now in some places; but the presumptive rates announced are still well below market rates.
The broad message is clear: make land taxation a much more central part of the tax system than it is at present. Not only would it be less distortionary, but it would also help correct rampant profiteering and tax evasion.