One of the main debates among the countries of Central and Eastern Europe (CEE) is to identify the primary source of local government revenues that is sufficient for the local governments to fulfill the functions assigned to them. After all, unless “funding follows functions”, the ability of local governments to leverage their strength in delivering public services as the government level closest to the people is undermined.
With respect to local government funding, it appears that there is a growing international trend to focus on developing a greater reliance on property taxes rather than on alternative subnational funding mechanisms, such as personal income tax (PIT) sharing. It is useful to consider the advantages and disadvantages of this approach in Central and Eastern Europe, and in other countries around the world.
How Property Taxes Could Help Low-Income Countries Develop
A recent IMF blog titled How Property Taxes Could Help Low-Income Countries Develop provides some convincing arguments for utilizing the property tax more fully by local governments. The main points of the blog are the following:
- Large cities such as Delhi and Lagos show a way forward: Taxing property more efficiently can play a meaningful role in raising revenue at the local level, allowing countries to invest more in their people, according to the new IMF analysis. Previous IMF research has shown that countries have ample potential to raise more domestic tax revenue if they need it—up to 5 percentage points of GDP over two decades.
- By being locally collected and spent, they may be politically less challenging than increases in broad-base national taxes.
- Recurrent taxes on immovable property could help local governments capture the wealth generated through construction-intensive urbanization.
- The appeal of property taxes is clear when we look at revenue raised in advanced economies: more than 1 percent of GDP on average in OECD countries, and nearly 3 percent in some advanced economies. By contrast, they raise only around 0.1 percent of GDP in emerging Asia and Africa.
- When well-designed, property taxes become a reliable and progressive form of municipal financing. They enhance the accountability of local governments, since proceeds can be used to fund better local public services, and taxes the increase in wealth of those who own real estate that has appreciated due to urbanization and associated public-infrastructure development. The tight link at the local level between revenue and spending shields property taxes from national politics and imposes higher accountability standards on local councils for the effective use of the resources.
There are always the objections to the property tax that they are very difficult to administer and ownership is not clear and market values difficult to determine. However, the IMF blog suggests that there are new technology solutions which are being applied as follows:
- New property identification technologies and simplified valuation methods have become widely available. With policy reforms and better technology, recurrent property tax revenues in developing countries should be at least 10 times higher than current levels.
- Modern mapping technology, such as satellite imagery and aerial photography by drones, can be used to fast-track the expansion and coverage of property taxes to all parcels that ought to be included in the fiscal register.
- The increased precision of satellite images enables the accurate measuring of surface areas and the development of fiscal-register maps that depict buildings and their alterations. This allows the fast roll-out of an area-based property tax until valuation capacity has advanced to migrate toward a market value-based property-tax system that can raise more revenue.
Many CEE countries continue to rely on PIT sharing
Unfortunately, many countries of Central and Eastern Europe continue to utilize personal income tax (PIT) sharing based either on the place of employment or residence of the taxpayer as the main source of local government revenues. This has only increased the dependence of these local governments on very unstable sources and has contributed to inequities across local governments.
A recent NALAS report highlights the ongoing dependence of local governments in the Balkan countries and notes that fiscal decentralization is not improving. Titled “Fiscal Decentralization Indicators for South East Europe,” the report documents the developments observed over the past two decades.
To its credit, the NALAS report provides significant insights into how the property tax is increasing a major source of local government revenues. The report identified the following points in this development.
- The property tax is becoming the lead local government tax in South-East Europe. From a regional perspective, between 2006 and 2021, the yield of the property tax almost doubled, increasing from 5% to 9% of local revenues and from 0.3% to 0.6% of the GDP.
- The European model suggests that, in a long-term prospective, there is plenty of room for increasing the fiscal significance of property taxation.
Property tax innovations in CEE countries
The NALAS report indicates that several countries are making substantial progress in implementing a property tax with legal features and technological innovations. These include Bosnia and Herzegovina, the Republic of Srpska, and the Republic of Montenegro. Their main features are highlighted in the following:
Bosnia and Herzegovina, Republic of Srpska:
- The income from the real estate tax is 100% income of LGUs. The decision on determining the tax rate on real estate is the exclusive competence of LGUs, and they are obliged to submit the tax rate for each year.
- The recent Law on the Property Tax introduces the obligation for the Tax Administration of RS to share and submit data at the request of the city or municipality for properties located in their territories. This is clearly aims at establishing better coordination of these bodies for more efficient tax collection. In addition, the Law also introduces the obligation of the Republic Administration for Geodetic and Property Affairs to provide permanent access to the Tax Administration of RS and to local governments on property information.
- Equally importantly, recently the Republic Administration for Geodetic and Property Legal Affairs launched the project ‘Mass valuation of real estate in the Republic of Srpska’.
- To strengthen tax compliance and enforcement, the Law on the Property Tax also introduces a clause that prohibits the sale of those properties for which property tax was not paid. The deadlines for the payment of the property tax had been changed as well, to improve tax collection and at the same time improve budget sustainability.
Montenegro
- The property tax in Montenegro was decentralized in 2003. Since then, the collection of the tax has increased significantly. The tax rates are set between 0.25% and 1.00% of market value.
- Local governments are responsible for tax assessments based on data from the State Statistics Office and/or State Tax Authority on the market value of a square meter of property in each jurisdiction. Market value is calculated by multiplying a market price per m2 with the property surface area in square meters and other criteria that influence the market value: the use of the property; its location, its quality, size, and several other elements that could influence its value.
- According to the Law, the owners of land and buildings are liable for the tax. However, if the owner of a property is not known, the occupier or user of the property is the taxpayer.
- Local Tax Authorities create and update their Fiscal Registers of taxpayers based on data from the Cadastre Office, although the Cadastre data is often problematic for property tax purposes. The property valuation process is regulated by the Regulation on detailed Criteria and Methodology for the Determination of the Market Value of Properties.
Concluding thoughts
As the above country examples indicate; where there is political will and motivation to enable local governments to have more control over their revenue sources and enhance fiscal decentralization, the property tax is the main source to accomplish this. More consideration needs to be given by the countries of the CEE to more fully utilizing property taxes as the primary source of local government revenues.
This blog was prepared by Glen Wright (Co-Chair, LPSA ECA Regional Working Group), November 2024. It aims to spark further discussion on the potential of property taxes to drive fiscal sustainability and enhance the autonomy of local governments.
