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Lately, debate is growing on rising real estate prices and falling affordability for middle class. In a recent talk, celebrated economist Atif Mian noted that Pakistan’s ruling class lacks courage to implement structural reforms, a pertinent example of which is low tax on income on capital gains from urban land transactions. This misallocation of capital resources is perhaps one of the main reasons of falling productivity. Taxes and their compliance in the manufacturing sector is way higher than on real estate holdings.
Everyone – with legit or illegit funds – is parking substantial savings in real estate. And that is hindering investment in productive sectors. The ruling party must demonstrate courage to reform the real estate market and tax capital gains on its income. This could be the biggest dent in the elite capture in this country. But there would be no support from any influential circles -whether its politicians, army brass or civil bureaucracy, industrialists, trader class, or media tycoons as all are beneficiaries of this misallocation of resources at the cost of public welfare.
This government efforts to support housing and construction (in the shape of amnesty scheme and giving construction the status of an industry) to provide low-cost and affordable housing is failing as real estate prices have skyrocketed, and owning housing is becoming a distant dream for lower and middle classes. Sporadic efforts by a few (such as Akhuwat) to build a few thousands low-cost houses won’t cut it. The need is to have affordable housing for young and growing population that runs in hundreds of thousands, if not millions.
Vested interests from the real estate industry have prevailed as they won fixed taxes on per square foot basis -which is ridiculously low for expensive houses and apartments. Multiple land holdings are unchecked. Effective capital gain taxes are miniscule – considering the difference between valuation for tax purposes and actual prices. Net returns on real estate investment are much better than manufacturing businesses.
Real estate investors can make money without lifting a finger. On the other hand, manufacturing is heavily taxed and business owners (especially in case of SMEs) must work hard to run businesses and fulfill regulatory compliances. Seeing this, everyone has started investing retained earnings in real estate. In the process, investment in productive businesses is being compromised.
A meaningful and concerted campaign is warranted on taxing real estate and on bringing down the real estate prices to match earning capacities. There is no need for any incentive or amnesty schemes (which are usually captured by elite). Bring the real estate prices down to affordable levels. People (of genuine demand) will start making houses to spur construction and allied industries. The government should not put efforts to lower cement and steel prices; it rather work on lowering the prices of raw material of housing – land.
In the past, our national obsession with land holdings did not allow agriculture land reforms to take place. Now, obsession with urban
landholding has taken over. Pakistan must build a narrative to tax land holdings. There must be a mechanism to heavily taxing incremental land holdings – especially for those with multiple plots or holding urban land beyond a certain size. Unfortunately, this never becomes part of taxation discourse – with or without the IMF (International Monetary Fund) on taxing earnings from land and its holding. Instead every time, tax is increased on already documented businesses and on documented earnings. While the exuberant returns on real estate are simply ignored. The federal government walks away by saying that it is a provincial (or local) subject. Courage is needed to legislate on the subject and build consensus with the provinces.
The documentation narrative should also revolve around real estate holdings and pricing. Today, the government can check one’s bank accounts details, bills and SIM connection, vehicles registration, etc., based on CNIC number. But there is no mechanism to check any individual’s land holdings. The mantra of benami is missing on the benami land holdings. If that Pandora’s Box opens, fake bank accounts cases would look miniscule in comparison.
The question is who would bell the cat. Almost everyone influential in the country is beneficiary of this skewed system. Politicians’ land holdings are huge. Industrialists expand businesses by misallocating concessionary finance and invest earnings in real estate. DHA (Defence Housing Authority) projects have become too big for those behind them to correct distortive incentive structure. Corrupt officers in FBR (Federal Board of Revenue), FIA (Federal Investigation Agency) and other government agencies have parked ill-earned money in their real estate. Smugglers and tax evaders also do the same. Time is running out. National leadership must demonstrate courage to reset the distortive incentive structure in the real estate. That is where the greatest structural reform is needed.
Copyright Business Recorder, 2021
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