The government led by Imran Khan in pursuit of stopping the hoarding of commodities like wheat and sugar turns a blind eye to the cultivation of land hoarding. After the start of the construction amnesty program, house prices plummeted. The construction of low-cost housing (the so-called main objective) on a commercial basis does not take place. The dream of owning a house by the middle class is getting more expensive due to soaring prices. Then there is the unintended consequence of stimulating consumer demand, as the monetary transmission (expansion) of the wealth effect through escalating asset prices contributes to current account deficit slippages.
The aim of the construction amnesty program and the granting of industrial status to construction was to promote housing to create jobs and fill the void of millions of missing housing units. There is nothing substantial to say about promoting consumer housing (mortgage) finance; but the program has nearly doubled house prices in many cities in Pakistan. The growth in real wages is not even a small fraction of the increase in housing prices; and the dream of housing for the lower and middle classes has become even more distant.
Those who have money buy land in lots. Many influencers in the private and public sectors are closely linked to the land mafias. Politicians, bureaucrats (especially those in the RBF), industrialists and businessmen hold massive land holdings in Pakistan. In addition, senior army officers legally get their share of the land. It is not a socialist argument to speak against the accumulation of wealth; it is about correcting the biased allocation of resources and the tools available to the government to tax land holdings. The key is to use fiscal and regulatory tools to stop speculative activity on plots of land – particularly, on vacant plots in developed areas.
One of the most overlooked tax issues in Pakistan is that of land. According to a study by the IGC, the collection of property tax in Punjab is lower than that of Chennai in India, while the population of Punjab in Pakistan is more than 15 times higher. There is massive wealth parked in real estate with virtually no taxation. In contrast, savings in term deposits and stocks are heavily taxed on income and earnings; but there is no taxation on real estate, in which the initial investment is multiplied by several times in a short period of time.
Serious efforts are needed to bring down speculation on house prices. In Pakistan, monetary transmission due to the wealth effect in real estate is probably higher than private credit. Thus, controlling real estate speculation is an alternative tool to curb imports rather than interest rates. More than 7 trillion rupees (28% of the money supply) are currencies in circulation (hard cash) and are insulated from interest rates. Private credit is around Rs 8 trillion, and domestic consumer credit is not even Rs 1,000 billion. The impact of reducing speculation on house prices could be greater than reducing consumer demand by raising interest rates.
The point here is not to undermine the impact on monetary tightening by using interest rates; but to emphasize that demand reduction in the informal sector is an effective tool to reduce imported demand in order to stop the current account deficit. With soaring house prices, the perceived savings of landowners increase and they use the cash (or assets) to buy cars and spend on other consumer goods and services. This trend must be stopped.
There is no centralized data set on owners of real estate. On the other hand, everyone’s information on his (or her) shareholdings on the stock market, bank deposits are well documented, and the authorities can collect them in a few clicks. But there is no such information about tens of billions of rupees of wealth that are parked in real estate. Some fellow fellows spend Sunday afternoon counting the Karachi DHA Phase 8 plots to establish that the cumulative value of Karachi DHA Phase 8 plots is greater than the PSX float.
The history of other cities is no different. Speculation is also taking place in industrial terrain which is hampering the development of manufacturing facilities. People tend to invest in real estate because not only is it (almost) tax-free, but it’s probably the best way to mix black and white wealth – it’s all gray. Manufacturers find it more interesting to put the gains in real estate rather than reinvesting in their respective companies. And they use subsidized programs – such as TERF and LTFF, and tax breaks for expansion. The overall structure of incentives is heavily skewed.
Property taxes have always been low in Pakistan, and recently the construction amnesty program has proven to be a catalyst in boosting house prices. Any builder carrying out a project benefits from a tax amnesty. The purchaser of apartments (housing) resulting from these projects also benefits from a tax amnesty. Builders anticipate demand from those who want to launder and build units for them. For example, consider a builder has a project of 75 apartments of Rs50 million (Rs5 crore), each in an RBF approved project. He anticipates 75 buyers (or even less because buyers buy in lots) to acquire his project. Since both buyer and seller are granted amnesty, everyone who wants to clean up their money comes into play.
This washing machine works wonderfully. Construction activities were boosted. Money is spinning and the economy is booming. But it has side effects. Investment resources are skewed towards construction, which crowds out productive investment in the manufacturing sector. For this investment, manufacturers ask for cheap loans and tax breaks, because the opportunity cost is to invest in real estate where there are higher returns without tax (or too low).
The other problem is that the purpose of the construction package was to bridge the housing gap, a noble goal that has since been lost due to escalating house prices. In most RBF approved projects, the majority of buyers are those who already own a home. Many of them may already have more than one farm. This leaves real buyers dry. They buy to invest and launder. There is a fear of creating ghost houses – or maybe vacation homes or party spaces.
The government must end this amnesty now. Instead, it recently authorized its use by 11,000 other citizens. The other element is that the land must be taxed. It is a provincial subject, and the tax use is for local purposes. Existing property tax rates are tiny and with the recent increase in house prices, the effective rate is rounding off to zero.
Not only is the tax low, but the property tax (in the Punjab) is biased towards construction. The tax on built land is 9 times that of vacant land. The government encourages vacant land. The annual property tax on vacant plots varies from a few hundred to a few thousand rupees while the price of these plots is in the tens of millions of rupees.
The tax code must be progressive. It should increase with the increase in land holdings by a single person to discourage multiple holdings. For example, a landowner with five vacant plots of a canal in DHA phase 7 in Lahore would face an annual tax liability of at least Rs 0.3 to 0.5 million per plot of land in taxes. . The land is developed on the premise for people to live there. Housing authorities and municipal corporations spend on infrastructure to provide livability near these lands. But people hold on for years without use. If these are taxed, people can instead sell and use that money for productive purposes.
The bottom line is that an overhaul of property tax and regulations is imperative. The country needs to collect taxes. The country needs balanced economic growth, while the construction package is skewed towards expensive projects for the elite. Imran Khan could lose his popularity in the middle class struggling to move from the joint family system to the nuclear family system. The imbalance in the construction package towards the rich must be reversed.
Copyright Business Recorder, 2021