The Real Property Tax Simulation Model

The Real Property Tax Simulation Model : 

The Real Property Tax Simulation Model Norman R. Ramos Property Tax Policy Advisor

Nature of the Real Property Market : 

Nature of the Real Property Market The real property market-- land & improvements -- is among the oldest asset market in human history. Social structure, marriage institutions, inter-state relations & more broadly, socio-economic organizations, have been affected by & simultaneously have influenced the nature & functioning of real property markets. In terms of the risk-return trade-off, real estate is either lower or at par with the risk-return profile of common stocks & higher risk-reward than T-bills, municipal bonds, mortgage backed securities and investment grade corporate bonds, in that order. 2

Nature of the Real Property Market : 

Nature of the Real Property Market Housing is a mixed consumption-investment good. The attributes of commercial real estate are a function of derived demand emanating from the user business sector. Both types of real property demand will ultimately be affected by the state of economy as measured by the Gross Domestic Product (GDP). 3

Nature of the Real Property Market : 

Nature of the Real Property Market The positive impact of growing macroeconomic activity on the demand for real estate is, however, restricted by statutory limitations on land ownership & use. Taxation -- Power to tax the land to provide public revenue & to return to the community the costs incurred to pay for the various public benefits, services and environmental protection, which are provided by the government; Eminent Domain -- Right to use, hold or take land for common public uses and benefits; 4

Nature of the Real Property Market : 

Nature of the Real Property Market Police Power -- Right to regulate land use for the welfare of the public, in the areas of safety, health, morals, general welfare, zoning, building codes, traffic regulations and sanitary regulations; and Escheat -- Right to have land revert to the public's agent, the government, when taxes are not paid or when there are no legal heirs. These regulations, especially property tax laws, affect real estate operations and profitability, and consequently, demand for real estate. 5

Influence of Real Property Taxes : 

Influence of Real Property Taxes The tax instruments used by governments to raise revenues can have an impact on the nature, location, and density of development. Urban form can be influenced not only with planning tools but also with financial tools. In some cases, financial tools work together with planning tools, but in other cases they may have the opposite effect. 6

Real Property Tax & Tax Compliance: The Philippines : 

Real Property Tax & Tax Compliance: The Philippines The nominal annual real property tax (RPT) rate is as high as 2% to 3%, but the effective rate has been estimated at only 0.07% during the early nineties. Effective rates have since then improved but are still below the nominal rates. As of 2007 the average effective RPT rates for cities stand at 1.67% (1.81% for Metro Manila cities and 1.44% for cities outside Metro Manila). For provinces, the average effective property tax rate is only 0.55%. No statistically significant relationship between collection efforts and the size of taxable property values. Larger property tax bases do not necessarily get translated to more intensive and productive collection efforts. 7

Collection efficiency &Size of Taxable Property Values : 

Collection efficiency &Size of Taxable Property Values Provinces Cities 8

Analytical Framework : 

Analytical Framework The demand for physical space comes from different types of users: residential, commercial or industrial. These users need to maintain the same level of space services that may have been reduced by demolition or withdrawal. In equilibrium, the supply of property should be equal to the demand at various levels of property prices. Property prices respond to demand changes and over time, such price changes are translated to new construction (with corresponding financing sources) to keep the market in equilibrium. 9

Relationship between the Market for Real Property, Economic Activity & the Real Property Tax Rate : 

Relationship between the Market for Real Property, Economic Activity & the Real Property Tax Rate The total market for real property estate is a function of the economic activity as measured by the country’s Gross Domestic Product (GDP) and effective real property tax rate (EPTR). Whenever there is an increase (or decrease) in the property tax rate while keeping economic activity level constant, quantity demanded increases (or decreases) correspondingly. Whenever economic activity increases (or decreases), there is a corresponding upward (or downward) shift in the real property market . 10

Tax Revenue Effect of Changes in the Effective Property Tax Rate : 

Tax Revenue Effect of Changes in the Effective Property Tax Rate 11

Tax Revenue Effect of Changes in the Effective Property Tax Rate : 

Tax Revenue Effect of Changes in the Effective Property Tax Rate The net tax revenue effect of reductions in real property tax rates will be a balance of : the revenue reductions arising from the rate cutbacks and the potential positive revenue effects of the resulting increase: in the revenue base (REGVA) through the tax rate effect and the increase in GDP due to the increased real property market activity via the multiplier effect of the property sector. 12

Alternative GDP Forecasts : 

Alternative GDP Forecasts The forecast results of the chaos type model over the five-year forecast period closely match the historical growth performance of the economy during the last 18 years, and are the set that will be used for revenue simulations. 13

Chaos-type GDP Model : 

Chaos-type GDP Model Chaos-type equations are deterministic systems (exhibiting regular and predictable behavior) that also exhibit seemingly irregular, random, and even turbulent behavior and are highly sensitive to initial conditions. Seemingly chaotic movements of the annual percentage changes in GDP (∆ GDPt) from 1990 to 2008 were statistically modeled using the two alternative dynamic equations: one with a time trend variable, and another without. 14 The equation with a time trend variable shows a better performance in terms of tracking the “turning points.”

Chaos-type GDP Model : 

Chaos-type GDP Model The lagged change in GDP (∆ GDPt-1) follows usual time series models where the past period’s value affects the current period value. Introducing a quadratic GDP term introduces a “hump” — in this case a maximum. Changes or variations in the value of variables like GDP and prices have been observed to be proportional to the square root of the time. The election variable introduces a cyclical element wherein elections “dampen” the growth of the economy probably due to the uncertainties and fears generated by administration changes. The uncertainty generated by the constant challenge, e.g., EDSA 3, to the legitimacy of the presidency between 2001 and 2003 dampened the growth of the economy. The extraordinary huge presidential election expenditures in 2004 boosted the growth of the economy. 15

Results of Elasticity Analyses : 

Results of Elasticity Analyses The elasticities of both Gross Value Added in Real Estate (REGVA) with respect to economic activity (GDP) and the Effective Real Property Tax Rate (EPTR) are all statistically significant and are of the correct signs: (+) with respect to GDP and (-) with respect to EPTR. The (-) sign with respect to EPTR confirms the often expressed belief/opinion that property taxes have a dampening effect on real estate investment. The coefficients of determination (R2) of the regression equations are all higher than 90% indicating that the equations are useable for forecasting purposes. 16 Substantial tax rate effects can be expected from the estate tax, the donor’s tax, and VAT.

The Estate Tax and Capital Formation: 2005 : 

The Estate Tax and Capital Formation: 2005 Analyses of available international cross-section data indicate that the estate tax negatively affects investments. The negative tax rate elasticity of 0.84 between the statutory maximum estate tax rate of a country and its gross domestic capital formation (GDCF) implies that for every 1% reduction in the maximum level estate tax rate of a country, there is a potential 0.84% increase in a country’s GDCF. 17

The Impact of the Real Property Sector on GDP : 

The Impact of the Real Property Sector on GDP Every 1% change in REGVA , there will be a corresponding 1.45% change in GDP. Available Year 2000 Input-Output (IO) data show that the real property sector has a total industry activity multiplier ≈ 1.20, meaning that every peso spent in real property yields a peso of direct sales to the other sectors plus Php 0.20 of indirect sales to the other sectors of the economy. 18

Statutory RPT Rates & Collection Efficiency: 2007 : 

Statutory RPT Rates & Collection Efficiency: 2007 All Philippine Cities Cities with COE ≥ 100% Excluded 19 Real property tax compliance and statutory RPT rates are inversely related with a tax rate elasticity that ranges from -0.09 to -0.12 indicating that a 1% reduction in RPT rate could increase collection efficiency by 0.09 to 0.12%. The result is supportive of the proposal to base the RPT directly on market values and just compensate by lowering the tax rate. Such a lowering will help encourage RPT compliance in Philippine LGUs.

The Real Property Tax Simulation Model : 

The Real Property Tax Simulation Model