China’s housing sector has become too big to fail. Real-estate investment accounted for over 10 percent of the economy last year. And, according to the International Monetary Fund, when combined with the construction industry, the two sectors accounted for a third of China’s GDP growth in 2013.
With investment in housing growing by 19 per cent on average over the past two decades, the rapid growth has significantly improved living conditions in China.
But more investment is needed. Urbanisation and upgrading needs will create an estimated demand for 6 billion square metres of housing from 2017 to 2021, translating into housing investment growing of around 5 per cent in real terms over the next five years.
"A property bubble is brewing in China; the question is what can be done about it."
Following a stock market correction in 2015, house prices soared in a large part of the country, driven by both real and investment demand. Signs of property bubbles prompted the government to introduce tightening measures since the fourth quarter last year, putting restrictions on purchases, sales, prices and mortgages. Price increases have moderated in recent months, but at the cost of suffocating market activity, with slower housing investment expected in the near term.
Thwarting high-end manufacturing
Our calculations suggest that China needs to develop about 4.4 billion square metres of living area in order to meet real demand over the next five years. The challenge is to contain any overbuilding.
Given China’s relatively closed capital account, housing remains the preferred investment vehicle for most people. The risk-adjusted return from property investment has been much higher than from other forms of investment, such as stocks and bank deposits, fuelling consumers’ desire to own multiple homes. This has artificially increased housing demand, pushing prices higher and stimulating housing investment.
Excessive investment, however, could derail China’s rebalancing and industrial upgrading agenda. Building homes and keeping them empty represents a waste of natural and human resources, to say the least. More importantly, with resources flowing unduly to the construction sector, China’s ambition to become a world leader in innovation and high-end manufacturing may be thwarted. In addition, rapid growth in property investment and house prices has led to a concentration of wealth, exacerbating social inequality.
Introducing a property tax
A property bubble is brewing; the question is what can be done about it.
We think long-term solutions should include a tighter bias for monetary and credit policy, more supply to meet ‘real’ demand and, more importantly, a nationwide property tax to contain investment demand.
"China’s local governments are reluctant to introduce a property tax for fear that it would discourage property investment and slow economic growth"
The benefits of a property tax go beyond the housing sector, because as a recurrent tax, it increases the cost of holding multiple homes; as a dedicated local tax, it helps put local government finances on a sustainable path; and as a direct tax levied on assets, it can mitigate the concentration of wealth.
However, China’s local governments are generally reluctant to introduce a property tax for fear that it would discourage property investment and slow economic growth. For households, an additional tax burden on top of already high home prices is difficult to swallow, given that households acquire only 70-year land-use rights when they purchase a home.
The tax, therefore, would need to be carefully designed and accompanied by supporting measures in order to succeed. A minimum living area per capita should be defined and exempted from the property tax, with the purpose of sparing a large portion of the population, presumably the less wealthy. Plus, some of the existing property-related taxes could be merged into the new property tax.
Rates on other taxes – such as income tax, VAT and consumption tax – could be lowered to offset the impact of the property tax, leaving total tax revenue unchanged in principle. Last but not least, adoption of a property tax needs to be accompanied by the granting of greater asset rights to households. In other words, the renewal of land-use rights after they expire in 70 years should be guaranteed.
So could China introduce a property tax soon? While it’s not on the legislation cards right now, we do expect the idea to regain momentum after the 19th Party Congress (18-24 October).