by
Roy and Pratik Datta.
Manmohan Singh as finance minister killed off smuggling, by
eliminating customs duties. Black money in the real estate sector
attracted his attention. He suggested lowering of stamp duties
to check the flow of black money in this sector. But will this solve
the problem of black money? And how will the State compensate for
the loss of revenue collected from stamp duty?
Stamp duty is a transaction tax; it is charged as a percentage of
the transaction value of the property. Public economics teaches us
that all transaction taxes are bad taxes, that the right level for the
stamp duty is zero (as it is for all taxation of transactions).
The stamp duty distorts the behaviour of parties to the
transaction. Stamp duty on property is usually paid by the
buyer. Hence, the buyer tries to coax the seller to agree to
undervalue the property on paper (the transaction value declared to
the government) and accept the rest in black money. On the other hand,
sellers have an incentive in accepting black money from the buyer in
order to evade the taxation of capital gains. As long as real estate
capital gains are taxed, eliminating the stamp duty will influence the
behaviour of the buyer but not that of the seller.
Hence, modest changes in the stamp duty rate will not solve the
problem of black money in real estate. When stamp duty is eliminated,
the buyer will be comfortable with zero evasion, but the seller will
still urge him to take some black money.
Bad taxes should be eliminated because they are bad taxes. There
should be no attempt at finding a direct replacement. As an example,
India largely phased out customs duties, because the economists said
these are bad taxes, without specifically trying to find a
replacement. The elimination of customs duties enabled high GDP
growth, and the main pillars of taxation (income tax and the VAT)
generated bountiful revenues. A similar story will hold for stamp
duty.
The economists teach us that all taxation of transactions is
wrong. The property tax suffers from no such problems. Much work is
needed in India in building a sound property tax system. In some
countries, property tax revenues can be as large as 1% of GDP, which
is a very big number compared with the financing of local government
in India. The key issue is that the average value of property in each
micro neighbourhood (e.g. a 200 metre stretch of road) needs to be
assessed correctly and revised every year. This should then be used as
a preumptive property tax rate, per square foot, for that micro
neighbourhood. Once this is done, property tax collections will be a
powerful source of revenue for local government.
There is a link between these two issues. As long as there is a
stamp duty and high taxation of real estate capital gains, the
reported data will understate property values. This will hamper the
revenues obtained through the property tax. To the extent that we
solve the twin problems of stamp duty and capital gains taxation,
the data in the hands of government about real estate prices will
improve, and this will bring property tax to life as a significant
revenue source.
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