Real estate amnesty: elite capture?

Imran Khan-led government in quest of arresting hoarding of commodities like wheat and sugar is turning a blind eye to land hoarding culture. After the launch of construction amnesty scheme, the real estate prices have run amok. Construction for low-cost housing (supposedly the main purpose) on commercial basis is not happening. The dream of owning a house by middle class is becoming dearer due to spike in prices. Then there is the unintended consequence of boosting consumer demand as monetary transmission (expansion) of wealth effect through asset prices escalation is contributing to slippages in the current account deficit.

The purpose of construction amnesty scheme and providing construction an industry status was to promote housing to generate jobs and to fill in the gap of millions of housings unit shortage. There is nothing substantial to talk on promoting consumer housing (mortgage) finance; but the scheme has nearly doubled the real estate prices in many cities of Pakistan. The real wages growth is not even a small fraction of increase in housing prices; and the housing dream of low and middle classes has become even distant.

Those who have money are buying land in lots. Many of the private and public sector influencers are hand in glove with the land mafias. Politicians, bureaucrats (especially those in FBR), industrialists, and businessmen have massive landholdings in Pakistan. Moreover, senior army officers legally get their share of land. This is not a socialist argument to talk against wealth accumulation; the point is to correct the skewed allocation of resources, and the tools available to the government to tax land holdings. The key is to use taxation and regulatory tools to arrest speculative activities in land parcels - especially, on vacant plots in developed areas.

One of the most ignored tax issues in Pakistan is of land. According to an IGC study, Punjab's land tax collection is less than Chennai's in India - whereas the population of Pakistan's Punjab is over 15 times. There is massive wealth parked in real estate with virtually no taxation. In contrast, savings in fixed deposits and stocks are heavily taxed on income and gains; but there is no taxation on real estate, in which initial investment gets multiplied by several times in a short span.

Some serious effort is required to bring down the speculation in the real estate prices. In Pakistan, monetary transmission due to wealth effect in real estate is probably higher than private credit. Thus, controlling speculation in real estate is an alternate tool to curb imports rather than interest rates. Over Rs 7 trillion (28 percent of money supply) is currency in circulation (hard cash) and is insulated from interest rates. Private credit is around Rs8 trillion and within it, consumer credit is not even one trillion rupees. The impact of curbing speculation in real estate prices could be higher than curtailing consumer demand by increasing interest rates.

The point here is to not undermine the impact on monetary tightening by using interest rates; but to highlight that curbing demand in the informal sector is an effective tool in curtailing imported demand to arrest current account deficit. With real estate prices boom, the perceived savings of land holders increases, and they use the liquid cash (or assets) to buy cars and spend on other consumer goods and services. This trend needs to be arrested.

There is no centralized dataset of real estate holders. In contrast, anyone's information on his(er) holdings in stock exchange, bank deposits are well-documented, and authorities can collect over a few clicks. But there is no such information on tens of trillions of rupees worth of wealth which is parked in real estate. A few stock market friends spend Sunday's afternoon in counting plots in DHA phase 8 of Karachi to establish that the cumulative value of Karachi's DHA Phase 8 plots is higher than the free float at PSX.

The story of other cities is not different. Speculation is also taking place in industrial plot that hinders development of manufacturing facilities. People have a tendency to invest in real estate as not only it is (almost) tax free, but it is probably the best way to mix black and white wealth - it is all grey. Industrialists find it more attractive to put the earnings in real estate rather than reinvesting in their respective businesses. And they use subsidized schemes - such as TERF and LTFF, and tax breaks for expansion. Overall incentive structure is heavily distorted.

Land tax was always low in Pakistan, and recently, construction amnesty scheme has proved to be a catalyst for spurring real estate prices. Any builder constructing a project receives tax amnesty. The buyer of apartments (housing units) from these projects benefits from tax amnesty as well. The builders are foreseeing demand from those who want to launder and constructing units for them. For example, consider a builder has a project of 75 flats of Rs50 million (Rs5 crore), each in an FBR approved project. He anticipates 75 buyers (or even less as buyers are buying in lots) to buy his project. Since both buyer and seller have amnesty, all those who want to clean their money come in play.

This laundry machine is working superbly. Construction activities have received a boost. The money is churning, and economy is booming. But it has side-effects. The investment resources are skewed towards construction, and this is crowding out productive investment in manufacturing. For that investment, industrialists ask for cheap credit and tax breaks, as the opportunity cost is investing in real estate where there are superior returns with no (or too low) tax.

The other issue is that the purpose of the construction package was to bridge the housing gap, a noble goal which has since become lost due to property price escalation. In most of the FBR approved projects, majority of buyers are those who already own homes. Many of them perhaps already have multiple holdings as well. This is leaving genuine buyers high and dry. They are buying for investment and laundering. There is a fear of creating ghost houses - or perhaps vacation houses or party pads.

The government must end this amnesty now. Instead, it has recently allowed it to be used by another 11,000 citizens. The other element is that land must be taxed. It is a provincial subject, and the tax use is for local purposes. The existing tax rates on land are minuscule and with recent rise in property prices the effective rate rounds off to zero.

Not only the tax is low, but the land tax (in Punjab) is skewed toward building. The tax on constructed land is 9 times that of vacant land. The government is encouraging vacant land holdings. The annual land tax on vacant plots ranges from a few hundred to a few thousand rupees whereas the price of those pieces runs in tens of millions of rupees.

The tax code must be made progressive. It should increase with increase in land holdings by a single person to discourage multiple holdings. For example, a landholder with five one-kanal vacant plots in DHA Phase 7 Lahore should face an annual tax liability of at least Rs0.3-0.5 million per piece of land in taxes. The land is developed on the premise for people to live. Housing authorities and municipal corporations spend on infrastructure to provide livability near that land. But people are holding for years with no use. If these are taxed, people may rather sell and use that money in productive use.

The bottom line is that an overhaul in the real estate tax and regulations is imperative. The country needs to collect taxes. The country needs balanced economic growth, while the construction package is skewed towards expensive projects for elite. Imran Khan may lose his popularity in the middle class struggling to move from joint to nuclear family system. The construction package's lopsidedness towards rich needs to be flipped.

Copyright Business Recorder, 2021