Why Beijing will endure property tax’s drag on housing market

The government’s pursuit of ‘common prosperity’ and reduced inequality mean a further slowdown in the housing market is not a deal-breaker
Some fundamental changes are deemed more critical for the country’s future and will better position it against the changing demographic and geopolitical landscape

Hao Zhou

Published: 4:30am, 3 Nov 2021

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While China’s property sector is already on a downward trend, plans to expand the property tax will probably only add to the housing market’s woes. The market is wondering why Beijing is sticking to its property tightening amid intensifying economic headwinds and, more importantly, whether further deterioration in the property market will endanger financial stability.

There have been rumours about a new round of property tax pilot programmes for some time now. President Xi Jinping’s essay in Qiushi, a journal controlled by the Communist Party, appears to have given this policy a final push.

In the essay, Xi said: “We should actively and steadily promote the legislation and reform of real estate tax and do a good job in the pilot work.”

The government’s tax reform will be set against the backdrop of Chinese authorities prioritising “common prosperity” in their political agenda.

The first trial run for the property tax took place in Shanghai and Chongqing in 2011 and only affected a small group of people. The tax was primarily focused on those with second homes or who live in luxury properties.

While there is little data available, it appears property tax receipts contribute little to government revenue. In Shanghai, for example, property tax revenue in 2020 was about 20 billion yuan (US$3.1 billion), only accounting for about 1.2 per cent of total tax revenue. Property tax revenue in Shanghai also includes tax paid by businesses, so payments from households were even smaller.

Even with the government’s support for the policy, there is still strong resistance among homeowners. Given that the final form of the scheme will most likely tax households with more than one property and could include a progressive tax regime, it makes sense that wealthy families would be displeased with the plan.

This should be one of the most important factors driving the new pilot tax schemes. As Beijing pushes forward with its pursuit of “common prosperity”, it must narrow the income and wealth gaps. From this perspective, the property tax is a feasible option for rebalancing wealth distribution.

In the meantime, a strange phenomenon has emerged in China’s property market in the past few years. While growth in mortgage lending has slowed, housing sales and property prices – particularly in big cities – have still risen.

This seems to suggest that many people are using other instruments to finance their property purchases. There have been reports of people taking out business loans and using the money to buy property. A wealthy family could buy a flat with cash and later collateralise the property and take out loans from commercial banks, claiming the reason for borrowing was to run a business.

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This family would need to own a company to qualify for business loans, of course. But the Shenfangli case earlier this year in Shenzhen showed how shell companies could be registered to get bank financing that is used in the housing market.

This suggests that the actual financing exposure to the property market could be much higher than official figures suggest. It also shows how the dynamics of the property market matter in maintaining financial stability.

The obvious question is whether a property market collapse would threaten China’s financial stability. The answer is “yes”, but Beijing’s bottom line of preventing systematic risks in the financial system remains intact.

Several recent cases involving property developers going into default might shed some light on the issue. Financial regulators have kept up their tough tone on the property market. However, they have also urged developers to complete their unfinished projects, restructure debts and prepare to make upcoming bond coupon repayments.

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Past cases of debt restructuring already point to a calibrated policy approach, which suggests that the entire debt restructuring process will be a prolonged one.

I believe Beijing will use the same tactics and take a step-by-step approach in its implementation of the property tax. While the countrywide scheme is likely to be approved shortly, its execution will still be cautious and calibrated.

This could also mean the regulatory controls on property prices will remain in place for a while yet. During that time, the market will gradually adjust its expectations. As long as “common prosperity” remains at the heart of the government’s strategy, though, property prices are likely to stagnate or even fall in the coming years.

Given the importance of the housing sector in China’s overall economy, a property slowdown suggests the country’s economic growth will be less impressive going forward.

It seems Beijing has accepted the prospect of slower growth, though. It sees that some fundamental changes are more critical for the country’s future and will better position it against the changing demographic and geopolitical landscape.

Hao Zhou is senior emerging markets economist at Commerzbank