1

PROPERTY RATES BILL:

dplg RESPONSE TO QUESTIONS POSED BY PORTFOLIO COMMITTEE

ON PROVINCIAL AND LOCAL GOVERNMENT

November 18, 2003

2

MAIN ISSUES TO BE RESOLVED

Choice of Rates Base: land and improvements or land only?

Choice of Rating System: uniform or variable?

Constitutionality of Exclusions Public Service Infrastructure Protected Areas

Rating of Agricultural Land Religious, Welfare and Charitable, Independent Schools

3

CHOICE OF RATES BASE

With regard to the base: Why have we chosen to rate land and

improvements versus land only?

4

ARGUMENTS FOR BASE BEING LAND ONLY

If only land is rated, owner will have incentive to develop land to fullest use

Counter argument: Little quantitative evidence Several other factors that affect land

development - no empirical evidence to support that property rates play major role

Issues such as comfort, space, investment play major role

5

ARGUMENTS FOR BASE BEING LAND ONLY

Cost of valuation process is lowerCounter argument: Same number of properties have to be valued

regardless of the base Valuing land and improvements together is

administratively easier and more objective - more sales data available

6

ARGUMENTS FOR BASE BEING LAND ONLY

Land rating has a strong relation to notion of public good

Counter argument: Assumes that land is largely undeveloped

and that State controls most of land - not true in South Africa

7

ARGUMENTS FOR LAND AND IMPROVEMENTS

Provide more comprehensive measure of affluence so likely to be more progressive

Easier to assess than land only More sales data available

Total property value is concept most property owners understand

8

ARGUMENTS FOR LAND AND IMPROVEMENTS

Politically more acceptable Lower nominal rate needed to generate same revenue

Current practice shows that two-thirds of municipalities have historically included land and improvements in their rates base Administrative costs will not be prohibitive

To the extent that there is a trend in developing countries is towards improved value

9

TREND IN OECD COUNTRIES

L = LandImprv = Improvements

Australia L or L + Imprv

Canada L + Imprv

Japan L, Imprv

Germany L + Imprv

U.K L + Imprv

New Zealand L or L + Imprv

Netherlands L + Imprv

Ireland L + Imprv

Sweeden L + Imprv

10

TREND IN CENTRAL & EASTERN EUROPE

Hungary Unimproved Value (vacant land) or Imprv

Latvia L + Imprv

Poland L + Imprv

Russia Land for land tax, Imprv for property tax

Ukraine L

Czech Republic L & Imprv separately

Estonia L

Albania Agricultural L, Imprv

Slovenia Imprv

11

TREND IN LATIN AMERICAArgentina L + Imprv

Brazil L + Imprv

Chile L + Imprv

Colombia L + Imprv

Nicaragua L + Imprv

Mexico L + Imprv

12

TREND IN CARIBBEANJamaica L

Grenada L + Imprv

Barbados L + Imprv

St Lucia L + Imprv

Trinidad L + Imprv

13

TREND IN ASIA

China L + Imprv

India L + Imprv

Indonesia L + Imprv

Philippines L + Imprv

Thailand L + Imprv

Malaysia L + Imprv

Hong Kong L + Imprv

Singapore L + Imprv

Taiwan L

Lao L + Imprv

14

TREND IN AFRICA

Botswana L + Imprv

Guinea L + Imprv

Kenya L + Imprv

Lesotho L + Imprv

Malawi L + Imprv

Namibia All options but in practice mainly L & Improv separately

Swaziland All options (legislation)

Tanzania Imprv only

Tunisia L + Imprv

Zambia L + Imprv

Zimbabwe All options (legislation)

15

RESULTS FROM dplg CASE STUDIES

Property rates base and total amount collected in rates will increase as a result of base shifting from land only to land and improvements:

7% in Greater Tzaneen 5% in Matjhabeng 20% in Mbombela 48% in Ulundi

16

RESULTS FROM dplg CASE STUDIES

Increase in rates income will be used to reduce rates burden on current ratepayers, particularly in the residential sector

Residential sector’s share of property rates will fall: From 70.6% to 50.4% in Ulundi From 56.7% to 39.4% in Phokwane From 34.4% to 29% in Mbombela

17

RESULTS FROM CITY OF CAPE TOWN STUDY

If rates base were changed from land and improvements to land only: Residential properties would have borne a higher

incidence of rates than commercial properties Share of residential properties would have increased

from 30% to 55%

Within each residential and commercial area, shift would have occurred from properties with high-value improvements to those with little or no improvements

18

CONCLUSIONS FROM STUDIES

Residential sector will bear smaller proportion of total rates bill relative to commercial sector

Poorer property owners will bear a smaller proportion of total rates bill relative to wealthier owners

Rates base and rates revenue for municipalities will be optimised

Results comply with government’s national objectives and White Paper on Local Government

19

CHOICE OF RATING SYSTEM

With regard to the rate: Why mandate a uniform rate (same rate on

land and improvements) and not a variable rate?

20

REASONS FOR UNIFORM RATE

Determine fiscal capacity of municipalities Enable national monitoring and prescription Achieve equitable treatment of citizens Easier for people to understand and engage

in rates policy consultation process

21

REASONS FOR UNIFORM RATE

If we allow for variable rate: Some municipalities might opt for zero rating

improvements – tantamount to the base being land only i.e. a non-uniform base that we have already argued against

Valuers will have to arrive at separate values for land and improvements - subjective and will not realise optimal revenue base

22

RESULTS FROM dplg CASE STUDIES

Ethekwini: Rates land and improvements at uniform rate for

residential property but at variable rates for commercial, industrial, government and non-industrial

If it rates land and improvements at a uniform rate, rates burden on residential properties will fall

Rates burden will fall for low value and increase for high value residential property

23

RESULTS FROM dplg CASE STUDIES Phokwane:

Rates land and improvements at different rates If it rates land and improvements at a uniform rate on

all properties, rates burden on residential properties will fall from 56.7% to 39.4%

Rates burden will fall for all classes of residential property

24

CONCLUSIONS FROM STUDIES

If we have a uniform rate instead of a variable rate: Rates burden will be lower for residential than for

commercial sector Low-value residential property owners will pay less

than high-value residential property owners - more equitable

Will enable newly emerging middle class to afford property since their relative rates burden will be lower that that for the rich

25

CONSTITUTIONALITY OF EXCLUSIONS

Is there any constitutional basis for the exclusion of property from the municipal rates base?

Can Section 229 (2) of the Constitution be used to exclude property rather than to regulate it?

Can the framework in clause 3 (3) of the Property Rates Bill be used to create mandatory exemptions?

Is everything in clause 15 (2) of the Property Rates Bill consistent with Section 229 (2) (a) of the Constitution?

26

CONSTITUTIONAL BASIS FOR EXCLUSION

Section 229 (2) (b) of the Constitution provides the constitutional basis for exclusion since the term “regulate” includes the power to describe circumstances under which a municipality would not be entitled to impose property rates

27

CONSTITUTIONAL BASIS FOR EXCLUSION

The constitutionality of this power to exclude would depend on whether or not such a limit or restriction violates Section 151 (4) of the Constitution:“The national or a provincial government may

not compromise or impede a municipality’s ability or right to exercise its powers or perform its functions.”

28

CONSTITUTIONAL BASIS FOR EXCLUSION

Section 229 (2) (a) of the Constitution cannot be used to exclude property - only when a municipality has exercised its power can a question arise as to whether or not it has violated Section 229 (2) (a)

29

USE OF 3(3) TO CREATE MANDATORY EXEMPTIONS

The national framework in 3 (3) cannot be used to create mandatory exemptions

Only Parliament has the power to exclude - not the Minister

30

CONSISTENCY OF 15 (2) WITH SECTION 229 (2) (a)

Given that 229 (2) (a) cannot be used to justify exclusions, the consistency of 15 (2) is not an issue

Legal opinion recommends that 15 (2) be delinked from 15 (1)

Are exclusions in 15 (2) consistent with 151 (4) of the Constitution?

Impact would vary from one municipality to another so must be very careful when specifying exclusions

31

PUBLIC SERVICE INFRASTRUCTURE

Does the public service infrastructure benefit the public directly?

Should structures be taken out of the definition? How do we deal with State-owned vis-a-vis privately

owned? What is current practice with regard to rating of public

service infrastructure as defined in the Bill? Recommendations for treatment of public service

infrastructure

32

BENEFIT TO PUBLIC

Only infrastructure that benefits the public directly must be included in the definition

Thus, ancillary infrastructure, which is part of the cost of doing business (e.g. railway lines used by Eskom to transport goods) should not be excluded from rates

Must remember that any exclusion deprives municipality of much-needed revenue and may violate Section 151 (4) of the Constitution

33

TREATMENT OF STRUCTURES

Structures that house the infrastructure are improvements and hence should be rated

Decision made to take out power stations and substations out of part (c) of definition

34

STATE-OWNED VIS-A-VIS PRIVATELY OWNED

Level of State ownership - Eskom and Transnet 100% State owned, Telkom only 41%

Do enterprise make a profit? If State owned enterprises are given preferential treatment for rates purposes, how does this affect equitable treatment of competitors?

Tariffs of Eskom and Telkom are independently regulated; not so for Transnet

Eskom, Transnet and Telkom pay income tax - so rates are deductible as a cost of doing business

Decision that only State-owned infrastructure should be considered

35

CURRENT MUNICIPAL PRACTICE

SALGA canvassed municipalities on current and preferred treatment of public service infrastructure

General position of 5 municipalities who presented on August 13, 2003: Public service infrastructure forms an important

source of rates revenue Any exemptions should be at the discretion of

municipalities

36

CURRENT MUNICIPAL PRACTICE

dplg conducted subsequent survey in August 2003

Survey questionnaires sent to 23 municipalities 14 municipalities are not rating any components

37

CURRENT MUNICIPAL PRACTICE

9 municipalities are currently rating some of the aspects of public service infrastructure such as power stations and substations, runways and aprons, telecommunication towers, water supply reservoirs, and servitudes

2 municipalities indicated that exclusions would have a significant negative impact (Moses Kotane would lose about 5% while the City of Cape Town 0.95% of its rtaes revenue); 7 municipalities said it would not impact negatively.

38

RECOMMENDATIONS

Define publicly controlled in the Bill: Owned by or otherwise under the control of

the state, including: A public entity listed in the PFMA; A municipality; or A municipal entity as defined in the Structures Act

39

RECOMMENDATIONS Change definition of public service infrastructure in

the Bill: Publicly controlled infrastructure of the following kinds

Roads Water or sewer schemes serving the public Electricity schemes serving the public Schemes for transporting gas or liquid fuels National railway system Runways or aprons at international, national or provincial airports Waterways at harbours Rights of way, easements and servitudes in connection with the

above

40

RECOMMENDATIONS Only public service infrastructure connected with the

provision of free basic services (water, sanitation and electricity) should be given special consideration

ALL public service infrastructure should be valued at a national level to ensure uniformity and consistency of valuations

Values apportioned to each municipality who is then free to rate infrastructure as it sees fit

Exception: Basic service infrastructure whose value will be reduced

41

PROTECTED AREAS Sub-Committee agreed to exclude privately owned land

declared as a protected area in terms of the Protected Areas Act

Agreement reached that exclusion would remain until protected area is de-proclaimed

Arrear rates on privately owned de-proclaimed land to be levied to base date of valuation cycle where: Property owner withdraws from agreement Minister has cancelled agreement due to breach of contract by owner

Term “developed or used” to be retained

42

RATING OF AGRICULTURAL LAND

What is the rationale for rating the agricultural sector given the concerns raised by KWANALU, Katz Commission and independent expert?

43

RATING OF AGRICULTURAL LAND

Summary of concerns raised by agricultural sector in public submissions: Rating agricultural land will lead to a drop in

value of agricultural land The definition of “improved value” is

ambiguous in relation to farmland (not necessarily the same as market value)

Use value versus improved value

44

RATING OF AGRICULTURAL LAND

Summary of concerns (cont.): Level of taxation is quite high (2%) and main

trading partners do not rate agricultural land or rate it at low levels

Farmers are already being taxed (RSC levies) and their tax burden will increase, affecting international competitiveness

Municipalities deliver virtually no services to farmland - 38 functions provided by them mostly benefit urban dwellers

45

RATING OF AGRICULTURAL LAND

Summary of concerns (cont.): Property rates on agriculture will impact

negatively on between 5 and 8 desired outcomes of the Strategic Plan on Agriculture

Privately owned conservation and protected land should be excluded from property rates

Possibility of deferred rates in the event of natural disasters

46

KATZ COMMISSION RECOMMENDATIONS

47

BACKGROUND Katz Commission appointed in 1995 to consider

introduction of land tax in South Africa Subcommittee presented initial report in November 1995 Despite the vehement opposition to a tax on rural land

by organised agriculture, mining and hospitality industries, Subcommittee was of opinion that such objections are best heard at the local level, where consideration of level of services to be provided from proceeds of the tax can be fully accounted for

48

RECOMMENDATION Katz Commission supported recommendation that,

although a rural land tax should not be levied at a national level, in principle, such a tax at local government level should be given serious consideration Sufficient international experience on implementation and

administration of such a tax Imposition would not represent a new tax in South Africa – had

been previously levied by former Cape Province on divisional council level (and subsequently in all provinces at local council level)

49

KATZ COMMISSION RATIONALE FOR LAND TAX

Rural land tax: Has potential to raise revenue for rural

municipalities Will give greater fiscal autonomy to rural

municipalities Will seek to entrench horizontal equity

principles in taxation since urban dwellers liable for property rates

50

FURTHER INVESTIGATION

Katz Commission mandated further investigation and Subcommittee presented further findings in August1998

Findings were presented in the interim phase of local government transformation

51

KATZ COMMISSION MAIN RECOMMENDATIONS

Tax status of rural rates: Subcommittee recommended that rural property

rates be a provisional income tax payment Katz Commission, however, recommended that

rural property rates be deductible for income tax purposes Neutrality and horizontal equity require that tax

treatment of rural property rates be similar to urban property rates

52

KATZ COMMISSION MAIN RECOMMENDATIONS Tax base:

Katz Commission recommended that: All land within municipal boundaries must be

included in tax base Tax base should exclude mineral and water rights Tax base should be improved value (land and

improvements)

53

KATZ COMMISSION MAIN RECOMMENDATIONS Tax rate:

Katz Commission recommended uniform rate on improved value of land

Tax rate and desirability of rate-capping: Katz Commission recommended that there

should be no setting of the tax rate or rate-capping in legislation in the interest of allowing rural municipalities to play the role envisaged for them in the Constitution

54

KATZ COMMISSION MAIN RECOMMENDATIONS

Method of valuation: Subcommittee recommended that tax be

based on use value rather than market value Katz Commission, however, is of opinion that

market value is a more certain and equitable method of valuation than use value

55

KATZ COMMISSION MAIN RECOMMENDATIONS Tax relief measures:

Katz Commission recommended that guidelines should be provided regarding: Types of tax relief measures that are allowable; and Conditions under which such measures may be

implemented (such as prescriptions for more transparent and participative processes)

Experience has shown that exemptions, rebates and tax deferrals should be kept to an absolute minimum

56

CONCERNS RAISED BY AGRICULTURAL SECTOR IN

PUBLIC SUBMISSIONS

57

CONCERN

Rating agricultural land will lead to a drop in value of agricultural land 1% property rate on agricultural land will lead to a

16% to 20% reduction in land values 5% property rate would reduce land value to 20% or

make land worthless Therefore, agriculture recommend a maximum rate of

0.5% on improved value of farmland as this would reduce land values by between 8% and 10%.

58

dplg RESPONSE Problems with assumptions:

Assumes very high rate of capitalisation (80% to 100%). Studies have found wide-ranging rate: Oates (1969): 66% Edel and Sclar (1974): 50% Reinhard (1981): 31% Palman and Smith (1998): 63% Shapiro et al (1999): 20%

Katz Commission assumes a 26.5% rate of capitalisation.

59

dplg RESPONSE Problems with assumptions (cont.):

Assumes cause and effect relationship between property rates and fall in land values. Other factors, such as location, productivity of land, proximity to infrastructure and amenities, also affect land values

Ignores the fact that municipal expenditure on services in the area may actually lead to land values going up

60

dplg RESPONSE

Problems with assumptions (cont.): Rental return is a static ratio which is used to capture

the effect of a dynamic situation in which income and costs change over time

Ignores key variables such as: Rate of inflation Rate of growth of cost and revenue streams associated with

property (costs of doing business) Rate of income taxation Tax deductibility of property rates

61

CONCLUSION

The serious problems with assumptions do not justify maximum limit of 0.5%

Besides, Katz Commission recommended that there should be no rate-setting or capping at the national level

62

CONCLUSION Also, there are sufficient clauses in the Bill that

protect key sectors like agriculture and mining: Minister, with concurrence of Minister of Finance, can

limit the rate or growth in rate of categories of property Minister can prescribe a ratio between residential and

non-residential property In addition, any exemptions and rebates granted to

agricultural sector will have to be borne by other property rate payers. Municipalities are best placed to determine these trade-offs

63

CONCERN

Use value as opposed to market value as a method of valuation for agricultural land

64

dplg RESPONSE

The main disjuncture between use value and market value for agricultural land arises in the case of peri-urban areas.

In other cases, use value is the same as market value

If you apply market value in peri-urban areas, it will lead to better utilisation of land

Market value is used as method of valuation for determining capital gains tax

65

CONCERN

The definition of the term “improved value” is ambiguous in relation to farmland

Improved value for farmland is not the same as market value (which includes the value of standing crops)

Value of standing crops should, therefore, not be included in value of property

66

dplg RESPONSE

The method of valuation is market value. This implies that the value of annual crops

and growing timber will not be considered in determining the value of the land

67

VALUATION OF AGRICULTURAL PROPERTY

There is generally accepted valuation practice to arrive at the market value for agricultural land

If one legislates that vineyards, orchards etc. should not be considered in the valuation of agricultural property, then one would be departing from market value and it would be tantamount to arriving at land value for that piece of agricultural property

The method of valuation for the capital gains tax is market value – vineyards and orchards are considered in the determination of market value but annual crops and growing timber are not

68

PROPOSED WORDING

In determining the market value of an agricultural property, the value of any annual crops and growing timber on the property that have not yet been harvested as at the date of valuation must be disregarded.

69

CONCERN

Level of taxation is quite high (2%) and our main trading partners do not rate agricultural land or rate it at low levels.

This negatively influences our ability to compete internationally

70

dplg RESPONSE

Independent expert acknowledges that developing countries rate agriculture

Issue of competitiveness is acknowledged but this has to be dealt with at a national level - cannot make this a local problem

National government dealing with this in WTO negotiations

Katz Commission has shown that a 2% tax on land will reduce land values by only 12.32% (compared to KWANALU’s 32% to 40%).

71

CONCERN

Farmers are already being taxed through the RSC levy and their tax burden will increase with the introduction of property rates on farmland

This will again affect international competitiveness

72

dplg RESPONSE Farmers are not the only ones who pay the

RSC levy; all other sectors pay not only the RSC levy but also property rates

In fact, some parts of the agricultural sector have received favourable treatment with regard to property rates because some farms were outside municipal boundaries; other farms have historically been rated

73

dplg RESPONSE

It is imperative that all property owners are part of the property rates system and contribute equitably to financing local government activities

Municipalities, in particular rural ones, have huge developmental challenges and property rates are important for sustainable development in these areas

74

CONCERN

Municipalities deliver virtually no services to majority of inhabitants on farmland

Farmers sometimes provide many of these services themselves

38 functions to be provided by municipalities are largely to the benefit of urban dwellers

75

dplg RESPONSE

Property rates are not tariffs; they are the most important source of general revenue to municipalities

Revenue is used to provide services that benefit the community as a whole as opposed to individual households - firefighting services, building and operating clinics, parks and recreational facilities, funding municipal administration and costs of governance

76

dplg RESPONSE

It is not only urban areas that have access to these services; farmers access these as well

Also, farmers make use of towns that act as service centres and benefit from overall infrastructure provided in towns

77

dplg RESPONSE

The provision of housing, health and basic services is essential for productivity of farmworkers which translates into increased productivity on farms and consequently profits for farmers

78

dplg RESPONSE One should not assume that the whole agricultural

sector is a homogeneous entity in this regard In some farms, owners provide good services and

treat workers well but this is not the case across the country

Many articles, including article in Natal Witness (September 3, 2003) draw attention to human rights abuse on farms

79

dplg RESPONSE

Complaints ranged from illegal evictions to lack of social services, lack of access to health care, education and so on

Municipalities face problems in accessing farms because they are private property

Farmers can participate in the community consultation process and apply for rebates on good cause

80

CONCERN

Property rates on agriculture will impact negatively on between 5 and 8 of desired outcomes of the Strategic Plan on Agriculture

81

dplg RESPONSE Other taxes such as income taxes and VAT

also have this effect The issue is not whether or not property rates

will have this effect but whether or not they materially and unreasonably prejudice national economic policies

In any event, we can no longer use Section 229 (2) (a) of Constitution to justify exclusions

82

CONCERN

Privately owned conservation and protected land should be excluded from property rates

83

dplg RESPONSE

Some, but not all privately owned protected land should be excluded

Danger of excluding all land proclaimed by national or provincial legislation

Might lead to discernible impact on rates base for municipalities

84

dplg RESPONSE

Only land declared in terms of national (not provincial) legislation for the following purposes should be excluded (provided it meets national norms and standards): Special nature reserves National parks Nature reserves (only some categories)

85

CONCERN

How do you deal with natural disasters and climatic conditions that are beyond the control of farmers – drought, floods, etc.?

86

dplg RESPONSE

Allow for the possibility of deferred rates by explicitly providing for it in clause 23 (1) (b)

87

CONCLUSIONS Agricultural sector should not be excluded from property

rates No limits should be imposed on property rates for

agriculture Definition of market value should be clarified in legislation

to avoid confusion Deferred rates should be explicitly provided for in

legislation Consideration of agricultural sector in rates policy of

municipalities

88

CONCLUSIONS Agricultural sector should not be excluded from property

rates No limits should be imposed on property rates for

agriculture Definition of market value should be clarified in legislation

to avoid confusion Deferred rates should be explicitly provided for in

legislation Consideration of agricultural sector in rates policy of

municipalities

89

DECISIONS TAKEN BY SUB-COMMITTEE

No exclusions for agriculture Method of valuation:

Existing use: No Market value: Yes

Given that method of valuation is market value: Annual crops and growing timber not considered in

valuation Vineyards, orchards considered in valuation

No tax rate setting or capping – consider provision that representatives from particular sector can approach Minister

90

DECISIONS TAKEN BY SUB-COMMITTEE

Consider workers accommodation and schools and services provided by farmers in rates policy of municipalities for rebate purposes

Newly rateable property – consider including property formerly outside municipal boundaries before December 5, 2000

Yes to tax deferment but no to national exclusions in case of natural disasters (taken care of by national policy)

Bona-fide farmers: More information needed

91

RELIGIOUS, WELFARE AND CHARITABLE, INDEPENDENT

SCHOOLS Places of worship and residence of minister

excluded Definition of welfare and charitable legally

problematic; hence change to include some public benefit activities (welfare and humanitarian, health care, education and development) performed by PBOs

One year grace period to be granted to organisations that conduct the above public benefit activities and are currently exempt from rating

92

RELIGIOUS, WELFARE AND CHARITABLE, INDEPENDENT

SCHOOLS Consideration needs to be given to including

these categories of property in Clause 8 of the Bill

No exclusions for independent schools – will be considered in rating policy

All agreements reached in all Subcommittees are tentative – pending review in Committee

93

THE END

THANK YOU