Understanding the Logic behind Land Value Taxation

posted on Uganda Land Alliance - http://ulaug.org/2011/07/undertanding-the-logic-behind-land-taxation/


“The economic argument for land taxation stems from the fact that, if income from labor, buildings or machinery and factories are taxed, people are discouraged from constructive investments and enterprise and effective developments are penalized due to the disincentive effects of the excess burden of taxation.”

Throughout Africa today, land policy reforms attempt to find lasting solutions to land tenure conflicts that result from the simultaneous operation and often discouraging effects of several tenure systems juxtaposed to each other. The government’s role in the orderly management of land resources increases through the granting of titles and the delivery of affordable housing and human settlements. This is made possible by the introduction of formal land use planning, environmental regulations, tax incentives and other strategies for disseminating land use decisions.

This being so, and in view of Uganda’s steadily increasing pressure on land resources exerted by a growing population and conflicting claims, a clear policy on land is important for ensuring security of tenure, peaceful co-existence and growth-oriented investments. A good land policy is an equally important reflection of the values of Ugandans and the structure of incentives necessary to assure the effective utilization of land.

In emphasizing the need for sustainable and optimal use of land, the policy acknowledges the fact that land resources have been chronically under-utilized and inefficiently managed. The policy stipulates incentives for productive use and development of land by calling for the creation of an enabling investment climate, as well as facilitating investors to access land.

To ensure efficient and equitable development of Uganda’s land and land based resources, the policy draws attention not just to the land ownership and tenure regularization objective. A process of systematic adjudication, formalization and registration is expected to generate data for use in developing evidence of proprietary interest in land; but such parcel specific data is the building blocks for the aggregating and/ or disaggregating pertinent land information in a manner to assist in creating a land tax cadastre.

In fact, a tax cadastre needs to record only such information about boundaries, ownership and improvements. In essence, a land tax or site valuation tax is a levy on the unimproved value of land. It is an ad valorem tax on land excluding the value of buildings and other capital improvements.

A land value tax is different from other property taxes, because these are taxes on the combination of land, buildings and improvements to the site. The land value tax takes into account the effects of location on land value such as proximity to public roads, schools, hospitals, access to electric power, etc. or of improvements made to neighboring land, such as proximity to shopping complex, pristine parks and recreation facilities.

The philosophical basis for levying the land tax derives from the fact that the appreciation in value of land is created by the combination of public works and the collective actions of the community and therefore belongs to the community. The economic argument for land taxation stems from the fact that, if income from labor, buildings or machinery and factories are taxed, people are discouraged from constructive investments and enterprise and effective developments are penalized due to the disincentive effects of the excess burden of taxation.

This does not apply to taxing land which is the creation of nature. Provided that the supply of land is fixed by nature, land values are determined by scarcity and what tenants and potential developers looking for land in the market are prepared to pay, rather than on the expenses of landowner. The rent accruing to the landlord is the result of the location of the land relative to public works and other natural soil attributes and the competition generated by the market and not as a result of any direct investment by the landlord.

As a result, a land value tax set as a proportion of ground rent leaves the income from land owners, capital improvements such as buildings, commercial farming and other land based enterprises free from taxation. It is this feature of land value taxation which discourages land speculation. In fact, placing the tax burden on land rent rather than the improvements can be justified because it will not deter production.

Instead, the necessity to pay the tax encourages landowners to develop vacant and underused land properly or to lease the land to others who will develop the land to generate the income needed to pay the tax. The goal is not to reduce the rental value of land to zero. Instead, a land value tax only reduces the amount of the communally generated land value appreciation that is captured privately as an increase in the market price of the land by the landowner.

Tax Administration

There are legitimate questions concerning the administrative feasibility and realistic assessment of the advantages of using a land value tax for the land management aspirations outlined in the National Land Policy. Modern principles of taxation require that optimal revenue needs for a desired policy objective and/or economic growth rate be compared with the potential impact on capital formation and equity implications of such a tax policy. However, during the land policy consultative process, it was evident from public sentiments that the majority of Ugandans were opposed to the speculative accumulation and holding of nonproductive land which contributes to shortage of land for settlement, investment and production.

The policy, therefore has recommended the adoption of a land tax to deal with this pattern but cautions that such a tax cannot be designed solely for raising revenue. Instead, it should aim to achieve optimality in the use of land and to provide incentives to encourage land conservation and habitat preservation, while taking into account the protection of smallholder producers with low acreage, agricultural practices that entail fallowing to restore soil fertility.

In general, levying a land value tax is straightforward, requiring only a valuation of the land and a register of the identities of the landholders. However, determining the value of land can be difficult in practice. In most cases, the market is the best determinant of value. The valuation of land involves fewer variables than the valuation of buildings and modern computerization and statistical techniques now makes the process quite easy.

Land value for tax purposes is assessed using market evidence. Such evidence may comprise both selling prices and land rentals even in rural areas. Where development already exists on a site, the value of the site can be discovered most easily by the residual valuation method. That is, the value of the site is the total value of the property minus the depreciated value of buildings and other structures. The simplicity of the valuation method makes the system relatively ease to implement.

The land value data is then collated and stored in a database linked to unique property identification numbers and mapped using GIS and translated onto a fiscal cadastre for each jurisdiction. However, leaving the valuation process up to Valuers often causes numerous methodological complexities, as well as non-uniform valuations due to inadequate policies and their interpretations.

Rate Determination

The full sale price, based on open market transactions, is the preferred standard for tax valuation. The value of the improvement is ascertained by subtracting the land value from the total sale price. However, in practice, the valuation office establishes standard values per plot based on the pattern and distribution of land sales for use as the basis for land valuation.

In urban areas, commercial property rates should be computed by the capitalization of net rents when the required information is readily available. However, this is usually not the case in most countries. The more common practice is to use the market approach to value existing buildings and the cost approach to value new buildings. The data required is easily compiled from information submitted to the deed registry and retained by each municipality.

In Uganda as in many other African countries, Land Value Tax is difficult to implement because of lack of certainty regarding land titles and clearly established land ownership and tenure systems. For instance, wetlands, grazing land and other forms of communally land administered by the village elders may be difficult to tax. If the government cannot accurately define ownership boundaries and ascertain the proper owners, it cannot know from whom to collect the tax. Even in urban areas, low land registration and poorly surveyed land boundaries as well as elusive landlord can make it significantly more difficult to administer the land tax efficiently.

However, because local authorities and municipalities are responsible for providing public works, social services and amenities that enhances the value of land, removing almost all business taxes, including property taxes on improvements, and replacing them with taxes on land values that reflect the additional social cost of public services provided to citizens and communities would substantially strengthen the efficiency of local authorities to provide services in their respective districts and should be encouraged.

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