Chinese authorities recently announced that they will roll out a pilot property tax plan in different parts of the country and likely implement property taxes nationwide in the future. This will undoubtedly be a major blow to China’s urban middle class that greatly affects their spending power.
On Oct. 23, the Standing Committee of China’s rubber-stamp legislature announced that it authorized the State Council to carry out a five-year real estate tax reform trial plan in certain regions. Based on the trial results, the legislature may formulate a nationwide real estate tax law five years later.
Shanghai and Chongqing have already been trial cities for 10 years, paying a nominal tax.
The new list of trial cities will be announced at the end of this year. Several media outlets have provided hints as to which cities will likely be on the list.
According to a report by the Wall Street Journal, the Chinese Communist Party’s (CCP) initial plan was to conduct a test run in 30 cities, but they reduced it to 10 cities after some pushback within the Party.
An Oct. 23 report by The Economic Observer, a Chinese economic newspaper, revealed that officials from six cities attended a pilot tax plan symposium in Beijing in May. The six cities are Shenzhen, Hangzhou, Suzhou, Jinan, Shanghai, and Chongqing, and according to the report, they share some common features.
First, these cities are economically developed, and the pilot program is expected to have little impact on economic fundamentals. Second, home prices in these cities have risen rapidly. Third, government income from land sales in these cities has been relatively high, and if selected as trial cities, the outcome can be used to analyze to what extent the revenue from real estate taxes can replace the income from land sales.
A research report by CITIC Securities, a Chinese investment bank, predicts that only four regions will be taxed—Shanghai, Chongqing, Shenzhen, and Hainan Province.
Hainan is a unique province because many homeowners in Hainan are “migratory birds” who spend most of their time in the north and come to Hainan only in the winter to enjoy the warm weather. The local government will undoubtedly make a killing if they collect property taxes from these non-local homeowners.
If the CITIC Securities report is correct, Shanghai and Chongqing will expand the scope of property tax collection by increasing the tax rate, and Shenzhen and Hainan will become the only two newly added regions for the trial.
Since 2011, Shanghai has only been targeting multiple-home owners who must pay taxes for their second, third, and other homes, while Chongqing has been targeting high-end homeowners or, in other words, homes with large square footage.
If these two cities are selected once again for the new tax plan, the scope of taxation will inevitably expand. In Shanghai, luxury homes that are primary residences may be taxed. In Chongqing, the taxation is expected to reach ordinary homes.
Therefore, the new property tax will likely be calculated based on two factors: the number of properties owned, and the living space. The research report by CITIC Securities disclosed that pilot cities may set a per capita exempt living space of 430–646 square feet. As a result, homeowners of small houses do not have to worry about paying property taxes, the report said.
Chinese authorities have made meticulous preparations for the upcoming property tax plan.
The Ministry of Housing and Urban-Rural Development spent several years trying to establish a unified nationwide real estate registration system, and completed the registration platform in June 2018. If a person lives in a city that’s not a trial city, but owns a home in a trial city, that property will still be taxed. There likely won’t be any loopholes.
Conversely, if a person owns a second home in a city not to be taxed, he may want to sell it in the next five years if he wants to avoid paying property taxes in the future.
Homeowners in the trial cities must be anxious to know how much tax will be collected. On the one hand, it depends on taxable living space; on the other hand, it depends on the tax rate. Currently, there are two clues regarding the tax rate.
In the past 10 years, Shanghai has adopted a fixed tax rate. Taxes are levied annually at 0.6 percent of the real estate appraisal value. Total taxes collected were more than $3.12 billion every year.
Chongqing has three levels of real estate taxes: 0.5 percent, 1 percent, and 1.2 percent respectively, with multiple-home owners and high-end owners paying higher tax rates.
For the upcoming trial, Chongqing’s model will most likely be applied. Moreover, it’s unlikely that the authorities will impose too high of a tax rate, as the plan will eventually be applied to the entire country.
The CITIC Securities report posits that each pilot city will determine the local real estate tax rate on its own, and the overall tax rate is expected to be between 0.2 percent and 1 percent. If this proves to be true, homeowners who have only one house may be subjected to the lowest tax rate, such as 0.5 percent, while owners of multiple homes or luxury homes will have to pay a higher rate, such as 1 percent or more. The tax will be levied based on 70 percent of market value, considering that homeowners in China own only the dwellings but not the land, the report said.
Fleecing the Middle Class
The CCP has now entered the economic stage of “fleecing the sheep” in the middle class. This population group was relatively fortunate in the past, but it’s about to change.
To assess the impact on an individual level, let’s look at a theoretical example. If a homeowner in Shanghai has a second home with a living space of 1,076 square feet, its current market price is close to $624,440, as Shanghai’s property values are at $6,200 per square foot. The taxable portion, at a 30 percent discount, is $437,300. At a 1 percent property tax rate, he will have to pay $4,373 a year.
The average annual salary in Shanghai last year was $18,740. After deducting personal income tax and social security contributions, the average per capita disposable income was about $12,493. The $4,373 real estate tax is equivalent to one-third of his annual after-tax income.
In the past, owners of multiple homes rented out their extra houses to pay the mortgages. They also held them as investments, hoping that their value would appreciate. Property taxes are a big additional expense for these middle class investors. The extra cost can’t realistically be transferred to their tenants who are not rich to begin with. As a result, many homeowners will want to sell their second home. With more homes for sale and fewer buyers on the market, home prices will drop, and holding real estate will no longer be a good investment. Falling home prices will also translate into shrinking assets for China’s middle class families.
The macroeconomic effects of real estate taxation is surely negative. Chinese middle class families are hit twice with the taxation: they have to pay property tax every year, and their properties are losing value. This will certainly affect their spending power.
China’s middle class used to spend lavishly in the past when home prices kept rising. Now they can no longer afford to continue such an extravagant lifestyle.
The overall declining consumption will further hurt the service and manufacturing industries, which are already in a depression. When the nationwide property tax plan is rolled out, it will be the time when China’s middle class takes a nosedive.